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Accounting FORDUMmIES‰4THEDITION Accounting FORDUMmIES‰ 4THEDITIONBy John A. Tracy, CPA Accounting. Download Intermediate Accounting For Dummies ebook free by Maire Loughran in pdf/epub/mobi. Accounting and finance have a language of their own with a variety of statements nies do not publish a trading account as such, they are free to use what-.


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to all of you! I hope I have done you proud with Accounting Workbook For Dummies. is, “There's no such thing as a free lunch,” but I digress.) Well, there's. As of today we have 78,, eBooks for you to download for free. No annoying ads, no download limits, Nonprofit Bookkeeping & Accounting for Dummies. These records are maintained by using an accounting system. Accounting for . business organization and is relatively free from legal complexities. One major.

However, financial reporting practices vary quite a bit on this matter. This means that the expense amount is being subtracted from sales revenue. The number below the underline, therefore, is a calculated amount. Trying to read down a jagged column of numbers that are not right-aligned would be asking too much; the reader might develop vertigo. Really big businesses round off to the nearest million and drop the last six digits.

However, this gives a false sense of precision. Accounting for business transactions cannot be accurate down to the last dollar; this is nonsense. The late Kenneth Boulding, a well-known economist, once quipped that accountants would rather be precisely wrong than approximately correct. This is about as carried away as accountants get in their work — a double underline.

Instead of a double underline for a bottom-line number, it may appear in bold. Some need to break across two lines of text. Well, perhaps I get more pumped up about accounting than you. So, one question you may have is this: Do I really have to read every sentence in the book?

To be honest, you can skip the paragraphs marked with the Technical Stuff icon. You can simply leapfrog over these sections without missing a beat. If you have time, you can return to these topics Introduction later.

Also, the sidebars in the chapters are interesting, but not essential for understanding the topics at hand. For instance, consider the income statement example in the previous section. You should understand that the bottom-line profit is the amount remaining after all expenses are deducted from sales revenue. Foolish Assumptions Although I assume that you have a basic familiarity with the business world, I take nothing for granted regarding how much accounting you know.

I have written this book with a wide audience in mind. I could put others in the above list. But I think you get the idea that many different people need to understand the basics of accounting.

Perhaps someone who leads an isolated contemplative life and renounces all earthly possessions does not need to know anything about accounting. How This Book Is Organized This book is divided into parts, and each part is further divided into chapters. The following sections describe what you can find in each part. Part I: Opening the Books on Accounting In Chapters 1 and 2, I introduce the three primary business financial statements gradually, one step at a time.

Rather than throwing you in the deep end of the pool, hoping that you learn to swim before drowning in too many details, I make sure you first learn to float and then move on to some basic Introduction strokes. The information for financial statements comes from the bookkeeping system of the entity. So, in Chapter 3, I offer a brief overview of bookkeeping and accounting systems. You could jump over this chapter, if you must. But I recommend at least a quick read. In Chapter 7, I explain that businesses are not in a straitjacket when it comes to deciding which accounting methods to use for recording their revenue and expenses.

They can select from two or more equally acceptable methods for recording certain revenues and expenses. The choice of accounting methods affects the values recorded for assets and liabilities.

Part III: Accounting in Managing a Business To start a business and begin operations, its founders must first decide on which legal structure to use. Chapter 8 explains the legal entities for carrying on business activities. Each has certain advantages and disadvantages, and each is treated differently under the income tax law.

Chapter 9 explains an extraordinarily important topic: designing an accounting report template that serves as a good profit model, one that focuses on the chief variables that drive profit and changes in profit. A hands-on profit model is essential for decision-making analysis.

Frequently bought together

A manager depends on the profit model to determine the effects of changes in sales prices, sales volume, product costs, and the other fundamental factors that drive profit. In Chapter 10, I discuss accounting-based planning and control techniques, through the lens of budgeting. Managers in manufacturing businesses should be wary of how product costs are determined, as Chapter 11 explains.

The chapter also explains other economic and accounting cost concepts relevant to business managers. Next I discuss how investors and lenders read financial statements see Chapter Business managers need more information than is included in an external financial report to investors and lenders. In Chapter 14, I survey the additional information that managers need. I close this part of the book with a chapter that explains audits of financial statements by CPAs and the very serious problems of accounting and financial reporting fraud see Chapter If there were no Enrons in the world, things would be a lot simpler.

I hate to say it, but the next Enron is just waiting to happen. Chapter 16 reviews ten important ways business managers should use accounting information. Chapter 17 gives business investors handy tips for getting the most out of reading a financial report — tips on how to be efficient in reading a financial report and the key factors to focus on.

Glossary The accounting terminology in financial statements is a mixed bag. Sometimes it must seem like accountants are speaking a foreign language. I must admit that accountants use jargon more than they should. In some situations accountants resort to arcane terminology to be technically correct, much like lawyers use arcane terminology in filing lawsuits and drawing up contracts. Where I use jargon in the book, I pause and clarify what the terms mean in plain English. Also, I present a helpful glossary at the end of the book that can assist you on your accounting safari.

This glossary provides quick access to succinct definitions of key accounting and financial terms, with relevant commentary and an occasional editorial remark.

This is better than your average glossary. Introduction Icons Used in This Book This icon points out especially important ideas and accounting concepts that are particularly deserving of your attention. The material marked by this icon describes concepts that are the undergirding and building blocks of accounting — concepts that you should be very clear about and that clarify your understanding of accounting principles in general.

I use this icon sparingly; it refers to very specialized accounting stuff that is heavy going, which only a CPA could get really excited about. However, you may find these topics important enough to return to when you have the time. Feel free to skip over these points the first time through and stay with the main discussion.

This icon calls your attention to useful advice on practical financial topics. It saves you the cost of downloading a yellow highlighter pen.

This icon is like a caution sign that warns you about speed bumps and potholes on the accounting highway. Taking special note of this material can steer you around a financial road hazard and keep you from blowing a fiscal tire. In short — watch out! You might start with Chapters 4, 5, and 6 which explain the three primary financial statements of businesses, and finish with Chapter 13 on reading a financial report. You might jump right into Chapters 9 and 10, which explain the analysis of profit behavior and budgeting cash flows.

The book is not like a five-course dinner in which you have to eat in the order the food is served to you. In this part, you find out why. Accounting is equally vital in managing the business affairs of not-forprofit and governmental entities. From its accounting records, a business prepares its financial statements, its tax returns, and the reports to its managers.

In financial reports to investors and lenders, a business must obey authoritative accounting and financial reporting standards. If not, its financial reports would be misleading and possibly fraudulent, which could have dire consequences.

Bookkeeping — the record-keeping part of accounting — must be done well to ensure that the financial information of a business is timely, complete, accurate, and reliable — especially the numbers reported in its financial statements and tax returns.

Wrong numbers in financial reports and tax returns can cause all sorts of trouble. A ccounting is all about financial information — capturing it, recording it, configuring it, analyzing it, and reporting it to persons who use it. But I talk a lot about how accountants communicate information in financial statements, and I explain the valuation methods accountants use — ranging from measuring profit and loss to putting values on assets and liabilities of businesses.

As you go through life, you come face to face with accounting information more than you would ever imagine. Accounting information is presented on the assumption that you have a basic familiarity with the vocabulary of accounting and the accounting methods used to generate the information.

In short, most of the accounting information you encounter is not transparent. The main reason for studying accounting is to learn its vocabulary and valuation methods, so you can make more intelligent use of the information.

The purpose of this book is to make you a knowledgeable spectator of the accounting game. Let me point out another reason you should know accounting basics — I call it the defensive reason. A lot of people out there in the cold, cruel financial world may take advantage of you, not necessarily by illegal means but by withholding key information and by diverting your attention from unfavorable aspects of certain financial decisions.

These unscrupulous characters treat you as a lamb waiting to be fleeced. Accounting Is Not Just for Accountants One main source of accounting information is in the form of financial statements that are packaged with other information in a financial report. Accountants keep the books and record the financial activities of an entity such as a business. From these detailed records the accountant prepares financial statements that summarize the results of the activities. Financial statements are sent to people who have a stake in the outcomes of the activities.

If you own stock in General Electric, for example, or you have money in a mutual fund, you receive regular financial reports. If you invest your hard-earned money in a private business or a real estate venture, or you save money in a credit union, you receive regular financial reports. In summary, one important reason for studying accounting is to make sense of the financial statements in the financial reports you get. I guarantee that Warren Buffett knows accounting and how to read financial statements.

Affecting both insiders and outsiders People who need to know accounting fall into two broad groups: insiders and outsiders. Business managers are insiders; they have the authority and responsibility to run a business. They need a good understanding of accounting terms and the methods used to measure profit and put values on assets and liabilities.

Chapter 1: Accounting: The Language of Business, Investing, Finance, and Taxes Accounting information is indispensable for planning and controlling the financial performance and condition of the business. Likewise, administrators of nonprofit and governmental entities need to understand the accounting terminology and measurement methods in their financial statements.

The rest of us are outsiders. We are not privy to the day-to-day details of a business or organization. Therefore, we need to have a good grip on the financial statements included in the financial reports.

For all practical purposes, financial reports are the only source of financial information we get directly from a business or other organization. By the way, the employees of a business — even though they obviously have a stake in the success of the business — do not necessarily receive its financial reports.

Only the investors in the business and its lenders are entitled to receive the financial reports. Of course, a business could provide this information to those of its employees who are not shareowners, but generally speaking most businesses do not. The financial reports of public businesses are in the public domain, so their employees can easily secure a copy.

However, financial reports are not automatically mailed to all employees of a public business. In our personal financial lives, a little accounting knowledge is a big help for understanding investing in general, how investment performance is measured, and many other important financial topics. Keep in mind that this is not a book on bookkeeping and recordkeeping systems. I offer a brief explanation of procedures for capturing, processing, and storing accounting information in Chapter 3.

Financial Accounting For Dummies

Even experienced bookkeepers and accountants should find some nuggets in that chapter. However, this book is directed to users of accounting information. I focus on the end products of accounting, particularly financial statements, and not how information is accumulated. In larger organizations, the treasurer may be responsible for some of these cash flow and cashhandling functions. In addition to payroll checks, a business writes many other checks during the course of a year — to pay for a wide variety of downloads, to pay property taxes, to pay on loans, and to distribute some of its profit to the owners of the business, for example.

The accounting department prepares all these checks for the signatures of the business officers who are authorized to sign checks. The accounting department keeps all the supporting business documents and files to know when the checks should be paid, makes sure that the amount to be paid is correct, and forwards the checks for signature. Accounting departments usually are responsible for keeping track of all download orders that have been placed for inventory products to be sold by the business and all other assets and services that the business downloads — from postage stamps to forklifts.

A typical business makes many downloads during the course of a year, many of them on credit, which means that the items bought are received today but paid for later.

So this area of responsibility includes keeping files on all liabilities that arise from downloads on credit so that cash payments can be processed on time. The accounting department Chapter 1: The Language of Business, Investing, Finance, and Taxes also keeps detailed records on all products held for sale by the business and, when the products are sold, records the cost of the goods sold.

A typical business owns many different substantial long-term assets called property, plant, and equipment — including office furniture and equipment, retail display cabinets, computers, machinery and tools, vehicles autos and trucks , buildings, and land.

Except for relatively small-cost items, such as screwdrivers and pencil sharpeners, a business maintains detailed records of its property, both for controlling the use of the assets and for determining personal property and real estate taxes. The accounting department keeps these property records. The accounting department may be assigned other functions as well, but this list gives you a pretty clear idea of the back-office functions that the accounting department performs.

Quite literally, a business could not operate if the accounting department did not do these functions efficiently and on time. And to repeat one point: To do these back-office functions well the accounting department must design a good bookkeeping system and make sure that it is accurate, complete, and timely.

Focusing on Transactions Accounting focuses on transactions. A good bookkeeping system captures and records every transaction that takes place without missing a beat. Transactions are economic exchanges between a business or other entity and the parties with which the entity interacts and makes deals. Transactions are the lifeblood of every business, the heartbeat of activity that keeps it going.

Understanding accounting, to a large extent, means understanding how accountants record the financial effects of transactions. The immediate and future financial effects of some transactions can be difficult to determine. A business carries on economic exchanges with six basic types of persons or entities: Figure illustrates the interactions between the business and the other parties in its economic exchanges.

Even a relatively small business generates a surprisingly large number of transactions, and all transactions have to be recorded. Certain other events that have a financial impact on the business have to be recorded as well. Events such as the following have an economic impact on a business and are recorded: The liability to pay the damages is recorded. The waterlogged assets may have to be written down, meaning that the recorded values of the assets are reduced to zero if they no longer have any value to the business.

For example, products that were being held for sale to customers until they floated down the river must be removed from the inventory asset account.

As I explain in more detail in Chapter 3, at the end of the year the accountant makes a special survey to make sure that all events and developments during the year that should be recorded have been recorded, so that the financial statements and tax returns for the year are complete and correct. Transactions between a business and the parties it deals with. Financial Statements I devote a good deal of space in this book to discussing financial statements. In Chapter 2, I explain the fundamental information components of financial statements, and then Part II gets into the nitty-gritty details.

Financial statements are prepared at the end of each accounting period. A period may be one month, one quarter three calendar months , or one year. Financial statements report summary amounts, or totals. Accountants seldom prepare a complete listing of the details of all the activities that took place during a period, or the individual items making up a total amount. Business managers occasionally need to search through a detailed list of all the specific transactions that make up a total amount.

When they want to drill down into the details, they ask the accountant for the more detailed information. But this sort of detailed listing is not a financial statement. Outside investors in a business see only summary-level financial statements. For example, investors see the total amount of sales revenue for the period but not how much was sold to each and every customer. This is called the statement of financial condition or, more commonly, the balance sheet. The date of preparation is given in the header, or title, above this financial statement.

A balance sheet shows two sides of the business, which I suppose you could think of as the financial yin and yang of the business: On one side of the balance sheet the assets of the business are listed, which are the economic resources owned and being used in the business.

The asset values reported in the balance sheet are the amounts recorded when the assets were originally acquired — although I should mention that an asset is written down below its historical cost when the asset has suffered a loss in value.

And to complicate matters, some assets are written up to their current fair values. Some assets have been on the books only a few weeks or a few months, so their reported historical values are current. The values for other assets, on the other hand, are their costs when they were acquired many years ago.

On the other side of the balance sheet is a breakdown of where the assets came from, or their sources. Assets are not like manna from the heavens. Assets come from two basically different sources: First, the creditors: Businesses borrow money in the form of interest-bearing loans that have to be paid back at a later date, and they download things on credit that are paid for later.

So, part of total assets can be traced to creditors, which are the liabilities of a business. Second are the owners: Every business needs to have owners invest capital usually money in the business.

Also, businesses retain part or all of the annual profits they make, and profit increases the total assets of the business. Otherwise its books would be out of balance, which means there are bookkeeping errors. Owners bear the risk that the business may be unable to make a profit. The financial condition of the business in this example is summarized in the following accounting equation in millions: Double-entry bookkeeping is based on the accounting equation — the fact that the total of assets on the one side is counterbalanced by the total of liabilities, invested capital, and retained profit on the other side.

I discuss double-entry bookkeeping in Chapter 3. Basically, double-entry bookkeeping simply means that both sides of transactions are recorded. This is the economic nature of transactions. Double-entry means two-sided, not that the transactions are recorded twice.

Reporting profit and loss, and cash flows Other financial statements are different from the balance sheet in one important respect: They summarize the flows of activities over the period. An example of a flow number is the total attendance at Colorado Rockies baseball games over its entire 82 home game regular season; the cumulative count of spectators passing through the turnstiles over the season is the flow.

Accountants prepare two types of financial flow reports for a business: Deducting expenses from revenue and income leads down to the wellknown bottom line, which is the final net profit or loss for the period and is called net income or net loss or some variation of these terms. Opening the Books on Accounting Alternative titles for this financial statement are the statement of operations and the statement of earnings. The accounting profession has adopted a three-way classification of cash flows for external financial reporting: Respecting the importance of this trio I explain more about the three primary financial statements balance sheet, income statement, and statement of cash flows in Chapter 2.

These individuals have invested capital in the business, or the business owes them money; therefore, they have a financial interest in how well the business is doing. They are absolutely essential in helping managers control the performance of a business, identify problems as they come up, and plan the future course of a business.

Managers also need other information that is not reported in the three basic financial statements. The president and chief executive officer of a business plus other top-level officers are responsible for seeing that the financial statements are prepared according to applicable financial reporting standards and according to established accounting principles and methods.

For this reason, business managers should understand their responsibility for the financial statements and the accounting methods used to prepare the statements. This situation is a little scary; a manager who Chapter 1: Business managers at all levels need to understand financial statements and the accounting methods used to prepare them.

Also, lenders to a business, investors in a business, business lawyers, government regulators of business, entrepreneurs, anyone thinking of becoming an entrepreneur and starting a business, and, yes, even economists should know the basics of financial statement accounting. The bottom line is found in the income statement, not the balance sheet! They work for businesses, government agencies, nonprofit organizations, and other organizations and associations.

Accountants take these snide references in stride and with good humor. Actually, accountants rank among the most respected professionals in many polls.

Certified public accountant CPA In the accounting profession, the mark of distinction is to be a CPA, which stands for certified public accountant. The term public means that the person has had some practical experience working for a CPA firm; it does not indicate whether that person is presently in public practice as an individual CPA or as an employee or partner in a CPA firm that offers services to the public at large rather than working for one organization.

Opening the Books on Accounting To become a CPA, you go to college, graduate with an accounting major in a five-year program in most states , and pass the national, computer-based CPA exam.

You also must satisfy professional employment experience; this requirement varies from state to state but generally is one or two years. After satisfying the education, exam, and experience requirements, you get a CPA certificate to hang on your wall. More important, you get a permit from your state to practice as a CPA and offer your services to the public.

States require continuing education hours to maintain an active CPA permit. The controller: The chief accountant in an organization The top-level accounting officer in a business organization is usually called the controller.

The controller designs the entire accounting system of the business and keeps it up-to-date with changes in the tax laws and changes in the accounting rules that govern reporting financial statements to outside lenders and owners.

Controllers are responsible for hiring, training, evaluating, promoting, and sometimes firing the persons who hold the various bookkeeping and accounting positions in an organization — which range from payroll functions to the several different types of tax returns that have to be filed on time with different government agencies. The controller is the lead person in the financial planning and budgeting process of the business organization.

Furthermore, the controller designs the accounting reports that all the managers in the organization receive — from the sales and marketing managers to the downloading and procurement managers.

All the tough accounting questions and problems get referred to the controller. Smaller businesses may employ only one accountant. Smaller businesses often call in a CPA for advice and help. The Language of Business, Investing, Finance, and Taxes State incorporation laws typically require that someone in the business be designated the treasurer, who has fiduciary responsibilities.

Also, these laws usually require that someone be designated the secretary. The organizational charts of larger businesses usually put their controller under their vice president for finance, or chief financial officer CFO. The accounting functions in a business are integrated with and work in close coordination with its financial, treasury, and secretary functions.

A springboard to other careers Many CPAs move on to other careers. A recent article in the Journal of Accountancy featured former CPAs who moved on to other interesting careers.

After a few years in public accounting, I went back to school, got my Ph. These days, the starting salaries for new assistant professors of accounting are well into six digits! In this chapter, you get some juicy details. Then, in Part II, you really get the goods. Think back to when you learned to ride a bicycle.

Chapter 1 is like getting on the bike and learning to keep your balance. In this chapter, you put on your training wheels and start riding. The financial effects of making profit are not as simple as you may think. Profitmaking activities cause changes in the financial condition of a business — but maybe not the changes you suppose.

Making profit leaves many footprints on the financial condition of a business. Also in this chapter, I briefly discuss financial accounting and reporting standards. Businesses comply with established rules for recording revenue, income, expenses, and losses; for putting values on assets and liabilities; and for presenting and disclosing information in their financial reports.

The basic idea is that all businesses should follow uniform methods for measuring and reporting profit performance, and reporting financial condition and cash flows. Consistency in accounting from business to business is the goal. I explain who makes the rules, and I discuss two important recent developments: Opening the Books on Accounting Introducing the Information Content of Financial Statements This chapter focuses on the basic information components of each financial statement reported by a business.

In this first step, I do not address the classification, or grouping, of these information packets within each financial statement. The first step is to get a good idea of the information content reported in financial statements. Setting up the business example To better illustrate the three primary financial statements, I need a realistic business example. The information content of its financial statements depends on the line of business a company is in — in other words, which types of products and services it sells.

The financial statements of a movie theater chain are different from those of a bank, which are different from those of an airline, which are different from an automobile manufacturer. Here, I use a fairly common type of business example. Here are the particulars of the business I use for the example: Chapter 2: Dollar amounts in the three financials are rounded off to the nearest thousand, which is not uncommon.

Dollar amounts can be reported out to the last dollar, or even the last penny for that matter. But too many digits in a dollar amount are hard to absorb, so many businesses round off the dollar amounts in their financial statements. These financial statements are stepping-stone illustrations that are concerned mainly with the basic information components in each statement.

Full-blown, classified financial statements are presented in Part II of the book. The financial statements in this chapter do not include all the information you see in actual financial statements.

Also, I use descriptive labels for each item rather than the terse and technical titles you see in actual financial statements.

And I strip out subtotals that you see in actual financial statements because they are not necessary at this point.

Oops, I forgot to mention a couple of things about financial statements. I should give you quick heads-up on these points. Financial statements are rather stiff and formal. Financial statements would get a G in the movies rating system. Seldom do you see any graphics or artwork in a financial statement itself, although you do see a fair amount of photos and graphics elsewhere in the financial reports of public companies.

However, I might mention that in his annual letter to the stockholders of Berkshire Hathaway, Warren Buffett includes some wonderful humor to make his points.

The income statement The income statement is the all-important financial statement that summarizes the profit-making activities of a business over a period of time. Figure shows the basic information content for an external income statement: The income statement in Figure shows six lines of information: Virtually all income statements disclose at least the four expenses shown in Figure The first two expenses cost of goods sold and selling, general, and administrative expenses take a big bite out of sales revenue.

The other two expenses interest and income tax are relatively small as a percent of annual sales revenue but important enough in their own right to be reported separately. Opening the Books on Accounting Figure Basic information components of the income statement.

For example, a business could disclose separate expenses for advertising and sales promotion, depreciation, salaries and wages, research and development, and delivery and shipping — though reporting these expenses is not common.

Businesses do not disclose the compensation of top management in their external financial reports although this information can be found in the proxy statements of public companies that are filed with the Securities and Exchange Commission.

These internal profit performance reports to the managers of a business include a good deal more detailed information about expenses, and about sales revenue also. Reporting just four expenses to managers as shown in Figure would not do. Sales revenue is from the sales of products and services to customers. Income refers to amounts earned by a business from sources other than sales; for example, a real estate rental business receives rental income from its tenants.

In the example, the business has only sales revenue. As I mention above, businesses report the expenses shown in Figure — cost of goods sold expense, selling and general expenses, interest expense, and income tax expense. Further breakdown of expenses is at the discretion of the business.

Net income, being the bottom line of the income statement after deducting all expenses from sales revenue and income, if any , is called, not surprisingly, the bottom line. It is also called net earnings. A few companies call it profit or net profit, but such terminology is not common. The income statement gets the most attention from business managers, lenders, and investors not that they ignore the other two financial statements. The very abbreviated versions of income statements that you see in the financial press, such as in The Wall Street Journal, report the top line sales revenue and income and the bottom line net income and not much more.

Refer to Chapter 4 for much more information on income statements. Financial Statements and Accounting Standards The balance sheet Figure shows the building blocks basic information components of a typical balance sheet. One reason the balance sheet is called by this name is that its two sides balance, or are equal in total amounts. Generally speaking, five or more assets are reported in a typical balance sheet, starting with cash, and then receivables, and then cost of products held for sale, and so on down the line.

Generally five or more liabilities are disclosed, starting with trade credit liabilities from downloading on credit , and then unpaid expenses, and then proceeding through the interest-bearing debts of the business. Basic information components of the balance sheet. Opening the Books on Accounting Most businesses need a variety of assets. You have cash, which every business needs, of course.

Businesses that sell products carry an inventory of products awaiting sale to customers. Businesses need long-term resources that are generally called property, plant, and equipment; this group includes buildings, vehicles, tools, machines, and other resources needed in their operations. I include just four basic assets in Figure These are the hardcore assets that a business selling products on credit would have.

In this example, the business owns these so-called fixed assets. They are fixed because they are held for use in the operations of the business and are not for sale, and their usefulness lasts several years or longer. So, where does a business get the money to download its assets? Most businesses borrow money on the basis of interest-bearing notes or other credit instruments for part of the total capital they need for their assets.

Also, businesses download many things on credit and at the balance sheet date owe money to their suppliers, which will be paid in the future.

These operating liabilities are never grouped with interest-bearing debt in the balance sheet. The accountant would be tied to the stake for doing such a thing. Note that liabilities are not intermingled among assets — this is a definite no-no in financial reporting. You cannot subtract certain liabilities from certain assets and only report the net balance. You would be given 20 lashes for doing so. Well, not likely — unless the business has been losing money hand over fist.

In the vast majority of cases a business has more total assets than total liabilities. For two reasons: Sometimes this amount is referred to as net worth, because it equals total assets minus total liabilities. However, net worth is not a good term because it implies that the business is worth the Chapter 2: The market value of a business, when it needs to be known, depends on many factors.

A balance sheet could be whipped up anytime you want, say at the end of every day. In fact, some businesses such as banks and other financial institutions need daily balance sheets, but most businesses do not prepare balance sheets that often.

In external financial reports those released outside the business to its lenders and investors , a balance sheet is required at the close of business on the last day of the income statement period.

If its annual or quarterly income statement ends, say, September 30; then the business reports its balance sheet at the close of business on September Its more formal name is the statement of financial condition. Just a reminder: The profit for the most recent period is found in the income statement; periodic profit is not reported in the balance sheet. The profit reported in the income statement is before any distributions from profit to owners.

By the way, notice that the balance sheet in Figure is presented in a top and bottom format, instead of a left and right side format.

Either the vertical or horizontal mode of display is acceptable. You see both the portrait and the landscape layouts in financial reports. The statement of cash flows To survive and thrive, business managers confront three financial imperatives: Opening the Books on Accounting The income statement reports whether the business made a profit. The balance sheet reports the financial condition of the business. Smart business managers hardly get the word net income or profit out of their mouths before mentioning cash flow.

Business is a two-headed dragon in this respect. Ignoring cash flow can pull the rug out from under a successful profit formula. Still, some managers are preoccupied with making profit and overlook cash flow.

For external financial reporting, the cash flows of a business are divided into three categories, which are shown in Figure The actual cash inflows from revenues and outflows for expenses run on a different timetable than when the sales revenue and expenses are recorded for determining profit. I give a more comprehensive explanation of the differences between cash flows and sales revenue and expenses in Chapter 6.

The second part of the statement of cash flows sums up the long-term investments made by the business during the year, such as constructing a new production plant or replacing machinery and equipment. If the business sold any of its long-term assets, it reports the cash inflows from these divestments in this section of the statement of cash flows.

The cash flows of other investment activities if any are reported in this part of the statement as well. The third part of the statement sums up the dealings between the business and its sources of capital during the period — borrowing money from lenders and raising new capital from its owners.

Cash outflows to pay debt are reported in this section, as well as cash distributions from profit paid to the owners of the business. As you can see in part 3 of the statement of cash Chapter 2: By the way, in this example the business did not make cash distributions from profit to its owners. I should make one point clear here: I could tell you that the statement of cash flows is relatively straightforward and easy to understand, but that would be a lie.

The statements of cash flows reported by most businesses are frustratingly difficult to read. More about this issue in Chapter 6. Figure presents the statement of cash flows for the business example as simply as I can possibly make it.

Actual cash flow statements are much more complicated than the brief introduction to this financial statement that you see in Figure Basic information components in the statement of cash flows. Opening the Books on Accounting Imagine you have a highlighter pen in your hand, and the three basic financial statements of a business are in front of you.

What are the most important numbers to mark? Financial statements do not have any numbers highlighted; they do not come with headlines like newspapers. You have to find your own headlines. Bottom-line profit net income in the income statement is one number you would mark for sure. Another key number is cash flow from operating activities in the statement of cash flows. This gap between profit and cash flow from operating activities is not unusual.

Where is it? Is there some accounting sleight of hand going on? These are good questions, and I will try to answer them as directly as I can without hitting you over the head with a lot of technical details at this point. Remember that the business sells on credit and its customers take time before actually paying the business.

For example, a business that sells products downloads or makes the products, and then holds the products in inventory for some time before it sells the items to customers. Cash is paid out before the cost of goods sold expense is recorded. This is one example of a difference between cash flow connected with an expense and the amount recorded in the income statement for the expense. In Chapter 6, I explain the several factors that cause cash flow and bottom-line profit to diverge.

At this point the key idea to hold in mind is that the sales revenue reported in the income statement does not equal cash collections from customers during the year, and expenses do not equal cash payments during the year. Cash flow almost always is different from net income.

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Gleaning Key Information from Financial Statements The whole point of reporting financial statements is to provide important information to people who have a financial interest in the business — mainly its outside investors and lenders. From that information, investors and lenders are able to answer key questions about the financial performance and condition of the business.

I discuss some of these key questions in this section. In Chapters 13 and 17, I discuss a longer list of questions and explain financial statement analysis. Here, I use the data from Figures and the dollar amounts are in thousands: Opening the Books on Accounting Profit looks pretty thin compared with annual sales revenue. The company earns only 5 percent return on sales.

In other words, 95 cents out of every sales dollar goes for expenses, and the company keeps only 5 cents for profit. Many businesses earn 10 percent or higher return on sales. Is there enough cash? Cash is the lubricant of business activity. A business should keep enough cash on hand to keep things running smoothly even when there are interruptions in the normal inflows of cash.

A business has to meet its payroll on time, for example. Keeping an adequate balance in the checking account serves as a buffer against unforeseen disruptions in normal cash inflows. This cash balance is available for general business purposes.

If there are restrictions on how it can use its cash balance, the business is obligated to disclose the restrictions. Interestingly, businesses do not have to comment on their cash balance.

So, it has enough cash to pay these liabilities. Lenders are more interested in the ability of the business to control its cash flows, so that when the time comes to pay off loans it will be able to do so. They know that the other, non-cash assets of the business will be converted into cash flow.

Receivables will be collected, and products held in inventory will be sold and the sales will generate cash flow.

On the other hand, if it turns out that the business is not able to collect its receivables and is not able to sell its products, it would end up in deep doo-doo.

In the example, the business has an ending cash balance equal to 35 days of sales, calculated as follows: Can you trust the financial statement numbers?

Whether the financial statements are correct or not depends on the answers to two basic questions: What can I tell you? There are a lot of crooks and dishonest persons in the business world who think nothing of manipulating the accounting numbers and cooking the books. Also, organized crime is involved in many businesses. In short, there is a risk that the financial statements of a business could be incorrect and seriously misleading.

Opening the Books on Accounting To increase the credibility of their financial statements, many businesses hire independent CPA auditors to examine their accounting systems and records and to express opinions on whether the financial statements conform to established standards.

In fact, some business lenders insist on an annual audit by an independent CPA firm as a condition of making the loan. The outside, non-management investors in a privately owned business could vote to have annual CPA audits of the financial statements. Public companies have no choice; under federal securities laws, a public company is required to have annual audits by an independent CPA firm.

Two points: CPA audits are not cheap, and these audits are not always effective in rooting out financial reporting fraud by high-level managers. I discuss these and other points in Chapter Why no cash distribution from profit? In this example the business did not distribute any of its profit for the year to its owners.

Distributions from profit by a business corporation are called dividends. Why not? In most cases, this would be the upper limit on how much cash a business would distribute from profit to its owners. But you got no cash return on your investment in the business. But you did not see any of this increase in your wallet. Deciding whether to make cash distributions from profit to shareowners is in the hands of the directors of a business corporation.

Its shareowners elect the directors, and in theory the directors act in the best interests of the shareowners. Generally the main reason for not making cash distributions from profit is to finance the growth of the business — to use all the cash flow from profit for expanding the assets needed by the business at the higher sales level.

Ideally, the directors of the business would explain their decision not to distribute any money from profit to the shareowners. But, generally, no such comments are made in financial reports. Financial Statements and Accounting Standards Is making profit ethical?

Many people have the view that making profit is unethical; they think profit is a form of theft — from employees who are not paid enough, from customers who are charged too much, from finding loopholes in the tax laws, and so on. I must admit that profit critics are sometimes proved right because some businesses make profit by using illegal or unethical means, such as false advertising, selling unsafe products, paying employees lower wages than they are legally entitled to, deliberately under-funding retirement plans for employees, and other immoral tactics.

Of course in making profit a business should comply with all applicable laws, conduct itself in an ethical manner, and play fair with everyone it deals with. In my experience most businesses strive to behave according to high ethical standards, although under pressure they cut corners and take the low road in certain areas.

Keep in mind that businesses provide jobs, pay several kinds of taxes, and are essential cogs in the economic system. Even though they are not perfect angels, where would we be without them? Keeping in Step with Accounting and Financial Reporting Standards The unimpeded flow of capital is absolutely critical in a free market economic system and in the international flow of capital between countries.

To make these decisions, they need the accounting information provided in financial statements of businesses. Imagine the confusion that would result if every business were permitted to invent its own accounting methods for measuring profit and for putting values on assets and liabilities.

What if every business adopted its own individual accounting terminology and followed its own style for presenting financial statements? Such a state of affairs would be a Tower of Babel. Recognizing U. Opening the Books on Accounting complied with GAAP in reporting its cash flows, profit-making activities, and financial condition — unless the business makes very clear that it has prepared its financial statements using some other basis of accounting or has deviated from GAAP in one or more significant respects.

If GAAP are not the basis for preparing its financial statements, a business should make very clear which other basis of accounting is being used and should avoid using titles for its financial statements that are associated with GAAP. For example, if a business uses a simple cash receipts and cash disbursements basis of accounting — which falls way short of GAAP — it should not use the terms income statement and balance sheet. The general consensus backed up by law is that businesses should use consistent accounting methods and terminology.

General Motors and Microsoft should use the same accounting methods; so should Wells Fargo and Apple. Of course, businesses in different industries have different types of transactions, but the same types of transactions should be accounted for in the same way.

That is the goal. There are upwards of 10, public companies in the United States and easily more than a million private-owned businesses. Now, am I telling you that all these businesses should use the same accounting methods, terminology, and presentation styles for their financial statements? Putting it in such a stark manner makes me suck in my breath a little. The correct answer is that all businesses should use the same rulebook of GAAP.

However, the rulebook permits alternative accounting methods for some transactions. Furthermore, accountants have to interpret the rules as they apply GAAP in actual situations. The devil is in the details. In the United States, GAAP constitute the gold standard for preparing financial statements of business entities although the gold is somewhat tarnished, as I discuss in later chapters.

The presumption is that any deviations from GAAP would cause misleading financial statements. If a business honestly thinks it should deviate from GAAP — in order to better reflect the economic reality of its transactions or situation — it should make very clear that it has not complied with GAAP in one or more respects. If deviations from GAAP are not disclosed, the business may have legal exposure to those who relied on the information in its financial report and suffered a loss attributable to the misleading nature of the information.

Financial Statements and Accounting Standards Financial accounting and reporting by government and not-for-profit entities In the grand scheme of things, the world of financial accounting and reporting can be divided into two hemispheres: A large body of authoritative rules and standards called generally accepted accounting principles GAAP have been hammered out over the years to govern accounting methods and financial reporting of business entities in the United States.

Accounting and financial reporting standards have also evolved and been established for government and not-for-profit entities. This book centers on business accounting methods and financial reporting. Financial reporting by government and not-for-profit entities is a broad and diverse territory, which is beyond the scope of this book.

Federal, state, and local government entities issue financial reports that are in the public domain, although few taxpayers are interested in reading them. The members or participants may have an equity interest or ownership share in the organization and, thus, they need financial reports to apprise them of their financial status with the entity. Government and other not-for profit entities should comply with the established accounting and financial reporting standards that apply to their type of entity.

Many not-forprofit entities use accounting methods different than business GAAP — in some cases very different — and the terminology in their financial reports is somewhat different than in the financial reports of business entities.

Getting to know the U. The basic idea behind the development of GAAP is to measure profit and to value assets and liabilities consistently from business to business — to establish broad-scale uniformity in accounting methods for all businesses. The idea is to make sure that all accountants are singing the same tune from the same hymnal. The purpose is also to establish realistic and objective methods for measuring profit and putting values on assets and liabilities.

The authoritative bodies write the tunes that accountants have to sing. Opening the Books on Accounting Who are these authoritative bodies? Also, the federal Securities and Exchange Commission SEC has broad powers over accounting and financial reporting standards for companies whose securities stocks and bonds are publicly traded.

Actually, the SEC outranks the FASB because it derives its authority from federal securities laws that govern the public issuance and trading in securities. GAAP also include minimum requirements for disclosure, which refers to how information is classified and presented in financial statements and to the types of information that have to be included with the financial statements, mainly in the form of footnotes. The SEC makes the disclosure rules for public companies.

Disclosure rules for private companies are controlled by GAAP. Chapter 12 explains the disclosures that are required in addition to the three primary financial statements of a business the income statement, balance sheet, and statement of cash flows.

The official set of GAAP rules is big — more than a thousand pages! These rules have evolved over many decades — some rules remaining the same for many years, some being superseded and modified from time to time, and new rules being added.

Like lawyers who have to keep up on the latest court cases, accountants have to keep up with the latest developments at the FASB and SEC and other places as well. Some people think the rules have become too complicated and far too technical.

However, if the rules are not specific and detailed enough, different accountants will make different interpretations that will cause inconsistency from one business to the next regarding how profit is measured and how assets and liabilities are reported in the balance sheet. So, the FASB is between a rock and a hard place. For the most part it issues rules that are rather detailed and technical.

In short, the flow of capital has become international. Accounting and financial reporting standards in other countries are not bound by U. GAAP, and in fact there are significant differences that cause problems. The IASB was founded in Over 7, public companies have their securities listed on the several stock exchanges in the European Union EU countries.

Just the opposite: They are on a convergence course. They are working together toward developing global standards that all businesses would follow, regardless of which country a business is domiciled in.

Of course political issues and national pride come into play. The term harmonization is favored, which sidesteps difficult issues regarding the future roles of the FASB and IASB in the issuance of international accounting standards. One major obstacle deterring the goal of world-wide accounting standards concerns which sort of standards should be issued: Its pronouncements have been very detailed and technical.

The idea is to leave very little room for differences of interpretation. Under this approach, accounting standards are stated in fairly broad general language and the detailed interpretation of the standards is left to accountants in the field.

The two authoritative bodies have disagreed on some key accounting issues, and the road to convergence of accounting standards will be rocky, in my view. The stability, development, and growth of an economy depend on securing capital from both inside and outside the country. The flow of capital across borders by investors and lenders gives enormous impetus for the development of uniform international accounting standards.

Stay tuned; in the coming decade I think we will see more and more convergence of accounting standards in different countries. Then again, I could be dead wrong. Noting a divide between public and private companies Traditionally, GAAP and financial reporting standards were viewed as equally applicable to public companies generally large corporations and private generally smaller companies. Today, however, we are witnessing a growing distinction between accounting and financial reporting standards for public versus private companies.

For example, many private companies still do not include a statement of cash flows in their financial reports, even though this has been a GAAP requirement since Private companies do not have many of the accounting problems of large, public companies.

For example, many public companies deal in complex derivative instruments, issue stock options to managers, provide highly developed defined-benefit retirement and health benefit plans for their employees, enter into complicated inter-company investment and joint venture operations, have complex organizational structures, and so on.

Most private companies do not have to deal with these issues. Finally, I should mention that smaller private businesses do not have as much money to spend on their accountants and auditors. Big companies can spend big bucks and hire highly qualified accountants. Furthermore, public companies are legally required to have annual audits by independent CPAs see Chapter The annual audit keeps a big business up-to-date on accounting and financial reporting standards. Frankly, smaller private companies are somewhat at a disadvantage in keeping up with accounting and financial reporting standards.

In other words, the accounting methods used for figuring taxable income and for figuring business profit before income tax are Chapter 2: Financial Statements and Accounting Standards in general agreement. Having said this, I should point out that several differences do exist. A business may use one accounting method for filing its annual income tax returns and a different method for measuring its annual profit both internally for management reporting purposes and externally for preparing its financial statements to outsiders.

Many people argue that certain income tax accounting methods have had an unhealthy impact on GAAP. For example, the income tax law permits accelerated methods for depreciating long-lived operating assets — machines, tools, autos and trucks, and office equipment. Even the cost of buildings can be depreciated over shorter life spans than the actual lives of most buildings.

Other depreciation methods may be more realistic, but many businesses use accelerated depreciation methods both in their income tax returns and in their financial statements.

SAP ERP Financial Accounting and Controlling

Following the rules and bending the rules An often repeated accounting story concerns three persons interviewing for an important accounting position. They are asked one key question: This story exaggerates, of course, but it does have an element of truth. Depending on estimates and assumptions The importance of estimates and assumptions in financial statement accounting is illustrated in a footnote you see in many annual financial reports such as the following: Examples of the more significant estimates include: The accountant can choose either pessimistic or optimistic estimates, and thereby record either conservative profit numbers or more aggressive profit numbers.

One key prediction made in preparing financial statements is called the going-concern assumption. The accountant assumes that the business is not facing imminent shutdown of its operations and the forced liquidations of its assets, and that it will continue as usual for the foreseeable future.

If a business is in the middle of bankruptcy proceedings, the accountant changes focus to the liquidation values of its assets. Many accounting standards leave a lot of wiggle room for interpretation. Guidelines would be a better word to describe many accounting rules.

Deciding how to account for certain transactions and situations requires seasoned judgment and careful analysis of the rules. Furthermore, many estimates have to be made. A business may resort to creative accounting to make profit for the period look better, or to make its year-to-year profit less erratic than it really is which is called income smoothing. Like lawyers who know where to find loopholes, accountants can come up with inventive interpretations that stay within the boundaries of GAAP.

I warn you about these creative accounting techniques — also called massaging the numbers — at various points in this book. Massaging the numbers can get out of hand and become accounting fraud, also called cooking the books. Massaging the numbers has some basis in honest differences for interpreting the facts.

Cooking the books goes way beyond interpreting facts; this fraud consists of inventing facts and good oldfashioned chicanery.

I say more on accounting fraud in Chapters 7 and You may balance your checkbook against your bank statement every month and somehow manage to pull together all the records you need for your annual federal income tax return. Personal computer programs are available to make bookkeeping for individuals more organized, but you still have to enter a lot of data into the program, and most people decide not to put forth the effort.

Individuals can get along quite well without much bookkeeping — but the exact opposite is true for a business. The business depends on the accounts and records generated by its bookkeeping process to prepare these statements; if 54 Part I: Opening the Books on Accounting the accounting records are incomplete or inaccurate, the financial statements are incomplete or inaccurate.

In fact, inaccurate and incomplete bookkeeping records could be construed as evidence of fraud. This chapter shows you what bookkeepers and accountants do, mainly so you have a clear idea of what it takes to be sure that the information coming out of your accounting system is complete, timely, and accurate. Bookkeeping and Beyond Bookkeeping refers mainly to the record-keeping aspects of accounting; it is essentially the process some would say the drudgery of recording all the information regarding the transactions and financial activities of a business or other organization, venture, or project.

Bookkeeping is an indispensable subset of accounting. The term accounting is much broader, going into the realm of designing the bookkeeping system, establishing controls to make sure the system is working well, and analyzing and verifying the recorded information. Accountants give orders; bookkeepers follow them. You can think of accounting as what goes on before and after bookkeeping.

Accountants prepare reports based on the information accumulated by the bookkeeping process: Measuring profit is a critical task that accountants perform — a task that depends on the accuracy of the information recorded by the bookkeeper. The accountant decides how to measure sales revenue and expenses to determine the profit or loss for the period.

Pedaling Through the Bookkeeping Cycle Figure presents an overview of the bookkeeping cycle side-by-side with elements of the accounting system. You can follow the basic bookkeeping steps down the left side.

The accounting elements are shown in the right column. The basic steps in the bookkeeping sequence, explained briefly, are as follows. Chapter 3: Bookkeeping and Accounting Systems Steps in Bookkeeping Cycle Accounting Functions 1 Identify and prepare source documents for all transactions, operations, activities, and developments that should be recorded.

Design source documents that specify the detailed information to record and which approvals and signs-offs are required. Establish specific rules and methods for determining the financial effects of transactions and other events.

Establish formal chart of accounts, both control and subsidiary accounts, in which transactions and events are recorded. The basic steps of the book- 5 Prepare adjusted trial balance, to provide the up-to-date and accurate keeping listing of all accounts at end of period.

Oversee, review, and approve the endof-period adjusting and correcting entries, both routine and unusual ones. Prepare and distribute: Prepare source documents for all transactions, operations, and other events of the business; source documents are the starting point in the bookkeeping process. When downloading products, a business gets a download invoice from the supplier. When borrowing money from the bank, a business signs a note payable, a copy of which the business keeps.

When preparing payroll checks, a business depends on salary rosters and time cards. All of these key business forms serve as sources of information into the bookkeeping system — in other words, information the bookkeeper uses in recording the financial effects of the activities of the business. Opening the Books on Accounting 2. Determine and enter in source documents the financial effects of the transactions and other events of the business.

Examples of typical business transactions include paying employees, making sales to customers, borrowing money from the bank, and downloading products that will be sold to customers. The bookkeeping process begins by determining the relevant information about each transaction. The chief accountant of the business establishes the rules and methods for measuring the financial effects of transactions. Of course, the bookkeeper should comply with these rules and methods.

Make original entries of financial effects into journals and accounts, with appropriate references to source documents. Only the official, established chart of accounts should be used in recording transactions.

A journal is a chronological record of transactions in the order in which they occur — like a very detailed personal diary. In contrast, an account is a separate record, or page as it were, for each asset, each liability, and so on. One transaction affects two or more accounts.

The journal entry records the whole transaction in one place; then each piece is recorded in the two or more accounts that are affected by the transaction. Expecting a big demand from its customers, a retail bookstore downloads, on credit, 50 copies of Accounting For Dummies, 4th Edition, from the publisher, Wiley.I explain internal controls in Chapter 3.

When downloading products, a business gets a download invoice from the supplier. Some assets have been on the books only a few weeks or a few months, so their reported historical values are current. So, part of total assets can be traced to creditors, which are the liabilities of a business. Businesses do not disclose the compensation of top management in their external financial reports although this information can be found in the proxy statements of public companies that are filed with the Securities and Exchange Commission.

When they want to drill down into the details, they ask the accountant for the more detailed information. The history of accounting is quite interesting but beyond the scope of this book.

They can select from two or more equally acceptable methods for recording certain revenues and expenses. Even experienced bookkeepers and accountants should find some nuggets in that chapter.