Personal Finance guide

Accounting is one of the most important internal aspects to any business that is to be financially successful in today’s market. It is the process of documenting all relevant economic information about a firm and communicating that information to key players. Managers and Executives need accounting information to make decisions and run their business to achieve maximum profitability. Shareholders need accounting information to make informed investments.

There are many types of accounting that all have different roles in the business world. Probably the best-known and most ‘classic’ type of accountant is a CPA, or Certified Public Accountant. A CPA has a very diverse client list. They can serve anyone including individuals, private firms, large publicly traded corporations, the government, or non-profit organizations. They can perform the role of an independent auditor, tax advisor, or financial consultant.

When performing an audit, a CPA will produce an independent auditor’s report that will tell the client four key pieces of information. First it identifies the documents that were audited and describes that the purpose of this report is to express an opinion about the documents in questions. Next it explains the standards used to analyze the data. Third is the actual opinion of the auditor in regards to the financial documents reviewed. Finally, the auditor elaborates on his opinion regarding the effectiveness of the financial reporting of the firm.

Another type of accountant is a CMA, or Certified Management Accountant. A CMA serves a smaller customer base, because they typically work for a single firm. The major role is to advise the company on their financial management, accounting processes, and budgetary issues. A CMA may work with individual employees of that company, but their main function is to advise the executives on the company’s complete financial structure. They are often involved in major decisions for the company.

A subset of managerial accounting is cost accounting. A cost accountant works closely with the budget structure of a company. They are typically involved with determining the internal costs of many functions and the profitability of the routine company operations. Cost accountants have a very future-oriented job in that they are primarily concerned with using historical data to forecast what the prospective financial strength of the company will be.

A third major type of accounting is a financial accounting. Financial accountants are primarily responsible for the preparations of the financial documents for review by the corporate decision makers. Managerial accountants, cost accountants, top management, and shareholders use these documents to make major business decisions. Financial accountants assemble an annual report including balance sheets, income statement, statement of cash flows, and statement of change in owners’ equity (or retained earnings). These documents are usually targeted to an external audience.

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The Unresolved Flaws in Financial Accounting

The users of accounting information include company owners, managers, investors, creditors, and government agencies. It is generally acknowledged that most financial reporting is “primarily externally oriented” and most of the users are nonaccountants who get frustrated trying to understand the statements. Since they are not part of the management team, they more or less are looking from the outside in.

Despite the many accounting associations from the Accounting Principles Board to the American Institute of Certified Public Accountants to the Financial Accounting Association that established the Financial Accounting Standards Board, there continues to be alternative ways of reporting which adds to the confusion and limitations of financial reporting.

Recognizing and Reporting Methods:

FIFO vs. LIFO:

FIFO and LIFO are two of the major methods of reporting transactions. Because these are alternative methods left to the discretion of the entities, two similar companies in the same industry could report the same transactions for similar goods and arrive at two separate conclusions. The FIFO method assumes that earliest goods purchased are the first to be sold. The LIFO method assumes that the latest goods purchased are the first to be sold “as a result the first cost assigned to ending inventory are the costs of the beginning inventory.” So goods purchased in September can be included in a prior month’s cost of goods sold. This method, though acceptable alters final reporting for better or for worse.

ACCRUAL vs. CASH:

Under current generally accepted accounting principles, financial accounting is backward looking. By reporting past transactions that rely on accrual accounting to conform to the matching principle, financial statements do not account for how much of the outstanding debit accrued under accounts receivable will actually be collected. This could mislead non accountants into over estimating assets in the immediate period after the release of a report because the adjustments due to non collection are done much later. In this scenario, a report released at the end of the year may project that a firm has $10,000.00 in accounts receivable. That projects $10,000.00 more in the asset column of the firm. This may give a more positive outlook when in actuality the firm may end up recouping only $3,000.00 of its account receivable. An investor attracted to the company on the basis of its strong outlook may be disappointed to find out later that in trying to collect on the accounts receivable only one-third was actually obtained. This weakness was the reason of the now defunct cash basis versus the current accrual basis. In the cash basis accounting, revenue or expenses were recorded when actual units of measurement (money) exchanged hands.

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Ratios are highly essential profit tools in financial analysis that help financial analysts implement plans that improve profitability, liquidity, financial structure, reordering, leverage, and interest coverage. Although ratios report mostly on past performances, they can be predictive too, and provide lead indications of potential problem areas.

Ratio analysis is primarily used to compare a company’s financial figures over a period of time, a method sometimes called trend analysis. Through trend analysis, you can identify trends, good and bad, and adjust your business practices accordingly. You can also see how your ratios stack up against other businesses, both in and out of your industry.

There are several considerations you must be aware of when comparing ratios from one financial period to another or when comparing the financial ratios of two or more companies.

• If you are making a comparative analysis of a company’s financial statements over a certain period of time, make an appropriate allowance for any changes in accounting policies that occurred during the same time span.
• When comparing your business with others in your industry, allow for any material differences in accounting policies between your company and industry norms.
• When comparing ratios from various fiscal periods or companies, inquire about the types of accounting policies used. Different accounting methods can result in a wide variety of reported figures.
• Determine whether ratios were calculated before or after adjustments were made to the balance sheet or income statement, such as non-recurring items and inventory or pro forma adjustments. In many cases, these adjustments can significantly affect the ratios.
• Carefully examine any departures from industry norms.

Ratio Analysis is a useful tool in the following aspects:

Evaluation of Liquidity: The ability of a firm to meet its short term payment commitments is called liquidity. Current Ratio and Quick Ratio help to assets the short-term solvency (liquidity) of the firm.

Evaluation of Profitability: Profitability ratios i.e. Gross Profit Ratio, Operating Profit Ratio, Net Profit Ratio are basic indicators of the profitability of the firm. In addition, various profitability indicators like Return on Capital Employed (ROCE), Earnings per share (EPS), Return on Assets (ROA) etc. are used to assess the financial performance.

Evaluation of Operating Efficiency: Ratios throw light on the degree of efficiency in the management and utilization of assets and resources. These are indicated by activity or performance or turnover ratios e.g. Stock Turnover Ratio, Debtors Turnover Ratio. These indicate the ability of the firm to generate revenue (sales) per rupee of investment in its assets.

Evaluation of Financial Strength: Long-term solvency strength is indicated by Capital Structure Ratios like Debt-Equity Ratio, Gearing Ratio, Leverage Ratios etc. These ratios signify the effect of various sources of finance e.g. debt, preference and equity. They also show whether the firm is exposed to serious financial strain or is justified in the use of debt funds.

Inter-firm and Intra-firm comparison: Comparison of the firm’s ratios with the industry average will help evaluate the firm’s position vis-à-vis the industry. It will help in analyzing the firm’s strengths and weaknesses and take corrective action. Trend Analysis of ratios over a period of years will indicate the direction of the firm’s financial policies.

Budgeting: Ratios are not mere post-modern of operations. They help in depicting future financial positions. Ratios have predictor value and are helpful in planning and forecasting the business activities of a firm for future periods, e.g. estimation of working capital requirements.

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All organizations, whether private, public, or non-profit, need to prepare financial statements on their performance to provide fiscal accountability and accuracy to their stakeholders and people with an interest in the company. Financial statements enable management to make business decisions, enable creditors to evaluate loan applications, and provide individuals with information to make investment decisions.

Financial statements provide information from an organization’s accounting documents about their economic resources and obligations on a specific date, as well as their financial activities over a period of time. Financial statements are usually prepared in accordance with Generally Accepted Accounting Principles (GAAP), which are the standards issued by the American Institute of Certified Public Accountants (AICPA), but they may also be prepared on other comprehensive basis of accounting, such as cash basis or tax basis, depending on the needs of the users of the financial statements.

The lowest level of assurance in regards to financial statements is compiled financial statements. One of the main reasons these are used in lieu of other financial statement presentations is for the timely release of financial information about an organization. Compiled financial statements are presentation of various financial reports and documentation, which is the representation of management or owners of an organization. Compilation standards allow the organization to omit note disclosures as long as there is no intent to mislead the users. This is the only type of financial statement that allows omitted disclosures.

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All organizations, whether private, public, or non-profit, need to prepare financial statements on their performance to provide fiscal accountability and accuracy to their stakeholders and people with an interest in the company. Financial statements enable management to make business decisions, enable creditors to evaluate loan applications, and provide individuals with information to make investment decisions.

Financial statements provide information from an organization’s accounting documents about their economic resources and obligations on a specific date, as well as their financial activities over a period of time. Financial statements are usually prepared in accordance with Generally Accepted Accounting Principles (GAAP), which are the standards issued by the American Institute of Certified Public Accountants (AICPA), but they may also be prepared on other comprehensive basis of accounting, such as cash basis or tax basis, depending on the needs of the users of the financial statements.

The middle level of assurance in regards to financial statements is reviewed financial statements. A Certified Public Accountant (CPA) must obtain a reasonable basis for expressing limited assurance that the financial statements meet the requirements of the US GAAP are free of material misstatements or false/missing information.

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Introduction:

Accounting principles are the assumptions and rules of accounting the methods and procedures of accounting and the application of these rules, methods and procedures to the actual practice of accounting.

Definition of Accounting:

The American Institute of Certified Public Accountants defines accounting as “the art of recording, classifying and summarizing in a significant manner and in terms of money transactions and events, which are, in part at least, of financial character, and interpreting the results thereof”.

From the above, it is clear that, Financial Accounting basically deals with Financial Transaction. Its functions are described as follows:

Functions:

1. Recording – Journal entry
2. Classifying – Ledger accounts
3. Summarizing – Trail Balance, Profit and Loss account, Balance Sheet.
4. Interpreting – Financial performance by Profit and Loss account, Financial Position by Balance sheet.

CLASSIFICATIONOF ACCOUNTING PRINCIPLES:

Accounting Concepts:

1. Separate Legal Concept – here Business and Owners of the business are two separate entities. Example: The money invested by the proprietor of the business is treated as capital and shown as Liability. The business feels, one day or other it has to be returned back.
2. Going Concern Concept – Accounts are prepared on the basis that company will continue forever. Example: Credit sales are made, with the view that business will continue and collection can be made later.
3. Money Measurement Concept – here all Transactions must be expressed in terms of Money.
4. Cost Concept – Fixed Assets are shown at Purchase price as the base and Market value is not considered. Example: Land and Building may have increased; yet not considered. Exceptions to closing stock where valuation is done either at Cost price or Market price whichever is lower.
5. Dual Aspect Concern – For every Debit there is an equivalent Credit value. Example: Machinery purchased for Rs.2000.

Machinery a/c Dr. 2000

To Cash a/c 2000.

6.Accounting Period Concept – Though the company considered to be going concern, I order to measure the performance and also to ascertain its Financial Position the business transaction are related to particular segments called Accounting Period. The accounting period may be April to March or Jan to Dec.

7.Periodic Matching of Cost and Revenue – here an attempt is made to relate Revenue made with the Cost incurred. Example: Sales for accounting year is 500000, sales commission paid 20000. Assume the actual commission is to be paid is 50000. In order to match cost and revenue. Rs 30000 are cost relating to this accounting year, so the treatment goes as follows.

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