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Accounting is "the process of identifying, measuring and communicating economic information to permit informed judgement and decisions by users of the information." (AAA, 1966). A more detailed description comes from AICPA:
Accounting has a number of facets:
The information is usually quantiative, financial in nature, and is usually presented in the form of reports, which need to be tailored for the intended audience.
Accounting is used by both individuals and enterprises for planning, controlling and decision making. Enterprises also use accounting to present information about themselves to external users (financial accounting). Financial accounting is for everyone (including external users), whilst managerial accounting is specificially for internal users only, usually management. External users can be grouped into:
| annual report | balance sheet, income statement (profit and loss statement), cashflow statement, misc. extras |
| enterprise | any organisation involved in commercial dealings |
| entity | any individual or body, company or business, group, etc. |
| external users | users outside an entity eg, tax, shareholders, creditors, special-interest groups |
| financial accounting | information for external users (eg. annual report) |
| internal users | users inside an entity (eg. management, owner, partners) |
| management accounting | information for internal users |
| qualitative | an opinion or value judgement, eg. "this is a good idea" |
| quantitive | real-world, factual information, eg. 1+1 |
| scarce resources | any resources where supply is limited, or obtained at a price |
| users | any entity that uses accounting information |
| asset | an item that has likely and measurable service potential or future economic benefit (SPFEB), controlled by the entity as a result of past transactions or events (AARF, 1995) |
| liability | likely and measurable future sacrifices of SPFEB than an entity is obliged to make as a result of past transactions or events (AARF, 1995) |
| expense | likely and measurable consumption or loss of SPFEB in terms of decreased assets/increased liability, not including owner's withdrawals (AARF, 1995) |
| revenue | likely and measurable increase in inflow/reduction of outflows of SPFEB in terms of increased assets/decreased liability, not including owner's contributions (AARF, 1995) |
| equity | what's left after assets minus liabilities (the definition is dependent on the definition of assets/liabilities) |
| operating cycle | go-to-woe; from raw materials to finished product |
| realisation period | length between production of financial reports - usually 12 months |
| wealth | what a business controls vs. what it owes; A vs. L+E |
| income | profit |
| profit | difference in wealth at the start and end of a period (performance) |
| liquidity | the ease with which an asset can be converted to cash |
| current asset | an asset that in the normal course of business would be consumed or converted to cash within 12 months after the end of the period |
| non-current asset | an asset that isn't current |
| current liability | a liability which in the normal course of business would fall due within 12 months of the end of the period |
| non-current liability | a liability which isn't current |
| original cost | the cost of the item to the entity at the time of the transaction |
| historic cost | original cost; not useful if time has passed |
| replacement cost | the cost of the item should it be purchased at today's prices; not useful if the item is not to be replaced |
| net realisable value | estimated proceeds of sale minus all further costs of sale |
| residual value | estimated value of an asset at the end of its useful life |
| written-down value | net book value: the value of an asset after depreciation |
| capital expenditure | adds value to an asset |
| revenue expenditure | affects only the current period (eg. repair of storm damage) |
| debtors | accounts receivable: entities who owe through provision of goods and services on credit |
| creditors | accounts payable: entities who are owed through provision of goods and services on credit |
| bad debts | unpaid accounts. PFDD (contra). % of credit sales (PL) or age of accounts (BS). |
| prepayments | payments in advance; where there is unused SPFEB in an expense paid upfront. |
| accruals | payments owed, where the amount is not known, eg, phone, energy bill. |
| depreciation | the allocation of a portion of the cost of an asset, as an expense, against the value of an asset, over the life of the asset as it is used. That is, as the SPFEB of an asset is consumed, the value of the SPFEB is deducted from the value of the asset. This permits reflection of a loss in value of an asset due to time, wear and tear, technological advances etc. Depreciation must be systematic, consistent and rational. Depreciation requires estimates of the useful life of the asset, the residual value of the asset, and the historical cost of the asset. Depreciation can be straight-line or reducing balance. straight-line = (cost-residual)/useful life; reducing balance = 1-(useful life root (residual/cost)). Straight-line assumes that the asset will be equally useful throughout its life; reducing assumes that the asset will be most useful when it is new. Straight-line is best for time-based things such as buildings, while reducing is best for output-based things like car engines. |
| fixed costs | costs that remain constant irrespective of output. eg rent |
| variable costs | costs that vary according to output, eg raw materials |
| total cost | fixed costs + variable costs |
| cost-volume-profit analysis | use of the CVP equation to assess financial position. CVP equation: Sx=VCx+FC+P where S=sales, VC=variable costs, FC=fixed costs, P=profit and x=units of output. |
| break-even point | where sales revenue cancels costs. Where P=0. |
| contribution margin | contribution per unit: (sale price/unit)-(variable cost/unit) or (S-VC)x Since Cx=FC+P (because the contribution margin eliminates cost and creates profit), the margin can be used to calculate breakeven from FC and C data. P is 0 (since we are at breakeven) thus Cx=FC, thus x=FC/C. |
| auditing | a process by which entities have their financial statements analysed by an external third party. The analysis is accompanied by an opinion from the auditor, and both serve to add credibility to the financial statements and the entity as a whole; users expect the audit to give them a 'true and fair' picture of the financial position of the entity. Corporations Law requires all companies, barring exempt proprietary companies, to undertake an audit, however, many entities outside the corporate sphere, such as clubs and societies, also undertake an audit, either through alternate legislation or voluntarily. Auditors use industry standards, such as those issued by the PSASB, ratio analysis (eg debt:equity), statistical methods, comparisons with previous audits and the 'rule of thumb' to arrive at their conclusions. An expectation gap arises where the users of financial reports, hence the users of audits, expect additional information or reliability from the audit. The gap is damaging because it undermines confidence in the audit process and consequently reduces its effectiveness. |
| financial risk | the difference between debt finance, such as loans, and equity finance, such as owner contributions. The difference between interest repayments and interest earnings is leverage, and can be used as a method of expansion. Financial risk can be generally thought of as the degree of likelihood of a safe return of investment. |
| business risk | the degree of likelihood of an entity being able to survive in its marketplace. It takes into account the size and nature of the business, the diversity of the product line, the susceptibility of the product line to technological change, and the vulnerability to competition. Business risk also considers the social, political and economic environment within which the business operates. |