The 9 Types of Accounting and How They Work

Explore the different types of accounting to choose the right solution for your business

Accurate accounting is an essential function for every business. When you’re preparing to expand operations, identify growth opportunities, and analyze business performance, you need to know how much money the business brings in and how much it costs to get your product or service to market.

In order to get a complete picture of your company’s financial position, you need more than just cash flow reports and profit statements. Say, for example, you’re ready to expand your product line. You’ll need information on which products are bringing in the highest revenue, as well as details on production costs, equipment, and personnel used to create each item.

Accountants can help you gather and analyze this data, which is why accounting currently has a market size of nearly $600 billion^[1] and continues to grow. In fact, the U.S. Bureau of Labor Statistics expects the demand for accounting services^[2] to mimic the overall health of the economy.

Whether you’ve outgrown your current accounting system or have a specific accounting need that you can’t address on your own, it’s worth your time to explore the different types of accounting and how they work.

What are the types of accounting?

Businesses use multiple types of accounting to track and measure their performance. The more you understand the function of these various methods, the better prepared you are to choose the right accounting solution to meet your business needs.

Accounting information systems

Accounting information systems (AIS) are the tools and processes used by businesses to collect and process accounting data. The components of an accounting information system include the people, the processes they follow, and the tools they use to complete accounting tasks.

• Data: Accounting-related information recorded in the system

• Hardware: Computer systems and networks used to run the accounting information system and connect users

• Human resources: Accountants, bookkeepers, managers, and other employees who use the system

• Software: Computer programs used for accounting

In its broadest sense, an accounting information system is a structure used within an accounting department. Having this structure in place ensures that all users have access to the same information and increases transparency at all levels of the business.

Auditing

An audit is an examination. In the field of accounting, it refers to examining a company’s financial statements—whether internally or externally. Accountants who specialize in auditing may be responsible for preparing the documents used by the auditors, including the balance sheet, cash flow statement, and income statement. Auditing accountants also may oversee an internal review of the company’s financial statements. This requires an objective view of the documents and knowledge of industry regulations.

The three types of audits each serve a specific purpose for the company. All three provide an evaluation of the accuracy of a company’s financial documents and compliance with regulations. However, who performs the audit and how the information is used varies.

• Internal: Useful for making decisions within the company and identifying the strengths and weaknesses of systems and processes

• External: Performed by a third party to ensure the company is following the law and provide an unbiased view of the company’s documents

• Government: Done by the Internal Revenue Service to ensure the company accurately reported information on its tax return

Cost accounting

Business leaders rely on cost accounting to make decisions about profitability, production costs, and product pricing. This type of accounting examines and collects data about all the costs required to get a product to market and helps determine how much a company should charge for its goods or services.

You can further divide cost accounting into four types:

• Activity-based: Examines the different departments and tasks used in the production process and the cost of each step

• Lean: Used to identify and reduce waste within the production process so leaders can boost efficiency, quality control, and speed.

• Marginal: Takes into account the cost of producing one more unit to set prices and determine the profitability of a product

• Standard: Compares actual production costs with budgeted production costs to assist managers with future planning and budgeting.

Financial accounting

Chances are that when you think about the work of an accountant, financial accounting is what comes to mind. This makes perfect sense when you consider that the financial accountant’s audience is ultimately the general public and company stakeholders. They gather financial information and generate financial statements, namely balance sheets, cash flow statements, and income statements. Everyone with a financial interest in the company, from investors to creditors and regulators, reviews these statements to assess the company’s profitability.

Financial accounting includes two main types: cash accounting and accrual accounting. With the cash accounting method, you record transactions only when you receive or spend money. The accrual accounting method lets you record revenue and expenses before actual cash changes hands. You’ll find that small businesses tend to use the cash accounting method, while accrual accounting is more prevalent among large companies.

Forensic accounting

Forensic accounting is a highly specialized type of accounting that requires sharp investigative and analysis skills. A forensic accountant’s role is to follow the money—usually with the intent to identify illegal activity like bribery, embezzlement, and fraud.

Although forensic accountants typically work with law enforcement agencies or the Internal Revenue Service, they also can play a role within a company. Companies may hire a forensic accountant to examine the financial documents, identify theft, or prepare for an audit. For example, if you want to buy one of your competitors, a forensic accountant would work to ensure the company’s financial documents are accurate and show no signs of fraud that could later create problems for your company.

Governmental accounting

Governmental accounting differs from financial accounting in three key ways: standards, statements, and reporting procedures. Since governments collect their money through mandatory taxes and have a broad range of stakeholders (compared to a for-profit company), they are held to a different set of standards. Taxpayers want to know how agencies allocate their tax money, and these standards and reporting methods reflect this desire.

Government accountants follow standards established by the Government Accounting Standards Board (GASB) and the Federal Accounting Standards Advisory Board (FASAB) when producing and reporting financial information. Government agencies must include three types of financial statements: a statement of activities, a statement of cash flows, and a statement of net assets.

Managerial accounting

In many ways, managerial accounting (or management accounting) is similar to financial accounting. Although their roles do overlap, the primary difference is how they organize financial information for their target audiences. Managers rely on the work of managerial accountants to make operations decisions.

A managerial accountant produces regular reports—usually monthly or quarterly—to share with the company’s decision-makers. Business leaders then use the information in these reports to create budgets, develop forecasts, maximize profits, and minimize losses. Their analysis includes the following:

• Constraints: Locate inefficiencies in a system and analyze how they affect the company’s profitability

• Margins: Calculate the break-even point for a particular product to optimize production

• Trends: Identify patterns in production costs, notably the difference between budgeted and actual costs

Public accounting

Accounting services can come from an in-house accounting team or a third party that offers services for a fee. These third-party companies fall under the umbrella of public accounting. Public accounting firms typically have a large number of certified public accountants (CPA), as well as other accounting professionals on staff, and they may specialize in a type of accounting or provide general services.

You may choose to hire a public accounting firm to handle a specific task, like preparing for an audit or doing due diligence for mergers and acquisitions. If your company is small or your staff needs temporary support, a public accounting firm can assist with day-to-day operations.

Tax accounting

Tax accounting is another highly specialized type of accounting. Instead of looking at the company’s financial statements, a tax accountant focuses on the company’s taxes. Their work is highly important to the company, as they stay on top of changing regulations and tax laws to ensure the company stays in compliance with federal, state, and local tax laws. At the same time, a tax accountant helps the company lower its tax liability to improve profitability.

A tax accountant spends time examining the transactions that directly relate to the company’s tax burden. For example, they may review accounts receivable documents to ensure the company collected the correct amount of tax from customers. They prepare tax documents, including business tax returns, employee wage reports, unemployment tax forms, retirement distributions, and more.

Find out more about accounting types

No matter what your accounting goals are for your business, taking the time to learn about them before purchasing a product or service can help you find the best option for your business needs now and in the future.