Accounting can be broadly divided into two categories: financial accounting and management accounting.
Financial Accounting: Financial accounting is a particular field of accounting that addresses the needs of decision makers outside a company or organization. These decision makers may include credit and equity investors, suppliers, lenders, government agencies and regulatory bodies, special interest groups, labor unions, consumer groups and the general public.
Financial accounting tends to be driven by rules, issued by the Securities and Exchange Commission (SEC), the Financial Accounting Standards Board (FASB) and the International Accounting Standards Committee (IASC).
The objectives of financial reporting are to provide information that is:
(1) Useful to those making investment and credit decisions who have a reasonable understanding of business and economic activities;
(2) Helpful to present and potential investors and creditors and other users in assessing the amount, timing and uncertainty of future cash flows; and
(3) About economic resources, the claims to those resources and the changes in them.
While these objectives are aimed at satisfying the equity and credit investors (whom the FASB considers to be the primary users of financial statements), they are likely to be useful to all other user groups.
Different financial statement users have both coinciding and conflicting needs for the various statements. In general, equity investors are concerned with a company's long-term earnings and growth, as well as its ability to offer returns via dividends and stock price appreciation. Equity investors bear the company's largest and most volatile risk, and thus require comprehensive analyses that offer the highest level of scrutiny. On the other hand, credit investors, such as banks and other lenders, place more specific emphasis on the company's ability to assure the repayment of their investment (via interest payments and the return of principal at maturity).
The financial accounting process culminates in the preparation of financial reports relative to the enterprise as a whole that help answer the following questions about a firm's financial success: What is the financial position of the firm on a given day? How well did the firm do during a given period?
To answer these questions, and to satisfy the fiduciary reporting responsibility of management, accountants prepare a single set of general-purpose financial statements that are expected to fairly, clearly, and completely present the economic facts of the operations of the enterprise. In preparing financial statements, accountants are confronted with the potential dangers of bias, misinterpretation, inexactness and ambiguity.
The four primary financial statements are the Balance Sheet, Income Statement, Statement of Retained Earnings and Statement of Cash Flows. (See p. 19 for an explanation of these statements.)
Management Accounting: As opposed to financial accounting, management accounting serves internal management decision makers at a company or organization. Examples of these managers would include top executives at corporations, college deans and hospital administrators.
Management accounting involves the identification, measurement, accumulation, analysis, preparation, and communication of financial information that is then used by managers to plot strategy and make decisions.
Management accountants may make recommendations on business strategy, resource allocation, cost efficiencies and operations to improve financial performance. The Chief Financial Officer (CFO) position can be considered the highest management accounting position.
A History of Accounting
As old as civilization itself
Accounting is nearly as old as civilization itself. Early accounting practitioners played pivotal roles in the development of writing (the first known instances of writing are inventory records in the Near East) and the creation of money and banking systems. By making business more efficient (and thus freeing up more capital for the endowment of the arts), accounting also played a pivotal role in the flourishing of the Italian Renaissance.
Accounting was firmly established as a distinct profession in 19th century Great Britain during the Industrial Revolution. The rapid rise of manufacturing innovation increased entrepreneurs' concerns over operating costs, leading to the development of rudimentary cost accounting systems. With bankruptcy rates high, such systems helped firms identify and reduce costs and more quickly respond to economic downturns. The advancements also necessitated an increase in formal business regulation and taxation, setting the stage for the establishment of the first professional accounting firms in London by William Deloitte (1845), Samuel Price and Edwin Waterhouse (1849), William Cooper (1854), William Peat (1867), and George Touch. These firms soon established offices in America after the turn of the century (along with the Ernst brothers, Charles Haskins, William Lybrand, Adam and Edward Ross, Elijah Sells, Arthur Young and Arthur Andersen) to oversee investments in America's growing industries. (These early firms still exist as what are called the "Big Four" accounting firms.)
Accounting in the U.S.
Before 1900, the U.S. economy required a relatively unsophisticated type of accounting function; the accounting profession per se was virtually nonexistent. In the 1800s and before, single ownership was the dominant form of business organization in the U.S. Accounting reports for these businesses emphasized solvency and liquidity and were limited to internal use and scrutiny by banks and other lending institutions. Audits were a minor aspect of an accountant's practice; when they were performed, they were viewed as a way to make managers and directors accountable to absentee stockholders for the stewardship of assets.
From 1900 to 1929, the growth of large corporations and the increasing investment and speculation in the stocks of these corporations created the phenomenon of absentee ownership - businesses were owned in large part by outside investors, as opposed to families who directly managed and owned businesses. This in turn created a demand for greater disclosure and a change from the concern with solvency to a concern with income-producing ability. A constitutional amendment in 1913 authorizing the federal government to impose an income tax on businesses and individuals intensified the emphasis on income measurement. As a result of the stock market crash of 1929, the Great Depression and widespread dissatisfaction with the integrity and completeness of available accounting reports, the federal government, the stock exchanges and the accounting profession all made efforts to improve accounting. Since that time, the environmental influences on the development of accounting principles have been primarily institutional or organizational.
Government regulation
The Great Depression, which resulted in the widespread collapse of businesses and the securities market, was the impetus for government intervention and regulation of business. This intervention involved a good deal of attention to financial statements and accounting standards. A direct result was the creation of the Securities and Exchange Commission (SEC) as an independent regulatory agency of the U.S. government to administer the Securities Act of 1933, the Securities Exchange Act of 1934 and several other related pieces of legislation. Companies that issue securities to the public or are listed on stock exchanges are required to file annual audited financial statements with the SEC. In addition, the SEC was given broad powers to prescribe, in whatever detail it desires, the accounting practices and standards to be employed by companies that fall within its jurisdiction.
Until the 1960s, the SEC acted with remarkable restraint in the area of developing accounting standards. Generally, it relied on a trade organization called the American Institute of Certified Public Accountants (AICPA) to regulate the accounting profession and develop and enforce accounting standards. However, during the era of the beleaguered Accounting Principles Board (from 1959 to 1973), the SEC took a more active interest in the development of accounting standards, pressing for quicker action, specific announcements and eventually for the demise of the APB (after which the Financial Accounting Standards Board was established). Now, the FASB establishes the pronouncement of a common set of standards and procedures called Generally Accepted Accounting Principles (GAAP).
Today, the SEC interacts with the FASB as both a supporter and a prodder. Because it confronts the financial accounting and reporting practices of U.S. businesses, the SEC frequently identifies emerging problems for the FASB to address.