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What Is Accounting? Definition and Basics, Explained

Hillary Crawford

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Accounting is the practice of tracking your business's financial data and interpreting it into valuable insights. This allows you to generate crucial financial statements, such as a balance sheet, cash flow statement, and profit and loss report. It sounds simple, but in reality, a lot of behind-the-scenes work goes into accurately reporting on a business's financial state.

Accounting requires meticulous record-keeping and financial transaction tracking year-round. Moreover, keeping accurate records helps ensure your business is prepared to file taxes, present information to investors or even apply for a loan.

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Accounting basics

Recording financial transactions.

For a small business, accounting involves tracking money flow in various forms, including operating expenses (e.g., marketing, utilities, rent), cost of goods sold, accounts receivable and sales. It also takes into account liabilities, such as accounts payable, business loans and taxes, and the value of your assets, such as cash and inventory.

Let's say a client just paid their invoice online, or money was withdrawn from your checking account to pay a utility bill. Each transaction — money in or money out — gets recorded. Most business owners opt for small-business accounting software to help automate the process and reduce the likelihood of error.

Organizing financial transactions

A chart of accounts helps organize and make sense of all of a business's recorded transactions. It's essentially a list of financial accounts, and each time you record a transaction, you classify it under a particular account. Most accounts fall into five overarching account types: assets, liabilities, equity, expenses or revenue. Categorizing transactions accurately is critical for producing financial statements, which each pull information from specific accounts.

After you enter a transaction and categorize it under an account, your accounting software will create a journal entry behind the scenes. Most modern accounting software uses the double-entry accounting system , which requires two book entries — one debit and one credit — for every business transaction. These entries are summarized in the general ledger.

Running accounting reports

After recording and categorizing transactions, you can analyze the results by running reports. There are a few main financial statements that businesses rely on:

Income statement . Also called a profit and loss statement, the income statement consolidates data on revenue and expenses to show how profitable your business was over a specific period. It also shows how much it's paid in expenses and taxes. 

Balance sheet . The balance sheet takes your business's assets (e.g., inventory, equipment and accounts receivable), liabilities (e.g., accounts payable or taxes owed) and equity into account. 

Cash flow statement . As the name implies, this accounting report gives you an overview of your business's cash flow . It breaks down how your business earns cash and what that cash is going toward. Ideally, your cash flow will be positive and indicate that you have enough cash to cover future liabilities. 

The figures in your reports will look different depending on whether you use cash or accrual basis accounting .

Following accounting standards

Gaap accounting.

The Financial Accounting Standards Board, an independent organization recognized by the federal government, established a set of standards called generally accepted accounting principles , or GAAP, that publicly traded companies must comply with. For example, a company has to reference specific time periods in reports and follow the same accounting method across time periods to ensure accurate comparisons. Though small businesses aren't required to follow the same rules, doing so can help ensure a higher level of consistency.

How do small businesses use accounting?

You can use accounting to track cash flow and quantify your company's financial health. In addition, accounting makes it possible to create financial projections to plan for the future and anticipate sales and expenses. Without accounting, it would be incredibly difficult to gauge your business's performance and whether it's on track to meet its goals and obligations.

What do accountants do?

Small businesses hire accountants to advise them on their financial situation and help file taxes. Aside from handling taxes and compliance issues, they can help you optimize budgets, spot opportunities to save, and even apply for business loans.

Whereas you might only periodically consult your accountant, a bookkeeper touches base more frequently and handles daily accounting tasks. Regardless of who you hire, knowing basic accounting principles can help you understand your business better and have more productive conversations with your financial team.

» MORE: Best accounting and bookkeeping apps for small businesses

Accounting consists of tracking financial transactions and analyzing what they mean for your business.

Accounting helps you gauge where your small business stands financially, what it can afford at any given time, and where its money is coming from and going. In addition to this financial overview, proper accounting practices prepare your business to file taxes and produce financial statements needed for potential investors or business loan applications.

When running a small business, you should choose an accounting software product and consider hiring an accountant. Accounting software does a lot of the heavy lifting (such as keeping track of debits and credits) for you. However, it's still important to understand basic accounting principles to know what's happening behind the scenes. Business owners should be able to enter transactions, reconcile accounts and interpret financial statements accurately.

Accountants can help take some of the pressure off tax season by handling the preparation and filing for you. If your business can afford to hire an accountant, doing so could save you time and potentially even tax dollars.

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Home Accounting Bookkeeping: Definition, Importance, Types and Tasks

Bookkeeping: Definition, Importance, Types and Tasks

Tally Solutions | Updated on: February 14, 2023

--> published date: | updated on: --> <--, what is bookkeeping, why bookkeeping is important for all business, tasks and examples of the bookkeeping system.

  • Accounting period

Types of Bookkeeping

Method of bookkeeping, principles of bookkeeping.

  • How to record entries in bookkeeping

Posting entries and documentation

Influence of bookkeeping on the chart of accounts, frequently asked questions.

Bookkeeping is a process of recording and organizing all the business transactions that have occurred in the course of the business.  Bookkeeping is an integral part of accounting and largely focuses on recording day-to-day financial transaction of the business.

All the financial transactions such as sales earned revenue, payment of taxes, earned interest, payroll and other operational expenses, loans investments etc. are recorded in books of accounts.

The way the bookkeeping is managed determines the accuracy of the overall accounting process that is been followed by the business. Thus, bookkeeping ensures that the record of financial transactions are up-to-date and more importantly, accurate

Just like to prepare a report, you need a source of data, bookkeeping is a source that gets summarized into the financial statements or any other accounting report that you see. With bookkeeping tracks and records all the financial transactions, it becomes the starting point of accounting. No bookkeeping = No accounting.

Thus, it becomes important for businesses, small or big to have bookkeeping in place.

The following are the importance of bookkeeping:

  • Bookkeeping helps to keep track of receipts, payments. Sales, purchases and record of every other transaction made from the business.
  • It helps to summarize the income, expenditure and other ledger records periodically.
  • It provides information to create financial reports which tells us specific information about the business as how much profits the business has made or how much the business is worth at a specific point of time.

With the definition of bookkeeping, it’s clear that the bookkeeping task involves all that is required to track, record and organize all the financial transaction that has occurred in the business.

The person is responsible for managing bookkeeping usually entrusted with the responsibility of tracking all the transaction related to business. The following are the bookkeeping tasks examples:

  • Billing for goods sold or services provided to clients.
  • Recording receipts from customers.
  • Verifying and recording invoices from suppliers.
  • Recording payment made to suppliers and so on…

 Are accounting and bookkeeping different? Read ‘ Bookkeeping and Accounting’

Bookkeeping  period

The accounting period that a business entity chooses for its business becomes part of its bookkeeping system and is used to open and close the financial books. The accounting period affects all aspects of the company’s finances, including taxes and analysis of your financial history.

In most of the countries, the accounting period is the financial year which starts from 1st April and ends on 31st March of every year. In some countries like the Middle East (UAE, Saudi, Bahrain etc) the calendar year is used as an accounting period i.e. 1st January to 31st December.

Business entities choose from two types of bookkeeping systems, although some entities use a combination of both.

The single-entry system of bookkeeping requires recording one entry for each financial activity or transaction. The single-entry bookkeeping system is a basic system that a company might use to record daily receipts or generate a daily or weekly report of cash flow.

The double-entry system of bookkeeping requires a double entry for each financial transaction. The double entry system provides checks and balances by recording corresponding credit entry for each debit entry. The double-entry system of bookkeeping is not cash-based. Transactions are entered when a debt is incurred or revenue is earned.

Read ' Types and Methods of Bookkeeping System' to know more.

The cash-based system of accounting records financial transactions when payment is made or received. This system recognizes revenue or income in the accounting period in which it is received and expenses in the period in which they are paid.

The accrual basis method, which is favoured under the generally accepted  principals of accounting,  record income in the accounting period in which it is earned and records expenses in the period incurred.

To ensure the all the transactions are recorded and organized systematically, bookkeeping principles are applied. The following are the bookkeeping principle

  • Revenue principle
  • Expense principle
  • Matching principle
  • Cost principle
  • Objectivity principle

Read ' Principles of Bookkeeping' to know more.

How to record entries in Bookkeeping

Entries in bookkeeping are recorded in the archaic method of journal entry . Here, the respective individual or accountant manually enters the account numbers and performs individual action of debits and credits for each transaction. This approach is time-consuming and subject to error, and so is usually reserved for adjustments and special entries.

All Financial transactions undertaken by a business entity are posted in ledgers using the information from receipts and other documentation. Ledgers summarize the transactions recorded.  Most bookkeeping software  automates the posting of transaction details to respective ledgers and reports.

Most entities post financial transactions daily, while others post in batches or outsource the posting activity to accounting professionals. Posting entries regularly helps in generating on-time financial statements or reports.

Financial transactions documentation is an important element of a company’s bookkeeping system. It requires maintaining files of receipts and other documents. The duration period for maintaining documentation records depends on your company policy and legal or tax requirements.

A business entity can create more comprehensive bookkeeping system when it includes accounts for each area of financial transactions.  Financial accounts  are grouped or categorized based on the nature of accounts or impact on the financial statements. This usually includes balance sheet accounts and income statement accounts.

Balance sheet  accounts are assets, liabilities, and stockholder or owner equity. Income statement accounts are operating and non - operating revenues, expenses, gains and losses.

What exactly does a bookkeeper do?

A bookkeeper is primarily responsible to record and track a company's financial transactions which include, purchases, sales and expenses. These transactions are first recorded as general ledger, which are later used while preparing a balance sheet.

What is the difference between Accounting and Bookkeeping?

Accounting is a broad subject. It calls for a greater understanding of records obtained from  bookkeeping  and an ability to analyze and interpret the information provided by bookkeeping records.

Bookkeeping is the recording phase while accounting is concerned with the summarizing phase of an  accounting system . Bookkeeping provides necessary data for accounting and accounting starts where bookkeeping ends.

Take a look at the difference between Bookkeeping and Accounting

Is it hard to be a Bookkeeper?

No. Bookkeeping is a rather simple and straight forward process which can be easily learnt while you're on-the-job. 

What are the 2 kinds of Bookkeeping?

The single-entry and double-entry bookkeeping systems are the two methods commonly used. While each has its own advantage and disadvantage, the business has to choose the one which is most suitable for their business.

More on types of Bookkeeping system

Read More on Bookkeeping

Bookkeeping Principles , Types of Bookkeeping System , Elements of Bookkeeping , Bookkeeping Vs. Accounting , Difference between Accountant & Bookkeeper , Basic Accounting Assumptions Basis Bookkeeping

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What is Accounting? Definition, Objectives, Advantages, Limitation, Process

  • Post last modified: 22 February 2022
  • Reading time: 35 mins read
  • Post category: Finance

What is Accounting?

Accounting is the art of recording, classifying, summarising and analyzing business transactions and interpreting the results thereof. In accounting, only those transactions and events are recorded which can be measured in terms of money.

The basic objective of accounting is to provide the desired information to the owner as well as to all other interested parties i.e. investors, creditors, employees, financial institutions, government etc.

In short, we can say that accounting is the language of business by which all the financial and other information are communicated to various interested parties.

Table of Content

  • 1 What is Accounting?
  • 2 Introduction to Accounting
  • 3 Definition of Accounting
  • 4 Characteristics of Accounting
  • 5.1 Financial Accounting
  • 5.2 Management Accounting
  • 5.3 Cost Accounting
  • 5.4 Tax Accounting
  • 5.5 Social Accounting
  • 5.6 Human Resource Accounting
  • 5.7 National Accounting
  • 5.8 Green Accounting
  • 5.9 Creative Accounting
  • 5.10 Forensic Accounting
  • 6.1 Stewardship functions
  • 6.2 Managerial functions
  • 6.3 Statutory compliance function
  • 7.1 Reliability
  • 7.2 Understand ability
  • 7.3 Comparability
  • 8.1 Single Entry
  • 8.2 Double Entry System
  • 9 Concept of Accounting Process
  • 10.1 Maintaining systematic records
  • 10.2 Communicating the financial results
  • 10.3 Meeting legal needs
  • 10.4 Stewardship
  • 10.5 Fixing responsibility
  • 11.1 Owners/Shareholders
  • 11.2 Managers
  • 11.3 Prospective Investors
  • 11.4 Creditors, Bankers and other Lending Institutions
  • 11.5 Government
  • 11.6 Employees
  • 11.7 Customers
  • 12.1 Helpful in the Determination of Financial Results
  • 12.2 Comparison of Results
  • 12.3 Assistance to Management
  • 12.4 Helpful in Assessing the Tax Liability
  • 12.5 Helpful in the Case of Insolvency
  • 12.6 Provides Information to Interested Parties
  • 12.7 Raising of Funds Become Easy
  • 13.1 Recording of Monetary Items Only
  • 13.2 Effect of Inflation
  • 13.3 Accounting Information May be Biased
  • 13.4 Conflict Between Accounting Principles
  • 14.1 Identification of Transaction
  • 14.2 Recording the Transaction
  • 14.3 Classifying
  • 14.4 Summarising
  • 14.5 Presentation of Financial Information

Introduction to Accounting

Accounting is a business language which explains the various kinds of transactions during a given period of time. Accounting is used by business entities for keeping records of their money or financial transactions.

A businessman who invested money in his business would like to know whether his business is making a profit or incurring a loss, the position of his assets and liabilities and whether his capital in the business has increased or decreased during a particular period. The main object of a business house is to earn profit. Accounting is the medium of recording business activities and it is considered a language of business.

To find out the results of a business, the information relating to the cost of the products and revenues from the products is collected. Then the costs and revenues are compared to find out the profit or loss of the business. If volume of sales of the products is high and the number of transactions of the business is very high, it is impossible to keep all these transactions in the mind of a businessman.

Thus a need of recording of all these business transactions rose. The recording of business transactions or activities is done through a process of accounting.

Definition of Accounting

The Accounting definition is given by the American Institute of Certified Public Accountants (‘AICPA’) clearly brings out the meaning of accounting. According to it, accounting is “ the art of recording, classifying and summarizing in a significant manner and in terms of money, transactions and events which are, in part at least, of a financial character and interpreting the results thereof ” .

As per Robert N. Anthony , “ Accounting system is a means of collecting, summarizing, analyzing and reporting, in monetary terms, information about the business”.

As per Smith and Ashburne , “ Accounting is the science of recording and classifying business transactions and events, primarily of a financial character and the art of making significant summaries, analysis and interpretations of these transactions and events and communicating the results to persons who must take decisions or form judgment.”

As per R.N. Anthony “Nearly every business enterprise has accounting system, it is a means of collecting, summarising and reporting in monetary terms, information about business.”

Characteristics of Accounting

Following are the characteristics of accounting :

  • Accounting is an art which it helps us in attaining our aim of ascertaining the financial results, that is, operating profit and financial position. Analysis and interpretation of financial data require special knowledge, experience and judgement.
  • In accounting the financial transactions are recorded in the Journal. With the help of Journal, the recorded data are classified into ledger under appropriate heads. Then with the help of ledger the trial balance and financial statements are prepared.
  • It records only those transactions and events which are of financial character: If a transaction has no financial character then it will not be measured in terms of money and not recorded.
  • It records transactions in terms of money. All transactions are recorded in terms of common measure i.e. money.
  • On account of recording of business transactions in a systematic manner, it is also called a science. First the business transactions are recorded in the primary books i.e. Journal, for classification the ledger is prepared. With the help of ledger the Trial Balance, Profit and Loss account and Balance Sheet is prepared. Profit and Loss account is prepared after a period to find the result of the business and Balance Sheet to know the financial position of the business

Divisions of Accounting

Accountants tend to specialize in various types of accounting work and this has resulted in the development of different branches of accounting. Some of the divisions of accounting are given as:

Financial Accounting

Management accounting, cost accounting, tax accounting, social accounting, human resource accounting, national accounting, green accounting, creative accounting, forensic accounting.

Accounting designed or meant for outsiders is known as financial accounting. It is concerned with the recording of business transactions and the periodic preparation of income statement, balance sheets and cash flow statement from such records.

It is concerned with the interpretation of accounting information to guide the management for future planning, decision-making, control, etc. Management accounting, therefore, serves the information needs of the insiders, e.g., owners, managers and employees.

It has been developed to ascertain the costs incurred for carrying out various business activities and to help the management to exercise strict cost control.

This branch of accounting has grown in response to the difficult tax laws such as relating to income tax, sales tax, excise duties, customs duties, etc. An accountant is required to be fully aware of various tax legislations.

This branch of accounting is also known as social reporting or social responsibility accounting. It discloses the social benefits created and the costs incurred by the enterprise. Social benefits include such facilities as medical, housing, education, canteen, provident fund and so on while the social costs may include such matters as extra hours worked by employees without payment, environment pollution, unreasonable terminations, etc.

It is concerned with the human resources of an enterprise. Accounting methods are applied to evaluate the human resources in money terms so that the society might judge the total work of the business enterprises including, its non-human assets.

It is, therefore, accounting for the people of the organisation. Unfortunately, no objectively verifiable method has been developed for universal application.

The accounting for the resources of the nation as a whole. It is generally not concerned with the accounting of individual business entities and is not based on generally accepted accounting principles. It has been developed by economists and statisticians.

The concept of green accounting is related to the calculation of national income in which standard measures of income and output are Gross National Product (GNP) Gross Domestic Product (GDP) Gross National Income (GNP) etc.

In simple words, Green Accounting is a kind of accounting that tries to take into consideration the environmental costs in the calculation of the operating income of an enterprise. Green Accounting discloses or emphasizes more clearly about the quality of economic growth in terms of sustainable development.

It is the primary duty of the persons in accounting professions, the accountants, to report a true and fair view of the financial statements, namely: the profit and loss account and the balance sheet.

Creative accounting is nothing but the manipulation of the operating results and financial position of the company, of course, within the confines (limits) of the accounting standards.

Financial scams and frauds in accounting practices have drawn attention of the users of the accounting information supplied by business enterprises. Even the well-governed multinational companies like Enron and other World companies have not escaped from the fraudulent accounting practices.

Auditors who are also qualified accountants have the increased responsibility of detecting the frauds and scams in the corporate world

Functions of Accounting

As mentioned earlier, accounting information is used by different stakeholders, especially the management, to decide the future course of action for the organisation.

There are three main functions of accounting, which are explained as follows:

Stewardship functions

Managerial functions, statutory compliance function.

These functions of accounting include the following:

  • Recording, classifying and summarising the financial transactions of an organisation
  • Analysing the financial data
  • Representing the financial position of the organisation by displaying various results such as net profit, credit, debit, loan, etc.
  • Communicating the financial information to the interested stakeholders.
  • Formulating a financial policy
  • Conducting planning
  • Preparing budget and controlling costs
  • Preventing financial errors and frauds

These functions include the following:

  • Submitting financial statements such as profit and loss account, balance sheet, etc. to regulatory bodies as a legal and regulatory requirement
  • Providing the bases for filing returns for both direct and in- direct taxes

Qualitative Characteristics of Accounting Information

Relevance: Financial information obtained through financial statements should be according to the objectives of the organization. The objective-oriented information helps the investors, managers and creditors to take decisions about the business. The information should be given according to the priorities and needs of each and every interested party.

Reliability

Understand ability, comparability.

Financial Information should be based on facts which can easily be verified. Financial information can be verifiable if it is based on original source documents. Source documents include cash memo, purchase invoices, sales invoices, property transfer papers and written agreements, etc.

Financial information should be presented in a simple and easy way so that the users i.e. investors, debenture holders, employees and government officials can understand it easily. It should be simple enough even for a person who is not aware about the rules and terms used in accounting. Some explanatory notes should be given so as to make the information more understandable.

The financial statements must show corresponding information for the preceding year(s) so that the users may be able to compare the financial performance, position and cash flows of different years. The measurement and display of the net financial effects of similar type of transactions must be treated in a consistent form.

Methods of Accounting

Single entry.

It is an incomplete system of recording business transactions. The business organization maintains only cash book and personal accounts of debtors and creditors. So the complete recording of transactions cannot be made and trail balance cannot be prepared.

Double Entry System

The double entry system is based on scientific principles and is, therefore, used by most of business houses. The system recognizes the fact that every transaction has two aspects and records both aspects of each and every transaction.

Under this system, in every transaction an account is debited and other account is credited. The crux of accountancy lies in finding out which of the two accounts are affected by a particular transaction and out of these two accounts which account is to be debited and which account is to be credited.

Concept of Accounting Process

Accounting process is the complete sequence of accounting procedures which begin with the recording of business transactions from source documents in the Journal or in subsidiary books, as the case may be, and end with the preparation of two basic financial statements, namely Income Statement (or profit and loss account) and Balance Sheet. In the case of Limited Liability Companies, the Cash Flow Statement is also prepared.

The essential steps in the Accounting Process are:

  • To enter the transactions in the source documents such as purchase invoice, sales invoice, cash receipts, bank pay-in-slips etc.
  • To record or enter the transactions in the Journal or in subsidiary books, as the case may be.
  • Classifying the transactions (i.e., the entries found in the Journal or Subsidiary Books) to post or transfer those entries in the appropriate accounts in the ledger.
  • To enter the adjustments, if any, in the Journal.
  • To balance the various accounts in the ledger to prepare the trial balance in order to check the arithmetical accuracy of the ledger accounts.
  • To prepare the final accounts or final statements in the form of trading and profit and loss account (i.e., income statement) and Balance Sheet from the Trial Balance, at the end of the accounting period to ascertain profit or loss of the business for the accounting period and the financial position of the business at the end of the accounting period.

Objectives of Accounting

Following are the objectives of accounting :

Maintaining systematic records

Communicating the financial results, meeting legal needs, stewardship, fixing responsibility.

Business transactions are properly recorded, classified under appropriate accounts and summarized into financial statement.

Accounting is used to communicate financial information in respect of net profits (or loss), assets, liabilities etc., to the interested parties.

The provisions of various laws such as Companies Act, Income Tax and GST Acts require the submission of various statements, i.e., annual account, income tax returns and so on.

Accounting assists the management in the task of planning, control and coordination of business activities.

In the case of limited companies, the management is entrusted with the resources of the enterprise. The managers are expected to act true trustees of the funds and the accounting helps them to achieve the same.

Accounting helps in the computation of the profits of different departments of an enterprise which help in fixing the responsibility of departmental heads.

Users of Accounting Information

Owners/shareholders, prospective investors, creditors, bankers and other lending institutions.

The primary aim of accounting is to provide necessary information to the owners related to business.

In large business organizations and in corporations, there is a separation of ownership and management functions. The management of such business are more concerned with the accounting information because they are answerable to the owners.

The person who is contemplating an investment in a business will like to know about its profitability and financial position. They derive this information from the accounting reports of the concern.

Trade creditors, bankers and other lending institutions would like to be satisfied that they will be paid on time. The financial statements help them in judging such position. Banks and other lending agencies rely heavily upon accounting statements for determining the acceptability of a loan application.

The Government is interested in the financial statements of business enterprise on account of taxation, labour and corporate laws.

Employees are interested in financial statements on accounts because their wage increase and payment of bonus depend on the size of the profit earned.

Customers may also have either short-term or long-term interest in the reporting entity or long-term interest in the reporting entity and they may be satisfied with the profitability, liquidity and solvency position.

Advantages of Accounting

Following are the advantages of accounting :

Helpful in the Determination of Financial Results

Comparison of results, assistance to management, helpful in assessing the tax liability, helpful in the case of insolvency, provides information to interested parties, raising of funds become easy.

Accounting is very useful in the determination of the profit and loss of a business and showing the financial position of the business.

Accounting information when properly recorded can be used to compare the results of one year with those of earlier years so that the significant changes can be analyzed.

The accounting information helps the management to plan its future activities by preparing budgets in respect of sales, production, expenses, cash, etc. Accounting helps in the coordination of various activities in different departments by providing financial details of each department.

The managerial control is achieved by analyzing in money terms the departures from the planned activities and by taking corrective measures to improve the situation in future.

Generally, a businessman has to pay corporate tax, VAT and excise duty, etc. Therefore, it is necessary that proper accounts should be maintained to compute the tax liability of the business.

Sometimes the businessman becomes insolvent. If he has properly maintained the accounts, he will not face the problems in explaining few things in court.

Interested parties like owners, creditors, management, employees, customers, government, etc. are interested in accounting information.

It helps in raising funds from investors or financial institutions by promising investors a fixed claim (interest payments) on the cash flows generated by the assets, with a limited or no role in the day-to-day running of the business.

Limitation of Accounting

Following are the limitation of accounting :

Recording of Monetary Items Only

Effect of inflation, accounting information may be biased, conflict between accounting principles.

In accounting, only those transactions, which have monetary value, are recorded. And those transactions which do not have financial value whether those are important in business are not recorded in the accounting.

In accounting, the transactions are recorded at the historical cost. Accordingly, the assets of the business are shown at cost in the balance sheet. Thus the balance sheet prepared on the basis of historical cost ignores the price-level changes (inflation). In this way, the balance sheet of the business does not present the true and fair picture of the business.

Accounting information is not without personal influence or bias of the accountant. In measuring income, accountant has a choice between different methods of inventory valuation, deprecation methods, treatment of capital and revenue items etc. Hence, due to the lack of objectivity income arrived at may not be correct in certain cases.

In accounting, one accounting principle conflicts another. For instance, inventory should be valued on the basis of ‘least of the cost and market price’ as per the principle of conservatism.

Accounting Process

Accounting process involves the following steps or stages:

Identification of Transaction

Recording the transaction, classifying, summarising, presentation of financial information.

In accounting, only business transactions are recorded. A transaction is an event which can be expressed in terms of money and which brings a change in the financial position of a business enterprise. An event is an incident or a happening which may or may not being any change in the financial position of a business enterprise.

Therefore, all transactions are events but all events are not transactions. A transaction is a complete action, to an expected or possible future action. In every transaction, there is a movement of value from one source to another.

For example, when goods are purchased for cash, there is a movement of goods from the seller to the buyer and a movement of cash from buyer to the seller. Transactions may be external (between a business entity and a second party, e.g., goods sold on credit to Hari or internal (do not involve a second party, e.g., depreciation charged on the machinery).

Journal is the first book of original entry in which all transactions are recorded event-wise and date-wise and presents a historical record of all monetary transactions. It may further be divided into sub-journals as well which are also known subsidiary books.

Accounting is the art of classifying business transactions. Classification means statement setting out for a period where all the similar transactions relating to a person, a thing, expense, or any other subject are groped together under appropriate heads of accounts.

Summarising is the art of making the activities of the business enterprise as classified in the ledger for the use of management or other user groups i.e. Sundry debtors, Sundry creditors etc. Summarisation helps in the preparation of Profit and Loss Accounts and Balance sheet for a particular fiscal year.

Analysis and Interpretation The financial information or data as recorded in the books of an account must further be analyzed and interpreted so to draw useful conclusions. Thus, analysis of accounting information will help the management to assess in the performance of the business operations and forming future plans also.

The end users of accounting statements must be benefited from analysis and interpretation of data as some of them are the ‘stock holders’ and other one the ‘stakeholders’. Comparison of past and present statements and reports, use of ratio analysis and trend analysis are the different tools of analysis and interpretation.

From the above discussion, one can conclude that accounting is a art which starts and includes steps right from recording of business transactions of monetary character to the communicating or reporting the results thereof to the various interested parties.

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Payroll accounting: What are its uses?

Payroll accounting: What are its uses?

If you want to run a successful company, there will be many challenges to overcome. Apart from the operational side of things, one of the main focuses is the bureaucratic burden which will grow exponentially as long as your company does. Payroll accounting, for example, goes far beyond the timely processing of monthly salaries : Reporting requirements need to be complied with, and personnel master data must be maintained without losing track of your employees. This is much easier said than done. There are many companies that decide to outsource payroll accounting to external service providers, and for good reason.

What is payroll accounting?

Creating and maintaining employee payroll accounts., registering and deregistering employees for social security, reporting obligations during employment, reporting obligations at the end of employment, end of year payroll accounting obligations, when is payroll accounting necessary, payroll accounting: is it worth doing yourself or should you outsource it.

Payroll accounting deals with the recording, settlement and distribution of wages and salaries , as well as employees’ statutory and voluntary deductions. The purpose of this is to calculate the salary entitlement (gross and net) of all employees for the period in question. Additionally, however, the results of payroll accounting serve as the basis for the calculation of payroll costs, as well as the associated social expenses in company accounting . Accounting documents include timesheets, work time-cards and employment contracts.

Payroll accounting includes the following tasks:

  • Maintaining personnel master data
  • Fulfilment of statutory reporting obligations (e.g. payroll tax declaration)
  • Creation of DTA files (disk exchange method)

Each employee is assigned their own payroll account in the department. What kind of data should be recorded is laid out in the

Fair Labor Standards Act of 1938 29 U.S.C.   § 203

Payroll accounting is the recording, settlement and posting of company wages and salaries. It is a key part of the company’s accounts and is mandatory for the majority of all companies. Payroll accountants need extensive knowledge in the fields of labor law, payroll tax law and social security law.

Payroll accounting: Their key tasks

The cost of payroll accounting doesn’t just depend on the size, but also on the kind of company. In particular, the type of staff remuneration pays a major role here: If employees or workers are paid by the hour, and if overtime and working hours are paid additionally at the weekends, this results in a lot more work for the payroll accounting department, compared to if exclusively fixed salaries were paid. The general personnel policy also affects the payroll accountant’s workload, as frequent additions and departures in the staff requires much more bureaucracy than a constant workforce. But what are payroll accounting’s specific tasks and responsibilities?

As mentioned above, a separate payroll account must be created and maintained for each employee. This account will contain general information about the person and their salary. In the case of an external payroll audit, the payroll account makes it easier for the tax authorities to check each person’s payroll tax deductions. The payroll account also serves as the basis for calculating different insurances. Personal and salary information should include:

  • Employee’s first and last name
  • Full address
  • Social security number
  • Date of payment
  • Payroll period
  • Hours worked
  • Payment type – wages, salary, commission, etc. (separated into cash and non-cash remuneration)
  • Withheld payroll taxes
  • Employer's portion/expense for Social Security taxes, Medicare taxes, state and federal unemployment taxes
  • Special payments (e.g. paid vacation, Christmas bonuses) taxed on a flat-rate basis
  • Employer's portion/expense of fringe benefits such as health and dental insurance, paid holidays, vacations and sick days, pension and savings plan contributions, worker compensation insurance, etc.
  • Any lost income for more than 5 consecutive days

Individual personnel account records may be kept by third parties, as long as the accounting format and procedures used are in accordance with the principles of proper accounting . Most importantly, the data must be kept available during the mandated retention period and should be made available to the tax office at any time in a comprehensive form. To this end, the tax authorities require a certain standard whether the records be transferred electronically or in paper form.

The following retention periods apply to payroll accounting :

3 years: Hiring papers, 1-9 documents, time-cards, employee handbooks, FMLA Leave details, termination documents, information pertaining to raises or changes in employee pay.

4 years: Pay slips, W-4 and other tax documents.

6 years : Retirement and 401k contribution information.

Be sure to check with your state authorities for any additional or changes to the retention periods.

One of the basic payroll accounting tasks is to register new employees or deregister old employees for social security. This is done with information provided on an employee’s W-2 Form. In order for an employee to be able to fill out their W-2 form and be registered as an employee, they will need to provide you with their social security number, as well as their personal information. This number should be obtained by the employee at the beginning of the employment relationship or when they began working for the first time, if this is not their first job. Be sure that the number the employee has provided you with is definitely a social security number, and not an ITIN number. If the person does not have an SSN and only has an ITIN, there is a good chance they are not legally permitted to work in the USA and employing someone illegally can lead to many problems down the line. Check out the IRS website for more information on this topic.

For the duration of an employee’s time working at your company, payroll accounting is responsible for reporting and paying withheld taxes on behalf of the employee. This can be done online through EFTPS . Additionally, the payroll department is required to pay employee and employer social security and Medicare taxes with Form 941 and make unemployment contributions through the 1FUTA tax by filing Form 940 . A full list of due dates for filing these documents can be found here .

Regardless of how the employment relationship has ended (termination, end of contract, etc.), there are certain obligations still in place for the payroll accounting department. They are obliged to notify tax authorities that the employee is no longer working there, which can also be done electronically through EFTPS. The employee departure must also be reported to the relevant social security, Medicare or private health insurance bodies.

When an employee is deregistered with the tax authorities, the company is no longer classified as their main employer. Once this has happened, the new employer can become registered as the primary employer and receive information from the EFTPS database.

All companies are obliged to carry out an annual payroll tax settlement at the end of the year. The purpose of this is to check monthly withheld payroll tax at the end of the year against the annual payroll tax table. This allows compensation for differences that may arise when comparing annual income tax with payroll tax actually paid. This kind of difference may occur, for example, if the salary has changed during the year or if bonuses have been distributed.

Payroll is also required to inform the relevant social security and Medicare bodies of their employees’ salaries, so that if contributions are means tested, they can be adjusted accordingly.

As soon as a company employs people, they’re automatically obliged to perform payroll accounting. This is due to the notification obligations previously mentioned to the various social security and Medicare institutions, as well as tax obligations. While there is no federal law requiring employers to issue paychecks, many states have legislation in place requiring this, so you will have to check with your local authorities and issue them accordingly.

Payroll accounting responsibilities and tasks are extensive. Even in smaller companies, these tasks involve a great amount of time and effort. In particular, accuracy is very important when creating remuneration statements: if there are errors, the tax authorities as well as the social security and health insurance agencies will quickly notice, and you could face penalties. Using an external service provider will ensure that your payroll accounting needs are being met to the highest professional standards.

The main advantage of having an external payroll accounting department is the wealth of experience these offer, since they are usually serving a large number of clients. Error-free payroll accounting is always in their interests, so they will always strive to be up-to-date with current federal and state legislation . A good relationship between a company and their external payroll provider is important to guarantee correct payroll accounting. The following table summarizes the measures for minimizing risks in external and internal payroll accounting:

Click here for important legal disclaimers.

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What Is Cost Accounting?

Understanding cost accounting.

  • Cost vs. Financial Accounting
  • Cost Accounting FAQs

The Bottom Line

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Cost Accounting: Definition and Types With Examples

Yarilet Perez is an experienced multimedia journalist and fact-checker with a Master of Science in Journalism. She has worked in multiple cities covering breaking news, politics, education, and more. Her expertise is in personal finance and investing, and real estate.

task accounting definition

Cost accounting is a form of managerial accounting that aims to capture a company's total cost of production by assessing the variable costs of each step of production as well as fixed costs, such as a lease expense.

Cost accounting is not GAAP-compliant , and can only be used for internal purposes.

Key Takeaways

  • Cost accounting is used internally by management in order to make fully informed business decisions.
  • Unlike financial accounting, which provides information to external financial statement users, cost accounting is not required to adhere to set standards and can be flexible to meet the particular needs of management.
  • As such, cost accounting cannot be used on official financial statements and is not GAAP-compliant.
  • Cost accounting considers all input costs associated with production, including both variable and fixed costs.
  • Types of cost accounting include standard costing, activity-based costing, lean accounting, and marginal costing.

Investopedia / Theresa Chiechi

Cost accounting is used by a company's internal management team to identify all variable and fixed costs associated with the production process. It will first measure and record these costs individually, then compare input costs to output results to aid in measuring financial performance and making future business decisions. There are many types of costs involved in cost accounting , each performing its own function for the accountant.

Types of Costs

  • Fixed costs are costs that don't vary depending on the level of production. These are usually things like the mortgage or lease payment on a building or a piece of equipment that is depreciated at a fixed monthly rate. An increase or decrease in production levels would cause no change in these costs.
  • Variable costs are costs tied to a company's level of production. For example, a floral shop ramping up its floral arrangement inventory for Valentine's Day will incur higher costs when it purchases an increased number of flowers from the local nursery or garden center.
  • Operating costs are costs associated with the day-to-day operations of a business. These costs can be either fixed or variable depending on the unique situation.
  • Direct costs are costs specifically related to producing a product. If a coffee roaster spends five hours roasting coffee, the direct costs of the finished product include the labor hours of the roaster and the cost of the coffee beans.
  • Indirect costs are costs that cannot be directly linked to a product. In the coffee roaster example, the energy cost to heat the roaster would be indirect because it is inexact and difficult to trace to individual products.

Cost Accounting vs. Financial Accounting

While cost accounting is often used by management within a company to aid in decision-making, financial accounting is what outside investors or creditors typically see. Financial accounting presents a company's financial position and performance to external sources through financial statements , which include information about its revenues , expenses , assets , and liabilities . Cost accounting can be most beneficial as a tool for management in budgeting and in setting up cost-control programs, which can improve net margins for the company in the future.

One key difference between cost accounting and financial accounting is that, while in financial accounting the cost is classified depending on the type of transaction, cost accounting classifies costs according to the information needs of the management. Cost accounting, because it is used as an internal tool by management, does not have to meet any specific standard such as  generally accepted accounting principles (GAAP) and, as a result, varies in use from company to company or department to department.

Cost-accounting methods are typically not useful for figuring out tax liabilities, which means that cost accounting cannot provide a complete analysis of a company's true costs. 

Types of Cost Accounting

Standard costing.

Standard costing assigns "standard" costs, rather than actual costs, to its cost of goods sold (COGS) and inventory. The standard costs are based on the efficient use of labor and materials to produce the good or service under standard operating conditions, and they are essentially the budgeted amount. Even though standard costs are assigned to the goods, the company still has to pay actual costs. Assessing the difference between the standard (efficient) cost and the actual cost incurred is called variance analysis.

If the variance analysis determines that actual costs are higher than expected, the variance is unfavorable. If it determines the actual costs are lower than expected, the variance is favorable. Two factors can contribute to a favorable or unfavorable variance. There is the cost of the input, such as the cost of labor and materials. This is considered to be a rate variance.

Additionally, there is the efficiency or quantity of the input used. This is considered to be a volume variance. If, for example, XYZ company expected to produce 400 widgets in a period but ended up producing 500 widgets, the cost of materials would be higher due to the total quantity produced.

Activity-Based Costing

Activity-based costing (ABC) identifies overhead costs from each department and assigns them to specific cost objects, such as goods or services. The ABC system of cost accounting is based on activities, which refer to any event, unit of work, or task with a specific goal, such as setting up machines for production, designing products, distributing finished goods, or operating machines. These activities are also considered to be cost drivers , and they are the measures used as the basis for allocating overhead costs .

Traditionally, overhead costs are assigned based on one generic measure, such as machine hours. Under ABC, an activity analysis is performed where appropriate measures are identified as the cost drivers. As a result, ABC tends to be much more accurate and helpful when it comes to managers reviewing the cost and profitability of their company's specific services or products.

For example, cost accountants using ABC might pass out a survey to production-line employees who will then account for the amount of time they spend on different tasks. The costs of these specific activities are only assigned to the goods or services that used the activity. This gives management a better idea of where exactly the time and money are being spent.

To illustrate this, assume a company produces both trinkets and widgets. The trinkets are very labor-intensive and require quite a bit of hands-on effort from the production staff. The production of widgets is automated, and it mostly consists of putting the raw material in a machine and waiting many hours for the finished good. It would not make sense to use machine hours to allocate overhead to both items because the trinkets hardly used any machine hours. Under ABC, the trinkets are assigned more overhead related to labor and the widgets are assigned more overhead related to machine use.

Lean Accounting

The main goal of lean accounting is to improve financial management practices within an organization. Lean accounting is an extension of the philosophy of lean manufacturing and production, which has the stated intention of minimizing waste while optimizing productivity. For example, if an accounting department is able to cut down on wasted time, employees can focus that saved time more productively on value-added tasks.

When using lean accounting, traditional costing methods are replaced by value-based pricing  and lean-focused performance measurements. Financial decision-making is based on the impact on the company's total value stream profitability. Value streams are the profit centers of a company, which is any branch or division that directly adds to its bottom-line profitability.

Marginal Costing

Marginal costing (sometimes called cost-volume-profit analysis ) is the impact on the cost of a product by adding one additional unit into production. It is useful for short-term economic decisions. Marginal costing can help management identify the impact of varying levels of costs and volume on operating profit. This type of analysis can be used by management to gain insight into potentially profitable new products, sales prices to establish for existing products, and the impact of marketing campaigns.

The  break-even point —which is the production level where total revenue for a product equals total expense—is calculated as the total fixed costs of a company divided by its contribution margin. The contribution margin , calculated as the sales revenue minus variable costs, can also be calculated on a per-unit basis in order to determine the extent to which a specific product contributes to the overall profit of the company.

History of Cost Accounting

Scholars believe that cost accounting was first developed during the  industrial revolution  when the emerging economics of industrial supply and demand forced manufacturers to start tracking their fixed and variable expenses in order to optimize their production processes.

Cost accounting allowed railroad and steel companies to control costs and become more efficient. By the beginning of the 20th century, cost accounting had become a widely covered topic in the literature on business management.

How Does Cost Accounting Differ From Traditional Accounting Methods?

In contrast to general accounting or financial accounting, the cost-accounting method is an internally focused, firm-specific system used to implement  cost controls . Cost accounting can be much more flexible and specific, particularly when it comes to the subdivision of costs and inventory valuation. Cost-accounting methods and techniques will vary from firm to firm and can become quite complex.

Why Is Cost Accounting Used?

Cost accounting is helpful because it can identify where a company is spending its money, how much it earns, and where money is being lost. Cost accounting aims to report, analyze, and lead to the improvement of internal cost controls and efficiency. Even though companies cannot use cost-accounting figures in their financial statements or for tax purposes, they are crucial for internal controls.

Which Types of Costs Go Into Cost Accounting?

These will vary from industry to industry and firm to firm, however certain cost categories will typically be included (some of which may overlap), such as direct costs, indirect costs, variable costs, fixed costs, and operating costs.

What Are Some Advantages of Cost Accounting?

Since cost-accounting methods are developed by and tailored to a specific firm, they are highly customizable and adaptable. Managers appreciate cost accounting because it can be adapted, tinkered with, and implemented according to the changing needs of the business. Unlike the  Financial Accounting Standards Board (FASB)-driven financial accounting, cost accounting need only concern itself with insider eyes and internal purposes. Management can analyze information based on criteria that it specifically values, which guides how prices are set, resources are distributed, capital is raised, and risks are assumed.

What Are Some Drawbacks of Cost Accounting?

Cost-accounting systems ,and the techniques that are used with them, can have a high start-up cost to develop and implement. Training accounting staff and managers on esoteric and often complex systems takes time and effort, and mistakes may be made early on. Higher-skilled  accountants  and  auditors  are likely to charge more for their services when evaluating a cost-accounting system than a standardized one like GAAP.

Cost accounting is an informal set of flexible tools that a company's managers can use to estimate how well the business is running. Cost accounting looks to assess the different costs of a business and how they impact operations, costs, efficiency, and profits. Individually assessing a company's cost structure allows management to improve the way it runs its business and therefore improve the value of the firm. These are meant to be internal metrics and figures only. Since they are not GAAP-compliant, cost accounting cannot be used for a company's audited financial statements released to the public.

Fleischman, Richard K., and Thomas N. Tyson. "The Economic History Review: Cost Accounting During the Industrial Revolution: The Present State of Historical Knowledge." Economic History Review , vol. 46, no. 3, 1993, pp. 503-517.

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  • Accounting Principles Explained: How They Work, GAAP, IFRS 10 of 51
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  • How Are Principles-Based and Rules-Based Accounting Different? 14 of 51
  • What Are Accounting Methods? Definition, Types, and Example 15 of 51
  • What Is Accrual Accounting, and How Does It Work? 16 of 51
  • Cash Accounting Definition, Example & Limitations 17 of 51
  • Accrual Accounting vs. Cash Basis Accounting: What's the Difference? 18 of 51
  • Financial Accounting Standards Board (FASB): Definition and How It Works 19 of 51
  • Generally Accepted Accounting Principles (GAAP): Definition, Standards and Rules 20 of 51
  • What Are International Financial Reporting Standards (IFRS)? 21 of 51
  • IFRS vs. GAAP: What's the Difference? 22 of 51
  • How Does US Accounting Differ From International Accounting? 23 of 51
  • Cash Flow Statement: What It Is and Examples 24 of 51
  • Breaking Down The Balance Sheet 25 of 51
  • Income Statement: How to Read and Use It 26 of 51
  • What Does an Accountant Do? 27 of 51
  • Financial Accounting Meaning, Principles, and Why It Matters 28 of 51
  • How Does Financial Accounting Help Decision-Making? 29 of 51
  • Corporate Finance Definition and Activities 30 of 51
  • How Financial Accounting Differs From Managerial Accounting 31 of 51
  • Cost Accounting: Definition and Types With Examples 32 of 51
  • Certified Public Accountant: What the CPA Credential Means 33 of 51
  • What Is a Chartered Accountant (CA) and What Do They Do? 34 of 51
  • Accountant vs. Financial Planner: What's the Difference? 35 of 51
  • Auditor: What It Is, 4 Types, and Qualifications 36 of 51
  • Audit: What It Means in Finance and Accounting, and 3 Main Types 37 of 51
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  • Chart of Accounts (COA) Definition, How It Works, and Example 40 of 51
  • What Is a Journal in Accounting, Investing, and Trading? 41 of 51
  • Double Entry: What It Means in Accounting and How It's Used 42 of 51
  • Debit: Definition and Relationship to Credit 43 of 51
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  • Closing Entry 45 of 51
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  • 6 Components of an Accounting Information System (AIS) 47 of 51
  • Inventory Accounting: Definition, How It Works, Advantages 48 of 51
  • Last In, First Out (LIFO): The Inventory Cost Method Explained 49 of 51
  • The FIFO Method: First In, First Out 50 of 51
  • Average Cost Method: Definition and Formula with Example 51 of 51

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