What is Accounting? – in a simple words

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This entry is part 1 of 3 in the series Introduction to Accounting

AccountingAccounting is the art of recording, classifying and summarizing in a significant manner and in the terms of money, transactions and events which are, in part at least, of a financial character and interpreting the result thereof.

The above definition is stated by the American Institute of Certified Public Accountants in 1961.

Every individual performs some kind of economic activity. Business runs for profit making. Non-profit groups like sports club, services provided local authorities and Government bodies for social benefits. A salaried person earning salary and spending the same over his / her home expenses, investments etc. Any way, such activities are performed through ‘transactions and events‘. Transaction is a performance of act while an event is a happening as a result of transaction (s).

Meaning through an example:

Mr. John runs a grocery shop. During January month, he purchased goods for $5,000 and sells for $7,000. He still have goods worth $500 in stock at the month-end. He pays shop rent of $500 per month.

Let’s understand about the economic activities in the terms of transactions and events. We will put January month’s incoming, outgoing and remaining in simple table as below:

Amount ($)
Goods Sold          7,000
Add: Goods in hand / remaining stock             500
         7,500
Less: Goods purchased          5,000
Less: Shop rent paid             500
         5,500
Surplus          2,000

 

Surplus of $2,000 and goods in hand of $500 are the events. These events are the result of transactions like purchase and sale of goods, payment of rent. Is it not logical that Mr. John will want to know the result of his activities? – It is!

Accounting discipline serves the purpose of keeping the records of all the transactions and events and to have adequate information as an aid to decision making.

Accounting is a process of identifying, measuring and communicating economic information to permit informed judgments and decision by the users of accounts.” – a definition by the American Accounting Association in 1966 is one of the widely accepted and is applicable in the present-day.

in current world, user of accounts is not restricted only to the owner of the business but also extended to creditors, customers, investors, employees and government. These users need data for the judgement and decisions.

Based upon Debit and Credit method of recording, accounting further evolves with an equation:

Assets = Liabilities + Shareholder Equity

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