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Accounting is an information system. More precisely, it is the measurement methodology and communication system designed to produce selected quantitative data (usually in monetary terms) about an entity engaged in economic activity. Alternatively, accounting has been described as the art of classifying, recording, and reporting significant financial events to facilitate effective economic activity. The accounting entity (the focus of attention) may be a profit-seeking business enterprise, a governmental unit or activity, an eleemosynary institution, or any other organization for which financial data will be useful in determining the proper conduct of its economic affairs.

The major functions of accounting are (1) to provide summarized reports of the financial position and progress of the firm to a variety of groups who are not part of management, including those who furnish capital, and (2) to furnish detailed data that will facilitate the effective control and planning of operations by management. To fulfill the first function, a statement of financial position (balance sheet), a statement of operations (income statement or profit and loss statement), and a statement of fund flows (sources and applications of funds) are usually furnished. These statements are designed to indicate the current status and the changes during the period of the entity’s resources and of the relative position of the various claimants—owners (stockholders), creditors, employees, and the government in its regulatory and taxing role. The second function includes all the appurtenances of cost accounting that are useful in the efficient administration of an entity’s resources—for example, standard costs, flexible budgets, cost-profit volume analysis, and responsibility accounting.

Historical development. From the very earliest times, the levying and collection of taxes by government has called for record keeping and reports. Governmental reporting requirements have served since antiquity to reinforce business needs for accounting systems and controls. Clay tablets used by Babylonian businessmen to record their sales and money lending some four thousand years ago are still in existence. Egyptian papyri describing tax collections before 1000 b.c. are on exhibit in museums. The Greeks and Romans had welldeveloped record-keeping systems, especially for government affairs. The Emperor Augustus is said to have instituted a governmental budget in a.d. 5. Somewhat later, inspectors from the central government in Rome were sent out to examine the accounts of provincial governors.

During the Middle Ages, accounting, in company with most other elements of learning and trade, languished. With a barter, manorial economy, the financial transactions that are the lifeblood of accounting tended to disappear. Only the church and strong monarchs maintained and occasionally pushed forward the earlier systems of record keeping and control. Conspicuous developments during the medieval era included the annual inventory of property instituted by Charlemagne in the year 800 and the pipe rolls of various English rulers, which recorded the taxes and other obligations due the monarch. The pipe roll of Henry i in 1131 may be the most complete of these records.

The revival of Italian commerce in the thirteenth and fourteenth centuries created a need for records: to help merchants control their dealings with customers and employees, to indicate the relative interests of creditors and owners, and to apportion profits among partners. The first double-entry systems of bookkeeping evolved during this period; there are extant sets of double-entry records prepared in Genoa in 1340. The earliest systematic description of the double-entry procedure was provided by the Franciscan friar Luca da Bargo Pacioli in 1494 in his book Summa de arithmetica, geometria proportioni et proportionalita (which was, incidentally, the first published work on algebra). The system outlined by Pacioli in the section entitled “De computes et scriptures” (“Of Reckonings and Writings”) was a surprisingly complete one, and for four centuries almost all texts on accounting were closely patterned after it.

As it has developed in the more than four and a half centuries since Pacioli, the term “double entry” has probably referred to the two-sided nature of transactions, to the debit and credit aspects of each event. Some writers, however, have chosen to emphasize the dual steps in recording, i.e., the use of a book of original entry (the journal) and a classified record by accounts (the ledger). A more refined requirement of double-entry record keeping is the provision of separate accounts for the recording and analyzing of gains and losses, with a periodic reckoning of income and closing of these accounts into ownership capital. Pacioli’s treatise dealt with all these attributes of double entry, and it still serves as the basis for the far more complex accounting systems of today. The many modifications and elaborations that have been introduced have largely resulted from the desire for periodic financial statements of publicly held corporations and the need for additional financial data to facilitate the control and planning of operations of the large-scale firm.

Financial statements. Commencing in the nineteenth century, increasing emphasis was placed on the preparation of annual financial statements. The position statement (or balance sheet) was originally viewed as the most significant financial report and frequently was the only statement prepared. More recently, interest has shifted to the operating data of the income statement, and this now usually commands major attention.

The income statement is a systematic array of revenues, expenses (including depreciation), income taxes, and interest charges, culminating in the net income. The disposition of net income between dividends and reinvested earnings is usually shown either at the bottom of the income statement or in a separate statement of retained earnings (surplus). One major problem of income statement presentation is the treatment to be accorded unusual gains and losses, especially where the event giving rise to the gain or loss relates to a different or longer time period than that of the income statement. Many accountants feel that these items should be treated as adjustments of capital, but the more common view is to include them in the income statement, segregating them in a nonoperating category.

The balance sheet is a schedule of financial position or financial condition; and one of these two terms is being increasingly used as the title of the statement. The balance sheet contains a list of the entity’s assets (economic resources), divided into current and longterm categories. Cash, marketable securities, receivables, and inventories are the major current asset items. Land, buildings, and equipment are usually the major items in the longterm (fixed) asset section. Intangible assets, such as patents, copyrights, and purchased goodwill, are often accorded a separate classification. Like other assets, they are valued at cost. The “going value” of the entity is not listed as an asset and must be judged by the ability of the firm to earn a higher than normal rate of return.

Total assets are equal to the total liabilities (the rights and claims of all creditors) plus the ownership equity. The ownership equity indicates the interest of the proprietor or partners of an unincorporated entity or the equity of the stockholders of a corporation. If there are several classes of stockholders, it is customary to show the interests of each group separately. It is common to stress the distinction between contributed capital and reinvested earnings portions of the stockholders’ equity.

A recent development is an alternative form of balance sheet presentation that emphasizes the entity’s current position. This is accomplished by deducting current liabilities from current assets and labeling the difference net working capital; to this subtotal, long-term assets are added and other liabilities deducted. The resulting figure is the excess of all assets over all liabilities. The components of the ownership equity are then listed, and their summation is equal to this total net asset figure.

The most recent of the three major accounting reports is the statement of fund flows (sources and applications of funds statement). Its general nature is well described by the title originally applied to it by Cole—a “where got, where gone” statement. The major sources of fund inflows for the period covered are shown (operating transactions with customers and clients, proceeds of the issuance of securities and debt instruments, and occasional sales of noninventory assets), and these are compared with the major uses of funds (distributions to investors, reduction of long-term debt, retirement of stock, and investment in plant and equipment). Funds are usually defined as net working capital (current assets minus current liabilities). An alternative definition that would exclude inventories from the funds total has been suggested. If this suggestion were adopted, change in inventories during the period under consideration would be shown explicitly as a source, or use, of funds. Other alternatives, such as defining funds as cash (or cash plus marketable securities), are occasionally used. The result, practically speaking, is to trace the flows of cash of the business.

Income determination. The usual economic concept of income relates it to the enhancement of wealth. Focusing on the business entity, periodic income can be described as the amount of wealth that can be distributed to the owners during a certain period without making the entity’s prospects less than they were at the start of the period. To make such a concept operational, it would be necessary to have well-defined rules for measuring the firm’s prospects or wealth at the start and close of the period. This requires a measure of the discounted value of the entity’s anticipated net cash inflows. Such a measure would be highly subjective, depending wholly on the measurer’s current prognosis of the likely amount, and timing, of future inflows and on the appropriate discount rate to employ.

A more restricted definition of wealth would limit it to the sum of the values of individual tangible assets, rather than the worth of the firm as a whole. With this definition of wealth, income would be determined by intertemporal differences in total asset values (adjusted for changes in liabilities and capital contributions and withdrawals). This view of income was widely accepted in accounting until the end of the first decade of the twentieth century. About that time, it became more and more apparent that there would be continuing increases in the significance of specialized long-lived assets that would be difficult to value; also, and perhaps more important, a graduated income tax was imposed in the United Kingdom in 1909, and the sixteenth (income tax) amendment and related legislation were adopted in the United States in 1913. These developments led to the gradual displacement of the increase in value view of income by one that emphasized market transactions. Early tax decisions of the U.S. Supreme Court that held that there was no income without “severance” of property from the firm added support to the newer view. This was reinforced by the unhappy experience of many firms with appraisal values during the late 1920s and early 1930s.

For several decades now, the emphasis has been shifted toward evaluation of enterprise operating performance and a more restricted view of income measurement that focuses on the matching of asset inflows (revenues) and asset outflows (expenses) in the rendering of services. The following four concepts play central roles in the income reporting process:

(1) Realization. Reflects accounting’s preference for objectivity. Only events that have come to fruition by a market transaction or some ascertainable change in an asset or liability are recorded in the accounts.

(2) Consistency. Indicates that comparable events are treated in similar fashion from period to period. Although some alternative procedures may be acceptable, consistency minimizes the yearto-year effects of different procedures by requiring that the same alternative be selected each period.

(3) Conservatism. Relates to the feeling that where a choice exists it is better to understate, rather than overstate, income and ownership equity.

(4) Disclosure. Emphasizes the need to furnish all relevant information about the firm’s financial position and operations. It accepts the fact that some financial events are difficult to express adequately in the formal reports; footnotes are integral parts of the reports, and significant information that is not indicated in the body of the report is disclosed by footnote.

In considering when to recognize revenue, there is controversy among experts about how liquid the asset received in a sales transaction must be. In some cases, especially for income tax reporting, it is held that revenue recognition should be deferred until the cash is in hand (the installment method). Usually, however, revenue is recognized when a bona fide sale results in a legally enforceable receivable. Neither the receipt of orders nor activity in the productive process is normally accepted as a basis for recognizing revenue; instead, the realization concept suggests that all revenue from a transaction should be recorded at the time of sale.

The measurement of expense is largely a matter of recognizing the expiration of the economic usefulness of assets. All purchases are made to acquire services that will benefit the production of revenue; in fact, the most operational definition of an asset is simply that of a service potential or an unutilized service that will render a future benefit to the firm. As services are utilized, assets become expenses. Determining when, or what portion of, service potential has expired is the difficult practical problem. Conservatism has long been a guiding principle in external financial reporting; in doubtful cases, accountants have tended to minimize recognition of anticipated future benefits. Under a conservative approach, costs of such items as research and development, advertising, and employee training are charged to expense in the period during which they are incurred. The extreme form of this view results in recording assets only when their physical presence makes it embarrassing to ignore them.

In the income determination process, the cost of purchased merchandise must be divided between expense (cost of goods sold) and asset (inventory); the operational rule for measuring remaining service potential (asset) in this area is the acquisition cost of units physically present in final inventory. Costs of long-lived assets, like plant, must similarly be apportioned between depreciation expense and asset valuation. Operating procedures for handling assets in this category stress a systematic apportionment of plant costs, based to some extent on the relative expiration of service potential during this period compared to estimated total service potential available from the asset.

At the time of acquisition, the present value of anticipated services from an asset must be at least equal to its acquisition cost, or the purchase would not be made. Thus minimum initial value is established by acquisition cost, and acquisition cost remains the basis for the accounting valuation of the asset as long as the asset retains its power of rendering services. As service expirations occur, the original cost valuations are charged to expense. In periods of rapidly changing prices, some expense figures may lag significantly behind current values. Since revenues tend to adjust to changing prices more rapidly, the matching process may result in the comparison of revenues stated in current price terms with expenses stated in prices of a different vintage.

To cope with this problem, some accountants have recommended that expenses be recognized on a replacement cost basis. This view has not received general acceptance, but partial approaches to the same goal have received some approval. The last-in, first-out (LIFO) inventory procedure has come to be generally accepted in the United States. By charging the cost of the most recent purchases to expense, it results in an expense figure that approximates current costs in most cases. The firstin, first-out procedure (FIFO) is based, in most cases, on a more realistic assumption about inventory flows, but the expense amount is stated in less current terms. In the late 1940s, efforts by a few American firms to base depreciation on replacement cost failed to win general approval, and advocacy of this method has waned. However, acceleration of depreciation charges based on acquisition cost, by recognition of a faster rate of service expiration, has won acceptance both in financial reporting and in the income tax laws; this may offset, in part, the effect of price level changes.

The use of replacement costs for expenses implies a concept of wealth measured by physical resources or productive capacity; income emerges only after resources or capacity are maintained. An alternative correction for price changes would apply an index of general price level change to all assets and then charge these restated costs to expense in the traditional fashion. This approach implies a purchasing power concept of wealth.

All measurements of income for periods shorter than the life of the entity are tentative. The shorter the time period of the income statement, the more difficult the measurement of income. Many asset acquisitions represent joint costs of long periods of service, and there is no known logical way of allocating their costs to shorter periods of income reporting. The date of expiration of service benefits of many other assets cannot be determined exactly. There are alternative, acceptable procedures in many areas. Reported income for relatively short periods is, at best, a rough indicator of enterprise performance. The seeming accuracy indicated by reporting income to the nearest dollar (or in larger firms to the nearest thousand dollars) gives an improper impression of precision. Since the income data have their greatest significance in guiding investment decisions and facilitating evaluation of management, a knowledge that income of a firm falls within a relatively narrow range may be virtually as satisfactory as knowing its exact amount. The effort of the accounting profession to reduce the number of permissible alternative procedures reflects the desire to narrow this range and increase the usefulness of income reporting.

Cost accounting. Cost accounting (managerial accounting) is chiefly concerned with measuring, analyzing, and reporting the operating costs of specific centers of activity. Early developments in cost accounting were associated almost exclusively with manufacturing operations. They focused on measuring the cost of products, processes, and departments for inventory valuation and pricing purposes. Since about 1930, there has been an enormous expansion in cost-accounting activity. It has been extended to administrative and distributive activities, and it has become clear that the more significant uses of cost accounting are found in the areas of cost control and cost planning, rather than in product costing for purposes of inventory valuation and income determination.

Cost accounting operates as a branch of the general financial accounting system. It provides a detailed analysis of the costs associated with specific products or processes that are important enough to warrant such attention. If costs are accumulated by departments or operating centers, the system is described as a process-cost system; if accumulated by jobs or products, it is known as a job-order system. Most existing systems, however, are hybrids that contain some aspects of both the process-cost system and the job-order system.

Certain costs, like production labor and raw materials, can be assigned directly to jobs or processes with little question. These costs usually vary with the level of operations. The jobs or processes responsible for the incurring of these costs can be identified, and they receive all of the benefits of the services used. However, there frequently are many costs that are not directly associated with individual jobs or processes but, instead, are joint to several activities. For the most part, these costs are fixed. Under a “full-costing” procedure, these common costs (fixed overhead) are also assigned, somewhat arbitrarily, to jobs or processes. The basis for assignment is usually some subjective estimate of relative benefit as measured by labor cost, labor hours, machine hours, or some other measure of activity.

There is a growing tendency to question the desirability of assigning indirect fixed costs to jobs and activities. The advocates of the direct-costing (variable-costing) view argue that the assignment serves no useful decision-making purpose and may distort the data that are relevant for short-run price, and output, decisions. They stress that in making short-period decisions the significant figure is the excess of additional revenues over variable costs, rather than over “full costs”. They describe the excess of revenue over variable costs as the “contribution” to the meeting of fixed costs and the earning of profit.

The control aspect of cost accounting is based upon the use of operating budgets and performance standards. Budgets have been used in government finance for many years, but their major purpose has been to place a limit on authority to spend. In contrast, managerial accounting views the budget as a financial plan and a control over future operations, a means whereby it is determined whether operations are proceeding in accord with management’s plans and policies. Recently some government budget practice has come closer to this view [seeBudgeting]. By combining performance standards (standard costs) with estimates of physical activity, the budget spells out the position that the firm should achieve at the end of the budget period. Comparison of the results of operations with budgeted figures indicates the areas where managerial attention and action may be needed.

To be effective as a control device, the budget must be prepared in sufficient detail for estimated and actual costs to be assigned to those areas specifically responsible for their incurrence. To prevent individual managers being charged with responsibility for costs that are not under their control, careful preliminary studies and even modification of organizational structure may be necessary before the installation of a budget and a standard-cost system.

Standard costs for units of performance are a central part of the control process. Standard costs have connotations of normative behavior and indicate what the effort expended (assets given up) to attain the entity’s production objectives should be. The development of appropriate standards is a complex task, which may require the cooperative effort of industrial engineers, psychologists, statisticians, personnel men, and accountants. Standards are usually expressed in terms of both prices and usage, and they frequently contain more detail than is found in the budget.

In a standard-cost system, actual costs are recorded for each activity, and differences between actual and standard costs are isolated in variance accounts; separate variance accounts for the cost of materials, materials usage, labor wage rates, labor effectiveness, idle capacity, and overhead expenditures are commonly provided. These are usually expressed in monetary units, although a minority view holds that the conversion of physical variances, that is, materials usage and labor effectiveness, to dollar terms serves no useful purpose. The investigation and analysis of major variances is a prime task of the internal accounting staff.

Cost accounting contributes to cost control in other ways as well. The timekeeping and payroll systems that are required for cost assignments help to assure management that workers are actually on the job and being paid according to wage agreements. Control of issuance of materials is usually built into the cost-accounting system, as are detailed records of machine and tool availability and maintenance costs.

Special studies utilizing data produced by the cost-accounting system play a central role in many planning decisions of management. Decisions on equipment replacement, size of production runs or quantities ordered, discontinuance of “unprofitable” products or territories, as well as make-or-buy decisions, are frequently guided by reports relying on cost-accounting information. The analysis underlying management decisions in these areas is based on incremental cost data rather than full costs. Proper classification of costs into fixed and variable categories for cost-measurement and cost-control purposes ensures that much of the needed information will be available for these special studies. Not all costs that are significant for measurement and control purposes are relevant for management planning. An effective cost-accounting system will have the capability of providing the data that are needed for all three purposes.

Auditing and public accounting. Auditing is concerned with the independent verification of the statement of financial position and the results of operations of an entity. An audit is an outside expert’s professional attestation that the financial reports have been prepared in conformity with generally accepted accounting principles on a basis consistent with that of the preceding period. This independent appraisal of the fairness of the financial statements has traditionally been the major function of the public accounting profession. The growth of large-scale enterprise, with its separation of ownership and management, emphasizes the need for an external verification so that present and potential investors may rely on the published financial statements.

Since 100 per cent checking of records would be prohibitively expensive, auditing necessarily uses sampling procedures. In the analysis of a firm’s activities and records, the independent public accountant examines selected documents and transactions until he is satisfied professionally that the financial statements prepared by management “present fairly” the position and results of operation of the firm. (The quoted words are from the standard auditor’s report in the United States; the British wording is a “true and fair view.”) In recent years, professional accountants have often relied on probability theory and formal statistical sampling techniques in deciding on how much testing and evidence is needed before an opinion on the financial statements can be rendered.

Public accounting and auditing have a long history in the commercial and industrial world, but the dramatic growth of the public accounting profession has been a fairly recent phenomenon. The first New York Directory, compiled in 1786, listed only three accountants in public practice in New York. At about the same time, similar directories prepared in Great Britain showed 14 public accountants in Edinburgh, 10 in Glasgow, and 5 each in London and Liverpool. The substantial growth of corporations in the nineteenth century demanded expanded and improved public accounting services for the protection of investors and the effective operation of securities markets. In order to improve standards, professional organizations evolved in most industrialized nations. Accreditation for public identification of professional competence and status developed somewhat later. Accreditation procedures take one of two general forms—acceptance to membership in a government-approved professional society, as in Great Britain; or state designation under an applicable statutory enactment, as in the United States.

The first British accounting society was founded in Edinburgh in 1854, followed in the next year by a similar society in Glasgow. These two societies form the basis of the Institute of Chartered Accountants of Scotland. The Institute of Accountants was formed in London in 1870 and ten years later was incorporated by royal charter as The Institute of Chartered Accountants in England and Wales. The Society of Incorporated Accountants was formed five years later and merged into the English and Scottish Institutes in 1957. The Association of Certified and Corporate Accountants came into being shortly after the turn of the century.

The Companies Act and various other legal enactments in the United Kingdom list certain responsibilities that may be discharged only by members of one of the institutes or societies. Each of the groups imposes an experience requirement for membership. To become a member of a chartered institute the experience must be acquired in an articled clerkship under the direction of an accountant who is a member of the group. In addition, satisfactory written examinations in accounting theory and practice, as well as related subjects, are required by each of the groups. By 1965, membership in these British organizations totaled more than fifty thousand.

In the United States, the title of certified public accountant (CPA) is conferred by each of the states. In 1896 New York became the first state to provide for such certification, followed in 1899 by Pennsylvania. By 1923, all the states provided for the legal designation of CPA’s. Each state has its own education and experience requirements for the certificate; many states require some college education and a small, but growing, number require a college degree as a prerequisite for certification. All the states use a uniform CPA examination, prepared and graded by the American Institute of Certified Public Accountants. In 1965 the number of CPA’s in the United States was approximately 90,000, compared with 38,000 in 1950, 13,000 in 1930, and 250 in 1900.

Most of the nations of the British Commonwealth and many European nations follow the English lead of having government-chartered organizations prescribe their own rules for membership and thus admission to the public accounting profession. A smaller number of countries use the American plan of licensing of qualified accounting practitioners.

The professional groups in each country have developed roughly comparable codes of ethics and standards of conduct. All emphasize the concept of independence, which intends that the auditor be able to give an unbiased evaluation of management’s representation about financial position and progress. Other rules stress maintenance of high levels of professional competence and integrity. The American Institute of Certified Public Accountants has, in addition, been active in seeking to define generally accepted accounting principles and to narrow the areas where alternative treatments are acceptable. The Opinions of the Accounting Principles Board, established by the American Institute, are widely accepted as authoritative statements on accounting concepts.

In addition to their auditing function, accountants have traditionally played an important role in the preparation of business and individual income tax returns. Although the statutory definition of taxable income differs to some extent from accounting formulations of income, the accountant’s familiarity with a firm’s financial records and the income measurement process makes him the natural person to perform this service.

More recently, many public accounting firms have extended their activities in the management services area, where they render consulting service on a wide range of management problems. When these problems are financial in nature or relate to information or control systems, the public accountant’s management services work is comparable to that performed by the internal accounting staff of many large industrial firms. All signs indicate that the management services function is likely to be the public accounting activity that will grow most rapidly in the years to come.

Sidney Davidson

[See alsoCost.]



Accountants’ Handbook. 4th ed. (1923) 1956 New York: Ronald Press.

American Institute of Certified Public Accountants1921 Accountants’ Index: A Bibliography of Accounting Literature to December, 1920. New York: The Institute. → The Index is kept up-to-date by supplements.

Dickey, Robert I. (editor) (1944) 1960 Accountants’ Cost Handbook. 2d ed. New York: Ronald Press. → The first edition, edited by Theodore Lang, was published under the title Cost Accountants’ Handbook.

Edwards, Edgar O.; and BELL, Philip W. 1961 The Theory and Measurement of Business Income. Berkeley: Univ. of California Press.

Horngren, Charles T. 1962 Cost Accounting: A Managerial Emphasis. Englewood Cliffs, N.J.: Prentice-Hall.

Kohler, Eric L. (1952) 1963 A Dictionary for Accountants. 3d ed. Englewood Cliffs, N.J.: Prentice-Hall.

Littleton, Ananias C. 1933 Accounting Evolution to 1900. New York: American Institute Publishing Company.

Mautz, Robert K.; and Sharaf, Hussein A. 1961 The Philosophy of Auditing. Madison, Wis.: American Accounting Association.

Paton, William A. 1952 Asset Accounting: An Intermediate Course. New York: Macmillan.

Paton, William A. 1955 Corporation Accounts and Statements: An Advanced Course. New York: Macmillan.

Paton, William A.; and Littleton, Ananias C. 1940 An Introduction to Corporate Accounting Standards. Chicago: American Accounting Association.


The Accountant (London). → Published weekly since 1874.

The Accounting Review. → Published quarterly with annual volume numbers since 1926.

Journal of Accountancy. → Published monthly (volume numbers semiannually) since 1905.

Journal of Accounting Research. → Published semiannually since 1963.

N.A.A. Bulletin. → Published by the National Association of Accountants from 1919. Title changed to Management Accounting in October 1965.

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Accounting has been defined as "the language of business" because it is the basic tool keeping score of a business's activity. It is with accounting that an organization records, reports, and evaluates economic events and transactions that affect the enterprise. As far back as 1494 the importance of accounting to the success of a business was known. In a book on mathematics published that year and written by the Franciscan monk, Luca Paciolo, the author cites three things any successful merchant must have. The three things are sufficient cash or credit, an accounting system to track how he is doing, and a good bookkeeper to operate the system.

Accounting processes document all aspects of a business's financial performance, from payroll costs, capital expenditures, and other obligations to sales revenue and owners' equity. An understanding of the financial data contained in accounting documents is regarded as essential to reaching an accurate picture of a business's true financial well-being. Armed with such knowledge, businesses can make appropriate financial and strategic decisions about their future; conversely, incomplete or inaccurate accounting data can cripple a company, no matter its size or orientation. The importance of accounting as a barometer of business healthpast, present, and futureand tool of business navigation is reflected in the words of the American Institute of Certified Public Accountants (AICPA), which defined accounting as a "service activity." Accounting, said the AICPA, is intended "to provide quantitative information, primarily financial in nature, about economic activities that is intended to be useful in making economic decisionsmaking reasoned choices among alternative courses of action."

A business's accounting system contains information relevant to a wide range of people. In addition to business owners, who rely on accounting data to gauge the financial progress of their enterprise, accounting data can communicate relevant information to investors, creditors, managers, and others who interact with the business in question. As a result, accounting is sometimes divided into two distinct subsetsfinancial accounting and management accountingthat reflect the different information needs of the end users.

Financial accounting is a branch of accounting that provides people outside the businesssuch as investors or loan officerswith qualitative information regarding an enterprise's economic resources, obligations, financial performance, and cash flow. Management accounting, on the other hand, refers to accounting data used by business owners, supervisors, and other employees of a business to gauge the enterprise's health and operating trends.


Generally accepted accounting principles (GAAP) are the guidelines, rules, and procedures used in recording and reporting accounting information in audited financial statements. In order to have a vibrant and active economic marketplace, participants in the market must have confidence in the system. They must be confident that the reports and financial statements produced by companies are trustworthy and based on some standard set of accounting principles. The stock market crash of 1929 and its aftermath showed just how damaging uncertainty can be to the market. The results of U.S. Senate Banking and Currency Committee hearings into the 1929 crash caused public outrage and lead to federal regulation of the securities market as well as a push for the development of professional organizations designed to establish standardized accounting principles and to oversee their adoption.

Various organizations have influenced the development of modern-day accounting principles. Among these are the American Institute of Certified Public Accountants (AICPA), the Financial Accounting Standards Board (FASB), and the Securities and Exchange Commission (SEC). The first two are private sector organizations; the SEC is a federal government agency.

The AICPA played a major role in the development of accounting standards. In 1937 the AICPA created the Committee on Accounting Procedures (CAP), which issued a series of Accounting Research Bulletins (ARB) with the purpose of standardizing accounting practices. This committee was replaced by the Accounting Principles Board (APB) in 1959. The APB maintained the ARB series, but it also began to publish a new set of pronouncements, referred to as Opinions of the Accounting Principles Board. In mid-1973, an independent private board called the Financial Accounting Standards Board (FASB) replaced the APB and assumed responsibility for the issuance of financial accounting standards. The FASB remains the primary determiner of financial accounting standards in the United States. Comprised of seven members who serve full-time and receive compensation for their service, the FASB identifies financial accounting issues, conducts research related to these issues, and is charged with resolving the issues. A super-majority vote (i.e., at least five to two) is required before an addition or change to the Statements of Financial Accounting Standards is issued.

The Financial Accounting Foundation is the parent organization to FASB. The foundation is governed by a 16-member Board of Trustees appointed from the memberships of eight organizations: AICPA, Financial Executives Institute, Institute of Management Accountants, Financial Analysts Federation, American Accounting Association, Securities Industry Association, Government Finance Officers Association, and National Association of State Auditors. A Financial Accounting Standards Advisory Council (approximately 30 members) advises the FASB. In addition, an Emerging Issues Task Force (EITF) was established in 1984 to provide timely guidance to the FASB on new accounting issues.

The Securities and Exchange Commission, an agency of the federal government, has the legal authority to prescribe accounting principles and reporting practices for all companies issuing publicly traded securities. The SEC has seldom used this authority, however, although it has intervened or expressed its views on accounting issues from time to time. U.S. law requires that companies subject to the jurisdiction of the SEC make reports to the SEC giving detailed information about their operations. The SEC has broad powers to require public disclosure in a fair and accurate manner in financial statements and to protect investors. The SEC establishes accounting principles with respect to the information contained within reports it requires of registered companies. These reports include: Form S-X, a registration statement; Form 10-K, an annual report; Form 10-Q, a quarterly report of operations; Form 8-K, a report used to describe significant events that may affect the company; and Proxy Statements, which are used when management requests the right to vote through proxies for shareholders.

On December 20, 2002, the SEC proposed a series of amendments to the rules and forms that it imposes on companies within its jurisdiction. These changes were mandated as part of the passage of the Sarbanes-Oxley Act of 2002. This law was motivated, in part, by accounting scandals that came to light involving firms as well known as Enron, WorldCom, Tyco, Global Crossing, Kmart, and Arthur Andersen to name a few.


An accounting system is a management information system responsible for the collection and processing of data useful to decision-makers in planning and controlling the activities of a business organization. The data processing cycle of an accounting system encompasses the total structure of five activities associated with tracking financial information: collection or recording of data; classification of data; processing (including calculating and summarizing) of data; maintenance or storage of results; and reporting of results. The primarybut not solemeans by which these final results are disseminated to both internal and external users (such as creditors and investors) is the financial statement.

The elements of accounting are the building blocks from which financial statements are constructed. According to the Financial Accounting Standards Board (FASB), the primary financial elements directly related to measuring performance and the financial position of a business enterprise are as follows:

  • Assetsprobable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events.
  • Comprehensive Incomethe change in equity (net assets) of an entity during a given period as a result of transactions and other events and circumstances from non-owner sources. Comprehensive income includes all changes in equity during a period except those resulting from investments by owners and distributions to owners.
  • Distributions to Ownersdecreases in equity (net assets) of a particular enterprise as a result of transferring assets, rendering services, or incurring liabilities to owners.
  • Equitythe residual interest in the assets of an entity that remain after deducting liabilities. In a business entity, equity is the ownership interest.
  • Expensesevents that expend assets or incur liabilities during a period from delivering or providing goods or services and carrying out other activities that constitute the entity's ongoing major or central operation.
  • Gainsincreases in equity (net assets) from peripheral or incidental transactions. Gains also come from other transactions, events, and circumstances affecting the entity during a period except those that result from revenues or investments by owners. Investments by owners are increases in net assets resulting from transfers of valuables from other entities to obtain or increase ownership interests (or equity) in it.
  • Liabilitiesprobable future sacrifices of economic benefits arising from present obligations to transfer assets or provide services to other entities in the future as a result of past transactions or events.
  • Lossesdecreases in equity (net assets) from peripheral or incidental transactions of an entity and from all other transactions, events, and circumstances affecting the entity during a period. Losses do not include equity drops that result from expenses or distributions to owners.
  • Revenuesinflows or other enhancements of assets, settlements of liabilities, or a combination of both during a period from delivering or producing goods, rendering services, or conducting other activities that constitute the entity's ongoing major or central operations.


Financial statements are the most comprehensive way of communicating financial information about a business enterprise. A wide array of usersfrom investors and creditors to budget directorsuse the data it contains to guide their actions and business decisions. Financial statements generally include the following information:

  • Balance sheet (or statement of financial position)summarizes the financial position of an accounting entity at a particular point in time as represented by its economic resources (assets), economic obligations (liabilities), and equity.
  • Income statementsummarizes the results of operations for a given period of time.
  • Statement of cash flowssummarizes the impact of an enterprise's cash flows on its operating, financing, and investing activities over a given period of time.
  • Statement of retained earningsshows the increases and decreases in earnings retained by the company over a given period of time.
  • Statement of changes in stockholders' equitydiscloses the changes in the separate stockholders' equity account of an entity, including investments by distributions to owners during the period.

Notes to financial statements are considered an integral part of a complete set of financial statements. Notes typically provide additional information at the end of the statement and concern such matters as depreciation and inventory methods used in the statements, details of long-term debt, pensions, leases, income taxes, contingent liabilities, methods of consolidation, and other matters. Significant accounting policies are usually disclosed as the initial note or as a summary preceding the notes to the financial statements.


There are two primary kinds of accountants: private accountants, who are employed by a business enterprise to perform accounting services exclusively for that business, and public accountants, who function as independent experts and perform accounting services for a wide variety of clients. Some public accountants operate their own businesses, while others are employed by accounting firms to attend to the accounting needs of the firm's clients.

A certified public accountant (CPA) is an accountant who has 1) fulfilled certain educational and experience requirements established by state law for the practice of public accounting and 2) garnered an acceptable score on a rigorous three-day national examination. Such people become licensed to practice public accounting in a particular state. These licensing requirements are widely credited with maintaining the integrity of the accounting service industry, but in recent years this licensing process has drawn criticism from legislators and others who favor deregulation of the profession. Some segments of the business community have expressed concern that the quality of accounting would suffer if such changes were implemented, and analysts indicate that small businesses without major in-house accounting departments would be particularly impacted.

The American Institute of Certified Public Accountants (AICPA) is the national professional organization of CPAs, but numerous organizations within the accounting profession exist to address the specific needs of various subgroups of accounting professionals. These groups range from the American Accounting Association, an organization composed primarily of accounting educators, to the American Women's Society of Certified Public Accountants.


"A good accountant is the most important outside advisor the small business owner has," according to the Entrepreneur Magazine Small Business Advisor. "The services of a lawyer and consultant are vital during specific periods in the development of a small business or in times of trouble, but it is the accountant who, on a continuing basis, has the greatest impact on the ultimate success or failure of a small business."

When starting a business, many entrepreneurs consult an accounting professional to learn about the various tax laws that affect them and to familiarize themselves with the variety of financial records that they will need to maintain. Such consultations are especially recommended for would-be business owners who anticipate buying a business or franchise, plan to invest a substantial amount of money in the business, anticipate holding money or property for clients, or plan to incorporate.

If a business owner decides to enlist the services of an accountant to incorporate, he/she should make certain that the accountant has experience dealing with small corporations, for incorporation brings with it a flurry of new financial forms and requirements. A knowledgeable accountant can provide valuable information on various aspects of the start-up phase.

Similarly, when investigating the possible purchase or licensing of a business, a would-be buyer should enlist the assistance of an accountant to look over the financial statements of the licensor-seller. Examination of financial statements and other financial data should enable the accountant to determine whether the business is a viable investment. If a prospective buyer decides not to use an accountant to review the licensor-seller's financial statements, he/she should at least make sure that the financial statements that have been offered have been properly audited (a CPA will not stamp or sign a financial statement that has not been properly audited and certified).

Once in business, the business owner will have to weigh revenue, rate of expansion, capital expenditures, and myriad other factors in deciding whether to secure an in-house accountant, an accounting service, or a year-end accounting and tax preparation service. Sole proprietorships and partnerships are less likely to have need of an accountant; in some cases, they will be able to address their business's modest accounting needs without utilizing outside help. If a business owner declines to seek professional help from an accountant on financial matters, pertinent accounting information can be found in books, seminars, government agencies such as the Small Business Administration, and other sources.

Even if a small business owner decides against securing an accountant he or she will find it much easier to attend to the business's accounting requirements if a few basic bookkeeping principles are followed. These include maintaining a strict division between personal and business records; maintaining separate accounting systems for all business transactions; establishing separate checking accounts for personal and business; and keeping all business records, such as invoices and receipts.


While some small businesses are able to manage their accounting needs without benefit of in-house accounting personnel or a professional accounting outfit, the majority choose to enlist the help of accounting professionals. There are many factors for the small business owner to consider when seeking an accountant, including personality, services rendered, reputation in the business community, and expense.

The nature of the business in question is also a consideration in choosing an accountant. Owners of small businesses who do not anticipate expanding rapidly have little need of a national accounting firm, but business ventures that require investors or call for a public stock offering can benefit from association with an established accounting firm. Many owners of growing companies select an accountant by interviewing several prospective accounting firms and requesting proposals which will, ideally, detail the firm's public offering experience within the industry, describe the accountants who will be handling the account, and estimate fees for auditing and other proposed services.

Finally, a business that utilizes a professional accountant to attend to accounting matters is often better equipped to devote time to other aspects of the enterprise. Time is a precious resource for small businesses and their owners, and according to the Entrepreneur Magazine Small Business Advisor, "Accountants help business owners comply with a number of laws and regulations affecting their record-keeping practices. If you spend your time trying to find answers to the many questions that accountants can answer more efficiently, you will not have the time to manage your business properly. Spend your time doing what you do best, and let accountants do what they do best."

The small business owner can, of course, make matters much easier both for his/her company and for the accountant by maintaining proper accounting records throughout the year. Well-maintained and complete records of assets, depreciation, income and expense, inventory, and capital gains and losses are all necessary for the accountant to conclude her work; gaps in a business's financial record only add to the accountant's time and, therefore, her fee for services rendered.

The potential management insights that can be gained from a study of properly prepared financial statements should not be overlooked. Many small businesses see accounting primarily as a paperwork burden and something whose value is primarily in helping to comply with government reporting requirements and tax preparations. Most experts in the field contend that small firms should recognize that accounting information can be a valuable component of a company's management and decision-making systems, for financial data provide the ultimate indicator of the failure or success of a business's strategic and philosophical direction.

see also Certified Public Accountants


Anthony, Robert N., and Leslie K. Pearlman. Essentials of Accounting. Prentice Hall, 1999.

Bragg, Steven M. Accounting Best Practices. John Wiley, 1999.

Fuller, Charles. The Entrepreneur Magazine Small Business Advisor. Wiley, 1995.

Lunt, Henry. "The Fab Four's Solo Careers." Accountancy. March 2000.

Pinson, Linda. Keeping the Books: Basic Record Keeping and Accounting for Successful Small Business. Business & Economics, 2004.

Strassmann, Paul A. "GAAP Helps Whom?" Computerworld. December 6, 1999.

Taylor, Peter. Book-Keeping & Accounting for Small Business. Business & Economics, 2003.

                              Hillstrom, Northern Lights

                              updated by Magee, ECDI

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Accounting is a field of specialization critical to the functioning of all types of organizations. Accounting often is referred to as "the language of business" because of its role in maintaining and processing all relevant financial information that an entity requires for its managing and reporting purposes.

Accountants often have a specific subspecialization and function at one of several levels. Preparation for the field is provided by secondary schools, postsecondary business schools, community colleges, and four-year colleges and universities.


Accounting is a body of principles and conventions as well as an established general process for capturing financial information related to an entity's resources and their use in meeting the entity's goals. Accounting is a service function that provides information of value to all operating units and to other service functions, such as the headquarters offices of a large corporation.

Origin of Accounting

Modern accounting is traced to the work of an Italian monk, Luca Pacioli, whose publication in 1494 c.e. described the double-entry system, which continues to be the fundamental structure for contemporary accounting systems in all types of entities. When double-entry accounting is used, the balance sheet identifies both the resources controlled by the entity and those parties who have claims to those assets.

Early histories of business identify the bookkeeper as a valuable staff member. As businesses became more complex, the need for more astute review and interpretation of financial information was met with the development of a new professionpublic accounting. In the United States, public accounting began in the latter part of the nineteenth century. The first organization was established in 1887; the first professional examination was administered in December 1896.

In the early days of the twentieth century, numerous states established licensing requirements and began to administer examinations. During the first century of public accounting in the United States, the American Institute of Certified Public Accountants (and its predecessor organizations) provided strong leadership to meet the changing needs of business, not-for-profit, and governmental entities.

Generally Accepted Accounting Principles (GAAP)

No single source provides principles for handling all transactions and events. Over time, conventional rules have developed that continue to be relevant. Additionally, groups have been authorized to establish accounting standards. The Financial Accounting Standards Board (FASB) assumed responsibility for accounting standards and principles in 1973. It is authorized to amend existing rules and establish new ones. In 1992, the Auditing Standards Board established the GAAP hierarchy. At the highest level of the hierarchy are FASB statements and interpretations; APB opinions were issued from 1959 to 1973 by the Accounting Principles Board (APB), and Accounting Research Bulletins, issued until 1959 by the Committee

on Accounting Procedure (CAP); both the APB and CAP were committees of the American Institute of Certified Public Accountants (AICPA).

What type of unit is served by accounting?

Probably no concept or idea is more basic to accounting than the accounting unit or entity, a term used to identify the organization for which the accounting service is to be provided and whose accounting or other information is to be analyzed, accumulated, and reported. The entity can be any area, activity, responsibility, or function for which information would be useful. Thus, an entity is established to provide the needed focus of attention. The information about one entity can be consolidated with that of a part or all of another, and this combination process can be continued until the combined entity reaches the unit that is useful for the desired purpose.

Accounting activities may occur within or outside the organization. Although accounting is usually identified with privately owned, profit-seeking entities, its services also are provided to not-for-profit organizations such as universities or hospitals, to governmental organizations, and to other types of units. The organizations may be small, owner-operated enterprises offering a single product or service, or huge multi-enterprise, international conglomerates with thousands of different products and services. The not-for-profit, governmental, or other units may be local, national, or international; they may be small or very large; they may even be entire nations, as in national income accounting. Since not-for-profit and governmental accounting are covered elsewhere in this encyclopedia, the balance of this article will focus on accounting for privately owned, profit-seeking entities.

What is the work of accountants?

Accountants help entities be successful, ethical, responsible participants in society. Their major activities include observation, measurement, and communication. These activities are analytical in nature and draw on several other disciplines (e.g., economics, mathematics, statistics, behavioral science, law, history, and language/communication).

Accountants identify, analyze, record, and accumulate facts, estimates, forecasts, and other data about the unit's activities; then they translate these data into information that can be useful for a specific purpose.

The data accumulation and recording phase traditionally has been largely clerical; typically and appropriately, this has been called bookkeeping, which is still a common and largely manual activity, especially in smaller firms that have not adopted state-of-the-art technology. But with advances in information technology and userfriendly software, the clerical aspect has become largely electronically performed, with internal checks and controls to assure that the input and output are factual and valid.

Accountants design and maintain accounting systems, an entity's central information system, to help control and provide a record of the entity's activities, resources, and obligations. Such systems also facilitate reporting on all or part of the entity's accomplishments for a period of time and on its status at a given point in time.

An organization's accounting system provides information that (1) helps managers make decisions about assembling resources, controlling, and organizing financing and operating activities; and (2) aids other users (employees, investors, creditors, and othersusually called stakeholders) in making investment, credit, and other decisions.

The accounting system must also provide internal controls to ensure that (1) laws and enterprise policies are properly implemented; (2) accounting records are accurate; (3) enterprise assets are used effectively (e.g., that idle cash balances are being invested to earn returns); and (4) steps be taken to reduce chances of losing assets or incurring liabilities from fraudulent or similar activities, such as the carelessness or dishonesty of employees, customers, or suppliers. Many of these controls are simple (e.g., the prenumbering of documents and accounting for all numbers); others require division of duties among employees to separate record keeping and custodial tasks in order to reduce opportunities for falsification of records and thefts or misappropriation of assets.

An enterprise's system of internal controls usually includes an internal auditing function and personnel to ensure that prescribed data handling and asset/liability protection procedures are being followed. The internal auditor uses a variety of approaches, including observation of current activities, examination of past transactions, and simulationoften using sample or fictitious transactionsto test the accuracy and reliability of the system.

Accountants may also be responsible for preparing several types of documents. Many of these (e.g., employees' salary and wage records) also serve as inputs for the accounting system, but many are needed to satisfy other reporting requirements (e.g., employee salary records may be needed to support employee claims for pensions). Accountants also provide data for completing income tax returns.

What is the accountant's role in decision making?

Accountants have a major role in providing information for making economic and financial decisions. Rational decisions are usually based on analyses and comparisons of estimates, which in turn, are based on accounting and other data that project future results from alternative courses of action.

External or financial accounting, reporting, and auditing are directly involved in providing information for the decisions of investors and creditors that help the capital markets to efficiently and effectively allocate resources to enterprises; internal, managerial, or management accounting is responsible for providing information and input to help managers make decisions on the efficient and effective use of enterprise resources.

The accounting information used in making decisions within an enterprise is not subject to governmental or other external regulation, so any rules and constraints are largely self-imposed. As a result, in developing the data and information that are relevant for decisions within the enterprise, managerial accountants are constrained largely by cost-benefit considerations and their own ingenuity and ability to predict future conditions and events.

But accounting to external users (financial accounting, reporting, and auditing) has many regulatory constraintsespecially if the enterprise is a "public" corporation whose securities are registered (under the United States Securities Acts of 1933 and 1934) with the Securities and Exchange Commission (SEC) and traded publicly over-the-counter or on a stock exchange. Public companies are subject to regulations and reporting requirements imposed and enforced by the SEC; to rules and standards established for its financial reports by the FASB and enforced by the SEC; to regulations of the organization where its securities are traded; and to the regulations of the AICPA, which establishes requirements and standards for its members (who may be either internal or external accountants or auditors).

If the entity is a state or local governmental unit, it is subject to the reporting standards and requirements of the Government Accounting Standards Board. If the entity is private and not a profit-seeking unit, it is subject to various reporting and other regulations, including those of the Internal Revenue Service, which approves its tax status and with which it must file reports.

Largely as a result of the governmental regulation of private profit-seeking businesses that began in 1933, an increasingly clear distinction has been made between managerial or internal accounting and financial accounting that is largely for external users. One important exception to this trend, however, was the change adopted in the 1970s in the objectives of financial reporting such that both managerial and financial accounting now have the same objective: to provide information that is useful for making economic decisions.

But it must be recognized that although the financial accounting information reported to stakeholders comes from the organization's accounting system, its usefulness for decision making is limited. This is because it is largely historicalit reflects events and activities that occurred in the past, not what is expected in the future. Even estimated data such as budgets and standard costs must be examined regularly to determine whether these past estimates continue to be indicative of current conditions and expectations and thus are useful for making decisions. Thus historical accounting information must be examined carefully, modified, and supplemented to make certain that what is used is relevant to expectations about the future.

But it also must be recognized that accounting can and does provide information that is current and useful in making estimates about future events. For example, accounting provides current-value information about selected items, such as readily marketable investments in debt and equity securities and inventories, and it provides reports on what the organization plans to accomplish and its expectations about the future in budgets and earnings forecasts.

Who uses accounting information for decision making?

The information developed by the accountant's information system can be useful to:

  • Managers in planning, controlling, and evaluating their organization's activities
  • Owners, directors, and others in evaluating the performance of the organization and determining operating, compensation, and other policies
  • Union, governmental, regulatory, taxing, environmental, and other entities in evaluating whether the organization is conforming with applicable contracts, rules, laws, and public policies and/or whether changes are needed;
  • Existing and potential owners, lenders, employees, customers, and suppliers in evaluating their current and future commitments to the organization
  • Accounting researchers, security analysts, security brokers and dealers, mutual-fund managers, and others in their analyses and evaluations of enterprises, capital markets, and/or investors

The services that accounting and the accountant can provide have been enhanced in many ways since the 1970s by advances in computers and other information technology. The impact of these changes is revolutionizing accounting and the accounting profession. But the changes have yet to reach their ultimate potential. For example, accounting in the 1990s began to provide current-value information and estimates about the future that an investor or other user would find useful for decision making. The availability of computer software and the Internet greatly enhanced the potential for data and information services. Such changes create opportunities for accounting and accountants and also will require substantial modifications in the traditional financial accounting and reporting model.

What is the profession of accounting?

At the core of the profession of accounting is the certified public accountant (CPA) who has passed the national CPA examination, been licensed in at least one state or territory, and engages in the practice of public accounting/auditing in a public accounting or CPA firm. The CPA firm provides some combination of two or more of four types of services: accounting, auditing, income tax planning and reporting, and management advising/consulting. Analysis of trends indicates that the demand for auditing services has peaked and that most of the growth experienced by public accounting firms is in the consulting area.

Accounting career paths, specializations, or subprofessions for CPAs who join profit-seeking enterprises include being controllers, chief financial officers, or internal auditors. Other career paths include being controllers or chief financial officers in not-for-profit or government organizations and teaching in colleges and universities. Students should note that non-CPAs also could enter these subprofessions and that certificates, but not licenses, could be earned by passing examinations in several areas, including internal auditing, management accounting, and bank auditing.

How do environmental changes impact the accounting profession?

Numerous changes in the environment make the practice of accounting and auditing much different in the new century than it was in the 1970s. For example, professional accounting firms now actively compete for clients by advertising extensively in various media, a practice that at one time was forbidden by their code of professional conduct. Mergers of clients have led CPA firms into mergers as well, such that the Big Eight is now the Big Five and the second-tier group has been reduced from twelve firms to about five. Another result of competition and other changes has been that some of the largest employers of CPAs now include income tax and accounting services firms such as H&R Block and an American Express subsidiary.

Competition among CPAs also has led the SEC to expand its regulatory and enforcement activities to ensure that financial reports are relevant and reliable. From its inception, the SEC has had legal authority to prescribe the accounting principles and standards used in the financial reports of enterprises whose securities are publicly traded, but it has delegated this responsibility to the accounting profession. Since 1973, that organization has been the FASB, with which the SEC works closely. But because the FASB is limited to performing what is essentially a legislative function, the SEC has substantially increased its enforcement activities to ensure that the FASB's standards are appropriately applied in financial reports and that accountants/auditors act in the public interest in performing their independent auditsfor which the Securities Acts have given the CPA profession a monopoly.

How does a student prepare for the accounting profession?

Persons considering entering the accounting profession should begin by doing some self-analysis to determine whether they enjoy mathematical, problem- or puzzle-solving, or other analytical activities; by taking some aptitude tests; or by talking with accounting teachers or practitioners about their work.

Anyone interested in becoming an accounting professional should expect to enter a rigorous five-year education program and to earn a master's degree in order to qualify to enter the profession and to sit for the CPA examination. To build a base for rising to the top of the profession, students should select courses that help them learn how to think and to define and solve problems. The courses should help them to develop analytical (logical, mathematical, statistical), communication (oral, reading, writing), computer, and interpersonal skills. The early part of the program should emphasize arts and sciences courses in these skill-development areas.

The person should begin to develop word-processing, data-processing, and Internet skills long before entering college and should expect to maintain competence in them throughout his or her professional career. These skills greatly enhance and facilitate all phases and aspects of what accounting and accountants attempt to do. What can be done is limited only by technology and by the sophistication of the system, its operators, and users.

see also Accounting Cycle; Accounting: Historical Perspectives; Careers in Accounting; Ethics in Accounting


Hansen, Don R., and Mowen, Maryanne M. (2000). Management Accounting (5th ed.). Cincinnati, OH: Southwestern College Publishing.

Kimmel, Paul D., Weygandt, Jerry J., and Kieso, Donald E. (2000). Financial Accounting (2nd ed.). New York: Wiley.

Harvey S. Hendrickson

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A system of recording or settling accounts in financial transactions; the methods of determiningincome and expenses for tax and other financial purposes. Also, one of the remedies available for enforcing a right or redressing a wrong asserted in a lawsuit.

Various accounting methods may be employed. The accrual method shows expenses incurred and income earned for a given period of time whether or not such expenses and income have been actually paid or received by that time. The cash method records income and expenses only when monies have actually been received or paid out. The completed contract method reports gains or losses on certain long-term contracts. Gross income and expenses are recognized under this method in the tax year the contract is completed. The installment method of accounting is a way regulated utilities calculate depreciation for income tax purposes.

The cost method of accounting records the value of assets at their actual cost, and the fair value method uses the present market value for the recorded value of assets. Price level accounting is a modern method of valuing assets in a financial statement by showing their current value in comparison to the gross national product.

Where a court orders an accounting, the party against whom judgment is entered must file a complete statement with the court that accounts for his or her administration of the affairs at issue in the case. An accounting is proper for showing how an executor has managed the estate of a deceased person or for disclosing how a partner has been handling partnership business.

An accounting was one of the ancient remedies available in courts of equity. The regular officers of the Chancery, who represented the king in hearing disputes that could not be taken to courts of law, were able to serve as auditors and work through complex accounts when necessary. The chancery had the power to discover hidden assets in the hands of the defendant. Later, courts of law began to recognize and enforce regular contract claims, as actions in assumpsit, and the courts of equity were justified in compelling an accounting only when the courts at law could not give relief. A plaintiff could ask for an accounting in equity when the complexity of the accounts in the case made it too difficult for a jury to resolve or when a trustee or other fiduciary was charged with violating a position of trust.

In the early twenty-first century, courts in the United States generally have jurisdiction both at law and in equity. They have the power to order an accounting when necessary to determine the relative rights of the parties. An accounting may be appropriate whenever the defendant has violated an obligation to protect the plaintiff's interests. For example, an accounting may be ordered to settle disputes when a partnership is breaking up, when an heir believes that the executor of an estate has sold off assets for less than their fair market value, or when shareholders claim that directors of a corporation have appropriated for themselves a business opportunity that should have profited the corporation.

An accounting may also be an appropriate remedy against someone who has committed a wrong against the plaintiff and should not be allowed to profit from it. For example, a bank teller who embezzles money and makes "a killing" by investing it in mutual funds may be ordered to account for all the money taken and the earnings made from it. A businessperson who palms off a product as that of a more popular manufacturer might have to account for the entire profit made from it. A defendant who plagiarizes another author's book can be ordered to give an account and pay over all the profits to the owner of the copyrighted material. An accounting forces the wrongdoer to trace all transactions that flowed from the legal injury, because the plaintiff is in no position to identify the profits.

Arthur Andersen and Other Accounting Failures

The accounting profession, which is largely self-regulated, has suffered through a series of fiascoes since the late 1990s, resulting in a call for major changes in accounting standards. The Financial Accounting Standards Board (FASB) has served since 1973 as one of the organizations responsible for establishing standards of financial accounting and reporting. Although the FASB is a private organization, its standards are recognized as authoritative by the securities and exchange commission (SEC) and the American Institute of Certified Public Accountants. In the late 1990s and early 2000s, debacles involving major accounting firms required the FASB and the SEC, as well as other regulatory organizations, to consider new rules designed to improve financial reporting. Between 1996 and 2002, investors lost an estimated $200 billion in earnings restatements and stock meltdowns following failures in auditing processes. A number of high-profile auditing failures decreased confidence in the accounting profession. Among these failures were incidents involving such companies as Bausch and Lomb, Rite Aid, Cendant, Sunbeam, Waste Management, Superior Bank, and Dollar General.

One of the most highly publicized accounting failures in this period involved Houston-based Enron Corporation and its accountant, Arthur Andersen, L.L.P. Enron suffered a collapse in the third quarter of 2001 that resulted in the largest bankruptcy in U.S. history and numerous lawsuits alleging violations of federal securities laws. Thousands of Enron employees lost 401(k) retirement plans that held company stock. The controversy extended to Arthur Andersen, which was accused of overlooking significant sums of money that had not been represented on Enron's books. Arthur Andersen was later found guilty on federal charges that it obstructed justice by destroying thousands of Enron documents. Enron reported annual revenues of about $101 billion between 1985 and 2000. On December 18, 2000, Enron's stock sold for $84.87 per share. Stock prices fell throughout 2001, however, and on October 16, 2001, the company reported losses of $638 million in the third quarter alone. During the next six weeks, company stock continued to fall, and by December 2, 2001, Enron stock dropped to below $1 per share after the largest single day trading volume for any stock listed on either the New York Stock Exchange or the NASDAQ.

Initial allegations focused upon the role of Arthur Andersen. The company was one of the "Big Five" accounting firms in the United States, and it had served as Enron's auditor for sixteen years. Arthur Andersen also served as a consultant to Enron, thus raising serious questions regarding conflicts of interests between the two companies. According to court documents, Enron and Arthur Andersen had improperly categorized hundreds of millions of dollars as increases in shareholder equity, thereby misrepresenting the true value of the corporation. Arthur Andersen also did not follow generally accepted accounting principles (GAAP) when it considered Enron's dealings with related partnerships. These dealings, in part, allowed Enron to conceal some of its losses.

Arthur Andersen was also accused of destroying thousands of Enron documents that included not only physical documents but also computer files and e-mail files. After investigation by the u.s. justice department, the firm was indicted on obstruction of justice charges in March 2002. After a six-week trial, Arthur Andersen was found guilty on June 16, 2002. The company was placed on probation for five years and was required to pay a $500,000 fine. Some analysts also questioned whether the company could survive after this series of incidents.

The accounting issues in the Enron case extended beyond Enron and Arthur Andersen. Prior to this case and since 1977, the accounting field was supervised considerably by the Public Oversight Board (POB). When SEC chairman Harvey L. Pitt in 2002 made a series of inquiries about the system of self-regulation in the accounting profession, he did not consult the POB. The POB voted to disband, effective May 1, 2002. After the Enron case, the FASB emerged in the public spotlight as the leader of the system of self-regulation and has taken a significant role in the reform of accounting rules. In January 2003, the FASB announced new accounting rules designed to force U.S. companies to move billions of dollars from off-balance-sheet entities into the companies' balance sheets. The SEC has also stepped up its oversight of company accounting.

further readings

Meyer, Charles H. 2002. Accounting and Finance for Lawyers in a Nutshell. 2d ed. St. Paul, Minn.: West Group.

Rachlin, Robert, and Allen Sweeny. 1996. Accounting and Financial Fundamentals for Nonfinancial Executives. New York: AMACON.


Accrual Basis; Cash Basis; Income Tax.

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accounting, classification, analysis, and interpretation of the financial, or bookkeeping, records of an enterprise. The professional who supplies such services is known as an accountant. Auditing is an important branch of accounting.

The Role of the Accountant

The accountant evaluates records drawn up by the bookkeeper and shows the results of this investigation as losses and gains, leakages, economies, or changes in value, so as to reveal the progress or failures of the business and also its future limitations and possibilities. Accountants must also be able to draw up a set of financial records and prescribe the system of accounts that will most easily give the desired information; they must be capable of arriving at a comprehensive view of the economic and the legal aspects of a business, envisaging the effect of every sort of transaction on the profit-and-loss statement; and they must recognize and classify all other factors that enter into the determination of the true condition of the business (e.g., statistics or memoranda relating to production; properties and financial records representing investments, expenditures, receipts, fiscal changes, and present standing). Cost accounting shows the actual cost, over a certain period of time, of particular services rendered or of articles produced; by this system unprofitable ventures, services, departments, and methods may be discovered.

Development of Modern Accounting

Although there were stewards, auditors, and bookkeepers in ancient times, the professional accountant is a 19th-century development. Unlike those precursors, modern accountants usually do not service a single client or employer; instead they offer their expertise, for a fee, to several individuals and businesses. The profession was first recognized in Great Britain in 1854, when the Society of Accountants in Edinburgh was given a royal charter. Similar societies were later established in Glasgow, Aberdeen, and London. In the United States the first such professional society was the American Association of Public Accountants, chartered by the state of New York in 1887.

All the states and Puerto Rico and the District of Columbia now have laws under which an accountant who fulfills certain educational and experience requirements and passes an examination may be granted the title Certified Public Accountant (CPA). CPAs have organized into state and national societies. The bodies representing the accounting profession in the United States are the American Institute of Certified Public Accountants, which is the contemporary successor organization of the American Association of Public Accountants, and the American Accounting Association, organized in 1916. In the United States, the Financial Accounting Standards Board, an independent nongovernmental organizaiton sponsored by financial-reporting industry groups, is the main institution responsible for establishing accounting standards and rules. The International Accounting Standards Board develops standards and rules that are accepted by many nations.

With the growth of corporate activity in the 20th cent., the field of accounting has increased greatly in importance and has seen many improvements in theory and techniques. The chief causes of changes in accounting methods have been more complex tax laws and regulations and the need to keep uniform accounts for possible governmental or public scrutiny. Contemporary accounting firms also have taken on managerial functions and are no longer concerned simply with ascertaining and reporting financial condition but also with advising a client how to act on this information; they also consult on information-technology systems and other services. This has greatly increased the potential for conflicts of interest, because the services provided to clients by accounting firms must be evaluated in their audits and because the fees paid by a client for such services may be more important to the accounting firm than that paid for an audit, potentially undermining the independence of the audit. As a result, in 2000 the Securities and Exchange Commission specified the types of services accounting firms could provide without compromising their independence as auditors.

A series of revelations concerning accounting firms' failure to detect or publicly challenge irregularities or fraud when auditing the finances of a number of corporations led Congress to establish (2002) the Public Company Accounting Oversight Board. The board is appointed by the Securities and Exchange Commission and has the power to register and regulate accountants and firms that act as auditors. It sets standards for audits and is responsible for reviewing audits and disciplining accountants and accounting firms.


See N. A. H. Stacey, English Accountancy, 1800–1954 (1954); M. Backer, ed., Modern Accounting Theory (1966); L. Goldberg and V. R. Hill, The Elements of Accounting (3d ed. 1966); J. D. Edwards, History of Public Accounting in the United States (1960); A. J. Briloff, Unaccountable Accounting (1972); M. Chatfield, A History of Accounting Thought (1977).

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ac·count·ing / əˈkounting/ • n. the action or process of keeping financial accounts.

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