Here are three types of accounting, which businesses use. Large firms or stock traded firms are likely to use all three together. I’ll describe tax, financial, and managerial accounting alongside household decisions. I learned a lot, when helping small businesses with accounting tasks.
Tax Accounting
Tax books track revenues or expenses according to the rules of the taxes in that place or market. After a few years of filing tax reports, people learn a degree of tax planning. This is part of why we buy a car, when we sell a car. This is part of why we buy a house, when we sell a house. Farmers know that a bumper crop means that it is time to buy new equipment. In that way, a down year is when to sell old (or newish) equipment. Tax rates may drive individuals to work in sales-tax states but to retire in income-tax states. This is also why we only live near good schools, when we have children in the house. I’m kinda joking but kinda not. The purpose of tax accounting is to get it right, pay your fair share, and to stay out of trouble. The purpose of tax planning is to reduce the taxed earnings.
Tax accounting supports tax planning; which may be a good investment with a high rate of return. Some say that they’d prefer to make their own decisions, spending in whichever way they want. Ignoring tax planning leads to a greater share of resources going into taxes. This reduces the amount of money the individual gets to spend.
Financial Accounting
Financial accounting is pretty useful; it changed my perspective of parking tickets. This method of accounting uses GAAP (Generally Accepted Accounting Principles) and for accountants it makes sense. I understand that accounting is not intuitive to everyone. To remain inclusive, I’ll note that for some people, accounting makes sense. That’s not most people, so don’t worry about it. Financial accounting allows a firm to give an optimistic picture of what is going on in the firm. To limit the reporting of fuzzy figures, GAAP standardizes the framework of optimism. Financial accounting is for investors or shareholders.
There are online articles for the distinctions between tax accounting and financial accounting. I liked them but I acknowledge that this isn’t for everyone. In short, the net income in financial accounting is greater than is the net income in tax accounting. Those two types of reports are not always the most import for the internal decisions of a firm.
Managerial Accounting
Managerial accounting uses the rules of cost accounting. These books guide decisions on how to operate the firm and profit. Cost-benefit analysis is often in mind, when I perform managerial accounting. Not every manager is aiming to profit but in some quantity, they are optimizing something. Managerial accounting books are usually secret to outsiders. I recall two times when a firm reported these.
There are shortcuts to reading a firm’s books, prospectus, or SEC filing. There are shortcuts to combining any two of the above types of accounting. Some combinations are worse than others. There is another triplet of accounting types; I consider describing those soon.
