There a number of accounting methods – eight, to be precise – you can use to track your business's finances.
- There are eight branches of accounting that allow businesses to track and measure their company's finances.
- Each branch has its own specialized use that reveals different insights into a business's financial status.
- Understanding the different branches of accounting is important for business owners, as it can have a significant impact on the long-term success and viability of your business.
- This article is for business owners who want to familiarize themselves with the various branches of accounting and what they entail.
While having a strong handle on your business's finances is important, the methods you use to track your expenses and income may differ from how other small businesses conduct their accounting. While you might use different accounting methods, it is important to be well versed in the particular types of accounting should the need ever arise. Here is more on the different branches of accounting and how they can benefit your business.
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What are the eight branches of accounting?
Not all forms of accounting are the same. Some focus on costs, others on audits, and some focus on taxes. The eight branches of accounting include the following:
- Financial accounting
- Cost accounting
- Managerial accounting
- Accounting information systems
- Tax accounting
- Forensic accounting
- Fiduciary accounting
Here's more on each type of accounting and the role it plays in tracking your business's finances. [Looking for accounting software for your business? Read all of our reviews and the best software options for small businesses.]
Financial accounting records, summarizes and reports a company's business transactions through financial statements. These include the income statement, the balance sheet, the cash flow statement and the statement of retained earnings. These financial reports provide insight into a company's performance to its creditors, investors and tax authorities. There are two types of financial accounting: cash accounting and accrual accounting.
Cash accounting focuses on business transactions involving cash. Using the cash accounting method, a company bookkeeper debits and credits the cash account in each journal entry. Transactions with no monetary input are not included in the financial statements. With this method, bookkeepers debit and credit the cash account in each journal entry depending on the transaction. For example, when recording customer remittances, the bookkeeper debits the cash account and credits the sales revenue account.
Accrual accounting records transactional data. The cash accounting method is used, but accrual accounting accounts for all transactions that make up a company's operating activities. Using the accrual method, revenue and expenses are recorded when a transaction occurs, rather than when payment is received or made.
The terms "accounts payable" and "accounts receivable" illustrate the concept of accrual. Accounts payable is money owed by a business to vendors. Payables accrue until the business settles the underlying debt. Accounts receivable represents money that is owed by clients to the business. As with accounts payable, the debt owed to the company accrues until payment is made by the client and the debt is subsequently satisfied.
Did you know? The financial statements used in financial accounting provide valuable information to creditors and investors regarding a company's performance.
Cost accounting records, analyzes and reports all of a company's costs (both variable and fixed) related to the production of a product. There are four major types of cost accounting.
Standard cost accounting
Standard cost accounting identifies and analyzes the difference between the cost of producing goods and all of the costs that should have occurred to produce said goods. These total costs are known as standard costs. Product costs, direct material costs, direct labor costs and manufacturing overhead costs all factor into the standard costs.
Standard costs are a great planning tool, but in reality, they differ from actual costs. That difference is known as variance. Using standard cost accounting assists greatly in finding variances and investigating the reasons behind them.
Activity-based cost accounting
Activity-based cost accounting (or ABC) identifies activities in an organization and assigns the cost of each activity to all products and services. The five steps of ABC are as follows:
- Identify costly activities needed to make the product(s).
- Assign overhead costs to the activities identified in step one.
- Identify the cost driver for each activity.
- Calculate a predetermined overhead rate for each activity.
- Assign overhead costs to products.
Activity-based cost accounting can help business owners and managers understand overhead and cost drivers, which can then allow management to reduce or eliminate elements or activities that are costly and don't provide value to the organization.
Lean accounting identifies and eliminates waste from operations. Whereas traditional accounting is designed to support mass production, lean accounting focuses on helping managers improve the overall efficiency of their operation. Lean accounting can help a business uncover ways to eliminate waste, improve quality, speed production and improve productivity.
Marginal cost accounting
Marginal cost accounting refers to the increase or decrease in the cost of producing one more unit or serving one more customer. To calculate the marginal cost, a business determines the point at which increasing production or service raises the average cost of the item being produced. Understanding a product's marginal cost can help a company assess its profitability so that management can make informed decisions. It is an important tool to use when setting pricing.
Key takeaway: Cost accounting helps identify where a company is spending its money, what it is earning and where it is losing money.
Auditing accounting is an objective examination and evaluation of a company's financial statements done internally or by a government entity, such as the Internal Revenue Service. There are three types of audits:
- Internal audit: These are used as managerial tools to improve processes and internal control.
- External audit: This audit is commonly performed by an accounting firm. It includes a review of both financial statements and the company's internal controls. The auditor's opinion is included in the audit report.
- IRS audit: This is a review of an organization's financial information and is performed to ensure that the information has been correctly reported according to tax laws.
The main objective of managerial accounting is to maximize profit and minimize losses. It identifies, measures, analyzes, interprets and communicates financial information to management. This information assists business owners managers in making well-informed decisions. Some examples of managerial accounting techniques include:
- Margin analysis: This technique explores optimizing production. It involves calculating the break-even point and determining the optimal sales mix for the company's products.
- Constraint analysis: This analysis helps identify inefficiencies and their impact on the company's ability to generate profits.
- Capital budgeting: This technique analyzes information required to make necessary decisions related to expenditures. Managerial accountants present their findings to owners and managers to help with budgeting decisions.
- Trend analysis and forecasting: Trend analysis and forecasting identifies patterns and trends of product costs and recognizes unusual variances from the forecasted values.
Key takeaway: Managerial accounting analyzes financial information and provides performance reporting, which assists business owners in comparing actual profits with projections.
Accounting information systems
An accounting information system (AIS), a computer-based method, tracks accounting activity that has been combined with information technology resources. AIS is a structure businesses use to collect, store, manage, process, retrieve, and report their financial data so it can be used by accountants, consultants, business analysts, chief financial officers, auditors, and tax agencies.
There are five basic components of accounting information systems, which include:
- Computer hardware: This is the physical technology that is involved with processing and/or storing the data. It can be a smartphone or a supercomputer. It also includes equipment such as keyboards, external drives and routers.
- Computer software: Software provides the information that tells the hardware what to do. The primary piece of system software is the operating system. Windows is an example of an operating system. Another type of software is application software. This is designed to handle specific tasks, such as creating a document or managing a spreadsheet.
- Telecommunications: Telecommunications is what transmits the information from your computer hardware and software to others. Connections can be made through wires or wireless through a Wi-Fi network. Tying computers together in a specific area, such as an office or school, uses a local area network (LAN). Connecting computers that are more widely dispersed use a network called a wide area network (WAN).
- Databases and data warehouses: A database is where your accounting data is stored and where it can be retrieved. A data warehouse contains all the data in whatever form the organization needs.
- Human resources and procedures: The final component is possibly the most important, the human element. These are the people who run the system: They compile the data and interpret the knowledge contained in the databases and data warehouse.
Tax accounting focuses on taxes rather than public financial statements. It focuses on transactions that impact a business's tax burden, and how those items relate to proper tax calculation and preparation of tax documents. It is governed by the Internal Revenue Code, which must be strictly followed when individuals and companies prepare their tax returns.
Tax accounting is important because tax laws are complex and often change. The main purpose of tax accounting is to determine a company's tax liability and to report that to the federal and state government using the correct tax forms. Hiring a tax accountant is recommended due to the complexity of tax laws.
Forensic accounting combines accounting, auditing, and investigative skills to examine the finances of an individual or business. Forensic accountants compile financial evidence and can communicate their findings using reports and presentations in legal proceedings. This type of accounting is often used in fraud and embezzlement cases, as it provides a detailed explanation of the nature and extent of a financial crime.
Fiduciary accounting is the recording of transactions associated with a trust or estate. It is dealt with on a cash basis. Cash is recorded when it is received and disbursements are recorded when paid. This information is then provided to beneficiaries and often the courts.
The rules surrounding fiduciary accounting vary from state to state and even county to county. The wishes of the decedent, or grantor, must be complied with as expressed in a will or trust document.
A fiduciary sets up an account on behalf of another person who owns the money. The owner of the money is known as the principal. Fiduciary accounting provides a comprehensive report of activity within a trust during a specific period of time, including a record of all receipts and disbursements managed by the executor of the trust or the trustee.