Financial accounting information plays an important role in almost all economies. It is used by managers, investors, financial analysts, creditors, regulators, and even employees and customers on occasion. All of these people need to understand both the current financial status of an organization, as well as the events that caused a change in that status from some prior point in time.

To satisfy these needs, an organization needs records that show what resources it has, where it obtained the funds to acquire them, and how it has used them. An accounting system collects, summarizes, and reports this information. Its end product is a set of financial statements, which typically includes a balance sheet, an income statement, and a statement of cash flows.

A BRIEF HISTORY

Accounting’s roots can be traced to the Italian Renaissance and the then-emerging city states. At that time, as commerce was increasing, merchants began to recognize a need for improved record keeping, both to avoid mistakes in keeping track of financial information, and to provide them with a better sense of the financial performance of their businesses.

The breakthrough came when an Italian monk, Fra. Luca Pacioli, devised the system of double-entry bookkeeping that remains the cornerstone of accounting today. Fra. Pacioli, a mathematician, reasoned that if, instead of making a single entry to the accounts each time a transaction took place, a bookkeeper made two entries in two different accounts, there could be a system of checks and balances. His insight gave rise to what is known as the dual aspect concept of accounting.

THE ACCOUNTING SYSTEM

The purpose of an accounting system is to collect, summarize, and report information concerning the impact of various business events on an organization’s financial status and financial performance. Organizations periodically report their financial status as of a certain date, and their financial performance for some period of time preceding that date, which is known as the accounting period. The accounting period is usually one year, generally called the fiscal year, but it also can be shorter, often as short as one month.

For many organizations, the fiscal year coincides with the calendar year. For others, the end date is governed by the organization’s industry. For example, the fiscal year for colleges and universities in the United States typically ends on June 30, which coincides with the end of an academic year. The fiscal year for many retail stores ends on January 31, which is immediately after the holiday season’s sales and returned gifts. The U.S. government’s fiscal year ends on September 30.

STANDARDS AND STANDARD SETTERS

For financial accounting information to be useful to readers of financial statements, it must be collected and presented in a reasonably similar fashion by all organizations. As a result, an accounting system must abide by a set of standards, called Generally Accepted Accounting Principles (GAAP) in the United States. The purpose of these standards is to assure financial statement users that a particular item means essentially the same thing on the financial statements of any organization doing business in any industry. This is a tricky proposition, however, and despite the presence of standards, most organizations have considerable latitude in the way they interpret information and present it on their financial statements.

The Financial Accounting Standards Board

The development of new accounting principles in the United States is the responsibility of the Financial Accounting Standards Board (FASB). The FASB is a private sector body with seven full-time members and a large staff. It has an annual budget of about $15 million, which is contributed by a variety of organizations, including public accounting firms.