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 Home > By Career > Banking and Finance > Accounting
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Accountancy is the process of communicating financial information about a business
entity to users such as shareholders and managers. The communication is generally
in the form of financial statements that show in money terms the economic resources
under the control of management; the art lies in selecting the information that
is relevant to the user and is reliable.[2] The principles of accountancy are applied
to business entities in three divisions of practical art, named accounting, bookkeeping,
and auditing.
Accountancy is defined by the Oxford English Dictionary (OED) as "the profession
or duties of an accountant".
Accounting is defined by the American Institute of Certified Public Accountants
(AICPA) as "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 financial character, and interpreting the results thereof."
Accounting is thousands of years old; the earliest accounting records, which date
back more than 7,000 years, were found in Mesopotamia (Assyrians). The people of
that time relied on primitive accounting methods to record the growth of crops and
herds. Accounting evolved, improving over the years and advancing as business advanced.
Early accounts served mainly to assist the memory of the businessperson and the
audience for the account was the proprietor or record keeper alone. Cruder forms
of accounting were inadequate for the problems created by a business entity involving
multiple investors, so double-entry bookkeeping first emerged in northern Italy
in the 14th century, where trading ventures began to require more capital than a
single individual was able to invest. The development of joint stock companies created
wider audiences for accounts, as investors without firsthand knowledge of their
operations relied on accounts to provide the requisite information. This development
resulted in a split of accounting systems for internal (i.e. management accounting)
and external (i.e. financial accounting) purposes, and subsequently also in accounting
and disclosure regulations and a growing need for independent attestation of external
accounts by auditors.
Today, accounting is called "the language of business" because it is the vehicle
for reporting financial information about a business entity to many different groups
of people. Accounting that concentrates on reporting to people inside the business
entity is called management accounting and is used to provide information to employees,
managers, owner-managers and auditors. Management accounting is concerned primarily
with providing a basis for making management or operating decisions. Accounting
that provides information to people outside the business entity is called financial
accounting and provides information to present and potential shareholders, creditors
such as banks or vendors, financial analysts, economists, and government agencies.
Because these users have different needs, the presentation of financial accounts
is very structured and subject to many more rules than management accounting. The
body of rules that governs financial accounting in a given jurisdiction is called
Generally Accepted Accounting Principles, or GAAP. Other rules include International
Financial Reporting Standards, or IFRS[8], or US GAAP.
Theory
The basic accounting equation is assets = liabilities + stockholders' equity. This
is the balance sheet. The foundation for the balance sheet begins with the income
statement, which is revenues - expenses = net income or net loss. This is followed
by the retained earnings statement, which is beginning retained earnings + net income
- dividends = ending retained earnings or beginning retained earnings - net loss
- dividends = ending retained earnings. The current ratio is current assets divided
by current liabilities. The debt to total assets ratio is total assets divided by
total liabilities.
Etymology
The word "Accountant" is derived from the French word Compter, which took its origin
from the Latin word Computare. The word was formerly written in English as "Accomptant",
but in process of time the word, which was always pronounced by dropping the "p",
became gradually changed both in pronunciation and in orthography to its present
form (see also comptroller).
History
Token accounting in ancient Mesopotamia
The earliest accounting records were found amongst the ruins of ancient Babylon,
Assyria and Sumeria, which date back more than 7,000 years. The people of that time
relied on primitive accounting methods to record the growth of crops and herds.
Because there is a natural season to farming and herding, it is easy to count and
determine if a surplus had been gained after the crops had been harvested or the
young animals weaned.
Early Accounting in India
Early references to accounting concepts are found in the Vedas: Vikraya is found
in the Atharvaveda and the Nirukta denoting ‘sale’. Sulka in the Rig veda clearly
means ‘price’. In the Dharma Sutras it denotes a ‘tax’.
Accounting in the Roman Empire
The Res Gestae Divi Augusti (Latin: "The Deeds of the Divine Augustus") is a remarkable
account to the Roman people of the Emperor Augustus' stewardship. It listed and
quantified his public expenditure, which encompassed distributions to the people,
grants of land or money to army veterans, subsidies to the aerarium (treasury),
building of temples, religious offerings, and expenditures on theatrical shows and
gladiatorial games. It was not an account of state revenue and expenditure, but
was designed to demonstrate Augustus' munificence. The significance of the Res Gestae
Divi Augusti from an accounting perspective lies in the fact that it illustrates
that the executive authority had access to detailed financial information, covering
a period of some forty years, which was still retrievable after the event. The scope
of the accounting information at the emperor's disposal suggests that its purpose
encompassed planning and decision-making.
The Roman historians Suetonius and Cassius Dio record that in 23 BC, Augustus prepared
a rationarium (account) which listed public revenues, the amounts of cash in the
aerarium (treasury), in the provincial fisci (tax officials), and in the hands of
the publicani (public contractors); and that it included the names of the freedmen
and slaves from whom a detailed account could be obtained. The closeness of this
information to the executive authority of the emperor is attested by Tacitus' statement
that it was written out by Augustus himself. Roman writing tablet from the Vindolanda
Roman fort of Hadrian's Wall, in Northumberland (1st-2nd century AD) requesting
money to buy 5,000 measures of cereal used for brewing beer. Department of Prehistory
and Europe, British Museum. Records of cash, commodities, and transactions were
kept scrupulously by military personnel of the Roman army. An account of small cash
sums received over a few days at the fort of Vindolanda circa 110 CE shows that
the fort could compute revenues in cash on a daily basis, perhaps from sales of
surplus supplies or goods manufactured in the camp, items dispensed to slaves such
as cervesa (beer) and clavi caligares (nails for boots), as well as commodities
bought by individual soldiers. The basic needs of the fort were met by a mixture
of direct production, purchase and requisition; in one letter, a request for money
to buy 5,000 modii (measures) of braces (a cereal used in brewing) shows that the
fort bought provisions for a considerable number of people.
The Heroninos Archive is the name given to a huge collection of papyrus documents,
mostly letters, but also including a fair number of accounts, which come from Roman
Egypt in 3rd century CE. The bulk of the documents relate to the running of a large,
private estate is named after Heroninos because he was phrontistes (Koine Greek:
manager) of the estate which had a complex and standarised system of accounting
which was followed by all its local farm managers. Each administrator on each sub-division
of the estate drew up his own little accounts, for the day-to-day running of the
estate, payment of the workforce, production of crops, the sale of produce, the
use of animals, and general expenditure on the staff. This information was then
summarized as pieces of papyrus scroll into one big yearly account for each particular
sub—division of the estate. Entries were arranged by sector, with cash expenses
and gains extrapolated from all the different sectors. Accounts of this kind gave
the owner the opportunity to take better economic decisions because the information
was purposefully selected and arranged.
Simple accounting is mentioned in the Christian Bible (New Testament) in the Book
of Matthew, in the Parable of the Talents.
Islamic accounting and algebra
In the Qur’an, the word "account" (Arabic: hesab) is used in its generic sense,
relating to one's obligation to account to God on all matters pertaining to human
endeavour. According to the Qur’an, followers are required to keep records of their
indebtedness (Sura 2, ayah 282), thus Islam provides general approval and guidelines
for the recording and reporting of transactions.
The Islamic law of inheritance (Sura 4, ayah 11) defines exactly how the estate
is calculated after death of an individual. The power of testamentary disposition
is basically limited to one-third of the net estate (i.e. the assets remaining after
the payment of funeral expenses and debts), providing for every member of the family
by allotting fixed shares not only to wives and children, but also to fathers and
mothers. The complexity of this law served as an impetus behind the development
of algebra (Arabic: al-jabr) by the Persian mathematician Muhammad ibn Mūsā al-Khwārizmī
and other medieval Islamic mathematicians. Khwārizmī's "The Compendious Book on
Calculation by Completion and Balancing" (Arabic: Hisab al-jabr w’al-muqabala, Baghdad,
c. 825) devoted a chapter on the solution to the Islamic law of inheritance using
linear equations.In the 12th century, Latin translations of al-Khwārizmī's "Book
of Addition and Subtraction According to the Hindu Calculation" (Arabic:Kitāb al-Jamʿ
wa-l-tafrīq bi-ḥisāb al-Hind) on the use of Indian numerals, introduced the decimal
positional number system to the Western world. The development of mathematics and
accounting was intertwined during the Renaissance. Mathematics was in the midst
of a period of significant development in the late 15th century. Hindu-Arabic numerals
and algebra were introduced to Europe from Arab mathematics at the end of the 10th
century by the Benedictine monk Gerbert of Aurillac, but it was only after Leonardo
Pisano (also known as Fibonacci) put commercial arithmetic, Hindu-Arabic numerals,
and the rules of algebra together in his Liber Abaci in 1202 that Hindu-Arabic numerals
became widely used in Italy.
Luca Pacioli and double-entry bookkeeping
Bartering was the dominant practice for traveling merchants during the Middle Ages.
When medieval Europe moved to a monetary economy in the 13th century, sedentary
merchants depended on bookkeeping to oversee multiple simultaneous transactions
financed by bank loans. One important breakthrough took place around that time:
the introduction of double-entry bookkeeping, which is defined as any bookkeeping
system in which there was a debit and credit entry for each transaction, or for
which the majority of transactions were intended to be of this form. The historical
origin of the use of the words ‘debit’ and ‘credit’ in accounting goes back to the
days of single-entry bookkeeping in which the chief objective was to keep track
of amounts owed by customers (debtors) and amounts owed to creditors. ‘Debit,’ is
Latin for ‘he owes’ and ‘credit’ Latin for ‘he trusts’.
The earliest extant evidence of full double-entry bookkeeping is the Farolfi ledger
of 1299-1300. Giovanno Farolfi & Company were a firm of Florentine merchants whose
head office was in Nîmes who also acted as moneylenders to the Archbishop of Arles,
their most important customer. The oldest discovered record of a complete double-entry
system is the Messari (Italian: Treasurer's) accounts of the city of Genoa in 1340.
The Messari accounts contain debits and credits journalised in a bilateral form,
and contains balances carried forward from the preceding year, and therefore enjoy
general recognition as a double-entry system.
Luca Pacioli's "Summa de Arithmetica, Geometria, Proportioni et Proportionalità"
(Italian: "Review of Arithmetic, Geometry, Ratio and Proportion") was first printed
and published in Venice in 1494. It included a 27-page treatise on bookkeeping,
"Particularis de Computis et Scripturis" (Italian: "Details of Calculation and Recording").
It was written primarily for, and sold mainly to, merchants who used the book as
a reference text, as a source of pleasure from the mathematical puzzles it contained,
and to aid the education of their sons. It represents the first known printed treatise
on bookkeeping; and it is widely believed to be the forerunner of modern bookkeeping
practice. In Summa Arithmetica, Pacioli introduced symbols for plus and minus for
the first time in a printed book, symbols that became standard notation in Italian
Renaissance mathematics. Summa Arithmetica was also the first known book printed
in Italy to contain algebra.
Although Luca Pacioli did not invent double-entry bookkeeping, his 27-page treatise
on bookkeeping contained the first known published work on that topic, and is said
to have laid the foundation for double-entry bookkeeping as it is practiced today.[31]
Even though Pacioli's treatise exhibits almost no originality, it is generally considered
as an important work, mainly because of its wide circulation, it was written in
the vernacular Italian language, and it was a printed book. According to Pacioli,
accounting is an ad hoc ordering system devised by the merchant. Its regular use
provides the merchant with continued information about his business, and allows
him to evaluate how things are going and to act accordingly. Pacioli recommends
the Venetian method of double-entry bookkeeping above all others. Three major books
of account are at the direct basis of this system: the memoriale (Italian: memorandum),
the giornale (Journal), and the quaderno (ledger). The ledger is considered as the
central one and is accompanied by an alphabetical index.
Pacioli's treatise gave instructions in how to record barter transactions and transactions
in a variety of currencies – both being far more commonplace than they are today.
It also enabled merchants to audit their own books and to ensure that the entries
in the accounting records made by their bookkeepers complied with the method he
described. Without such a system, all merchants who did not maintain their own records
were at greater risk of theft by their employees and agents: it is not by accident
that the first and last items described in his treatise concern maintenance of an
accurate inventory.
The nature of double-entry can be grasped by recognizing that this system of bookkeeping
did not simply record the things merchants traded so that they could keep track
of assets or calculate profits and losses; instead as a system of writing, double-entry
produced effects that exceeded transcription and calculation. One of its social
effects was to proclaim the honesty of merchants as a group; one of its epistemological
effects was to make its formal precision based on a rule bound system of arithmetic
seem to guarantee the accuracy of the details it recorded. Even though the information
recorded in the books of account was not necessarily accurate, the combination of
the double entry system's precision and the normalizing effect that precision tended
to create, produced the impression that books of account were not only precise,
but accurate as well. Instead of gaining prestige from numbers, double entry bookkeeping
helped confer cultural authority on numbers.
Double entry accounting means that each transaction requires the use of at least
two accounts.
Accounting in the internet era
In the IETF RFCs the act of accounting is usually defined as the act of collecting
information on resource usage for the purpose of trend analysis, auditing, billing,
or cost allocation.
For example when a user uses a connectivity service paid with a pay-per-view approach
the accounting process is based on a metering of the resource usage by the user
(usually time spent with an active connection or the amount of data tranferred using
that connection). The accounting is hence the recording of this connectivity service
consumption for subsequent charging of the service itself.
Accounting scandals
The year 2001 witnessed a series of financial information frauds involving Enron
Corporation, auditing firm Arthur Andersen, the telecommunications company WorldCom,
Qwest and Sunbeam, among other well-known corporations. These problems highlighted
the need to review the effectiveness of accounting standards, auditing regulations
and corporate governance principles. In some cases, management manipulated the figures
shown in financial reports to indicate a better economic performance. In others,
tax and regulatory incentives encouraged over-leveraging of companies and decisions
to bear extraordinary and unjustified risk.
The Enron scandal deeply influenced the development of new regulations to improve
the reliability of financial reporting, and increased public awareness about the
importance of having accounting standards that show the financial reality of companies
and the objectivity and independence of auditing firms.
In addition to being the largest bankruptcy reorganization in American history,
the Enron scandal undoubtedly is the biggest audit failure.The scandal caused the
dissolution of Arthur Andersen, which at the time was one of the five largest accounting
firms in the world. It involved a financial scandal of Enron Corporation and their
auditors Arthur Andersen, which was revealed in late 2001. After a series of revelations
involving irregular accounting procedures conducted throughout the 1990s, Enron
filed for Chapter 11 bankruptcy protection in December 2001.
One consequence of these events was the passage of Sarbanes-Oxley Act in 2002, as
a result of the first admissions of fraudulent behavior made by Enron. The act significantly
raises criminal penalties for securities fraud, for destroying, altering or fabricating
records in federal investigations or any scheme or attempt to defraud shareholders.
Another example of corporate fraud was the case of Australian telecommunications
company One-tel. The financial manager, Jodee Rich was subsequently charged with
fraud and spent several years in jail after fraudulently stating the companies financial
position, to encourage investment by some of Australia's richest people including
James Packer and Lachlan Murdoch.[40]When it collapsed in 2001, One-tel lost its
shareholders in excess of 920 million dollars.
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