1. 1
   What is accounting?
2. 2
   Purpose of accounting
3. 3
   Users of financial statements
4. 4
   Types / branches of accounting
5. 5
   Areas of practice
6. 6
   Types and forms of business
7. 7
   Summary
8. 8
   Quiz

Purpose of accounting

Economic Entity

Let's first define economic entity. An economic entity is a separately identifiable organization which makes use of resources to achieve its goals and objectives.

An economic entity may be a business entity operating primarily to generate profit, or a non-profit entity carrying out charitable and not-for-profit operations.

This means that a "business entity or business organization" refers to the for-profit type of economic entity. Some authors use "business entity" to refer to both for-profit and not-for-profit organizations. In any case, all economic entities whether business or non-profit rely on accounting in processing and providing financial information.

The Purpose of Accounting

From the illustration presented, and for a straightforward answer, it is clear that the ultimate purpose of accounting is to provide information to different users. The users utilize the information in making economic decisions.

It can actually be depicted from some definitions made by accounting bodies. According to the American Institute of Certified Public Accountants (AICPA):

"Accounting is a service activity. Its function is to provide quantitative information, primarily financial in nature, about economic entities that is intended to be useful in making economic decisions, in making reasoned choices among alternative courses of action."

And then, we have another definition – one which has been in use for a long time already – by the American Accounting Association (AAA).

"Accounting is the process of identifying, measuring and communicating economic information to permit informed judgment and decision by users of the information."

Both of the above definitions and the very nature of accounting suggest its basic purpose – to provide information needed by users in making economic decisions.

Accounting Information

Here's a list of the different types of information provided by accounting reports. These things will be clearer when you get to the tutorials on Financial Statements. For now, it would be good to be familiar with what kind of information we are talking about.

1. Results of operations. This pertains to the profit generated by the company for a certain span of time (for a year, for a quarter, for a month, etc.). This is measured by deducting all expenses from all income. The resulting amount is called net income.
2. Financial position. How much resources does the entity currently have? How much does the entity owe third parties? How much is left for the owners after we pay all obligations using our resources? The first question refers to the entity's total assets; the second to liabilities, and the third to capital.
3. Solvency and liquidity. Solvency refers to the entity's ability to pay obligations when they become due. Liquidity pertains to its ability to meet short-term obligations.
4. Cash flows. The financial statements also show the inflows and outflows of cash in the different activities of the business (operating, investing, and financing activities).
5. Other information. The financial statements provide qualitative, quantitative, and financial information. One of the characteristics of the financial statements is relevance. Any information that could affect the decisions of users should be included in the financial reports.