introduction to bookkeeping: Historical of Financial Accounting

Historical of Financial Accounting

( Go to the frist introduction to accounting bookkeeping )

It is all too easy to think of financial statements merely as pieces of paper with numbers written on them, rather than in terms of the economic events and physical assets for Ex. land - buildings - and equipment .. that underlie the numbers.

However, if readers of financial statements understand how and why financial accounting began, and how financial statements are used, they can better visualize what is happening within a business and why financial accounting information is so important.

Thousands of years ago - individuals or families were self-contained in the sense that they gathered their own food, made their own clothes, and built their own shelters.

When specialization began, some individuals or families became good at hunting, others at making arrowheads, others at making clothing, and so on. With specialization came trade, initially by bartering one
type of goods for another.

At first, each producer worked alone, and trade was strictly local. Over time, some people set up production shops that employed workers, simple forms of money were used, and trade expanded beyond the local area.

As these simple economies expanded - more formal forms of money developed and a primitive form of banking began, with wealthy merchants lending profits from past dealings to enterprising shop owners and traders who needed money to expand their operations.

When the first loans were made, lenders could physically inspect borrowers’ assets and judge the likelihood of repayment. Eventually, though, lending became much more complex. Industrial borrowers were developing large factories, merchants were acquiring fleets of ships and wagons, and loans
were being made to finance business activities at distant locations.

At that point - lenders could no longer easily inspect the assets that backed their loans, and they needed a practical way of summarizing the value of those assets. Also, certain loans were made on the basis of a share of the profits of the business, so a uniform - widely accepted method for expressing income was required.

In addition, owners required reports to see how effectively their own enterprises were being operated - and governments needed information for use in assessing taxes. For all these reasons, a need arose for financial statements - for accountants to prepare the statements, and for auditors to verify the accuracy of the accountants’ work. The economic systems of the industrialized countries have grown enormously since the beginning - and  the financial accounting has become much more complex.

However, the original reasons for accounting statements still apply:
Bankers and other investors need accounting information to make intelligent investment decisions - managers need it to operate their organizations efficiently; and taxing authorities need it to assess taxes in an equitable manner.

It should be no surprise that problems can arise when translating physical assets and economic events into accounting numbers. Nevertheless - that is what accountants must do when they construct financial statements.

To illustrate the translation problem - the numbers shown on the balance sheet to reflect a business’s assets and liabilities generally reflect historical costs and prices. However, inventories may be spoiled - obsolete - or even missing; land - buildings - and equipment may have current values that are much higher or
lower than their historical costs - and money owned to the business may be uncollectible. Also, some liabilities - such as obligations to make lease payments, may not even show up in the numbers. Similarly, costs reported on an income statement may be understated or overstated, and some costs - such as depreciation, do not even represent current cash expenses.

When examining a set of financial statements - it is best to keep in mind the physical reality that underlies the numbers and also to recognize that many problems occur in the translation process.
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The Users of Financial Accounting Information

Regulation and Standards in Financial Accounting
Financial Accounting Standards Board (FASB)
Generally accepted accounting principles (GAAP)
American Institute of Certified Public Accountants (AICPA)


Basic Concepts of Financial Accounting
The preparation and presentation of financial accounting data is based ona set of principles, the most important of which are:
(1) accounting entity,(2) going concern, (3) accounting period,
(4) objectivity, (5) reliability,(6) monetary unit,
(7) relevance, (8) full disclosure, (9) materiality,
(10) conservatism, (11) consistency, and (12) comparability.


The financial Accounting flowchart
This topic describes  the  financial accounting process.  It shows how  information about transactions and events is accumulated to produce the balance sheet and the income statement. This early presentation is quite basic; subsequent chapters will present more complex issues. the cash flow effects of various transactions are addressed in another topic, the statement of cash flows is actually covered in detail in other topic, “Statement of Cash Flows.”

accounting equation


Recording and Compiling Accounting Data
explain the following terms used in the recording and compiling of accounting data:
• Transaction
• Account
• Posting
• Chart of accounts
• General ledger
• T account
• Double entry system