2015-08-21
637
In order to provide useful financial information about a business enterprise, we need some means of keeping track of the daily business activities and then summarizing the results in accounting reports. The method used by a business to keep records of its financial activities and to summarize these activities in periodic accounting reports comprise the accounting system.
The first function of an accounting system is to create a systematic record of the daily business activity, in terms of money. For example goods and services are purchased and sold, credit is extended to customers, debts are incurred, and cash is received and paid out. These transactions are typical of business events which can be expressed in monetary terms, and must be entered in accounting records. The mere expression of an intend to buy goods or services in the future does not represent a transaction. The term transaction refers to a completed action rather than to an expected or possible future action.
Of course, not all business events can be measured and described in monetary terms. Therefore we do not show in the accounting records the appointment of a new chief executive, the signing of a labour contract or the appearance of a new competing business on the scene.
In addition to compiling a narrative record of events as they occur, we classify transactions and events into related groups or categories. Classification enables us to reduce a mass of detail into compact and usable form. For example, grouping all transactions in which cash is received or paid out is a logical step in developing useful information about the cash position of a business enterprise.
To organize the accounting information in a useful form, we summarize the classified information into accounting reports designed to meet the information needs of business decision makers.
These three steps we have described – recording, classifying, and summarizing – are the means of creating accounting information. It is important, however, to recognize that the accounting process is not limited to the function of creating information. It also involves communicating this information to interested parties and interpreting accounting information as it relates to specific business decisions. For example, you may want to compare the financial statements of Company A with those of Company B to determine which company is the more profitable – which is financially stronger – and which offers the better chance of future success. You can benefit personally by making this kind of analysis of a company you are considering to work for or invest in.
