Reading: Lesson 1 - Accounting Defined

The American Accounting Association—one of the accounting organizations discussed later in this Introduction—defines accounting as "the process of identifying, measuring, and communicating economic information to permit informed judgments and decisions by the users of the information". 1 This information is primarily financial—stated in money terms. Accounting, then, is a measurement and communication process used to report on the activities of profit-seeking business organizations and not-for-profit organizations. As a measurement and communication process for business, accounting supplies information that permits informed judgments and decisions by users of the data. 

The accounting process provides financial data for a broad range of individuals whose objectives in studying the data vary widely. Bank officials, for example, may study a company's financial statements to evaluate the company's ability to repay a loan. Prospective investors may compare accounting data from several companies to decide which company represents the best investment. Accounting also supplies management with significant financial data useful for decision making. Reliable information is necessary before decision makers can make a sound decision involving the allocation of scarce resources. Accounting information is valuable because decision makers can use it to evaluate the financial consequences of various alternatives. Accountants eliminate the need for a crystal ball to estimate the future. They can reduce uncertainty by using professional judgment to quantify the future financial impact of taking action or delaying action.

Although accounting information plays a significant role in reducing uncertainty within the organization, it also provides financial data for persons outside the company. This information tells how management has discharged its responsibility for protecting and managing the company's resources. Stockholders have the right to know how a company is managing its investments. In fulfilling this obligation, accountants prepare financial statements such as an income statement, a statement of retained earnings, a balance sheet, and a statement of cash flows. In addition, they prepare tax returns for federal and state governments, as well as fulfill other governmental filing requirements.

Accounting is often confused with bookkeeping. Bookkeeping is a mechanical process that records the routine economic activities of a business. Accounting includes bookkeeping but goes well beyond it in scope. Accountants analyze and interpret financial information, prepare financial statements, conduct audits, design accounting systems, prepare special business and financial studies, prepare forecasts and budgets, and provide tax services. Specifically the accounting process consists of the following groups of functions (see Exhibit 1 below):

• Accountants observe many events (or activities) and identify and measure in financial terms (dollars) those events considered evidence of economic activity. (Often, these three functions are collectively referred to as analyze.) The purchase and sale of goods and services are economic events. 
• Next, the economic events are recorded, classified into meaningful groups, and summarized. 
• Accountants report on economic events (or business activity) by preparing financial statements and special reports. Often accountants interpret these statements and reports for various groups such as management, investors, and creditors. Interpretation may involve determining how the business is performing compared to prior years and other similar businesses.