The Role of Accounting in Business

Types and Organizations of Businesses

When looking at the role of accounting in business, we must first look at what business is. A business is an organization in which basic resources (inputs - ie, material and labor) are assembled and processed to provide goods and services (outputs) to customers. Some of these are for profit businesses, while others are not-for-profit businesses. There are three basic types of businesses: Service, Manufacturing and Merchandising.

Service businesses provide services rather than products to customers. An example of a service business would be airlines, where they provide the service of transporting customers from point A to point B. Manufacturing business change the basic inputs into products that are then sold to individual customers. An example of a manufacturing business would be Dell Computers, who make computers to sell to others. Merchandising businesses provide products that they purchase from other businesses to customers. An example of this would be WalMart, who purchases the Dell computers, and then resells them to their customers.

In addition to the types of businesses, there are also types of business organizations. The four basic types are Proprietorship, Partnership, Corporation and Limited Liability Company.

A proprietorship is owned by one individual. These comprise about 70% of the business organizations in the US. Their cost of organizing is low, are limited to the financial resources of the owner, and are used by small businesses. In this organization, the owner can be held responsible for the company.

A partnership is similar to a proprietorship, but are owned by two or more people. These comprise about 10% of the US business organizations. They combine the skills and resources of more than one person.

A business that is organized under state or federal statutes as a separate legal taxable entity is a corporation. Each state has different rules for incorporation. These generate 90% of the total dollars of business receipts received, and comprise about 20% of the business organizations in the US. With this type of organization, the company and its owners are separate. Owners generally are not liable for the company's actions. That is not to say that the company can do whatever it wants, but it separates the owners from being directly held liable for the company's actions.

A Limited Liability Company, or LLC, combines the attributes of a partnership and a corporation in that it is organized similar to a corporation, but is taxed more like a partnership. An LLC limits the amount of liability that its owners have, but does not give it the same tax breaks that a corporation has. As with a corporation, each state has different rules for LLCs.

Stakeholders

A Business Stakeholder is a person or entity that has an interest in the economic performance and well-being of a business. This includes owners, suppliers, customers and employees. There are basically four types of stakeholders in a company. The managers and employees are Internal Stakeholders, as they work within the company. A Capital Market Stakeholder provide the major financing for the business. This includes banks and other long-term creditors. A Product or Service Market Stakeholder includes customers who purchase products or services and vendors who supply inputs to the business. Government Stakeholders are city, state and federal governments that have an interest in the economic performance of businesses, so they can collect taxes. Workers for the business are taxed on wages. The better a business does, the more taxes can be collected. City and state governments often provide incentives to get businesses into their jurisdictions.

Ethics in Business

Ethics are the moral principles that guide the conduct of individuals. In business, the main three factors of ethics are individual character (honesty, integrity, & fairness), firm culture ("Tone at the Top" - basically, senior managers set the firm culture through their behavior and attitude), and laws and enforcement (for example, SOX).

SOX stands for the Sarbanes-Oxley Act of 2002. This was established by the Public Company Accounting Oversight Board (PCAOB). It expanded management oversight and reporting, and strengthened whistle blowing protections. SOX came about due to many companies conducting their business in what could be considered unethical fashion. The most notable of these was ENRON, which fraudulently inflated its financial results. For more information on SOX, please visit Sarbanes-Oxley.com

Accounting in Business

Information system that provides reports to stakeholders about the economic activities and condition of a business is known as accounting. The process by which accounting provides information to stakeholders is:

  • Identify the business' stakeholders
  • Assess the informational needs of the stakeholders
  • Design the accounting information system to meet the needs of the stakeholders
  • Record economic data about the business activities and events
  • Prepare the accounting reports for the stakeholders

There are many specialized fields within accounting. The two most common are financial and managerial accounting. Financial Accounting is primarily concerned with the recording and reporting of economic data and activities for a business. These reports are primarily for owners, creditors, governmental agencies and the public. Managerial Accounting, also called Management Accounting, uses both financial accounting and estimated data for management in running day-to-day operations and planning future operations.

Whether they are working in financial accounting or managerial accounting, accountants are employed in either private accounting or public accounting. Private Accounting is for accountants employed by a business firm or a not-for-profit organization. Public Accounting is for accountants and their staff who provide services on a fee basis.

In addition, there are different accreditations that accountants can obtain. The most well known of these is the CPA, or Certified Public Accountant. This is for those in the public accounting field. In the private accounting field, there are a number of accreditations that are sponsored by different organizations. The Certified Management Accountant (CMA) is sponsored by the IMA, Institute of Management Accountants. The Certified Internal Auditor (CIA) is sponsored by the Institute of Internal Auditors. The Certified Information Systems Auditor (CISA) is sponsored by the Information Systems Audit and Control Association. The Certified Payroll Professional (CPP) is sponsored by the American Payroll Association. All accreditations require specific education, and testing.

If companies could record their records as they saw fit, it would be impossible to compare one company to another. Thus GAAP, or Generally Accepted Accounting Principles, must be followed by financial accountants when preparing reports. These principles are set by the Financial Accounting Standards Board (FASB) in the US. International rules are set by the International Financial Reporting Standards (IFRS). The rules for IFRS are slowly being accepted more and more, and eventually may overtake FASB. The SEC (Securities and Exchange Commission) has the final say on what is GAAP per SOX.

Part of GAAP is the Business Entity Concept. This is the concept that the business entity is separate from its owners. Economic data should be reported for the business only, and not include the owner's information. If something is not done as part of the business, then it should not be recorded.

The Cost Concept states that the amount entered is the exchange amount. This is what the willing buyer and willing seller agreed to. Even though something may be valued at a different price, or a different price may be requested, the final amount is the actual cost. The cost concept utilizes Objectivity and Unit of Measure. The Objectivity Concept requires that accounting records be based on objective evidence. The Unit of Measure Concept states that economic data is to be recorded in dollars. Money is the common unit of measure for reporting uniform financial data and reports.