1 What is accounting about?
Let's start with a question – we shall call questions ‘Activities’. For many of these activities you will need a pen and paper, or you can use the course Forum, to note down your own ideas. Once you have completed the Activity you should return to the text, read the comments that follow the activity, and then think again about your answer. Change it, if you like. Once you are happy that you have understood the comments and that your own answer is alright, you should continue to read the text. OK? Well, here’s the question:
What do you think is the main objective of accounting?
You may have found the question quite difficult. Maybe you didn’t? You may have said accounting’s main objective is any one (or more) of the following:
to let people know if they are making a profit or a loss
to let people know what their business is worth
to let people know what a transaction was worth to them
to let people know how much cash they have
to let people know how wealthy they are
to let people know how much they are owed
to let people know how much they owe to someone else
to enable people to keep a financial check on the things they do.
The list could go on and on. You could have used ‘organisation’ rather than ‘people’ and you could have used terms like ‘surplus’ and ‘deficit’ instead of ‘profit’ and ‘loss’.
If you thought the main objective of accounting is any of these, you did well. They are all similar. However, the primary objective is a bit more complicated, it is to provide information for decision-making. The information is usually thought to be financial, but it need not be – it could be, for example, the number of sheep owned by a farmer, or the number of cars belonging to a car dealer, or the number of footballers under contract for a football club. Now let’s consider what gave rise to accounting.
Accounting goes back many hundreds, even thousands of years. It began because people needed to record business transactions and to know if they were being financially successful in their businesses.
For many years, accounting was based on common sense – businesses recorded the data they considered necessary in order to obtain the information they required.
Let's see what information you might get from the records of accounting data you might keep.
(Remember, you should never look at the answer that follows before attempting an activity.)
Imagine a business recorded what it had sold, to whom, the date it was sold, the price it was sold at, and the date it received payment from the customer, along with similar data concerning the purchases made by the business.
What information do you think could be produced from this data? Take five minutes to write down your answer.
This data would enable the business to know how much it had sold and how much it had purchased, how much cash it had received and paid, how much was owing to it and how much was owed by it, and whether it was making a profit or a loss over a particular time period.
Sometimes, even these basic pieces of data were not recorded. Rather, the invoices (each of which shows the details of a transaction) and receipts (each of which confirms that a payment has been made) were kept and then given to an accountant to calculate the profit or loss of the business up to some point in time. The accountant would be someone who had learnt how to convert the financial transaction data (i.e. the data recorded on invoices and receipts, etc.) into accounting information. Quite often, it would be the owner of the business who performed all the accounting tasks. Otherwise, an employee would be given the job of maintaining the accounting records.
About 500 years ago, an Italian monk called Pacioli wrote down the basic rules for recording accounting data. These rules still form the basis of accounting.
As businesses grew in size, so it became less common for the owner to personally maintain the accounting records and more usual for someone to be employed as an accounts clerk. Then, as companies began to dominate the business environment, managers became separated from owners – the owners of companies (shareholders) often have no involvement in the day-to-day running of the business. This led to a need for some monitoring of the managers. Auditing of the financial records by accountants became the norm and this, effectively, established the accounting profession.
Accounting has expanded greatly from its intuitive beginnings. It is now heavily regulated and controlled and there are well-established procedures for virtually all the traditional accounting tasks. The environment within which accounting exists is known as the accounting information system (often abbreviated to ‘accounting system’). Let’s look at what an accounting information system is.