BAFS Study Notes: Purposes and Role of Accounting
Hello everyone! Welcome to your first key topic in accounting. Think of this as learning the alphabet before you start writing amazing stories. Understanding the purpose and role of accounting is the foundation for everything else you'll learn in BAFS. In these notes, we'll explore what accounting really is (hint: it's not just about maths!), why it's so important for every business, and the main jobs it performs. Let's get started!
Why is Accounting So Important? The Language of Business
What is Accounting?
At its heart, accounting is the process of recording, classifying, summarising, and communicating financial information about a business.
Imagine you own a small bubble tea shop. You have money coming in from sales, and money going out to pay for rent, tea leaves, and your staff's salaries. Accounting is the system you use to keep track of all this activity in an organised way. It turns messy raw data (like a pile of receipts) into useful, understandable information.
Analogy: Think of accounting as the 'language of business'. Just like English or Chinese helps us communicate ideas, accounting helps a business communicate its financial health and performance to the people who need to know.
Who Uses Accounting Information and Why? (Decision-Making)
The main goal of accounting is to provide information that helps people make smart decisions. We can group these people, known as users of accounting information, into two main categories:
1. Internal Users
These are people inside the business who need information to run it effectively.
Who: Managers, Business Owners
Why they need it: To make daily operational decisions.
Example Decisions:
- Is our new 'cheese foam green tea' profitable enough to keep on the menu?
- Do we have enough cash to buy a new, faster sealing machine?
- Should we hire more part-time staff for the summer holiday?
2. External Users
These are people and organisations outside the business who have an interest in its performance.
Who: Investors (current or potential)
Why they need it: To decide whether to invest in the business (buy shares).
Example Decision: 'Looking at this company's profit history, should I buy its shares?'
Who: Lenders (e.g., Banks)
Why they need it: To decide whether to lend money to the business.
Example Decision: 'Can this business afford to pay back a $500,000 loan?'
Who: The Government (e.g., Inland Revenue Department)
Why they need it: To ensure the business pays the correct amount of tax.
Example Decision: 'Based on its declared profit, how much profits tax does this company owe?'
Key Takeaway
Accounting provides the crucial financial information that both insiders (like managers) and outsiders (like investors and banks) need to make informed decisions about a business.
The Four Main Jobs of Accounting
To produce useful information, accounting performs four key functions. These happen in a logical order. A great way to remember them is RCSC.
Memory Aid: RCSC
Think: "Really Cool Students Communicate"
Let's break them down:
1. Recording
This is the starting point. Recording is the day-to-day process of writing down all the financial activities of a business, known as business transactions. A transaction is any event that has a financial impact on the business.
Example: When your bubble tea shop sells a drink for $25, pays the electricity bill of $1,000, or buys a new box of straws for $100, each of these is a transaction that must be recorded.
2. Classifying
Recording alone gives you a long, messy list of transactions. Classifying involves sorting and grouping similar transactions into categories, or 'accounts'.
Analogy: It's like sorting your laundry. You don't just throw everything in one drawer. You put all the socks in one place, all the t-shirts in another. In accounting, you put all the sales transactions into a 'Sales' account, and all rent payments into a 'Rent Expense' account.
3. Summarising
Once everything is classified, you need to make sense of it all. Summarising involves presenting the classified information in a clear and condensed way. This is where the main accounting reports, called financial statements, are created.
Example: Instead of looking at 1,000 individual sales transactions, the summary might show 'Total Sales for May: $80,000'. The most common financial statements are the Income Statement (showing profit or loss) and the Statement of Financial Position (showing assets and liabilities).
4. Communicating
The final, crucial step is communicating. This means sharing the summarised information (the financial statements) with the users we talked about earlier (managers, investors, banks, etc.). If the information isn't communicated, it's useless!
Analogy: This is like the school issuing a report card (the financial statement) to the parents and students (the users). The report card communicates the student's performance.
Key Takeaway
The four functions of accounting are a process: First, you Record transactions, then you Classify them into groups, next you Summarise them into financial statements, and finally, you Communicate these statements to users so they can make decisions.
The Accounting Cycle: From Transaction to Report
The "jobs" of accounting don't happen randomly. They follow a standard, repeating process called the accounting cycle. It's the set of steps accountants follow during an accounting period (e.g., a month or a year) to handle all the financial information.
Don't worry if the names of these steps seem technical at first. The goal here is to understand the flow of the process, not to be an expert in each step just yet!
Step-by-Step Flow of the Accounting Cycle
Step 1: Books of Original Entry (Journals)
This is where transactions are first recorded (the Recording function). They are written down in chronological order (by date) in books called journals.
Analogy: This is like the first draft or daily logbook of everything that happened financially.
Step 2: Ledgers
Next, the information from the journals is transferred, or 'posted', to the ledgers. The ledger contains a separate page (or account) for each category. This is the main part of the Classifying function.
Analogy: You take the information from your daily logbook and organise it into different folders, like a 'Cash' folder, a 'Sales' folder, and an 'Electricity Expense' folder.
Step 3: Trial Balance
Before preparing the final reports, the accountant prepares a trial balance. This is a list of all the accounts from the ledger and their balances. Its main purpose is to check that the accounting records are mathematically correct. It's an internal check, not a report for external users.
Analogy: It's like a quick calculation to make sure all your numbers add up correctly before you write your final essay.
Step 4: Period-end Adjustments
Sometimes, at the end of a period, certain transactions haven't been recorded yet (like salaries owed to employees for the last few days of the month). Adjustments are made to ensure all revenues and expenses for the period are correctly reported.
Analogy: Making final edits and adding footnotes to your essay to make sure it's completely accurate and up-to-date.
Step 5: Financial Statements
This is the final output! Using the adjusted information, the formal reports are prepared. This is the Summarising and Communicating function in action. These are the reports that managers, investors, and banks will use.
Analogy: Publishing your final, polished essay (the financial statements) for everyone to read.
Did you know?
The system of accounting we use today, called double-entry bookkeeping (which is the foundation of the accounting cycle), was first described in detail by an Italian mathematician named Luca Pacioli way back in 1494!
Key Takeaway
The accounting cycle is the orderly, step-by-step process that turns a raw business transaction into a final, useful financial statement. The basic flow is: Journals → Ledgers → Trial Balance → Adjustments → Financial Statements.