1.1 Bookkeeping and accounting
Bookkeeping is the process of identifying and recording transactions and other financial events affecting an enterprise in a systematic way. Transactions refer to the trading activities or buying and selling that every business needs to record. A financial event could be any change in the value of a business, such as theft or damage to property, that also needs to be recorded. For hundreds of years the owners of businesses have needed to rely on financial records kept by bookkeepers. Such records have little value unless they are accurate and reliable.
Accounting is broader than bookkeeping and refers to the process of classifying, interpreting, summarising and reporting on transactions and other financial events. This is done in order to generate useful information from the many different types of purchases and sales that are individually recorded by bookkeepers.
An example of useful information is a daily sales report for a particular product in order to determine if an advertising campaign has made any difference to sales. By producing such a report, the sales transaction data recorded by the bookkeeper is organised into a meaningful form that will help the accountant to decide if sales for the relevant period have changed as a result of the advertising.
The following animated video summarises the broad purpose and role of accounting today.
Transcript: Video 1 Accounting today
NARRATOR: Double-entry accounting developed in medieval Italy to solve the practical problems of keeping accurate and trustworthy business records in a complex, turbulent world. It's as important today as it was over 500 years ago. The modern, fast moving, electronically networked business environment depends on accurate and trustworthy financial records and reports.
From the smallest sole trader to the largest multinational enterprise, relevant and reliable accounting is crucial for the survival, let alone prosperity of all businesses. Every enterprise, however big or small, relies on a true picture of the profit or loss they are making, and how they are making them.
Accounting is needed to record, summarise, monitor, and report all transactions and other economic events. Those involving the immediate exchange of cash, and those where payment is only made further down the road. It is vital for every organisation to track the money that comes in, and the money that goes out. This is just one purpose of accounting that you will learn about in fundamentals of accounting.
Many people don't realise that accounting only needs relatively little knowledge of everyday maths. It is important, however, to be well organised, analytical, and methodical. The traditional stereotype of a dull, unimaginative bean counter, invariably male, is now outdated. Accounting today is a lot more than agonising over irrelevant beans, or any matters of minor importance.
Instead, the modern, professionally qualified accountant fulfils a number of diverse and vital roles in business. This could entail managing the finances, strategy, and regulatory responsibilities of the largest multinational enterprise to being the only business advisor of a small sole trader. Today we also depend on professionally qualified and regulated accountants for more specialised roles.
It could be protecting the stakeholders of a business that goes under, and even trying to rescue such a business. Another accounting role is to look after the tax obligations and planning of an enterprise, from the smallest to the biggest. Modern governments are no different from Roman emperors in wanting taxes to be paid in full and on time.
There are still severe penalties today for businesses that evade tax. Specialised training and experience allows certain accountants to become external auditors who represent the interests of all stakeholders in larger businesses. Such a service is especially important for owners who are not involved in the day to day management of such a business.
These owners need financial statements to be independently and expertly checked and approved before they are made publicly available. Auditors are not required for sole traders, the focus of the accounting you will be learning about. Sole traders are only obliged by law to report the state of their business to the government, and not the general public.
Only the tax office is sent the true financial picture of their business. Whatever the role of the accountant, and whatever the size and nature of the business they are serving, they need to develop a wide and deep range of knowledge and skills. Strategic leadership, effective communication, and thorough analysis are just three skills of a modern professional accountant.
Every accountant, however, needs to have the same fundamental skill to use double-entry accounting to produce meaningful financial reports. The business world is only getting more complex and turbulent, and the foundation of any business, barring the most simple, is still double-entry accounting.
The responsibility of accountants is to prepare reports that contain useful information for a range of decision makers and stakeholders inside and outside the business. Such reports need to give a complete answer to four crucial financial questions that will be discussed in the next section. Only in answering these fundamental questions is the accountant able to generate reports that meet the varying information needs of different stakeholders.