What is the Accounting Process?
Accounting or accountancy is significant to understand for anyone who owns a business or seeking a career in commerce-related fields. Accountancy is of crucial importance in commerce as it deals with measuring, processing, and analyzing financial information in a firm. It is rightly called the "language of business."
This crucial field has several subfields that deal with various aspects of the finances of a company.
Accountancy is an important subject for all commerce students. Students may find a few topics from accountancy difficult to comprehend as they are new to the subject and still getting a hang of it. Students may get overwhelmed by the amount of information that they need to learn and process to excel in the subject. Therefore, Vedantu brings you all the information you need to know about the accounting process. You will also read about different types of accounting processes and their workings.
So if you are someone who is desiring to understand the basics of accounting processes or a student who wishes to understand various aspects of accountancy, then this article is for you.
Vedantu's expert accounts professionals have gathered all the important information regarding the process of accounting and summed it up in an easy-to-understand manner for its readers.
History of Accounting
Accountancy is not a new field that has been recently developed. This subject has been used in its most basic form since ancient civilizations. Research shows that the first forms of accounting can be traced to the Mesopotamian civilization. Egyptians and Babylonians are said to be the first ones to develop auditing systems. Also, research in the earliest Roman Empire reveals that the Roman Government had access to detailed financial information.
Talking about India, it is well known that during the Mauryan Empire, Chanakya wrote a manuscript that was quite similar to a financial management book. Chanakya has also been credited to write a book named "Arthashastra" that contains detailed accounts of bookkeeping for a state.
In addition to these, one can easily find that all the earliest forms of civilization developed some form of accounting techniques to maintain records and go over their finances.
Therefore it can be safely said that the modern professional accounting that we see today is a product of the evolution of centuries-old traditions, needs, and thought about managing finances.
What is the Accounting Process?
Accounting is a process that helps in recording the financial transactions which are necessary for the business. This process includes summarizing, analyzing and reporting the transactions to give an overview to the agencies, regulators and tax collection entities. The financial statements that are used in accounting are in a concise summary format. Financial transactions which occurred over an accounting period summarizes the company's operations, the financial position and also the cash flows.
How Accounting Works?
Accounting is one of the most prior functions for almost any kind of business which may be handled by a bookkeeper or by an accountant at a small firm, or even by a sizable finance department with a dozen of employees at larger companies. The reports that are generated by various streams of accounting like cost accounting and managerial accounting are invaluable in helping the management to make an informed business decision.
Types of Accounting
Financial Accounting
This accounting refers to the processes that are used to estimate the interim and annual financial statements. These results in all the financial transactions which occur during the accounting period. They are summarized into a balance sheet, an income statement, and a cash flow statement.
Managerial Accounting
Managerial Accounting uses the same data as financial accounting. In managerial accounting, an accountant generally generates monthly and also the quarterly reports that a business's management team can implement the same to devise decisions about how the business should operate
Cost Accounting
Cost accounting helps the business to make decisions about costing. More importantly, cost accounting considers all of the costs related to producing a product.
Accounting Process Steps
The accounting is processed into three separate types of transactions which were used to record the business transactions. The information is then recorded into financial statements. The transactions are:
The First Step: to ensure that the entries are reversed from the previous period.
The Second Step: comprises the steps which are needed to record the individual business transactions in the accounting records.
The Third Step: is the period-end processing that is required to close the books and produce the financial statements.
First Step
Is to verify that all the transactions are designated as reversing entries in the preceding periods which have actually been reversed. Doing this will ensure that the transactions are not recorded twice in the same period. These transactions are generally tagged as being the reversing entries in the accounting software.
Second Step
The second step consists of further four steps:
Identifying the transaction.
Preparing the document.
Identifying the accounts.
Recording the transaction
The above-mentioned four steps are part of an accounting process that is used to record the individual business transactions in the accounting records.
Third Step
In this last step, the final recording is done:
Prepare Trial Balance - The trial balance lists the balance left in all the accounts. The total of all the debit in the trial balance equals the total of all the credit, while in contrast to this, there is an error in the entry of the original transactions which must be researched and corrected.
Adjust the Trial Balance - This may be required to adjust the trial balance, correct the errors or create the allowances.
Prepare an Adjusted Trial Balance - This is an original trial balance, plus or minus and other such adjustments are to be subsequently made.
Prepare Financial Statements - The financial statements are then adjusted from the trial balance. The asset, liability, and shareholders' equity items are recorded in the balance sheet.
Close the Period - For closing the period, the shifting of the balances is done in the revenue and expense accounts into the retained earning account.
FAQs on Accounting Process: From Journal to Final Accounts
1. What are the main steps in the accounting process, from recording a transaction to preparing the final accounts?
The accounting process, often called the accounting cycle, is a systematic procedure to record, classify, and summarise financial transactions. The key steps for a Class 11 student to understand, as per the CBSE syllabus, are:
- Identifying Transactions: Recognising financial events from source documents like invoices or receipts.
- Journalising: Recording these transactions chronologically in a Journal, which is the book of original entry.
- Posting to Ledger: Transferring journal entries to respective accounts in the Ledger.
- Preparing a Trial Balance: Listing all ledger account balances to check the arithmetical accuracy of the postings.
- Making Adjustments: Passing adjusting entries for items like outstanding expenses or accrued income (though basic problems may omit this).
- Preparing Financial Statements: Using the adjusted trial balance to create the Income Statement (or Trading and Profit & Loss Account) and the Balance Sheet.
- Closing the Books: Transferring revenue and expense account balances to prepare for the next accounting period.
2. What is the role of a 'Journal' in the accounting process?
The Journal is the very first book where financial transactions are recorded. It is known as the 'Book of Original Entry' because transactions are first documented here before being transferred anywhere else. Its primary role is to maintain a chronological (date-wise) record of all business transactions, complete with a narration explaining the transaction, ensuring no transaction is omitted from the records.
3. How are transactions transferred from the Journal to the Ledger?
The process of transferring transactions from the Journal to the Ledger is called 'Posting'. For each entry in the journal, the amount is transferred to the respective debit and credit accounts in the ledger. For example, if the journal entry is 'Cash A/c Dr. to Sales A/c', the amount will be posted on the debit side of the Cash Account and the credit side of the Sales Account in the ledger.
4. Why is a Trial Balance prepared before creating the final financial statements?
A Trial Balance is prepared for two primary reasons. Firstly, it serves as a fundamental check on the arithmetical accuracy of the posting process. If the total of the debit balances equals the total of the credit balances, it indicates that the ledger posting is likely correct. Secondly, it provides a consolidated list of all account balances in one place, which acts as the direct source for preparing the key financial statements like the Income Statement and Balance Sheet.
5. What are the key financial statements prepared at the end of the accounting process?
The end-product of the accounting process is a set of financial statements that summarise a company's financial performance and position. The main statements are:
- Income Statement: Also known as the Trading and Profit & Loss Account, it shows the company's revenues and expenses over a period, revealing the net profit or loss.
- Balance Sheet: This statement presents a snapshot of the company's financial position at a specific point in time. It lists the company's Assets, Liabilities, and Equity.
- Cash Flow Statement: This statement reports the cash generated and used during a period, categorised into operating, investing, and financing activities.
6. What is the fundamental difference between bookkeeping and accounting?
While often used interchangeably, bookkeeping and accounting are different. Bookkeeping is the initial part of the process and is primarily concerned with the accurate recording of financial transactions in the books of accounts (like the journal and ledger). Accounting is a much broader concept that starts where bookkeeping ends. It involves summarising, analysing, and interpreting the recorded data to provide insights for decision-making. In simple terms, bookkeeping is the record-keeping function, while accounting is the analytical and reporting function.
7. Can you provide a simple example of the accounting process for a basic transaction?
Certainly. Let's take the example of a business starting with ₹50,000 cash.
- 1. Transaction: The owner invests ₹50,000 cash into the business.
- 2. Journal Entry: The transaction is recorded in the Journal as:
Cash A/c Dr. ₹50,000
To Capital A/c ₹50,000
(Being business started with cash) - 3. Ledger Posting: The amount is posted to the debit side of the Cash Account and the credit side of the Capital Account in the Ledger.
- 4. Trial Balance: In the Trial Balance, Cash A/c will show a debit balance of ₹50,000 and Capital A/c a credit balance of ₹50,000.
- 5. Final Accounts: In the Balance Sheet, Cash of ₹50,000 will be shown as an Asset, and Capital of ₹50,000 will be shown as a Liability (Capital).
8. How does the accounting process help a business in making important decisions?
The accounting process is not just about recording transactions; it's a vital tool for decision-making. The financial statements generated provide critical information. For example, the Income Statement helps management assess profitability and decide on pricing or cost-cutting strategies. The Balance Sheet shows the financial health and solvency, guiding decisions about taking loans or making large investments. This data helps management move from guesswork to informed, strategic choices.
