Accounting has become the most significant and basic function of any business operating in any industry, irrespective of business size. Either in-house or outsourced, every business and company needs an accountant to manage the financial data. But was accounting always there?
It’s a question for many. The answer is that accounting has always existed in one or another form. But let’s look at the history of what we called accounting today.
Accounting is said to have roots as old as around 300 BC when it was first time used in Iran. The theory was given after the discovery of tokens and accounting scripts in Iran. However, modern accounting is contributed to Italians.
In 1494, an Italian, Luca Pacioli, described the double-entry system of bookkeeping as used by Venetian merchants. Therefore, Pacioli can’t be contributed as an inventor of accounting, but he is considered the first person to elaborate on it.
Debits, credits, journals, and ledgers, are the basics of accounting, and Pacioli is the one to describe them. Afterward, accounting advanced and modified through different eras, from Scotland’s modernization of accounting to the industrial revolution in the mid-1800s.
From start to end, the primary functions of accounting remained the same with little or more changes. Therefore, we are going to explain the primary functions of accounting in this article. Let’s get into it without a further ado.
What Is Accounting?
Accounting can be defined as,
“the science of measuring, processing, and communicating the financial information of any entity.”
The American Institute of Certified Public Accountants(AICPA) defines accounting 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.”
From the definition of accounting, we can deduct the primary functions or historical functions of the accounting as:
- Recording of data
- Classifying financial transaction
- Summarizing data by preparation of financial statements
- And communication of data to stakeholders
However, we will explain each function in further detail in the coming sections.
Primary Functions Of Accounting
The primary functions of accounting can be subcategorized as historical functions and managerial functions. Historical functions describe the supervisory functions of accounting. Managerial functions explain the internal functions of accounting to ensure accountability and fairness.
The historical accounting functions are also called stewardship functions that imply purposes related to the supervision and management of the financial data. Here are the most common historical functions of accounting.
Recording, Classifying, and Summarizing Financial Transactions
The primary function of accounting starts from bookkeeping, which records all the financial transactions carried out in an entity during financial periods. Recording encompasses financial records related to purchases, sales, account receivables, payables, receipts, payments, etc.
The second function of accounting related to financial transactions is classification. The classification function is important for the application of debit and credit rules. It implies identifying and separating different transactions into categories like assets, liabilities, expenses, revenues, real, personal, etc.
Finally, the trial balance preparation is the third primary function of accounting. It’s also referred to as the summarizing process. All the values from the classification of accounts are drawn in a separate statement called trial balance.
Preparation Of Financial Statements
The scope of accounting in any business entity also covers the preparation of the financial statements. Any business entity has four major financial statements to provide a snapshot of an entity’s financial health, performance, profitability, operations, and cash flow.
The five statements prepared are the income statement, balance sheet, statement of cash flow, and the statement of change in equity. The income statement aims to depict a company’s financial performance and profitability over a financial period. The balance sheet summarizes the financial position of the business assets and liabilities in a given financial year.
Analysis of Financial Data
The accountants are also responsible for analyzing the financial data presented in the company’s financial statements. The purpose of analysis can vary from internal to external use, short-term to long-term planning, etc.
The most common financial data analysis is a ratio, vertical, and horizontal analysis. The financial data analysis also helps the company to deduct meaningful information like work efficiency, transparency, an asset to liability ratio, profitability, repayment capability, outstanding payments, etc.
Communication of Financial Information To Stakeholders
After recording and preparing financial statements, the communication of financial information to stakeholders is the most important stewardship function of accounting.
The stakeholders of a company include owners(shareholders), employees, investors, government, creditors, suppliers, etc. The information deducted from the financial statements is necessary for the stakeholders to make important decisions regarding carrying out business with the entity.
The managerial functions of accounting help the internal employees to make decisions to ensure the smooth functioning of the business. The managerial functions of accounting are as follows:
Financial Policy Controls and Financial Planning
Financial policy control and planning are all about decisions taken by the management regarding future activities and business course of action. The management uses the data derived from financial statements and analysis.
Financial policy control encompasses the procedures, policies, and means used by the management of an entity to monitor and control the allocation, usage, and direction of financial resources. Financial policy control serves as the basis of financial planning, encompassing resource management, measures to improve operational efficiency, and achieving strategic objectives.
Financial information and historical data of the company serve as a basis for budgeting for the future financial period. Budgeting is also an important primary function of accounting which is the process of designing, implementing, and operating budgets.
The budget covers the estimates of incomes and expenses expected to be carried out by a business in the future. The budget is prepared using the historical data presented in the financial statements.
Cost control is also a primary function of accounting that involves identifying and reducing business expenses to increase profits. Cost control is the next step of budgeting, and it helps in the maintenance and growing profitability of the business.
Prevent Errors and Frauds In Financial Data
The main purpose of accounting in any business entity is to present the true and fair view of the business activities in terms of financial data. However, it’s only possible if the data is free of errors and fraudulent embezzlements.
Therefore, one primary function of accounting professionals is to ensure that the bookkeeping staff and accounting staff are recording data and preparing financial statements that are free of any errors or frauds. The prevention of errors and frauds is ensured during the internal as well as an external audit of the financial information.
Functions of the accounting also include payroll management which encompasses calculating the wages of employees to disbursement of paychecks. Payroll management also includes employee benefits, allowances, and profit-sharing as per the policy of the company.
Taxes and Compliance
Any entity must pay income taxes and sales taxes for every tax year according to the rules of the country where the business is operational.
Therefore, compliance with the government laws and standards in the preparation and presentation of financial data is also a function of accounting. Conformation to the standards prescribed by IRS and SECP is also the duty of the company’s accounting staff.
Different Types of Accounting
The accounting functions described above can be categorized into different types of accounting. Let’s briefly explain the accounting functions.
Cost accounting is the branch of accounting that deals with costs of operations, cost control policies, and procedures. Cost accounting helps the company to appropriate the per-unit cost of goods manufactured or traded. It also serves to set the sale price of goods/services and make important strategic decisions regarding buying costs.
Financial accounting is generally related to the historical functions of accounting. It involves recording, summarizing, and reporting a business entity’s financial transactions during the financial period. Preparation and communication of the financial statements also come under financial accounting.
Managerial accounting can be described as identifying, measuring, analyzing, and interpreting accounting information. Managerial accounting is more of the internal financial processes of the company and financial statement analysis to take important strategic decisions.
Tax accounting is a branch of accounting that controls the accounting methods that are focused on taxes instead of public financial statements. Tax accounting is based on the laws and standards as defined by the Internal Revenue Code.
We have discussed that accounting is the art of recording, measuring, summarizing, classifying, and presenting the financial data and information of the company in financial statements and analysis. The primary functions of accounting also revolve around the definition of accounting. We can summarize the functions of accounting at two levels.
The first level is the recording function that is related to recording & summarizing transactions and economic events. The second level is complex and related to accounting data measurement and presentation under the procedures, measures, and principles described by accounting bodies.