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For most people the language that financial and accounting people speak is unknown to them. The most unfortunate aspect of that inarguable truth is that your business life depends on your understanding the process and the numbers they are talking about.
The following information will help you understand the terminology they use and the processes they embrace.
This section is divided into three areas of understanding:
• The Rules of the Game
• The Flow of Finance & Accounting: (The Accounting Cycle, Debits & Credits, Fundamental
Equations and ‘Methods of ‘Recognition’)
• An ART vs. A SCIENCE
Spending some time becoming familiar with these concepts will pay rich dividends for your business.
Please Note! The following discussion is from a Business Perspective. It is not intended to be a discourse on Accounting & Financial Procedures professionals perform every day. It is, however, an attempt to familiarize you with what Finance & Accounting is all about, so that you will be able to understand the language and concepts being used and be better able to apply the information to achieve the results you need to avoid business failure.
FINANCIAL
COMMUNICATION
If you ask your accountant a question,
can you make sense out of what he or she is telling you?
A QUESTION TO CONSIDER...
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Rules of the Game
UNDERSTANDING THE RULES OF THE GAME
1929 witnessed the aftermath of the Stock Market crash and the ensuing Great Depression. In an effort to regulate the offer and sale of securities Congress enacted the Securities Act of 1933. Before the Act, regulating securities was primarily governed by individual State Laws, commonly referred to as ‘Blue Sky Laws’. The Act did not mitigate the Blue Sky Laws but superseded them in regard to compliance and disclosure. The primary purpose of The Act was to provide complete and accurate information to buyers of securities. It can be summed up in the phrase “Full and Accurate Disclosure”.
The Securities Act of 1933, was followed by The Securities Exchange Act of 1934. In a sweeping piece of legislation, Congress instituted rules and regulations governing the secondary trading of securities (stocks, bonds and debentures). The secondary trading of securities involves the trading of these original securities between people often unrelated to the issuer, mostly conducted through brokers and/or dealers. The 1934 Act also established the Securities and Exchange Commission (SEC). This agency is responsible for enforcement of federal securities laws enacted by the United States Congress. Think of the SEC as the ‘Watchdog of the Industry’.
In 1973, the SEC facilitated the formation of THE FINANCIAL ACCOUNTING STANDARDS BOARD (the FASB, pronounced faz-bee). FASB is a private, not-for-profit organization entrusted with the development of acceptable accounting standards. The SEC designated FASB as the entity responsible for setting generally accepted accounting principles for public companies in the United States. FASB’s stated mission is to “establish and improve standards of financial accounting and reporting for the guidance and education of the public, including issuers, auditors, and users of financial information.”
‘GAAP’ is an abbreviation for Generally Accepted Accounting Principles. GAAP refers to the framework of standard guidelines for financial accounting established by FASB. It includes acceptable standards, procedures, rules and regulations accountants follow in recording, summarizing and reporting financial information contained in financial statements. GAAP is not a single accounting rule, but rather a complex aggregate of how to account for ‘transactions’ incurred in business operations. Think of GAAP as our Rulebook for playing the game of business.
PLEASE NOTE! GAAP is being slowly phased out in favor of the International Accounting Standards as business becomes increasingly global. GAAP refers only to United States financial reporting. Although similar in many aspects the differences will merit fundamental changes in how we conduct business.
The Flow of Finance and Accounting
UNDERSTANDING THE FLOW OF FINANCE & ACCOUNTING
A. The Accounting Cycle
The Accounting Cycle1.TRANSACTIONS: It all begins with “transactions’. Transactions are anything of a financial nature that we want to record permanently. It could be a check received or given, cash received or paid, purchases, sales, etc.
TRANSACTIONS: It all begins with “transactions’. Transactions are anything of a financial nature that we want to record permanently. It could be a check received or given, cash received or paid, purchases, sales, etc.2.THE GENERAL JOURNAL: Accountants need a place to ‘capture transactions’. They put them in what is called the General Journal. Whenever you hear accountants say they are making a ‘journal entry’ they simply mean they are capturing transactions by putting them in the General Journal. (Do not confuse the General Journal with the General Ledger. We will discuss the General Ledger below.) Think of the General Journal as simply ‘a log’. In concept it is nothing more or less than a place to capture transactions chronologically as they occur so they will not be lost.
THE GENERAL JOURNAL: Accountants need a place to ‘capture transactions’. They put them in what is called the General Journal. Whenever you hear accountants say they are making a ‘journal entry’ they simply mean they are capturing transactions by putting them in the General Journal. (Do not confuse the General Journal with the General Ledger. We will discuss the General Ledger below.) Think of the General Journal as simply ‘a log’. In concept it is nothing more or less than a place to capture transactions chronologically as they occur so they will not be lost.3.AN ACCOUNT: Once accountants have ‘captured transactions’ in the General Journal they need a way to organize them so they can be found quickly and easily for use and future reference. Transactions that are similar in nature are grouped together in what accountants refer to as ‘Accounts’. An Account is nothing more or less that a grouping of “like transactions.’ Transactions can be grouped together and named in any way you would like. There is no standard way to group and name them. Any format that will help you track and use them is acceptable.
AN ACCOUNT: Once accountants have ‘captured transactions’ in the General Journal they need a way to organize them so they can be found quickly and easily for use and future reference. Transactions that are similar in nature are grouped together in what accountants refer to as ‘Accounts’. An Account is nothing more or less that a grouping of “like transactions.’ Transactions can be grouped together and named in any way you would like. There is no standard way to group and name them. Any format that will help you track and use them is acceptable.4.THE “T”: Accountants need a way to track activity after they have grouped like transactions. To track the increases and decreases in Accounts they use what is known as the “T” or the “T Account”. Most experts acknowledge the development of the “T” to an Italian mathematician and Franciscan friar, Luca Pacioli. Fra Luca Bartolomeo de Pacioli was a collaborator with Leonardo da Vinci. In fact, in 1497, he accepted an invitation from Duke Ludovico Sforza to work in Milan, where he subsequently met, collaborated with, lived with, and taught mathematics to Leonardo da Vinci. He is widely recognized as the seminal contributor to the field we know today as accounting. The “T” is a way to track activity by using what we know as ‘debits and credits’. (Debits and Credits will be discussed below.)
THE “T”: Accountants need a way to track activity after they have grouped like transactions. To track the increases and decreases in Accounts they use what is known as the “T” or the “T Account”. Most experts acknowledge the development of the “T” to an Italian mathematician and Franciscan friar, Luca Pacioli. Fra Luca Bartolomeo de Pacioli was a collaborator with Leonardo da Vinci. In fact, in 1497, he accepted an invitation from Duke Ludovico Sforza to work in Milan, where he subsequently met, collaborated with, lived with, and taught mathematics to Leonardo da Vinci. He is widely recognized as the seminal contributor to the field we know today as accounting. The “T” is a way to track activity by using what we know as ‘debits and credits’. (Debits and Credits will be discussed below.)5.THE GENERAL LEDGER: Now that accountants have captured transactions in the General Journal, grouped them into accounts and are tracking their activity, they need a place to store them. Accountants store account information in what is known as THE GENERAL LEDGER. The General Ledger is simply a place to keep accounts. There is a very important aspect of the General Ledger you should be aware of and remember. We mentioned that there is no standard way of naming accounts. There is, however, a specific way in which accounts are stored in the General Ledger. The General Ledger is broken down into five (5) distinct, separate areas: ASSETS, LIABILITIES, EQUITY, INCOME & EXPENSE. Every General Ledger, regardless of the business or the industry, groups accounts into these 5 areas. These 5 areas work together to provide a clear and accurate picture of how the organization is performing financially. (The significance becomes apparent using debits and credits.) The General Ledger’s specific grouping of accounts ties directly into the use of Financial Statements.
THE GENERAL LEDGER: Now that accountants have captured transactions in the General Journal, grouped them into accounts and are tracking their activity, they need a place to store them. Accountants store account information in what is known as THE GENERAL LEDGER. The General Ledger is simply a place to keep accounts. There is a very important aspect of the General Ledger you should be aware of and remember. We mentioned that there is no standard way of naming accounts. There is, however, a specific way in which accounts are stored in the General Ledger. The General Ledger is broken down into five (5) distinct, separate areas: ASSETS, LIABILITIES, EQUITY, INCOME & EXPENSE. Every General Ledger, regardless of the business or the industry, groups accounts into these 5 areas. These 5 areas work together to provide a clear and accurate picture of how the organization is performing financially. (The significance becomes apparent using debits and credits.) The General Ledger’s specific grouping of accounts ties directly into the use of Financial Statements.6.THE CHART OF ACCOUNTS: In order to locate accounts quickly in the General Ledger, accountants use what is referred to as The Chart of Accounts. The Chart of Accounts is simply a listing of all the accounts contained in the General Ledger. Accountants assign each account a specific number in order to find them easily. There is no standardization of the numbering system used by accountants. The numbering system may be specific to the accountant or the software utilized. The Chart of Accounts then can be compared to The Table of Contents of a book. The Table of Contents lists the chapter of the book and the associated page number. The Chart of Accounts lists the account specified for similar transactions and its associated reference number. If you have many accounts the numbering system may become elaborate. If you have few accounts the numbering system may be quite simplified.
THE CHART OF ACCOUNTS: In order to locate accounts quickly in the General Ledger, accountants use what is referred to as The Chart of Accounts. The Chart of Accounts is simply a listing of all the accounts contained in the General Ledger. Accountants assign each account a specific number in order to find them easily. There is no standardization of the numbering system used by accountants. The numbering system may be specific to the accountant or the software utilized. The Chart of Accounts then can be compared to The Table of Contents of a book. The Table of Contents lists the chapter of the book and the associated page number. The Chart of Accounts lists the account specified for similar transactions and its associated reference number. If you have many accounts the numbering system may become elaborate. If you have few accounts the numbering system may be quite simplified.7.‘ADJUSTING ENTRIES’: When you hear accountants use the phrase ‘adjusting entry’ they mean one of two things. An Adjusting Entry is either 1) correcting a mistake or 2) inserting additional information into your financial ‘books’ that needs to be recorded for future use and reference. Depreciation and Amortization are perhaps the best example of additional information accountants record as ‘Adjusting Entries’. (Depreciation and Amortization are addressed under CAPITAL CONSIDERATIONS listed on the Home Page.)
‘ADJUSTING ENTRIES’: When you hear accountants use the phrase ‘adjusting entry’ they mean one of two things. An Adjusting Entry is either 1) correcting a mistake or 2) inserting additional information into your financial ‘books’ that needs to be recorded for future use and reference. Depreciation and Amortization are perhaps the best example of additional information accountants record as ‘Adjusting Entries’. (Depreciation and Amortization are addressed under CAPITAL CONSIDERATIONS listed on the Home Page.)8.‘CLOSING ENTRIES’: Accountants use the phrase ‘closing entries’ at the end of the current accounting period when they are preparing the financial information for storage. Many times you will hear them use the phrase ‘Closing the Books’. Both phrases refer to the same thing—moving information from working accounts to storage. An account moves from working to storage status when it is placed in the Financial Statements. A good way to think of it is that working accounts are kept in the General Ledger, while information that is ‘closed out’ is stored in the Financial Statements.
‘CLOSING ENTRIES’: Accountants use the phrase ‘closing entries’ at the end of the current accounting period when they are preparing the financial information for storage. Many times you will hear them use the phrase ‘Closing the Books’. Both phrases refer to the same thing—moving information from working accounts to storage. An account moves from working to storage status when it is placed in the Financial Statements. A good way to think of it is that working accounts are kept in the General Ledger, while information that is ‘closed out’ is stored in the Financial Statements.9.FINANCIAL STATEMENTS: Whenever you hear the term Financial Statements think of ‘storage units’. Financial Statements are really nothing more or less than a place to store financial information that you want to keep for future reference. Once you have the information stored securely you can use it to evaluate and analyze the performance of the company over extended periods of time. When financial information is taken from the General Ledger it is stored in one of two financial statements: either 1) THE BALANCE SHEET (which will detail Assets, Liabilities and Equity) or 2) THE INCOME STATEMENT (which will detail Income and Expenses).
FINANCIAL STATEMENTS: Whenever you hear the term Financial Statements think of ‘storage units’. Financial Statements are really nothing more or less than a place to store financial information that you want to keep for future reference. Once you have the information stored securely you can use it to evaluate and analyze the performance of the company over extended periods of time. When financial information is taken from the General Ledger it is stored in one of two financial statements: either 1) THE BALANCE SHEET (which will detail Assets, Liabilities and Equity) or 2) THE INCOME STATEMENT (which will detail Income and Expenses).10.TRIAL BALANCES: Performing, or running, a ‘Trial Balance’ is an accountant’s way of saving time and preventing mistakes. A Trial Balance is simply a check and balance on the transaction information that has been captured in the General Journal and posted (copied) into an Account kept in the General Ledger. Accountants refer to the system of capturing and recording information in the General Ledger as “The Double Entry Bookkeeping System”. Simply stated each transaction is entered twice instead of once to minimize mistakes and potential errors. To understand better how trial balances work debits and credits have to be addressed.
TRIAL BALANCES: Performing, or running, a ‘Trial Balance’ is an accountant’s way of saving time and preventing mistakes. A Trial Balance is simply a check and balance on the transaction information that has been captured in the General Journal and posted (copied) into an Account kept in the General Ledger. Accountants refer to the system of capturing and recording information in the General Ledger as “The Double Entry Bookkeeping System”. Simply stated each transaction is entered twice instead of once to minimize mistakes and potential errors. To understand better how trial balances work debits and credits have to be addressed.B.Debits & Credits
Debits & Credits1.Debit means ‘left’. Credit means ‘right’. Period—that’s it—nothing more or less. Whenever accountants refer to debit and credit they simply mean left and right, not increase or decrease. We have been conditioned in business to think of debit in terms of decrease and credit in terms of increase. So whenever we hear accountants mention debit we think decrease, but in actuality they are referring to which side of the “T” account that information is placed. (In the case of debits it is the left.) The same holds for credit. It does not necessarily mean increase. When accountants talk about credits they are merely referring to information being placed on the right side of some “T” Account. What tends to get confusing is that accountants don’t always add and subtract on the same side of the “T” accounts. It depends upon which section of the General Ledger is being discussed. The following explanation should help you understand how debits and credits are increased and decreased.
Debit means ‘left’. Credit means ‘right’. Period—that’s it—nothing more or less. Whenever accountants refer to debit and credit they simply mean left and right, not increase or decrease. We have been conditioned in business to think of debit in terms of decrease and credit in terms of increase. So whenever we hear accountants mention debit we think decrease, but in actuality they are referring to which side of the “T” account that information is placed. (In the case of debits it is the left.) The same holds for credit. It does not necessarily mean increase. When accountants talk about credits they are merely referring to information being placed on the right side of some “T” Account. What tends to get confusing is that accountants don’t always add and subtract on the same side of the “T” accounts. It depends upon which section of the General Ledger is being discussed. The following explanation should help you understand how debits and credits are increased and decreased.ASSET or EXPENSE Accounts
Debit
Add or Increase
Credit
Subtract or Decrease
LIABILITIES, EQUITY or INCOME Accounts
Debit
Subtract or Decrease
Credit
Add or Increase
So, you can see from the above example that sometimes we add on the left side, sometimes we subtract. Sometimes we add on the right side, sometimes we subtract. Debit and Credit simply mean left and right, respectively, not add or subtract.
2.The Double Entry Bookkeeping System requires a transaction to be entered twice into our financial books. It then serves as a check and balance to save time and prevent mistakes. A simplified example may help in understanding the process.
The Double Entry Bookkeeping System requires a transaction to be entered twice into our financial books. It then serves as a check and balance to save time and prevent mistakes. A simplified example may help in understanding the process.EXAMPLE: Let’s suppose that I am leasing a small office space from MY LANDLORD, and let’s say that my lease payment each month is $1,000, for simplicity sake. I have executed a lease with MY LANDLORD and my payment is due the 1st of each month for the duration of the lease.
When the 1st of the month rolls around do I owe MY LANDLORD a payment of $1,000? Yes I do, if I want to keep my office space. So let’s see what this transaction looks like on my financial books.
At the 1st of the month I now have an Accounts Payable of $1,000. Accounts Payable are located in the LIABILITIES section of the General Ledger. Using the above Key to Debits and Credits I find that I increase an Accounts Payable on the right or Credit side. So on the right side (Credit) of my Accounts Payable “T” I would have $1,000.
Under the EXPENSE section of my General Ledger I could have a “T” entitled, ‘Rent’. At the 1st of every month when my lease payment is due, I would owe $1,000, to MY LANDLORD. So to track the expenses I pay toward ‘Rent’ I would increase that account. Using the above Key to Debits and Credits I find that I increase accounts in the EXPENSE section of the General Ledger, on the left (Debit) side of the “T”. So I would put $1,000, on the left side of my Rent “T”.
I have now entered a transaction into my General Ledger using the Double Entry Bookkeeping method. One entry is on the left side (Debit)of the Rent “T” and one entry is on the right side (Credit) of the Accounts Payable “T”. This illustrates a fundamental truth in the accounting process. Whenever an entry is made on one side of a “T” in the General Ledger it must be offset by an entry on the opposite side of another “T” somewhere in the General Ledger. Accountants would say that Debits and Credits have to equal each other. This is the check and balance inherent in the Double Entry Bookkeeping method.
PLEASE NOTE! We can now finish our discussion on TRIAL BALANCE. Periodically, as a safeguard ensuring that transactions have been entered correctly, accountants will add up all the left hand entries in the General Ledger and get a dollar total. They may refer to this as ‘Total Debits’. They then add up all the right hand entries in the General Ledger and get a dollar total. This becomes the ‘Total Credits’. Those dollar figures must equal one another. If not, it indicates that an error has been made in entering transactions. Debits must equal Credits. Left hand entries must equal right hand entries. This process is known as ‘Running a Trial Balance’. The more activity a business incurs the more entries are made into the General Ledger. And the more entries are made, the more Trial Balances are performed to ensure they have been entered correctly.
C.Fundamental Equations
Fundamental Equations1.There are three (3) equations that provide the foundation for Finance and Accounting. The first Fundamental Equation is known as The Accounting Equation:
There are three (3) equations that provide the foundation for Finance and Accounting. The first Fundamental Equation is known as The Accounting Equation:ASSETS = LIABILITIES + EQUITY
If you can remember one example that illustrates this principle you will never have any problem with this equation.
BUYING A HOME EXAMPLE: Let’s suppose that I wanted to purchase a home. And just for simplicity sake, let’s set the purchase price at $100,000. Let’s also suppose that I don’t have the $100,000, in cash, to buy the home. So I go to my friendly bank and apply for a loan. MR. BANKER tells me that he will loan me 80% of the money needed, but I have to supply 20% myself. Now, not considering closing costs and all the other expenses involved, here is what the financial picture looks like. The purchase price of the home is $100,000, the bank will loan $80,000, and I will supply $20,000. So then the Accounting Equation becomes:
$100,000 = $80,000 + $20,000
The Asset is the home, and it is worth $100,000. Does the bank expect me to repay the $80,000, they loaned me? Unfortunately, they do. The $80,000, becomes a Liability, a debt I must repay. And the $20,000, is the amount I contributed, so it becomes my beginning Equity in the home.
You can also think of The Accounting Equation in this regard. The left side of the equation represents things that have value. The right side of the equation represents the people who have claims against those things (assets). In this case the thing that has value is the home. The people who have claims against the home are the bank, and I as the owner.
The Accounting Equation is fundamental to Finance & Accounting because it becomes the foundation for the Financial Statement we call THE BALANCE SHEET.
2.The second Fundamental Equation is known as The Profit Equation:
The second Fundamental Equation is known as The Profit Equation:INCOME – EXPENSE = PROFIT
The Profit Equation covers the time frame of the accounting period being reviewed. In essence, you take all the income made by the business during that accounting period, from sales and services provided, and subtract all the expenses you incurred in producing that specific income. The amount you have left over is referred to as Profit. (If the expenses exceed the income you experience a Loss.) Profit is directly related to sales and services provided. (Contrast Profit to Revenue: Revenue includes all actual monies brought in by the business, not just sales and services provided.) For this reason, Profit has a direct correlation to an indispensable business tool we call THE BREAK EVEN POINT. (Covered under the discussion of PERFORMANCE MANAGEMENT.)
There are three (3) important facts to remember regarding Profit:
Profit is NOT CASH!
Profit is TAXABLE!
Profit in NO GUARANTEE of success or survival!
The Profit Equation is fundamental to Finance & Accounting because it becomes the foundation for the Financial Statement we call THE INCOME STATEMENT.
3.The third fundamental equation in Finance & Accounting is The Tax Equation:
The third fundamental equation in Finance & Accounting is The Tax Equation:REVENUE – DEDUCTIONS = TAXABLE INCOME
As noted above, Revenue differs from Profit in that it includes all monies brought in by the business operation. A good way to think of Revenue is Profit Plus.
Once you have calculated all the Revenue produced during the accounting period you subtract Deductions. Deductions can be thought of as any item or expense, which when subtracted from all revenue received reduce the amount of taxable income to the business.
Deductions are an incentive given by the federal government in hopes of generating more business in the marketplace. Their reasoning is that more business will result in more tax paid, thus more money for the government on which to operate.
There are three (3) main forms of Deductions: Depreciation, Amortization and Depletion.
Because assets don’t last forever, GAAP requires that the cost of an asset be proportionally expensed over the life of the asset. The proration of these expenses provide the basis for deductions allowed by the government.
Prorating the cost of an intangible asset (one that has value, but not necessarily physical substance—such things as patents, copyrights, trademarks and goodwill are considered intangible assets) over its lifetime is known as Amortization.
Spreading the cost of a physical asset over its lifetime is known as Depreciation.
Depletion is the allocation of the cost of natural resources over its lifetime.
The Tax Equation is fundamental to Finance and Accounting because it provides the foundation for compliance with federal regulations in order to keep the doors of the business open.
D.Methods of Recognition
Methods of RecognitionWhenever you hear accountants use the words ‘Recognize’ or ‘Recognition’ they actually mean “Record”. Methods of Recognition then can be interpreted to mean Methods of Recording. It refers to how we record transactions in our General Ledger.
There are primarily two (2) acceptable Methods of Recognition:
The Cash Basis Method
The Accrual Method
Before we delve into both methods, a simple illustration will help put things into context as we move forward. The illustration deals with concepts we call Obligations & Promises.
Obligations and Promises Example:
Let’s suppose that I own a Manufacturing Company and I produce a product for sale. And let’s say that I sell a unit of that product to MS. BUYER ONE. Does Ms. Buyer One always pay me immediately up front for what she just purchased? No. We might give 30 days with favorable terms for payment. And if the time gets extended without payment we may charge an additional fee for service.
But for me to make my product to sale, I first have to secure the raw materials necessary for production. So, I have to go to MS. SUPPLIER ONE and purchase the materials to make my products. Do I always pay Ms. Supplier One for my materials up front immediately? No. I might in fact hope that Ms. Buyer One pays me before I have to pay Ms. Supplier One.
Now watch what just happened. Would you say I just conducted business? I would. I bought something. I made something. I sold something. Hopefully, whatever I sold my unit of production for, was more than what it cost me to secure the necessary materials and make it. In other words, if it did, I made a PROFIT on the sale. (Please note: I owe tax on the profit I made.) But has any money actually changed hands in these transactions? NO! (Please note: I still owe tax on the profit I made. PROFIT IS NOT CASH! )
ALL BUSINESS OPERATES AROUND THE CONCEPTS WE HAVE JUST EXAMINED. I have an Obligation to pay Ms. Supplier One for my materials; and, I have a Promise from Ms. Buyer One to pay for the item she purchased. All business operates around this one principle: A Business incurs Obligations and secures Promises.
Given the above example of obligations and promises, how would accountants ‘recognize’ or record the transactions that occurred?
We first have to understand the definitions of the two methods involved: the Cash Basis Method and the Accrual Method.
1.THE CASH BASIS METHOD states that Revenue is recognized, or recorded, when cash is actually received. It says that Expense is recognized, or recorded in our General Ledger, when cash is actually paid.
THE CASH BASIS METHOD states that Revenue is recognized, or recorded, when cash is actually received. It says that Expense is recognized, or recorded in our General Ledger, when cash is actually paid.In the above example, has any cash changed hands? No; so if our financial books are being kept on The Cash Basis Method nothing can be recorded yet.
If we conduct an extensive amount of business and have many transactions, and if we are negligent to collect the monies owed the business when they are due, or if we are habitually late in paying our indebtedness, does it make sense to you that it is highly possible for us to lose track of all of our obligations and promises? That is exactly why the federal government provided another means of recognition—the Accrual Method.
2.THE ACCRUAL METHOD states that Revenue is recognized, or recorded, when one of three things happens: 1) A sale is made, or 2) When Title of Ownership legally passes, or 3) When a product is shipped. Expenses are recognized, or recorded, when one of three things happens: 1) When goods are received, or 2) When Title of Ownership legally passes, or 3) When services are rendered.
THE ACCRUAL METHOD states that Revenue is recognized, or recorded, when one of three things happens: 1) A sale is made, or 2) When Title of Ownership legally passes, or 3) When a product is shipped. Expenses are recognized, or recorded, when one of three things happens: 1) When goods are received, or 2) When Title of Ownership legally passes, or 3) When services are rendered.In the Accrual Method accountants have the discretion to choose the date that most realistically portrays what the business experiences. The key is to apply the date consistently to all transactions.
The Accrual Method allows accountants to record obligations and promises at the appropriate time, and not wait until actual cash changes hands. By so doing businesses can keep current on all obligations and promises, enabling them to be more effective and efficient.
Art vs. Science
UNDERSTANDING THAT FINANCE & ACCOUNTING
IS AN ART RATHER THAN A SCIENCE
A.Finance and Accounting can be considered more of an Art than it is a Science. In Science we have been conditioned to look for precise, exact, and accurate answers to the problems and challenges we encounter. In Finance and Accounting accountants are forced to rely on estimates and assumptions to try and quantify with numbers, results that are not always easy to quantify.
Finance and Accounting can be considered more of an Art than it is a Science. In Science we have been conditioned to look for precise, exact, and accurate answers to the problems and challenges we encounter. In Finance and Accounting accountants are forced to rely on estimates and assumptions to try and quantify with numbers, results that are not always easy to quantify.B.Accountants are forced to use limited data and information to accurately describe, as best they can at that point in time, how well a business is operating.
Accountants are forced to use limited data and information to accurately describe, as best they can at that point in time, how well a business is operating. Karen Berman and Joe Knight, in their book on FINANCIAL INTELLIGENCE, perhaps expressed it as well as it can be put. “Accounting and Finance are not reality, they are a reflection of reality, and the accuracy of that reflection depends on the ability of accountants and finance professionals to make reasonable assumptions and to calculate reasonable estimates.”
Business survival depends on knowing what to look for, understanding what it is telling you, and having the wisdom to apply it effectively.
RECOMMENDED READING
#5
FINANCE & ACCOUNTING for
NON-FINANCIAL MANAGERS
By: Steven A. Finkler
ISBN: 0-13-579343-2
Scroll through each page to uncover 11
RECOMMENDED RESOURCES
