The Nitty-Gritty Of Accounting

By: Samkern

Accounting is as ancient as man's attempts to transact with fellow human beings. With the predominance of money measurement in economically useful activities, accounting became the most vital tool. At the center of all accounting principles is the urge to ensure accuracy and consistency. This takes the form of double entry system of accounting. The 15th century Italian mathematician, Frater Luca Pacioli, first extolled about the features of the system.

Double entry method offers a convenient and accurate format for recording transactions. Put simply, all transactions have two aspects. Therefore, omissions or numerical errors would automatically stand out. Thus, it acts as a self-correcting mechanism.

The basic aspects of accounting relate to correct classification of transactions. There are four major accounting heads: assets, liabilities, revenues and expenses. At any given point of time, the firm's assets should equal its liabilities. This is the accounting equation. If they do not match, there is an apparent error in the accounting process.

The enterprise's assets represent the productive resources used by it. Plant and Machinery, building, stock of raw materials and stores, debtors or accounts receivables, cash and bank balances are some of the assets. Liabilities are the sources that finance the assets. Owner's capital, long-term loans, short-term bills, sundry creditors and other financing are the liabilities.

When revenues exceed expenses, the firm makes a profit and in the reverse it is a loss. Ultimately, profit or loss reflects in the financial position or the values of assets and liabilities on the given date. An increase in assets or decrease in liabilities means profit and decrease in assets or increase in liabilities mean loss.

Profit is the driver in any business enterprise and no wonder entrepreneurs seek to maximize it. More critical than profit is the measure of profitability because the latter reveals the firm's efficiency in utilization of financial resources. Return On Investment is the most common profitability ratio. The claim over profits of a business depends on the organizational type. In ownership or partnership firms, the owner or partners have total claim over the profit. In joint stock companies, the stockholders are entitled only to the dividend as declared by the Board Of Directors.

The work of an accountant is crucial as he reports the performance of the enterprise to the management and the owners. Based on the figures supplied by him, important decisions like capacity expansion, make or buy, retaining or hiving off unprofitable lines of business and employee incentive computation are taken.

Accounting As Simple As It Gets

By: Sean C Anderson

Many people look at accounting and say, "Accounting doesn't make a lot of sense." Well I hate to be bold but there is no better way to say, "Hey I'm a moron, I shouldn't be running a business." Accounting is the story of your business and you should know not only how to read that story but how to tell the story. There are a lot of complex accounting issues, they can be a nightmare. The chances are that you will never deal with them. Don't worry about the complex stuff, focus on the larger aspec of accounting. You should be able to understand ninety-nine percent of all accounting issues with just a basic understanding of the principles and constraints.

Accounting is an ongoing story, the financial statements are a snapshot in time of the continuous action taking place. To understand and develop this story you only need a basic understanding of the fundamental and constraints of accounting. The fundamentals of accounting are based on Relevancy, Reliability, Comparability, and Consistency. To test the relevancy principle just make sure that the information can be used by outside users to analyze your business. Reliable information is unbiased and not a crock of b.s. you cooked up. This can be done by getting a third party account who is unbiased to you business to actually make or confirm entries to the accounting system.

If you report in a comparable manner you report in a way that is typical of other businesses in your industry. This is to ensure nobody is comparing your apple company to someone else's orange company. I always get confused when I compare apples to oranges. Consistency involves simply staying in line with the current accounting practices. You can't just simply switch accounting methods mid-stream (without fixing historical information) to make numbers look better. Your accounting should follow the same logic/method over time.

When developing accounting information there are two important constraints to keep in mind conservatism and materiality. Conservatism is simply saying hey I can represent a loss here buy reporting this way or a gain if I report another way; I am gong to choose to take a loss. This can change with tax reporting. There conservatism is reporting the gain. The government likes that money and they don't get to tax you on losses. That is what AMT (Alternative Minimum Tax) is all about.

By now you may be asking yourself what this accrual garbage is about. Well if you just bought inventory, prepaid rent or you owe your employees a bonus at the end of the year how do you want to represent that. You want a way of keeping track of your inventory, how long you have the rights to a building and what those cost over time, or you should want to know why you are going to owe your employees so you can anticipate what you'll need to pay. Well this is where accruals come in handy.

With cash accounting you would have expenses upon purchase of goods. With accrual accounting you say I've got a benefit/asset here I want to represent this benefit to outside users. You do this by reporting it as an asset and expense the cost of inventory when the product is sold (Cost of Goods Sold). This helps you tell the story of a business by telling all the parts not just bits and pieces at a time when cash transactions are made. The same thing goes on with prepaid rent. When the account reaches zero and you have nothing to expense and you know you better pay that rent next month.

Now, for accruing liabilities. Well you tell your employees that you are going to pay them a bonus based on performance at the end of the year. Hopefully, you plan on paying this bonus, because you don't want to face the dreaded everybody quits on you at once type of turnover. STRIKE!!!! Well if you are keeping track of your companies performance you can keep track of what you owe them each month and record the liability and expense.

Basically, you promised employees 1% of net income at the end of the year. Simply, multiply 1% times your profit(loss) and make the appropriate entry. Tie your expense and liability to the month in which the profit was realized. Doing this will give you a better idea of the cash outlay you'll need to make at the end of year. Accounting is full of good ideas and methods to keep track of what is occurring in your business.

At the end of the day tell a full story of what is going on in your company, through accrual accounting. Don't embellish the story, keep a conservative outlook. Don't change your logic without letting everybody know through restatement of prior year financials. Put out information that doesn't waste the time of internal or external users. Last but not least don't be an accounting moron by excepting that you just don't understand.