Accounting 101: An Introduction to the Field

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.

Financial statements are vital to the success of any profitable business. Their purpose is to formally record all financial activities of the company or individual.  These statements summarize in a standard format the financial status of the company in both the short term and the long term. There are four main types of financial statements.

First, the balance sheet summarizes the company’s total assets, liabilities and owners’ equity at a given point in time. This report is also known as the statement of financial position. The balance sheet is used at the beginning of year as a starting point. At the end of the year a new balance sheet will conclude the fiscal cycle. The other financial statements that will be discussed are used to fill in the gap, because a lot can happen in a year.

The income statement summarizes the revenue and expenses for the year and highlights if the company operated at a profit or at a loss. It is in this report that the total gross income is defined as well as all of the expenses that were incurred along the way. The top line of the statement is net sales and the bottom line is net income.

The statement of change in owners’ equity, or statement of change in retained earnings also analyzes data over a time period. Typically this is over a fiscal year. The two major components of owners’ equity are paid-in capital, or cash investments, and retained earnings, or the net income less dividends. If retained earnings are negative because dividends have exceeded net income, this is considered a deficit.

The final major financial statement commonly used by shareholders is the statement of cash flows. The purpose of this report is to follow the company’s cash activities during the year. This is mainly concerned with cash transactions pertaining to operating, investing, and other financial activities.

Shareholders use the four major financial statements to make investment decisions and to see what the company is doing with their money. Executives and top management use statements to make internal budgetary decisions and forecast out for the future success of the business. There are many components that go into the financial reporting for a company, and all information is vital to its continued financial health.

Small Business Financial & Accounting (f&a) Offshore Outsourcing Cost

Fortune 500 companies have been off shoring the financial and accounting business processes (BPO) to countries like India, Philippians, China, etc. These companies have big budgets and a big team of consultants who analyzes the total cost and ROI of sending their financial and accounting work to the service providers in offshore locations. Though smaller companies have started off shoring their financial and accounting work to offshore locations but like big corporations small businesses do not have huge budget to hire consultants to identify the total cost of off shoring their financial and accounting work to offshore locations. But small businesses can still perform their due diligence in calculating total cost of their offshore engagement and gain critical knowledge in finding ROI of sending their financial and accounting work to offshore locations. In this report we will go through all of the hidden costs of offshoring financial and accounting business processes.

1. Different Costs of Offshoring Financial & Accounting Work

Small businesses mainly consider offshoring their work, they will consider only the hourly rate they need to pay to the offshore vendor for various accounting works like bookkeeping, accounts payable, accounts receivable, etc. There are several other additional hidden costs small business have to face in their offshore outsourcing engagement. Typically a small business goes through following offshore accounting work cycle in their offshore engagement:

• Selecting an offshore accounting vendor

• Sending the work to the offshore vendor

• Answering questions for the offshore vendor

• Receiving the finished work from the offshore vendor

• Verifying the finished work from the offshore vendor

• Monitoring the quality of the finished work from the offshore vendor

2. Cost of Selecting offshore accounting vendor

The cost associated with selecting an offshore accounting vendor will be small compared to other costs. Most of the time small businesses can find a qualified offshore accounting vendor simply by searching in Google or by contacting other small businesses those who are already using an offshore vendor, for detailed discussion on this topic read Offshore Accounting Success. This cost is the one time cost and it will be similar to selecting an onshore vendor.

3. Cost of sending the work to an offshore vendor

Small businesses must consider various types of cost like Scanner, High speed Internet, Backup Server, etc, to send their financial and account documents to an offshore vendor, but the good news is that it will be a one time investment and most of the small businesses will have these in place already. There are three different offshore accounting models you can use to send your accounting and financial work to the offshore vendors and for these you will incur following one time cost.

3.1. Scanner & Scanning software

Most of the accounting and financial data will be in your accounting software like QuickBooks, Peachtree etc, but there will be other documents like Bills, Checks, Invoices, Goods received notes, etc will be on paper and these should be digitized using a scanner and a scanning software to convert it into PDF documents which will be stored in your computer. Once the documents are in your computer then you can give access to the offshore vendor to view the PDF documents or they can retrieve it from your computer to perform their work in the offshore location.

Most of small businesses already have a scanner, if not a scanner (scanning software comes with the scanner) can be purchased for less than 00.00. The cost of the scanner will go up based on the volume of accounting and financial documents to be scanned in a given day. It will be a one time cost for the small business and also by scanning all their paper based accounting documents; you can improve the efficiency of overall accounting process.

3.2. High speed Internet Connection Cost

You need to have high-speed Internet connection to send and receive the work to and from offshore location. Again all most all small businesses already have DSL/T1 Internet connection if not they can get a DSL Internet connection for -100/month.

3.3. Secure FTP software

If small businesses are using Application Service Provider (ASP) like Quickbooks online, cpaasp.com, etc, then it is possible for offshore vendors to directly access your accounting data directly from the ASP vendor. In this case there is no need to use secure FTP software.

3.4. Backup Server

Once small businesses start digitizing their accounting documents for their offshore vendors, they need to start planning for the backup server to backup all their accounting documents. Most of the small businesses will have this feature already, if not it is a good investment to have a backup server to backup all their accounting and financial data from their main computer to the backup server. For any business “Business continuity” is a vital task and the backup server will help the small businesses to recover all the accounting data in case of main computer failure.

3.5. Additional Accounting software License cost

Small businesses use various accounting software packages like QuickBooks, MYOB, Microsoft Office Accounting etc, for doing all their accounting and financial work. When they offshore the work the offshore vendor will use the same accounting software to do the work. It is very difficult for the small businesses to find an offshore vendor who already owns the licenses for all the accounting software. As described in the offshore accounting models if small businesses decides to use Remote Server or ASP then there is no additional cost for small businesses. On the other hand if the small businesses decided to use Secure File Transfer then small businesses needs to buy additional accounting software license for the offshore vendor to use. Small businesses will incur this cost even if they outsource the work to onshore vendors. This cost is truly soley based on the accounting software package used by the small businesses. Accounting software packages comes with various flavors types of software licenses like concurrent users, fixed number of users, CPU based, Network based etc., Some times small businesses can completely avoid this cost altogether.

4. Managing Financial & Accounting offshore vendor

Once you send your accounting and financial work to the offshore vendor, you need to constantly mange and monitor the quality of finished work that comes back from the vendor. Initially you may need a full-time person educating the offshore accountants and bookkeepers about your accounting process and preparing proper instructions for them to follow in their work. Once you and the offshore team are comfortable in the working relationship then all you need is to verify the work periodically. Basically you need to consider the offshore team as your virtual team and educate them in your accounting processes and procedures, once you are comfortable with their work your own employee(s) will spend less time with the offshore vendors.

5. Offshore vendor wage

For the accounting and financial work performed by the offshore vendor, small businesses will pay either an hourly rate or a monthly rate to the offshore vendor. This will be the actual direct cost small businesses will pay to the offshore vendor and all other costs are indirect cost of sending the work to offshore vendor. Typically the wage cost will be 50-70% less than the cost paid to the onshore accounting and financial vendor. For small businesses this cost savings is one of the major reasons to use the offshore vendor for their financial and accounting work.

Small businesses need to consider several costs in their financial and accounting offshore engagement. As shown in the table Small business F&A offshore outsourcing – Fixed Cost Vs Monthly Cost some of the costs are fixed and some of them are monthly expanses incurred by the small businesses. Among the monthly cost only the offshore vendor wage is the direct cost paid to the offshore vendor. While performing ROI analysis small businesses must consider all these costs to find the Total Cost of doing business with offshore vendors. As shown in the table, for certain items finding out the exact cost may not be possible and it is highly based on the individual small businesses and the type of accounting and financial work that has been sent to offshore locations. The total cost may not be a fixed amount and it can change from month to month. For example in some months there will be more questions from the offshore vendor in clarifications and in other months there will be less questions, this cost will vary from month to month.

2 Basic Methods Of Accounting

When you’re working in accounting, there are two basic methods. You have your cash basis and accrual basis. Whichever methods you choose will depends on your type of business.

Cash basis is the simpler method. It is mainly use by service businesses that do not maintain inventory or startup businesses that do not offer credit. The accrual method is used by businesses that provide for credit sales or maintain an inventory.

In cash basis accounting, your record sales when cash is received and expenses when they are actually paid. Using the cash basis method is like maintaining a checkbook. Under this method, account receivable are not recorded as sales until they are collected. Account payable are not recorded as expenses until the account is paid.

Bad dept, accruals and deferrals are not appropriately recorded under cash basis because they are examples of outstanding credit or business notes. The cash basis method is not appropriate for businesses that extend credit.

In accrual basis accounting, you report income and expenses as they are earned or incurred rather than when they are collected or paid. Record credit sales as accounts receivable that have not yet been collected. The accrual basis also provides a method for recording expenditures paid in a single installment but covering more than one period. For example, interest may be paid semi-annually or annually, but it is recorded on a monthly basis.

The accrual method satisfies the matching concept, i.e., matching income with related expenditures. Consequently, it can provide a clear and accurate view of business operations for a given period.

Financial Accounting and Reporting and Accounting and Bookkeeping Services

Maintaining a comprehensive, accurate, detailed, transparent yet cost effective accounting setup for any business can be quite a challenge. That is where we step in.
We at KNR understand your need for understanding the running of your business transactions and also understand that you need to stay “in the loop”. Our consultants are at your disposal, to guide you and educate you at every step about what needs to be done to keep your business running smoothly. Whether you want assistance in setting up accounting systems for your enterprise or require year end accounting services, we are there to provide the best services for your business.
Accounting Consulting Services
KNR ‘s accounting consulting services are the result of years of experience put to practical use, which have provided impetus to many business ventures. Our team of consultants works dedicatedly to provide you with the best accounting consulting services , inclusive of financial accounting and reporting. We carry out the entire accounting and bookkeeping services that your business requires, depending on your business needs.
Capital being one of the main ingredients of a company’s structure, a company’s success depends highly on its management. Financial accounting and reporting can be a confusing and highly time consuming process. Outsourcing accounting and bookkeeping services will help you in cutting down costs and diverting resources to other objectives.
Financial Accounting and Reporting
Financial accounting and reporting is an important process in the successful running of any business. It mirrors the success or failure of an organization. It is through this tool, that the public, investors, creditors, government agencies, tax agencies and employees come to know of the worth of the business.
Financial accounting and reporting is important both for internal and external users.
Within the company, it becomes a necessity because of the following reasons:
• Basis of formulating budgets
• Required for internal audits
• Is an important source of information for stake holders
• Measuring current performance against past performances
• Means of making amends if any, judging from past experiences
• Gives a clear picture of the financial standing of the business, increasing employee expectations of returns
• Means of providing information to policy makers to create and implement plans
• Aids in determining areas of deficiency, thus helping in cutting costs
For external users too, financial accounting and reporting is of extreme importance:
• Gives a clear picture of the financial standing of the business to potential investors, helping them in deciding whether or not to invest in a particular firm
• Gives adequate information to existing investors about the future of their investments
• The financial statements are the main criteria for creditors to take decisions about extending credit to firms
• Financial statements are a mandatory tool for tax agencies and are required for external audits
KNR accounting consultants are financial experts who understand the minutest details of accounting and carry out the entire accounting process for you. We provide you with accurate and timely accounting consulting services that help you in maintaining financial data most efficiently.
Accounting and Bookkeeping Services
With the aid of expert accounting professionals, KNR provides you accounting and bookkeeping services that help you stay abreast with your standing in the market. With all your financial data available at a snap of your fingers, you’ll be ever ready to make financial decisions without fumbling or worrying about the accuracy of your accounts. KNR provides computerized accounting and bookkeeping services , which enable you to access information in the easiest and quickest manner.
KNR is known for its professionalism and reliability. KNR ‘s accounting consulting services enable you to judge the net worth of your enterprise. Our consultants would give you detailed analysis of your financial status, setting up an accounting system design that is the best fit for your business.
Companies spend hundreds of dollars in setting up account departments for dealing with the preparation of financial reports. Setting up a reliable financial accounting team is not only time consuming, but also expensive. Financial accounting and reporting is carried out by our experienced accounting team, which completes all your accounting needs from start to finish. From making profit and loss accounts, trial balances and balance sheets to carrying out audits, we do it all. KNR consultants carry out the job with perfection, saving you a great deal of money and hours of quality time. Our services enable you to invest your time and money in other aspects of your business, taking a great deal of pressure off you in performing painstaking accounting procedures because our specialized team does that for you in the shortest times span, giving you accurate and prompt results. At any given point in time, you would be able to pull up all information about your assets, liabilities, incomes, expenses, gains and losses. Our consultants would give you detailed reports that you would be able to comprehend completely, affording you a bird’s eye view of your financial structure and standing. Financial statements form the basis of financial decisions. Thus, by providing financial services as and when you want them, KNR allows you to run your business the way you want, at the same time enabling you to keep complete control of your enterprise’s resources.

Online Accounting Schools And Career In The Field Of Accounting

If you are looking to make a career in the field of accounting, but you don’t have the time to attend full time or part time college, then an online accounting degree is just the right choice for you. With a number of online accounting schools to choose from, you can now make sure that you get that accounting degree you want at your own pace.

Nowadays, there is a lot of demand for professionals in the field of accounting. If you are someone who would like to analyze the financial documents of a company or be involved in the different aspects of accounting administration within a company, then you can really do well as a professional accountant.

Typically, you would have to get your CPA (Chartered Public Accountant) degree. You can also specialize in a variety of areas within the field of accounting such as governmental accounting, managerial accounting and internal auditing. All of these career options have a lot of scope for advancement for you.

The curriculum will generally include a number of subjects like tax law, risk management, raising and managing capital, corporate finance, financial management, budgeting and planning.

Studying for your accounting degree online is the best option for you, especially if you are working in a full time job or have family or some other commitments which do not allow you to attend a full time course. Of course, this will involve you studying at home and sending in your assignments via e-mail.

You can study for a number of basic degrees before you apply for your CPA certificate. You can study for a Bachelors Degree in Accounting, or an Associate of Science Degree in Accounting. You can also go for a Bachelor of Science Degree in Accounting. You can also take a Bachelors Degree in Managerial Accounting or Financial Accounting. A number of options are available for you. You can apply for an online accounting degree course with almost any university or college. Most of the universities today will offer both – a full time course and an online course. Some may also offer part time courses. As a Certified accounting professional, you can expect to earn an annual salary in the range of ,000 to ,000.

Thus studying for an accounting degree and certification via an online accounting course can also help you to chart your career path in the field of accounting.

Explanation of T-account, Debit and Credit, and Double-entry Accounting System

Explanation of T-account, Debit and Credit, and Double-entry Accounting System


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Home Page > Finance > Accounting > Explanation of T-account, Debit and Credit, and Double-entry Accounting System

Explanation of T-account, Debit and Credit, and Double-entry Accounting System

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Explanation of T-account, Debit and Credit, and Double-entry Accounting System

By: Igor Voytsekhivskyy

About the Author

Igor Voytsekhivskyy is a CPA and CIA working in public accounting. He maintains a website SimpleStudies.com devoted to helping people learn accounting online for free.

(ArticlesBase SC #490669)

Article Source: http://www.articlesbase.com/Explanation of T-account, Debit and Credit, and Double-entry Accounting System





All accountants know several terms that create basis for any accounting system. Such terms are T-account, debit and credit, and double-entry accounting system. Of course, these terms are studied by accounting students all over the world. However, any business person, whether an investment banker or a small business owner, will benefit from knowing them as well. They are easy to grasp and will be helpful in most business situations. Let us take a closer look at these accounting terms.

T-Account

Accounting records about events and transactions are recorded in accounts. An account is an individual record of increases and decreases in a specific asset, liability, or owner’s equity item. Look at accounts as a place for recording numbers related to a certain item or class of transactions. Examples of accounts may be Cash, Accounts Receivable, Fixed Assets, Accounts Payable, Accrued Payroll, Sales, Rent Expenses and so on.

An account consists of three parts:

- title of the account

- left side (known as debit)

- right side (known as credit)

Because the alignment of these parts of an account resembles the letter T, it is referred to as a T account. You could draw T accounts on a piece of paper and use it to maintain your accounting records. However, nowadays, instead of having to draw T accounts, accountants use accounting software (i.e., QuickBooks, Microsoft Accounting, Peachtree, JD Edwards, Oracle, and SAP, among others).

Debit, Credit and Account Balance

In account, the term debit means left side, and credit means right side. These are abbreviated as Dr for debit and Cr for credit. Debit and credit indicate on which side of a T account numbers will be recorded.

An account balance is the difference between the debit and credit amounts. For some types of accounts debit means an increase in the account balance, while for others debit means a decrease in the account balance. See below for a list of accounts and what a debit to such account means:

Asset – Increase
Contra Assets – Decrease
Liability – Decrease
Equity – Decrease
Contribution Capital – Decrease
Revenue – Decrease
Expenses – Increase
Distributions – Increase

Credits to the above account types will mean an opposite result.

Double-entry Accounting System

A double-entry accounting system requires that any amount entered into the accounting records is shown at least on two different accounts. For example, when a customer pays cash for your product, an account would show the cash received in the Cash account (as a debit) and in the Sales account (as a credit). All debit amounts equal all credit amounts provided the double-entry accounting was properly followed.

Having a double-entry accounting system has benefits over regular, one-sided systems. One of such benefits is that the double-entry system helps identify recording errors. As I mentioned, if one amount is entered only once in error, then debits and credits won’t balance and the accountant will know that one or more entries were not posted fully. Note, however, that this check will help spot errors, but will not identify all cases of errors. For example, equal debits and credits will not identify an error when an amount was posted twice, but was posted to wrong accounts. Keep this in mind when analyzing causes of errors in accounting records.

 

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About the Author:

Igor Voytsekhivskyy is a CPA and CIA working in public accounting. He maintains a website SimpleStudies.com devoted to helping people learn accounting online for free.

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accounting, accounting balance, account, debit, credit, double entry accounting system, accounting lesson, accounting definition

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1. anca 15/03/2009

I am confused on how I could understand what is the purpose of making the debit equal to my credit.

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2. Kyle 17/03/2009

Think of it like science…remember when you talked about how “matter can not be created nor destroyed”? The same principle applies to money (unless you are the US government I suppose but that is not our current topic) in that you cannot just pull money out of thin air you have to pull it from an account to put it in a different account.


The best example I can think of is let’s say you make widgets and your whole purpose is to sell them to your customers(makes sense). Well let’s say you record a Sale to John for ,000. You cannot simply put it in your account as Revenue = ,000 because you have had a reduction to your inventory. So to balance your increase in Revenue of ,000 you would need to record a DECREASE to inventory of ,000. Once you understand this concept (which I fully admit is foreign at first) Accounting becomes much much easier…that is until you go global! =)


Good luck to you!

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Igor Voytsekhivskyy is a CPA and CIA working in public accounting. He maintains a website SimpleStudies.com devoted to helping people learn accounting online for free.


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Cash Accounting or Accrual Accounting

The tax authority require bookkeeping records to calculate the tax due. The choice for small business is basically cash accounting or accrual accounting each of which has advantages and disadvantages.

The date of the sales invoice and the date of purchase invoice are known as the tax point. The tax point does not determine the spread of that transaction over the tax period which can be different when accounts are prepared on an accruals basis as opposed to a cash basis.

For the purposes of cash accounting the effective inclusion of the transaction in the financial records is the date the cash or bank receipt or payment was made. The tax point date on the document is not the deciding factor to include the item in the accounts. The date the amount was paid out or received into cash funds or bank account is the date to be used fopr inclusion in the accounts.

There are disadvantages to maintaining accounts on a cash basis in that records must be kept of all payments received and paid out and those records supported by the actual primary accounting documents to which they relate. That entails matching the financial documents to the payments and receipts records, a feature many small businesses might find onerous as record keeping ios often regarded by samll business as an administrative burden.

Virtually all professional accountants adopt an accruals basis for clients accounting purposes as it is based upon recording all financial information whether relevant to the tax period or not and then adjusting the management accounting profit indicated to produce the net taxable profit or loss.

By operating an accruals basis all financial documents are recorded according to the tax point date. If every transaction was paid or received within the year then the cash accounting and accruals basis would produce the same tax accounts.

The main adjustment a small business or the accountant might make to accounts prepared on the accruals basis is to first prepare the set of accounts according to the tax point of the primary accounting records and then examine those transactions and adjust them according to their relevance to the financial period for which the accounts are being prepared.

A typical example of the difference would be the rent invoice for the business premises. Let us assume a quarterly rent invoice was received dated 1 December for the 3 months from December 1 to February 28 which was paid by the small business owner by cheque on December 31 and a year end date also of December 31

On a cash basis the rent would not technically be included in the accounts as it would be shown as a rent payment from the business bank account on January 2 or later if cashed by the recipient at a later date. Therefore that quarters rent would be included in the following year accounts not the current year as issuing a cheque is not a payment but actually a promise to pay.

Assuming the rent was paid in cash prior to the 31 December then the whole 3 months rent would be included in the current financial year. That treatment may have distorted the accounts as more or less than 12 months rent might have been included in the tax calculations.

On an accruals basis the rent invoice would have been entered in the accounting records with an effective date of December 1. The accountant or small business owner preparing the accounts would deduct 2 months from the qaurterly amount leaving one months rent in the current year accounts with the other 2 months being included the following year.

That is more accurate as the other side of the accounting would be for that same accountant or bookkeeper to further include the 2 months rent not already claimed to be included in the tax calculation for the next financial year. Mvoing the prepayment not specific to the accounting period is how business treats a prepayment under accrual accounting.

When operating cash accounting only transactions actually paid for or received are valid. On an accruals basis provisions can be made for costs incurred by the business whicvh have not yet been invoiced.

Cash accounting might appear easier but has the disadvantage of maintaining receipts and payments records in addition to the primary documents which should also be matched to the financial transactions to support the accounts.

Accrual accounting is based upon recording all financial transactions and then adjusting the end result to determine the most accurate net taxable profit. The accruals basis is favoured by accountants as it reaches an accurate tax liability as opposed to more or less tax being payable on the cash basis according to the credit control policies and practises of the business its suppliers and clients.

Investor?s Guide to Financial Accounting

When people decide to invest in anything the first question they ask is, “how much money will I make from this investment opportunity?”  The multitude of investment options has made it more difficult for the average investor to calculate risk and determine the best investment for their money.  Bank deposits with conservative returns have evolved into certificate of deposits, mutual funds, hedge funds, futures and options to name a few.    Fortunately there are many resources available to help navigate these difficult waters.  Instead of using costly professional advice or independent analysis from resources like Morningstar, we will begin to invest with confidence using financial accounting to drive our decisions.

Accounting is the process of identifying, measuring and communicating economic information so users of accounting can make informed decisions about a company’s performance.  There are many types of users of accounting from management focused on day to day operations to investors focused on future cash returns.  Investors should focus on a company’s past performance because there is a strong correlation to future success.  Financial accounting provides investors with historical results of a company through financial statements.  These financial statements include the balance sheet, income statement, statement of cash flows and statement of owner’s equity.

The balance sheet provides details about a company’s assets, liabilities and owner’s equity.  Unlike the other three financial statements, the balance sheet is for a point in time.  Most balance sheets are done at the end of a company’s fiscal year to show the company’s financial position at that point in time.  The most important thing to look for when investing in a company is its assets are greater than liabilities.  According to the accounting equation, assets = liabilities + owner’s equity, if assets are greater than liabilities the owner’s have positive equity in the company.  If the company were to liquidate its assets and pay off all of its liabilities there would be money left for the owners to recoup some if not all of their investment.  A positive trend in owner’s equity is a strong indicator of a sound investment.

When investing, it is important to focus on companies that have the assets necessary to remain in operation.  Both positive working capital and a current ratio greater than 1 are strong indicators of this.   Working capital is current assets minus current liabilities.  Positive working capital means a company has the necessary working capital to reinvest in its operations and drive future revenue.  The current ratio, current assets divided by current liabilities, shows that a company has the necessary current assets to pay for current liabilities and remain in business.   A current ratio of 2.0 is a good rule of thumb for adequate liquidity.  This shows that a company has two times the necessary current assets to pay off any current liabilities.

The income statement is another key indicator of a company’s past performance.  At the end of its fiscal year a company will determine its profit or loss by calculating its net sales and subtracting the expenses necessary to achieve those sales.  Net income shows that a company is profitable.   A positive trend in net income over time means a company continually performs well and is a strong indicator of future success.  Net income shows up on the Statement of Changes of Owner’s Equity under retained earnings.  It is this money that is available to investors through cash dividends.

The Statement of Changes of Owner’s Equity as mentioned above details the total owner’s equity for a period of time.   Over time an investor would like to see a positive trend in owner’s equity.  This shows an investor that throughout the fiscal year there is an increase in owner’s equity through retained earnings.  These earning are available to reinvest in the company and make it stronger in the future.

The Statement of Cash Flows identifies the use of cash by a company during the fiscal year.  This details the cash flows from operating activities, investing activities and financing activities.  It is impossible for a company to survive over time with negative cash flow therefore it is crucial to review the trends in this statement to make sure the company has positive cash flow over time.  The ending cash balance detailed in the Statement of Cash Flows becomes part of the Assets in the Balance sheet.  Consistent reduction in cash will reduce the owner’s equity and in turn reduce a return on investment.

The statements detailed above are critical pieces in making sound investment decisions.  Understanding these documents combined with your existing resources for investment decisions will make you more proactive in your investment decisions and help mitigate risks in your portfolio.

Inventory Techniques in Financial Accounting

Financial accounting provides an essential skill set that is applicable in virtually any situation that involves the sale and purchase of goods and services. Whether you own your own business or simply would like to know how to manage your own personal finances, a modest understanding of Generally Accepted Accounting Principles (GAAP) will permit you the ability to accurately identify, record, and communicate your selling and spending activity, and will, by default, allow you to make wiser financial decisions.

I will explain one concept that is fundamental, yet very essential, to businesses that operate on a perpetual inventory system. When a merchandising company orders new products for their inventory, it purchases them at a market-clearing price that changes over time. As the company begins to accumulate a volume of inventory after purchasing the same product at different times for different prices, the company must decide how to place a value on the goods that the sell and the goods that they have in inventory at a particular moment in time. Now, as you may have learned from even the most menial everyday undertakings, there are often a variety of correct ways to complete a task. Some approaches yield benefits that others do not. Similarly, there are different ways for a business to value its inventory. For the purposes of financial accounting, I will outline three of the most common techniques that accountants use to determine the value of goods in a business’s inventory—namely, FIFO, LIFO, and weighted average.

Suppose you own a business that buys skateboards from a distributor and sells them out of a shop in town. You buy ten skateboards for 0 each on the first day of your business’s operation. On the second day, you buy ten more skateboards for 0 each, which gives you a total of 20 skateboards valued at ,100 in total. Finally, on the third day, you sell twelve of the skateboards that you have in inventory, leaving eight skateboards in your inventory. According to GAAP, the amount reported on your business’s Cost of Goods Sold and Merchandise Inventory accounts depends on the way that you decide to value the goods that were sold.

First, consider the inventory technique of First In First Out (FIFO). This method ensures that the first items that arrived in inventory will also be the first to leave the store. Thus, in our example, when the twelve skateboards are sold on the third day, the seller will value the inventory sold giving priority to the cost of the first ten skateboards that arrived in inventory. Ten of the skateboards sold on the third day will be valued at 0 apiece and the last two will be valued at 0. Therefore, when computing the Cost of Goods Sold, there will be ten skateboards valued at ,000 total and two skateboards valued at 0 total, which will credit the Cost of Goods Sold account for a total of ,220. The ending inventory will then be calculated using the schedule of Cost of Goods Sold. The total inventory before any sales is ,100, and after the sale, the ending inventory is 0.

If, however, your business were operating according to the Last In First Out (LIFO) inventory technique, your Cost of Goods Sold and Ending Inventory accounts would not have the same amounts as they would if you were using FIFO. Instead of giving priority to the first items that arrived in inventory, the items that you most recently purchased will be the first ones to leave the store. Using the same example where twelve skateboards are purchased, you will cost the ten skateboards valued at 0 each and two of the skateboards valued at 0 each. Thus, the total Cost of Goods sold will be ,300 and the Ending Inventory will be 0, which is notably different than the values computed using the FIFO technique.

Another technique that is commonly used to calculate the value of inventory is Weighted Average (WAVG). When employing this technique, you compute the average cost of a single good by dividing the total value of goods in inventory by the total quantity of goods in inventory on the date of the sale. So, in our skateboard shop example, you would find the total value of the skateboards you have in inventory, ,100, and divide it by the total number of skateboards in inventory, 20, to find an average cost of 5 per skateboard. Thus, to compute the Cost of Goods Sold for the twelve skateboards sold on the third day, you would simply find the total price of the twelve skateboards valued at 5 each, which is ,260, leaving an Ending Inventory of 0.

To summarize, FIFO yielded an Ending Inventory of 0, where WAVG computed 0, and LIFO computed only 0. Clearly these values are quite significantly different and will affect the balance sheet accordingly. The question becomes which of these techniques is the best to use for the skateboard shop.

The assumption that the prices of goods generally rises over time has influenced many companies to enlist in the method that provides the greatest benefit for their particular firm. For example, many merchandising companies have subscribed to using LIFO because it provides an implicit tax benefit– the comparatively low Ending Inventory at the end of the period implies a lower amount of taxable assets. Thus, the company pays less in taxes.

The preceding example of inventory techniques illustrates the concept that an understanding of financial accounting principles can provide an individual with a framework to make better financial decisions. A holistic understanding of these concepts can only help you to manage your finances more effectively and make your business more competitive.

What is Accounting?

They say that accounting is a language of business. You can be a professional musician or a computer genius, but it’s not enough to get money. We also need to think about income and expenditures, and of course taxes. Filing a tax return can be rather a hard problem, especially in our country where we can observe instability in accounting laws and governmental orders concerning this field of business. So to get maximum profit, to speak to taxmen one language and not to let them  tease you every person got in touch with any type of business needs to know rules and principles of accounting.

So, what is it, accounting?

Accounting, as it’s said in dictionaries, is keeping financial records, recording income and expenditures, valuing assets and liabilities and so on. Accounting is a service activity. Its function is to provide quantitative information about economic entities. The information is primarily financial in nature and is used in making economic decisions. Accounting records are used in describing the activities and financial status of many different kinds of economic entities including hospitals, schools, cities, governmental agencies and profit-oriented businesses.

how does it work, you wonder? There are a lot of principles being used in the local and international practice, but to start with you should remember the simple rule: you nave to keep records that accurately reflect your financial life. That’s the bottom line, and then you go and get more complex forms of bookkeeping. By the way it seems to be necessary to explain what bookkeeping means. It’s the process of getting financial information, writing down the details of transactions (all economic exchanges of goods, services, money between two or more people). Actually, bookkeeping is only a part of accounting – the record-making part. And accounting itself includes also analytical and interpretation part, it shows the relationship between the financial results and events which have created them.

There are three main steps in making records in bookkeeping:

1) Recording every purchase and sale that a business makes in a journal

2) Entering these temporary records in the ledger (a book of secondary, final entry, containing individual accounts)

3) Transferring all the relevant totals to the profit and loss account.

The main principle of bookkeeping is a double-entry principle. It states that each transaction must be recorded as two separate entries: a value both received and parted with. Payments made or debits are entered on the left-hand (debtor) side of an account, and payments received or credits on the right-hand (creditor) side.

And what seems to be of importance is the way of recording expenses. You should not just take what comes in and what goes out, but it’s better to set up various categories to keep track of the income and expenses and to help with tax return problems.

As I’ve already said, accounting helps to control, evaluate and plan the work of the company. But what concerns accounting, from the different points of view we can speak about different aims and therefore different areas of accounting. For instance, financial accounting prepares financial statements of various kinds, and managerial accounting prepares financial information, such as budget and other financial reports, necessary for the company itself. We can speak about cost accounting , which aim is to work out the unit cost of product, including materials, labour and all other expenses. And we can speak about tax accounting with the process of calculating an individual’s or a company’s liabilities for tax. All these procedures are usually done by the company’s own accountants, but sometimes it should be checked by a second set of accountants. I am talking about auditing as an inspection and evaluation of accounts necessary to be done for some types of business and preferable for others.

But as you know not everyone wants to pay all taxes, so many companies use all available procedures and tricks to disguise the true financial position of a company. Of course it’s illegal, but rather wide-spread, and even has  its name – creative accounting. This funny name causes many misunderstanding as many people think it’s a certain sphere, area of accounting. But it’s the same as window-dressing or Chinese accounting – just illegal tricks.

So one more question can arise -what particular skills are needed for different kinds of accountants. I don’t speak about creative accounting, but about honest  business. It seems to be rather logical to say that all bookkeepers need accuracy and concentration as well as mathematical (or at least arithmetical) abilities. Tax accounting requires knowledge of tax laws and accounting, auditing requires strong analytic and synthetic skills, while   managerial and cost accounting require analytical and mathematical competence.

In accounting it’s always assumed that a business is a “going concern”, I mean it will continue indefinitely into the future. So, the current market value of its fixed assets is irrelevant, as they are not for sale. Consequently, the most common accounting system is historical cost accounting, which records assets at their original purchase price, minus accumulated depreciation charges. But this method understates the value of appreciating assets such as land, but overstates profits as it doesn’t record the replacement cost of plant or stock. So countries with persistently high inflation often prefer to use current cost or replacement cost accounting, which values assets at the price that would have to be paid to replace them today.

To be able to compare the activity of different companies, working in different spheres, to run accounting of the firm, European and American accountants follow GAAP (generally accepted accounting principles). They allow to run the company using unificated methods and rules, which is very useful. And speaking about our country I can say that Russian accountants are also follow these principles or at least part of them.

So according to International Accounting Standards, we can speak about

1) principle of the separate entity or accounting entity concept . An organisation is a separated establishment and it’s property is separated from the property of its’ owners and other firms’ assets.

2) the continuity or going concern concept. We presume that a firm is going to go on its activity

3) the unit-of-measure concept

4) the time-period or accounting period concept

5)  the revenue or realisation principle

We also know matching principle and consistency one, objectivity and conservatism principles, full disclosure and confidentiality ones and many other.

All these principles are of usage to speak one language with for example the American Institute  of Certified Public Accountants or IPS (Internal Revenue Service) – for American accountants or for instance Ministry of taxes or Institute of Professional Accountants of RF.

All information, all work accountants are doing throughout  a year is combined in the annual report, aimed to provide the shareholders with the information on the company performance and to file the tax return. This report consists of verbal and financial parts. At the second one we can observe figures presented by the three financial statements, notes, letters of auditor’s opinion. I’d like to talk in details about these three financial statements. The profit and loss account (income statement), the balance sheet and the source and application of funds statement (the statement of changes in financial position).

The profit and loss account shows the company’s revenue (inflows of assets received in exchange for goods and services  provided to customers as part of the major or central operations of the business) and expenditures (outflows or using up of assets as a result of the major or central operations of a business). Income statement usually gives figures for total sales or turnover (the amount of business done by a company over a year), and costs and overheads  (the various expenses of operating a business that cannot be charged to any one product, process or department). Part of the profit goes to the government in taxation, part is usually distributed to shareholders as a dividend, and part is retained by the company.

The second financial statement is called the balance sheet which shows a company’s financial situation on a particular date, generally the last day of the financial year. It lists the company’s assets, its liabilities, and shareholders’ (stockholders’) funds, which are written in two parts: assets on the left, and liabilities and share capital – on the right. What is important is that both parts should be balanced, I mean equal as they depict the same, but from the different points of view.

So to show it through mathematical equation I should say that Assets=Liabilities+Owners’ Equity(net assets).

Negative items on financial statements such as creditors, taxation and dividends are usually enclosed in brackets.

May be I should explain more accurately some definitions I’m talking about. First of all assets. it’s anything owned by a business (cash investments, buildings, machines, and so on) that can be used to produce goods and pay liabilities. Assets can be tangible and intangible. Intangibles are those assets whose value cannot be quantified or converted into cash without difficulty, such as goodwill, copyright, trademark, data base, know-how. Tangibles include current (inventory, marketable securities, accounts receivable, cash in hand and at bank) and fixed or capital or permanent (freehold property, machinery, office equipment, motor vehicles, etc) assets.

Liabilities are debts to lenders, all money that a company will have to pay to  someone else in the future, including taxes, debts, interests and mortgage payments. They can be current (to be paid out within one year) or long-term, with the term of payment more then one year. Sometimes this payments can be defined as prepayments (money paid in advance before the goods are delivered to the customer), sometimes – as deferred charges (money, whose payment is put off at a later date).

There are two types of liabilities – current and long-term ones. Current liabilities can be paid out within one year. Non-current or long-term liabilities are those, which should be paid within a period of time which, is more than one year.

Shareholders’ equity (net assets) includes share capital (money, received from the issue of shares), share premium (GB) or paid-in surpluses (US) – money, released by selling shares at above their nominal value -, and the company reserves including the year’s retained profits.

Some ratios can be applied to Balance sheet analysis. They are the liquidity ratio, the current ratio, return on capital employed ratio, profit on sales, debtors ratio, creditors ratio, debt/equity ratio.  Return on capital employed and profit on sales show a company’s profitability.

Return on capital employed =net profit/capital employed. (this ratio allows bankers to compare a company’s performance with similar companies in the industry)

Profit on sales = net profit/turnover (it shows the overall profit margins achieved on sales)

Debtors, creditors and debt/equity ratios display a company’s performance.

Debtors ratio =debtors/sales*365 days (it shows the effectiveness of credit control procedures and allows comparison with payment periods to creditors)

Creditors ratio =creditors/purchases *365 days (due to it we can see how much business is financed by trade creditors)

Debt/equity ratio =long-term loans/shareholders funds (it shows the degree to which the company depends on outside finance, e.g. banks, to run its business)

The third financial statement is the source and application of funds statement and it shows the flow of cash in and out of the business between balance sheet dates. Sources of funds include trading profits, depreciation provisions, borrowing, the sale of assets and the issuing of shares. Application of funds includes the purchases of fixed or financial assets, the payments of dividends, the repayment of loans and trading losses, if exist.

So we can speak about several types of assets. Current assets comprise inventories, marketable securities, accounts receivable, cash in hand and in bank. Liquid assets are anything that can quickly be turned into cash. Fixed assets consist of freehold properties, plants and machinery, office equipment, motor vehicles. We can also use words “capital assets”, “permanent assets” for fixed assets.

I’ve told a lot about different principles of accounting and different financial statements. And at the end I’d like to cover the last aspect – aspect of human factor in accounting. We can’t say that accounting is completely objective, because it’s not merely a collection of arithmetical techniques, but a set of complex processes and most accounting reports depend to a greater or lesser extent on people’s opinion. So to be professional it’s not enough just to study all rules and order of filing documents. You should feel the inner principles of all these numbers, understand accurately where our incomes and expenditures can be and try to get the maximum profit (of course without window-dressing)