The Goal of Accounting
Is there a goal in accounting?
What is the end we are trying to achieve with all these rules and principles?
Yes, there is a goal. The goal of accounting is communication. Income statements, balance sheets, cash flow statements etc., all communicate some information to the people who read them. This is essentially what accounting comes down to.
Accounting takes everyday business transactions, records them and presents them in a standard form.
Two parts of this sentence need some explanation.
‘business transactions’: A woman walks into a shoe shop, picks up a pair of shoes she likes, walks to the counter and hands over some money. The cashier takes the money, puts the shoes in a bag and gives her a receipt. Both smile and the happy shopper walks out the door. We’ve all done something like this before. But what we might not realise is that we have just been involved in a business transaction.
‘records them’: Whether it is a handwritten invoice, cash register or fancy computer. These are all ways in which businesses record transactions. In the above transaction the cashier, when he gives the woman her receipt, has added this event into the shops accounting system.
Now as you can imagine, transactions take place every day; a few times a day for six or seven days a week and fifty-two weeks a year. Also consider that other transactions are taking place during this time. The shop owners pays rent to the landlord, he pays staff that help him in the store, buys the shoes from the distributor etc. At the end of the month or year he has to give an account of his activities for that period.
Below is an example of what this account of activities may look like:
This is an income statement. You may have heard it called something else like ‘profit and loss statement’ or ‘statement of comprehensive income’. In essence this ‘statement’ given by the owners and/or managers of the business is meant to give us an idea of how their business has performed.
For example, we can see how many other expenses the shoe shop incurred in making these sales and how much profit the business made after expenses by looking at cost of sales.
Some other standard forms include the statement of changes in equity, balance sheets, as well as more summarised forms of income statements.
So, who uses this kind of information?
There are two categories of parties who are interested in seeing this information. Those outside the business, but who have an interest in how the business performs, and those inside the business who need to manage the business. Lets look at some examples.
Examples of those outside the business include SARS who wants to know how much profit the business has made so that they can collect their share of its earnings and/or Banks who may have loaned money to the business. They want to make sure that the business will be able to pay back the loan.
Other examples are shareholders (owners of businesses who are not involved in the day to day functions of the business), customers, suppliers and staff.
People inside the business also need to keep track of how the business is performing. Information about past sales, the cost of those sales, and other expenses incurred in producing that income can all be useful information to any business owner or manager when compared to performances in the past or budgeted/targeted results.
It’s interesting to note that all of these formal statements look exactly the same. If you took the name of the business off the page above, you wouldn’t really know what the business does by looking at these standard reports.
On the other hand, information for business management tends to be informal and varied. Examples include sales reports by customer, product or region. Production reports and costing reports. In fact managers and owners could put the information in pretty much any form that helps them to better run their business.
In the next section we will look at some basic accounting concepts and take a closer look at Trial Balances, Balance Sheets and Income Statements.