Join Earl Kay Stice for an in-depth discussion in this video What is accounting?, part of Accounting Foundations.
What is accounting and why does accounting exist? Those are the 2 questions of the ages. I'm sure you've thought about them for years. Let's find out what accounting is and why it exists. First, exactly how old is accounting? Well me tell you, it's old. Clay tokens have been found in Mesopotamia dating back to 7,000 years ago that are a primitive form of accounting. It was simple. A farmer would say, "Alright, "let's get some clay tokens to represent "how many sheep I have.
"And how much wheat I have. "And how many goats I have. "And a big black stone "to represent a cow or whatever. "We could keep track of our inventory "of farm produce with these simple tokens. "And we can compare what we got this year to what "we had last year so we can start to make some "simple decisions and some comparisons." Then somebody came up with the idea, rather than have these little rocks and stones, let's start making notations on clay tablets or with chalk on a wall. Is bookkeeping the earliest form of writing? I think so.
How crucial is accounting? Accounting, we see here, underlies all of modern civilization. So what exactly is accounting? Well first, it's quantitative. You knew this. It's numbers. I love numbers and so do you. Accounting is all about numbers. Second, accounting is financial in nature. That means money. Numbers about money. Our 2 favorite things right here, they're in accounting. Third, accounting is meant to be useful. Now there's a whole field of study in accounting theory.
And in another day in another place we could talk about accounting theory, but really the fundamental purpose of accounting is to be useful. It's a very practical field of study. Useful for what? That's the 4th aspect of accounting. Useful in making decisions. Accounting helps you use the past right now in the present to change the future. Accounting is quantitative. Numbers about money to help people, you and me, make better decisions. That's accounting.
There are 4 kinds of accounting, or I'll call them flavors of accounting. First, the most fundamental type of accounting is bookkeeping, just the routine gathering of the information, making sure that everything gets recorded. Because if it doesn't get recorded, we'll never know about it. So bookkeeping, gathering the information systematically. The second flavor of accounting is called financial accounting. This is reporting to people outside your organization. Summary reports, not the details, it's not people who are there everyday, but it's people who want to know how you're doing.
So give them a report of what economic resources you have. Did you make money last year? Did you lose money last year? Just summary reports to people outside who might be thinking of loaning you money. Or might be thinking of investing in your company. That's called financial accounting, reporting to outsiders. The 3rd flavor of accounting is managerial accounting. Those are the detailed, secret data that individuals use inside their organizations to make decisions, detailed decisions.
Should I raise my prices? Should I stop selling shirts and start selling shoes instead? Should I build my factory in Wyoming or should I build it in Alabama? Those detailed decisions that business people, and people running organizations make every day. And this is stuff that just they know. They don't reveal this to outsiders. It's secret information. That's called managerial accounting. And finally, the 4th kind of accounting, that some of you have an uncomfortable relationship with, is income taxes. The accounting that makes sure that you're in compliance with the law.
And that is the 4th flavor of accounting. Bookkeeping, financial accounting, managerial accounting, and income taxes. Those are the 4 flavors of accounting.
- What is accounting?
- Working with balance sheets and income statements
- Determining the costs of products
- Performing break-even analysis
- Determining average and marginal tax rates
- Understanding tax deductions and credits