Why Accounting is Important?

(written by: Willy Yanto Wijaya)

The 5th lecture of Managerial Perspective class was given by Mr. Jun Nagamine about the basics and introduction on accounting. The lecture was started with the history of accounting, the three forms in accounting, and the study case of how to read and analyze accounting data.

The history of accounting flashed back to several centuries ago when the Venetian merchants had trade interaction with the South-east Asia through Alexandria. These merchants bought pepper to preserve the meat. Meat was a precious food source since Europe had relatively poor soil and the productivity of the land was very bad. Because of the flow of the revenue and expenses in this trade, the Venetian merchants invented the method to record this by “Double Book Keeping”. This very basic characteristic has even remained till now, with only some modifications and improvement of the complexity.

Basically, accounting comprises three forms: Balance Sheet, Income Statement, and Cash Flow Statement. These three are, as the matter of fact, the essence of accounting. As shown in Fig.1 below, Balance Sheet is composed of Asset in the left-side and Debt as well as Equity in the right-side.

Fig.1. Balance Sheet    (as of …………)

Asset:

Current Asset

Tangible Asset

Intangible Asset, Investment, etc

Debt (Liabilities):

Current Liabilities

Long-term Liabilities

Equity (Stocks)

One interesting thing about the balance sheet is the proportion between Debt and Equity. In term of expenses burden point of view, Equity yield heavier burden to the company, however, in case that the company go bankrupt; the equity will yield lower priority of responsibility compared with the Debt (Liabilities). Therefore, if the proportion of the debt is too big, the debt owners will have higher risk of not getting back their money, and thus will inquire higher debt interest rate payments. On the other hand, if the equity is too big in proportion, the expenses burden of the company will be higher (and this means less profit).

The current asset is asset with high liquidity i.e. money. Tangible asset means asset that can be touched (land, building, machinery, etc). The example of investment asset is stocks (which can be purchased from other companies).

While Balance Sheet indicates the monetary condition of a company at a certain time (usually in the period of one year), it doesn’t tell us how the income (profit) and loss happened. Therefore, we need the Income Statement (Profit & Loss Statement) to understand how the profit or loss happened.

Actually these two forms could already give insightful ideas about monetary condition of a company. However, since the developing of more and more complex trade and payment system in modern era, Cash Flow Statement is then developed. This is also because the concept of revenue from a viewpoint of accounting is not the same as the “cash basis” view.

Another interesting topic discussed was about the similar characteristics of similar-type companies. For example, NTT and AT&T (both are telecommunication companies) apparently share almost similar monetary condition in their accounting data. Some investment companies like Goldman Sachs and Nomura have same very small proportion of Tangible (Fixed) Asset. Thus, by knowing the proportions of components in monetary data (accounting) of an unknown company, we can guess what type of company it is, how is the monetary condition currently, and the potential of that company to develop in the future.

Therefore, a manager, willingly or not, is required to be able to read the accounting data since it is the only language which can gauge a company’s performance from the monetary perspective.

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