What Is Accounting? Definition, Types, History, & Examples

Accounting is a broad discipline that focuses on the current state of an organisation’s financial activities. But today’s accountants are a far cry from the stereotypical “numbers person” who’s more comfortable with a spreadsheet than a strategic business plan. In fact, the insights produced by accountants—and finance teams overall—inform and shape strategy for all corners of the business.

Accountants work closely with stakeholders including executives, investors and boards as well as human resources, IT, and sales and marketing teams and act as liaisons between their companies and government, tax and regulatory agencies.

Startups, nonprofits, and small companies may work with fractional CFOs—an experienced CFO who works on a contract or part-time basis—or accounting partners, but whether internal or outsourced, the accounting function is vital to success.

What Is Accounting?

Accounting is the process of recording and categorising a company’s transactions, and then summarising, analysing, and reporting on these activities. The resulting information—in the form of the balance sheet, income and cash flow statement, forecasts, and other reports—is used to inform business leaders as they:

• Evaluate staffing and payroll
• Balance or assess inventory levels
• Investigate new business opportunities
• Maximise profitability
• Manage cash flow
• Analyse the financial health of the business

The reports and other information that accountants produce are also used outside of the company, by lenders, investors, auditors and, in the case of public companies, investors.

Key Takeaways

• Accounting encompasses a broad set of activities, from basic bookkeeping to analysing the company’s financial health, forecasting revenue, preparing taxes and ensuring legal compliance.
• Businesses use five main types of accounting: managerial, cost, project, tax, and financial accounting.
• Public companies in Australia(opens in new tab) must use the Australian Accounting Standards, which are modelled on International Financial Reporting Standards (IFRS).
• In the Philippines(opens in new tab), public companies must follow the Philippines Financial Reporting Standards (PFRSs), derived from IFRS.
• Public companies in New Zealand are subject to New Zealand International Financial Reporting Standards (NZ-IFRSs), also drawn from the IFRS framework.
• In Singapore, public companies must use the Singapore Financial Reporting Standards (SFRS), which are based on the IFRS.
• Hong Kong public companies must use the Financial Reporting Standards framework (FRS), modelled on the IFRS framework.

How Does Accounting Work?

Every business needs some form of accounting function. Deciding when to hire an in-house accountant is a major decision for entrepreneurs. For small businesses, a single person may perform all accounting tasks and act as the CFO. Alternatively, hiring an outside accountant may make sense, especially for tax purposes. Many small businesses use software to keep track of income and expenses and then send that information to an outsourced accountant for review.

Regardless of whether the company uses outside accounting partners or in-house employees, the accounting functions include recording, categorising, analysing, and reporting financial activities. Internally focused reports help managers allocate funds and make business decisions such as how much to charge for products. Other reports are used for compliance, taxes, attracting investors, and applying for loans.

What Are the Types of Accounting Practices?

There are many accounting specialties. Businesses use five main types: managerial, cost, project, tax, and financial accounting.

Managerial accounting

Managerial accounting provides the reporting, analysis and interpretation of financial data that decision-makers need to create and refine business strategy. Managerial accountants support planning by performing cost-volume-profit analysis, weigh in on organisational structure, and analyse variances.

Cost accounting

Cost accounting, a specialty within managerial accounting, is focused on how much a business spends to create its products, including labour and supply costs. The information gleaned from cost accounting is used to optimise operations—to value inventory, set selling prices for products, and create budgets for similar projects.

Tax accounting

Tax accounting deals with preparing tax returns and making tax payments. Each country has its own set of tax accounting regulations that must be followed. In Australia, tax accounting is governed by the Australian Taxation Office, in Singapore it is governed by the Inland Revenue Authority of Singapore, in Hong Kong it is governed by the Inland Revenue Department, in the Philippines it is governed by the Bureau of Internal Revenue, and in New Zealand it is governed by the Inland Revenue Department.

Tax accountants ensure that companies comply with complex and changing laws.

Project accounting

Professionals such as project managers and accountants use project accounting to integrate key financial tasks on a project-by-project basis and report their progress and success to management.

Project managers rely on project accounting to inform them of the status of direct costs, overhead costs and any revenues in a specific project. Project accountants generate these figures in financial reports. A project manager uses these reports to determine if they need to adjust the project’s budget and work breakdown structure (WBS).

Financial accounting

This discipline focuses on providing information to outside parties interested in the business. A financial accountant typically prepares balance sheets, income statements and cash flow statements to help investors understand the company’s performance or to make a case to a bank to loan money to the business.

Why Is Accounting Important?

Accounting supports several critical business functions. At a basic level, it enables the business to track revenue, expenses, assets, liabilities, and shareholder equity, and manage cash flow and know whether customers have paid, and whether the company has paid its own bills.

Accounting provides a business with insights that can help it plan for the future. For example, managers can use inventory accounting methods to learn whether the cost to produce a product has increased and adjust the price or change suppliers accordingly. They can examine sales data to inform decisions on what new products to add and which customers should get more attention.

Accountants also help their companies secure financing and find investors. Most lenders, whether they’re loaning money to small businesses or large corporations, need to see proof that the business is viable. Investors also want to assess the potential return they’ll get on their investments.

Finally, accounting helps with taxes and compliance. Producing accurate financial statements is necessary to report income to tax authorities for public companies, while both private and public companies are required to provide quarterly tax estimates and a yearly tax return. If reports are incorrect, a company could be under-reporting and subject to an audit or fines from the government or, conversely, over-reporting and paying more than it should. Other compliance issues arise for companies with loan covenants, and public companies are subject to additional reporting regulations from governing bodies such as the Australian Securities and Investments Commission (ASIC) in Australia, the Accounting and Corporate Regulatory Authority (ACRA) in Singapore, the New Zealand Companies Office in New Zealand, the Securities and Exchange Commission (SEC) in the Philippines, and the Securities and Futures Commission (SFC) in Hong Kong.

History of Accounting

Accounting has existed since ancient civilisations first began trading goods. The earliest evidence of accounting is found on clay tablets dating as far back as 3,300 BCE in Egypt and Mesopotamia.

Some of today’s accounting concepts emerged in Medieval Europe. Merchant Benedetto Cotrugli is credited with inventing the debit/credit accounting system in 1458. However, Italian mathematician and Franciscan monk Luca Bartolomes Pacioli is commonly known as the father of accounting and bookkeeping. He described double-entry bookkeeping in his 1494 book Summa de Arithmetica, Geometria, Proportioni et Proportionalita—“The Collected Knowledge of Arithmetic, Geometry, Proportion, and Proportionality”—a work that has influenced the teaching and practice of accounting to this day.

The Accounting Profession

Suffice it to say, the accounting profession has come a very long way since those days of ancient civilisation and early accounting books. Today, an accounting career offers many benefits, including stability, flexibility, and incredible growth potential.

What Does an Accountant Do?

An accountant generally performs a variety of financial duties. The most common include reviewing financial information, analysing accounts, providing insights about the company’s finances and preparing budgets and reports. Accountants at small businesses may also be tasked with bookkeeping, in which case they may maintain the general ledger, pay bills, handle payroll and reconcile accounts.

In Australia(opens in new tab), a certified practising accountant (CPA) can provide financial and taxation advice that enables businesses to maximise profits. The equivalent role in Singapore(opens in new tab), Hong Kong(opens in new tab) and the Philippines(opens in new tab), is a certified public accountant, also with the acronym CPA. Obtaining a CPA licence in these countries(opens in new tab) requires a candidate to complete an appropriate level of education, obtain real-world experience, and pass a CPA exam. Whereas accountants in New Zealand(opens in new tab) need a licence through the FMA, or must operate under a licensed financial advice provider (FAP), in order to provide financial advice.

Roles & Titles

Accounting Areas of Expertise

Corporate finance encompasses several areas of expertise. Larger companies may hire accountants who specialise in one or more of these areas:

• Payroll: Ensure that employees are paid accurately and on time and that the appropriate deductions, like taxes, are withheld from their paychecks.
• Cost: Value inventory, set selling prices for products, and create budgets using historical data.
• Accounts receivable/accounts payable (AR/AP): Focus on sending invoices, collecting payments and paying bills.
• Bookkeeping: Record transactions and balance the books.
• Collections: Track whether customers pay on time and take steps to obtain payment if they don’t.
• Tax: Ensure the business pays applicable taxes and maximises the deductions to which it is entitled.

Accounting vs. Bookkeeping

Although the terms “accounting” and “bookkeeping” are sometimes used interchangeably, bookkeeping is just one function within the broad discipline of accounting.

• Bookkeeping involves maintaining systematic records of financial transactions in the appropriate accounts, or ledgers. These records are ultimately reflected in the company’s general ledger, a master accounting document containing a complete record of the company’s transactions.
• Accounting encompasses much more than bookkeeping. It includes advanced functions like summarising, analysing and communicating data; preparing taxes; and ensuring legal compliance. For example, a senior accountant in a business would manage the general ledger, prepare financial statements and work with external auditors.

What are International Financial Reporting Standards?

International Financial Reporting Standards(opens in new tab) are global accounting and sustainability disclosure standards for public companies issued by the International Accounting Standards Board (IASB) and International Sustainability Standards Board (ISSB).

Many countries around the world, including Australia, Singapore, the Philippines, New Zealand, among others, have modelled their accounting regulations on IFRS. Public companies must comply with these regulations in their accounting practices, including when preparing financial statements. This helps investors and authorities assess and compare financial statements from different companies. Privately held companies do not need to comply with IFRS-derived regulations, but these businesses often choose to do so—especially if they plan to go public in the future.

Steps of the Accounting Cycle

The accounting cycle consists of eight main steps during each accounting period. Accounting software can automate most of these tasks.

1. Identify and categorise transactions: For example, an accountant would categorise sales orders as income.
2. Record journal entries: Individual transactions are entered in the appropriate accounts.
3. Post journal entries in the general ledger: This task must be performed in accordance with the rules of double-entry accounting.
4. Prepare an unadjusted trial balance: This report includes all the business’s accounts and their balances, comparing debits and credits. Debits and credits must balance.
5. Adjust accounting entries: At the end of an accounting period, an accountant will add any entries that haven’t been recorded previously, such as interest from bank accounts.
6. Prepare an adjusted trial balance: This report includes the adjustments made in the previous step.
7. Prepare financial statements: Use the account balances from Step 6 to create financial statements, including an income statement, balance sheet and cash flow statement.
8. Close the books: Prepare for the next accounting period.

Accounting for Small Business vs. Enterprise

While many principles of accounting are the same for a small business and a large enterprise, there are a few key practical differences—the biggest being the volume of financial activities. A small business may have only a few hundred transactions per month, while an enterprise may handle many thousands or even millions.

Another common difference is the method of recording transactions. There are two primary methods: cash basis accounting and accrual basis. Smaller businesses often use cash basis accounting, which is simpler. With this method, revenue and expenses are recorded when cash changes hands.

Businesses that need to comply with any national reporting standard based on IFRS, such as public companies, must use accrual basis accounting. Accrual basis accounting is more complex but generally gives a more accurate picture of a company’s financial position. With accrual basis accounting, a company records income when it is earned and expenses when they are incurred, regardless of when money changes hands. For example, a company that is paid in advance for a multi-year contract would record a portion of the revenue in each year.

Accounting Example

Accountants use the double-entry bookkeeping method to record transactions. Each transaction is recorded as a journal entry, with a credit to one account and a corresponding debit to another. These entries must balance each other. This method helps to ensure that each transaction is recorded in the appropriate amount and that the five major account types—revenue, expenses, assets, liabilities and equity—all balance.

Here’s an example of double-entry bookkeeping in accounting: A business sends an invoice to a customer. Using the double-entry method, the accountant records a debit to accounts receivable. The balancing credit is recorded in the sales revenue account.

When the customer pays the invoice, the accountant credits the accounts receivable account and debits the cash report.

The bookkeeping journal entries for this event are:

Managing an Accounting System

Using an accounting system helps businesses automate many routine accounting tasks, like paying bills and running reports. Accounting software can eliminate a lot of manual work, especially if the system is integrated with other business applications. That automation saves businesses money and reduces errors. Typically, the finance department will play a key role in setting up the system, particularly when it comes to creating custom reports and approval workflows.

The work involved in maintaining and updating the accounting software depends on the type of system you choose. Companies generally have a choice between on-premises and cloud-based accounting software. On-premises software typically requires IT expertise to install and manage on-site software and hardware. Cloud-based software or software-as-a-service systems are easier to manage because the provider updates the software automatically and users access the system over the internet using a browser.

No matter whether your business uses in-house skills or hires an independent provider, accountants provide expertise that’s essential to manage everyday financial activities, comply with tax and regulatory requirements and generate insights into the company’s performance.