Accounting is the process of identifying, measuring, recording, and communicating financial information about an entity to interested parties. It emphasizes accuracy, transparency, and relevance to support management and control of resources.
The American Institute of Certified Public Accountants defines accounting as:
The art of recording, classification 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.
Objectives
- Know whether the business has earned an adequate profit.
- Know whether the financial position of the business is sound.
- Communicate financial information to users.
- Support decision-making and resource management.
- Attract investors.
- Fulfill statutory reporting requirements.
- Minimize errors and omissions in recording transactions.
- Track project expenditures.
For Engineers
Engineers must be familiar with accounting concepts to:
- Manage project budgets effectively.
- Estimate and control costs more accurately.
- Communicate more clearly with finance teams.
- Make informed investment decisions.
- Allocate resources efficiently.
Users of Accounting Information
Internal Users
Parties within the entity who use accounting information for day-to-day management and control.
- Owners / shareholders
Assess profitability, return on investment, and dividend potential. - Managers
Use it for budgeting, cost control, pricing, and performance evaluation. - Employees / trade unions
Judge job security, negotiate salaries, and evaluate retirement benefits.
External Users
Parties outside the entity who use accounting information to make decisions about their relationship with it.
- Investors
Base investment decisions on profitability and risk. - Creditors
Assess ability to repay loans before granting credit. - Suppliers
Assess ability to pay for goods and services on time. - Customers
Judge long-term stability for warranty and service purposes. - Government / tax authorities
Determine tax liability and regulatory compliance. - Regulatory authorities
Verify compliance with reporting standards and corporate governance. - Competitors
Benchmark financial performance and market position. - General public
Gauge economic contribution, employment, and environmental impact.
Branches
Financial Accounting
Recording business transactions to determine the operating result of a period and the financial position on a given date, as stewardship for the benefit of shareholders. Mandatory, audited externally, and looks only at the past.
- Outputs
Summary annual statement of profit or loss and other comprehensive income, statement of financial position, and statement of cash flow, from historical transactions, for a fixed period, usually the financial year (aka. fiscal year). - Users
Stakeholders, creditors, tax authorities, regulators. - Basis
Standards such as IFRS or GAAP, fixing format, terminology, and recognition rules, so an external user can compare 2 companies’ statements directly.
Cost Accounting
Collection, classification, and ascertainment of the cost of production, including tracking and controlling project costs, materials, and labor.
- Outputs
Cost sheets and cost reports, per product, job, or process, tracked continuously as production happens rather than tied to a fixed period. - Users
Production and operations managers. - Basis
Historical cost and predetermined standard cost, the latter used to spot variances against actual cost. Feeds cost data into management accounting for pricing and efficiency decisions.
Management Accounting
Uses financial and cost accounting data for policy formulation, planning, control, and decision-making by management, to improve the economy, efficiency, and effectiveness of operations. Looks at the past, present, and future.
- Outputs
Detailed monthly and annual accounts by product and function, plus adhoc reports, forward-looking, with no fixed reporting cycle. - Users
Management, at all levels of the organization. - Basis
Combines historical data with projections and estimates. Not governed by external reporting standards, so report format is chosen freely to fit the decision at hand.
Concepts
Business Entity Concept
The business is a distinct accounting entity, separate from its owners.
Examples:
- The owner’s personal car purchase is not recorded in the business’s books.
Money Measurement Concept
Only information expressible in monetary terms is recorded.
Examples:
- Employee skill and brand reputation are not recorded, since neither can be reliably expressed in money.
Historical Cost Concept
Assets are shown at cost, not current market value.
Examples:
- Land bought 10 years ago for $50,000 is still recorded at $50,000, even if its current market value is $200,000.
Periodic Concept
Income or loss is measured over a fixed accounting period, e.g. calendar year (1 Jan to 31 Dec) or financial year (1 April to 31 March).
A business actually runs continuously, with no natural stopping point. The periodic concept cuts that continuous life into artificial fixed-length slices so results can be reported and compared at regular intervals, instead of only once, when the business eventually winds up.
Examples:
- A company closes its books every 31 March and reports that year’s profit, regardless of projects still in progress.
Matching Concept
Expenses incurred in a period are matched with the revenue earned in that period.
An expense is recorded in the same period as the revenue it helped generate, not in whichever period the cash happens to move. This keeps a period’s profit figure meaningful: it reflects the cost of earning that period’s revenue, not just that period’s cash outflows.
Examples:
- Commission owed for a sale made in March is recorded as a March expense, even if paid out in April.
Materiality Concept
Information is material iff its misstatement could influence the economic decisions of users.
Materiality is a threshold, not a fixed amount. It depends on the size of the item relative to the business, so the same dollar figure can be material for a small company and immaterial for a large one. Below the threshold, strict accounting treatment is skipped in favor of the simplest treatment, since the extra precision would not change any user’s decision.
Examples:
- A $2 stationery purchase is expensed immediately instead of depreciated, since tracking it changes no decision.
Going Concern Concept
The business is assumed to continue operating for the foreseeable future.
Examples:
- Machinery is valued as a productive asset in use, not at its forced-sale liquidation price.
Consistency Concept
Accounting methods are applied uniformly across periods.
Examples:
- A company using straight-line depreciation continues with it every year, instead of switching methods to alter reported profit.
Accrual Concept
Accounts are prepared on an accrual basis by default, though some entities use cash basis.
Examples:
- A sale made in December is recorded as December revenue, even if cash is received in January.
Realization Concept
Revenue is realized when goods or services are actually delivered.
Prudence Concept
Assets or profits are not overstated, and losses are not understated.
Recognizing an already-certain obligation, such as salary payable or interest payable, applies the accrual concept rather than prudence, since prudence governs uncertain future losses, not obligations already fixed in amount.
Examples:
- Recognize provision for trade receivable impairment.
- Recognize stock losses.
- Recognize gratuity provision expenses.
