by Daniel Schwartz

Created on: December 18, 2009   Last Updated: December 19, 2009

When most people hear the word accounting they think of a nerdy person wearing black framed glasses bent over a huge book writing down number after number and then summarizing those numbers.  While accounting is about numbers it is much more than that.

Accounting is about information.  That information arises from analyzing, classifying and recording of daily business transactions.  This information is used by two groups of people, those who have an internal interest in the business and those who have an external one. It is this second groups that financial accounting address.

While both can be used by those within the business itself, managerial accounting is used to help those in the business make better decisions about the day to day operations of the business.  Financial accounting however is used by those seeking to invest money in the business or loan money to the business.  These people are concerned with one main thing, cash flow.

They want to know if the business is solvent, is it profitable, will it have enough cash left over to pay its debts, and is it worth investing in either through equity investment or debt investment.  This means that financial accounting has to meet stricter standards and comes under greater scrutiny than managerial accounting.

These standards known as Generally Accepted Accounting Principles govern how transactions are to be recorded and how that information is to be reported.  GAAP is divided into four basic assumptions, four basic principles and four basic constraints.

The four basic assumptions assume the following:

The business is a separate entity into itself. It is an ongoing concern That all information is expressed in terms of money and that the value of money does not change. The activities of the business can be divided into artificial time periods.

In looking at these four assumptions one can see that they are quite self explanatory.  The first one means that activities of the business are to be kept separate from the personal activities of its owners or shareholders and of other businesses.

 An ongoing concern means the business will operate perpetually. Even though in reality this may not be the case, it does give credit to the idea of depreciation, amortization and capitalization.

The third assumption basically means that only those transactions that affect the basic accounting equation, Assets=Liabilities+ Owners’ Equity are recorded.

 The fact that its

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