What is accounting?

Based on data from hundreds or even thousands of financial transactions, important conclusions can be drawn based on a detailed understanding of a business’s operations and overall financial position.

The key functions of accounting include:

1. Recording (bookkeeping) – the initial stage that is often confused with accounting itself. Bookkeeping involves the recording of financial transactions such as purchases and expenses in an accounting system.
2. Classifying – transactions are then categorised into different accounts such as assets, liabilities and revenue.
3. Summarising – where data is summarised into financial statements. Typical examples include a balance sheet, cash flow statement and income statement.
4. Analysing and interpreting – where accounting professionals summarise the data to interpret financial performance and identify any trends. This analysis helps inform decisions around budgeting, forecasting and strategy.
5. Reporting – a key function of accounting where the results of the financial analyses are communicated to key stakeholders such as investors, management, shareholders and regulatory bodies.

The 5 types of accounting

Note that accounting is not a one-size-fits-all discipline. Five core types suit a variety of purposes, audiences and business needs, and each plays a specific role in the financial ecosystem.

1 – Financial accounting

Financial accounting is the most well-known accounting type and is focused on the creation (and presentation) of financial statements for key stakeholders.

The primary objective of financial accounting is to provide a clear and accurate picture of the financial health and performance of the business over a specific period (typically a financial year).

2 – Managerial accounting

Managerial accounting is similar to financial accounting but with one key difference. While financial accounting caters to the needs of external stakeholders, managerial accounting is designed for internal use by an organisation’s management team.

Specifically, the team may use the reports created by managerial accounting to assist with decision-making, planning and operational strategy.

3 – Cost accounting

Cost accounting is a subset of management accounting that captures and analyses all costs associated with business tasks and processes.

To that end, cost accounting considers three main elements:

1. Material costs – inputs to production that are further broken down into direct materials (such as raw materials) and indirect materials. These comprise any items that are not integrated into the final product.
2. Labour – this includes employee salaries and wages, and
3. Expenses/overheads – costs that cannot be directly attributed to the production of goods and services, such as utility bills and superannuation contributions.

Manufacturing businesses rely on this type of accounting to ensure costs remain competitive. However, it is also commonly used by law firms, medical services businesses and retail companies to analyse fixed and variable costs.

4 – Tax accounting

Tax accounting focuses on compliance with tax laws and regulations, preparation of tax returns and planning future tax obligations. This type of accounting applies to everyone – whether that be individuals, businesses, corporations or other entities.

To assist in this process, tax accountants help clients navigate the complex world of tax law and ensure they take advantage of deductions to minimise the amount of tax they need to pay.

5 – Auditing

Auditing involves an independent examination of a company’s financial statements and records.

Unlike the other types of accounting – which primarily involve the preparation and reporting of financial data – auditing is concerned with the accuracy, completeness and reliability of the data.

Auditors provide an objective assessment of whether such data provides a true and fair overview of the company’s financial position. This process includes

• Verifying whether the recording of financial transactions meets relevant accounting standards and principles.
• Checking for compliance with laws and regulations, and
• Looking for account discrepancies, unusual transactions and other inconsistencies that could be the hallmarks of fraud.

What is an accounting standard?

An accounting standard is a formal framework or declaration that sets out the required accounting for various types of events and transactions.

Accountants in Australia follow Australian Accounting Standards (AASs) which are set down by the Australian Accounting Standards Board (AASB).

Australian standards take their inspiration from the International Financial Reporting Standards (IFRS) – a so-called “global accounting language” used by 168 jurisdictions around the world.

This global language – which was conceived by the International Accounting Standards Board (IASB) – promotes consistent and transparent financial reporting across all sectors.

They also ensure that Australian accounting standards are comparable to those used in other countries, which facilitates international business and investment.

To conclude, let’s take a look at a few specific examples of accounting standards:

• AASB 101: Presentation of Financial Statements – key provisions relate to financial documents, comparative information and materiality and aggregation.
• AASB 9: Financial Instruments – this standard details how financial instruments such as loans, bonds and derivatives should be classified and measured.
• AASB 13: Fair Value Measurement – central to AASB 13 is a fair value hierarchy that helps finance companies measure the fair value of financial instruments in a way that is consistent, reliable and reflective of market conditions.

Summary:

• Accounting is the systematic process of recording, classifying, summarising, interpreting and reporting financial transactions and information.
• There are five primary types of accounting: financial accounting, managerial accounting, cost accounting, tax accounting and auditing. Each suits a specific purpose and context.
• Accounting in Australia follows standards established by the Australian Accounting Standards Board. These standards are based on the International Financial Reporting Standards (IFRS) that are used in 168 countries.