1.2 The Four Flavors of Accounting

J: Exactly how old is accounting?

K: Well, let me tell you, it's old. Clay tokens have been found in Mesopotamia dating back to 7,000 years ago that are a primitive form of accounting.

J: This early accounting was quite basic. A farmer would say, "Alright, these clay tokens represent how many sheep I have.”

K: And once you have a record of your number of sheep last year, you can compare that to what you have this year and can start to make some simple decisions and some comparisons.

J: Then somebody came up with the idea, rather than have these little clay tokens, let's start making notations on clay tablets or with chalk on a wall. Is bookkeeping the earliest form of writing? I think so.

K: This simple idea of numerical recording proved to be so useful that it persists to this day.

J: So what exactly is accounting? Well first, it's quantitative. It's numbers. Accounting is all about numbers.

K: Second, accounting is financial in nature. That means money. Numbers about money.

J: Third, accounting is meant to be useful. The fundamental purpose of accounting is to be useful. Accounting is a very practical field of study.

K: Useful for what? That's the 4th aspect of accounting. Useful in making decisions. Accounting helps you use information from the past to make decisions in the present to change the future.

J: Accounting is quantitative. Numbers about money to help people, you and me, make better decisions. That's accounting.

K: There are 4 kinds of accounting; we'll call them the 4 flavors of accounting.

J: First, the most fundamental type of accounting is bookkeeping, just the routine gathering of the information, making sure that everything gets recorded. So bookkeeping is gathering the information systematically.

K: The second flavor of accounting is financial accounting. This is reporting to people outside your organization. Summary reports, not the details. Just summary reports to people outside who might be thinking of loaning you money. Or might be thinking of investing in your company. That's called financial accounting, reporting to outsiders.

J: The 3rd flavor of accounting is managerial accounting. These are the detailed, secret data that individuals use inside their organizations to make decisions, detailed decisions. Should I raise my prices? Should I stop selling shirts and start selling shoes instead? Should I build my factory in Wyoming or should I build it in Alabama? The detailed information used in making decisions such as these is called managerial accounting.

K: And finally, the 4th kind of accounting is income tax accounting. This is the accounting that we use to make sure that we are in compliance with the law.

J: Bookkeeping, financial accounting, managerial accounting, and income taxes. Those are the 4 flavors of accounting.