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Businesses conduct numerous transactions daily, which can number in the hundreds or thousands depending on their size. It is impractical for a businessperson to remember all these transactions in detail. Therefore, it is essential to record these transactions systematically in books of account, a process known as bookkeeping.
Bookkeeping involves recording financial data and can be defined as:
"The art of maintaining a permanent record of business transactions is book-keeping."
From these records, details such as total sales, total purchases, total cash receipts, and total payments can be determined. However, since the main objective of a business is to earn profits, merely recording transactions is not enough. Accounting includes bookkeeping as well as many other activities. In 1941, the American Institute of Certified Public Accountants (AICPA) defined accounting as:
"The art of recording, classifying, summarizing, analyzing, and interpreting business transactions systematically and communicating business results to interested users in accounting."
Accounting is a system for recording business transactions to create economic information about business enterprises, aiding in decision-making. Its primary function is to provide quantitative financial information about economic entities, which is intended to assist in making economic decisions.
The American Accounting Association defined accounting as:
"It is the process of identifying, measuring, recording and communicating the required information relating to the economic events of an organization to the interested users of such information."
To understand the nature of accounting, consider the following aspects of its definition:
Economic Events: These are occurrences that affect a business organization and include transactions measurable in monetary terms. For example, purchasing and installing machinery involves several financial transactions such as buying the machine, transporting it, preparing the installation site, and incurring installation expenses.
Identification: Determining which transactions should be recorded, focusing on those of a financial nature. For example, recording purchases made for cash or credit, while non-financial items like changes in managerial policies are not recorded.
Measurement: Quantifying business transactions in financial terms using a monetary unit. Events that cannot be quantified in monetary terms are not recorded, such as appointments or contract signings.
Recording: Once economic events are identified and measured in financial terms, they are recorded in the books of account in date wise. This follows established accounting practices to ensure that necessary financial information is accurately summarized.
Communication: The recorded economic events are organized to generate and communicate relevant information to management and other internal and external users. Financial information is regularly communicated through accounting reports.
Organization: Refers to any business enterprise, whether for profit or not-for-profit.
Interested Users of Information: Various users need financial information to make important decisions, including investors, creditors, labor unions, trade associations, and others.
Bookkeeping and accounting can be differentiated on various bases such as nature, objective, function, basis, level of knowledge, etc.
Difference Between Bookkeeping and Accounting :
Basis of Difference | Bookkeeping | Accounting |
|---|---|---|
Nature | Involves identifying financial transactions, measuring them in monetary terms, recording, and classifying them. | Involves summarizing the recorded transactions, interpreting them, and communicating the results. |
Objective | To maintain systematic records of financial transactions. | To determine the business's income and financial position by maintaining records of transactions. |
Function | Focuses on recording business transactions, with a limited scope. | Encompasses recording, classifying, summarizing, and interpreting business transactions, and communicating the results, with a broader scope. |
Basis | Uses vouchers and other supporting documents as evidence to record business transactions. | Relies on bookkeeping records to provide accounting information. |
Level of Knowledge | Basic knowledge of accounting is sufficient. | Requires advanced and comprehensive knowledge. |
Relation | The initial step in the accounting process. | Continues where bookkeeping ends. |
Accounting and bookkeeping are closely related but distinct processes. Bookkeeping is the first step, involving the recording of financial transactions. Accounting starts where bookkeeping ends. To explore accounting more thoroughly, it's essential to understand its branches and objectives. Knowing the objectives of accounting is crucial for accounting learning.
In our next article, we will explore the objectives of accounting and its various branches.