Financial AccountingThe Accounting Process

The Accounting Process

As defined in the previous section, Accounting is the process in which financial transactions are recorded, summarized, analyzed, and reported.

Accounting Definition

1. Recording the transaction

The first step in the accounting process is to record the information, which further can be processed and used for decision-making in any organization.

The primary document to record financial transactions is Journal/ daybook. All transactions are recorded chronologically and a historical record of all financial transactions is presented.  It can be further subdivided into sub-journals which are also popular daybooks and widely used in different businesses. However, it is an important point to remember that ONLY transactions are recorded into a book of accounts and an accountant shall be vigilant enough to identify transactions from other business information.

  • Identification of transaction

As said earlier, accounting is the language of business and only transactions of a particular business are recorded in its books of accounts. The transaction can be defined as;

“A transaction is an EVENT that can be stated in monetary terms and changes the financial position of a business entity.”

Whereas; an event is the occurrence of anything in which the financial condition of the business enterprise may or may not change.

Therefore, all transactions are events but not all events are transactions.

  • Characteristics of Transactions
  • In every transaction, there is a movement of monetary value from one source to another. For example, when goods are purchased for cash, goods move from seller to buyer, and the cash moves from buyer to seller.
  • A transaction is a complete action, to make an expected or potential future action. · The transaction may be Internal (do not include any other party, such as charging depreciation on machinery) or external (between the business entity and the other party, such as goods sold on credit to a customer).


The part of accounting that deals with recording data are called bookkeeping. Bookkeeping is the method of recording business transactions into the books of accounts i.e. Journals/ daybooks etc.

Up till many years ago, all accounting data was manually recorded in books, hence the term “bookkeeping”. Nowadays, although handwritten journals are still in use (especially by small organizations), most accounting data is recorded electronically and stored electronically using a computer. On the other hand, Accounting is a broader term that makes various other uses of information presented through Bookkeeping.

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2. Classifying

After the transactions have been identified, the next step in the accounting process is classifying transactions. Similar transactions related to a person, thing, expense, or other matter are grouped under the various head of accounts.

For example, different types of goods were sold to Mr. A on credit and cash at various times during the past week. Now accountant is required to classify these transactions among others to Mr. A, Cash Sales, and Credit sales.

All transactions are classified into five (5) basic types of accounts;

1. Assets: – The right of business over economic resources is called an asset. Asset accounts cover all types of property, such as buildings, machinery, stock of goods and vehicles, etc. Assets also include receivables from customers and cash available with the company cashier and deposited in a bank account.

2. Liabilities: – The obligation owed by a business over economic resources, is called Liability. Examples of Liabilities include loans provided or goods/ services provided by lenders on credit that have not yet been paid back.

3. Capital: – A capital account represents the owner’s claim against the assets of the business. It is also called the owner’s equity or net worth of Assets. It also includes any profit retained to be used within the business, in addition to the funds invested in the business by the owners.

The word capital, however, is often used and termed as “net worth of business” OR “net assets”. Further, the withdrawal of economic resources (e.g., cash) by owners for use other than for business, is called the dividend and accounted for as a decrease in capital.

4. Income: – Increase in economic resources during the period. This increase in economic benefit can be in the form of

  • Enrichment of Assets, AND/ OR
  • Reduction in liabilities,

However, whatever the case is, it (income) will increase capital.

5. Expense: Contrary to the income as defined earlier, the expense is a decrease in economic resources during a period. This decrease can be in the form of

  • Decrease in the value of Assets AND/OR
  • Increase in the value of liabilities

Further, the expense will always result in a decrease in Capital, besides resulting in decreasing the value of assets or increasing liabilities.

3. Summarising

Classified transactions in the last stage are now required to be summarized, so they can be further presented for analysis and decision making. The most used form of summarizing financial information is the preparation of the Profit and Loss statement and Balance Sheet for a particular year.

4. Presentation or reporting financial information

At this stage of the accounting process, summarized financial information shall be presented to the end-users of accounting statements so they can benefit from the analysis and interpretation of data. The presented information shall be comparable with past and present statements and reports. Therefore, these statements shall be consistent.

5. Analysis and Interpretation

To draw useful conclusions and make rational economic decisions, it is important to further analyze and interpret the financial information or data presented in the books of accounts. These analyses of accounting information will help management to review the performance of various business activities and formulate plans.

From the above discussion, we can say that accounting is a process that starts from recording business transactions to communicating and informing the performance and financial health of an entity to stakeholders with different interests.

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