In January, I took a very short intensive introductory course to financial accounting. When I first signed up for it, I cringed to think what my old Nietzsche-thesis advisor would think of such a practical and putatively boring endeavor. But I actually – I really mean this and I’m not just writing this to impress some future employer – found it very intrinsically interesting. So this will just be a brief post in which I’ll expend what I learned, by telling you what’s so interesting and important about accounting. After that, I want to give a brief intro to some of the basic ideas and concepts of accounting, partly because I had been frustrated, when I first started the course, that they are not usually explained well to people who are not already familiar with the field.
So first, what is financial accounting? I would define it as the set of rules and concepts we use to prepare relatively simple financial statements that capture or represent important truths about a firm and convey them to outsiders—both what the firm is worth now and what it’s doing on an ongoing basis. This definition suggests both (1) why accounting is important and (2) why I think accounting is interesting.
First, financial accounting is very important because the information that firms convey to outsiders determines whether, how much, and on what terms those outsiders lend to or invest in those firms. We as a society have limited amounts of capital to invest and lend. So we have an interest in that capital being used very wisely. We want it to be lent to or invested in firms that will use it productively, doing innovative and transformative things, and not lent to or invested in, e.g., hopeless companies overseen by feckless managers who are desperate for another lifeline when, in fact, their business models are outdated. The world would be better off today if more capital had gone to Apple and less to Pets.com during the 1990s. We also want investors and creditors of firms – after they have invested or lent – to continue to have an accurate picture of what’s going on inside a firm, so that they can monitor and pressure managers to behave and do well. In this vein of thought, it’s really not an overstatement to say that modern capitalism—in which public companies, owned by outside shareholders, must compete in capital markets to access the capital they need to grow—depends on good accounting. (Lastly: we as a society also increasingly want information about things like, e.g., how a firm is effecting and harming the natural environment, so we can figure out how best to regulate and efficiently abate these costs—this will become a more significant part of accounting in the future.)