Accounting As Simple As It Gets

Many people look at accounting and say, "Accounting does not 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 should not 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. Do not 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 Relevance, 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 bs 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 not 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 buying 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 do not 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 do you have the rights to a building and what cost to spend? 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 do not 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 happening in your business.

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

Source by Sean C Anderson

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