The purpose of accounting

• Book-keeping is the detailed recording of financial transactions in the books of the business.
• Accounting uses those records to prepare financial statements, then analyses and interprets them.
• Profit or loss is measured to show whether the business is successful, how much the owner can draw out, whether to expand, and for tax and lenders.
• Accounting information lets owners and managers monitor progress (this year against last year, actual against plan) and make decisions.

Recording versus using the records

Book-keeping is the routine, detailed recording of every financial transaction: sales, purchases, receipts and payments. It is done in the books of prime entry and the ledger, using the double entry system. A book-keeper needs accuracy more than judgement.

Accounting starts where book-keeping stops. The accountant uses the ledger balances to prepare the trial balance and the financial statements (the income statement and the statement of financial position), then analyses and interprets them so that the owner can understand the results and make decisions.

Profit = revenue − expenses

Profit is the amount by which revenue (income) is greater than expenses for a period. If expenses are greater, the result is a loss. Profit is measured for a stated period, usually one year, in the income statement.

A business measures its profit or loss so that the owner can:

• see whether the business is successful and worth continuing;
• know how much can safely be taken out as drawings;
• decide whether to expand, cut costs or change prices;
• compare results with previous years and with other businesses;
• provide figures to banks and lenders deciding whether to lend, and to the tax authorities.