Why are there rules in accounting?
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Rules in accounting ensure that everyone is documenting things in a (theoretically) honest and compatible.
If everyone was doing something different the government couldn’t review your books, you may mislead investors or you might just have a bad system that tracks things poorly.
Well there are rules as far as how you must account certain things so that they may be reveiwed by government agencies, and these from a legal standpoint cannot be broken. This is to stop fraud, tax evasion, etc
and then there are “rules” which are widely taught, and widely considered as best practice. These you do not have to follow, so long as you feel you are producing an accurate accounting. However, as someone who has done more accounting than your average bear, best practice procedures help tremendously.
Real eli5:
you know how there are rules about how math works? 2+2 must always equal 4. If you don’t follow the rules correctly, you get wrong answers. Accounting is just a special form of math. Every accountant is supposed to use the same rules so that other people can trust that the final numbers are correct.
Also, you know that for big math problems, your teacher will make you “show your work”. They do this so they can make sure you understand the right way to get the answer and that you can apply the rules when you get a new problem. Much of accounting consists of ” showing your work “.
An accountant may, for example, list the value of property (like a company truck) as being lower this year than it was last year. This is because an old used truck isn’t worth as much as a brand new truck. You don’t want the accountant to just guess what the truck is worth, so there are sets of rules for how much value that property loses each year. When the accountant lists this years value for the truck, they will also make a note that is is based on its starting value, its age and which discount rate they used to get to the final answer
Accounting end goal are taxes and credit.
Tax purposes : Alex got paid 120$ to mow lawn through the year. Instead of paying 12$ on january, he paid 1$ every month from january to december. Because the 120$ payment is not for january but through out the year.
Credit purposes : Benny wants to borrow your money, you are not sure whether benny can pay you back. So you ask benny, how can you pay me back? And then Benny lists down his allowance money, the rest of his debt to your other friends. And he told you about that job his father has been having, he said he is going to get more money at the end of the month. With those assurance, you decided to lend him some money.
Accounting rule ensure that taxes are accrued accordingly and paid fairly. Makes sure that an entity can afford debt or investments.
The rule is a standardized guideline used by entity around the globe, so an entity cant just make things up and lie about their financials (to avoid tax for example)
So we don’t make everything up?
There are actually two types of accounting: Management Accounting and Public Accounting. The latter is what most people think of when they think of accounting and indeed it’s jam-packed with rules. It’s called “Public” accounting because it has to adhere to standards of all Public companies.
But then there is Management Accounting which is how companies manage their internal operations, and this is wide open: Companies can do pretty much as they please.
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