General accounting
What is a firm?
This lesson and the next seven lessons are introductory. To enter directly into the heart of double-entry accounting, go to lesson 9: Why single-entry accounting, like in the booklet of our checkbook, is insufficient.
Video
All over the world wealth is created either by individuals and small groups for their own consumption, or by firms for exchange on markets.
We shall describe the most typical firms, keeping in mind that there exists a wide variety of types (including firms comprising only one individual).
A firm is a group of people, with production tools, located in some premises, who, with work, transform raw materials into goods and services, and sell them.
The work and the raw materials are bought on some markets, and the goods and services are sold on other markets.
Physical and monetary flows: The flows of physical things, and the contraflows of money are represented below:
click on image to enlarge
Types of firms: We distinguish three types of firms:
- industrial firms : think of a workshop, a plant, or a group of plants
- commercial firms : think of a retailer, a wholesaler, or a large commercial organisation
- financial firms : banks, insurance companies, mutual funds
In the three cases, the accounting techniques which we shall study are identical.
A bit of history: Commercial firms and banks, as we know them, date from the late Middle Ages, at the time of strong development (demographic, economic, cultural) which Western Europe experienced between 1100 and 1300. Whereas if you except shipyards and some XVIIth century "manufactures", industrial firms date only from the Industrial Revolution, which began in England in the mining and textile industries in the second half of the XVIIIth century, following social changes and the invention of the steam engine. Protectionist laws passed in the middle of the XVIIIth century to protect the English woolen industry from Indian cotton imports played a rôle too: when only raw cotton was allowed to enter, English engineers created the spinning Jenny, the flying shuttle and other machines to produce cotton cloth locally.
Legal structures: In modern societies, a fim has the legal status of a moral person. It can sign contracts, hire employees, borrow money, get credit, buy and sell goods and services.
The two most common legal structures are:
- the small limited liability firm (or even in some places the sole proprietorship, where the owner is liable of any debt of his firm on his own wealth)
- the joint stock corporation (which also has a limited liability) listed on a stockmarket
The limited liability feature means that in case the firm incurs big losses, the responsability of its owners is limited to the initial money they put in. This legal structure was introduced in the XIXth century.
A firm has owners, also called shareholders. The firm owns various things, called assets: buildings, machines, inventories, other things we shall see. And it has a reserve of money, some of it on the premises, most of it in a bank.
The firm has employees, that is people with whom it signed a work contract, and from whom it buys work. It can also buy work from outside subcontractors.
Activities: Commercial firms buy and sell goods without performing any physical transformation on them. Their activity is made of all or part of selecting, transporting, warehousing, distributing, displaying these goods, helping clients, etc.
Industrial firms transform the raw materials and other supplies they buy into finished products which they generally sell to commercial firms.
The main activity of banks is to receive deposits from savers, and to lend this money to borrowers for investment projects or, since WWII, for consumption prior to payment.
All these comments are very general. Their sole purpose is to set a framework before going into the study of accounting.
Management information systems: So a firm is an organisation, with a managerial team. This team needs a great deal of information, internal and external, in order to correctly manage the firm. The elements of information are organised into various "management information systems" (MIS) for the use of the managers and sometimes partners of the firm.
General accounting is one of these MIS. It is the subject of this course.