Posted: May 25th, 2022

Paper on Accounting Process & Financial Statements

Accounting Process and Financial Statements.

A reliable internal system of accounting is an essential element of a solvent profit or nonprofit business entity. By recording virtually every business activity or endeavor, with regards to the creation of monetary inflows of sales revenue and monetary outflows of expenses resulting from operating activities; an accounting system should provide the financial information needed to evaluate the profitability or effectiveness of past and operations. Along with maintaining data for reporting purposes, an effective accounting system will effectively report the status of asset resources, creditor liabilities, and ownership equities of the business entity. With today’s rapid and ever expanding technological developments have lead to increasing operating speeds, convenient data storage capabilities, reliability and significantly reduced costs.

Historically, maintaining an effective accounting system involved extensive manual labor which was described as tedious, aggravating, and time exhaustive. Recording transactions, adding subtracting, summarizing, and checking for errors were primarily the responsibility of the individual. With the advent of inexpensive microcomputers and accounting software programs, advancements in information technology have made administering these duties calculations much simpler. As a result, managers can now maintain direct personal control of the accounting system. There still requires a high degree familiarity and mastery of traditional accounting principles and analysis techniques with a strong practical understanding of accounting principles, concepts, conventions and practices.

Specifically as it relates to developing business decisions, the recording of financial transactions is critical when analyzing transactions and information in the form of balance sheets, income statements, and other financial statements, often provided to users outside of businesses stockholders, creditors, lenders, governmental agencies, and other outside users who may be affected by the business decisions of management. When developing operational strategies accounting is concerned with providing internal information to managers who are responsible for directing and controlling operations. This information provides a basis for planning and decision making of alternative short- or long-term courses of action. Specific details of the budgetary plan can be monitored and as necessary, modified to meet the objectives of the selected course of action.

Accounting systems are not uniform as procedures and applications vary in accordance to their applicability with different businesses like services, retailing, and manufacturing businesses. For example, in manufacturing, all costs are generally assigned to products or product lines and are identified as direct or indirect costs. Direct costs include all materials and labor costs that are traceable directly to the product manufactured. Indirect costs generally refer to manufacturing or factory overhead; they include such items as administrative salaries, wages and miscellaneous overhead, utilities, interest, taxes, and depreciation. The basic nature of indirect costs, however, makes isolating specific costs since they are not directly traceable to a particular product. There are techniques, specific to indirect costs assigned by allocation techniques to each product or product line.

These types of businesses differ from say a hospitality operation because they do not normally require unique accounting procedures. Whereas a hospitality operation tends to be highly departmentalized, thus separating operating divisions that provide rooms as opposed to food, beverage, banquet, and gift shop services. A hospitality accounting systems generally have a several different sales revenue cycles. First, there is the daily operating cycle which applies particularly to restaurant operations which depend upon sales generated during meal periods. Second, there is a weekly cycle followed by a seasonal cycle that depends on vacationers to provide revenue for hospitality operations during vacation months. Fourth, a generalized business cycle will exist during recessionary inflationary cycles, and hospitality operations typically experience a major decline in sales revenue. These accounting cycles encountered in hospitality operations create unique difficulties in forecasting sales revenue and operating costs. In particular, variable costs like cost of sales and labor costs require unique planning procedures that assist in budget forecasting.

Costs directly traceable to a department or division are identified as direct costs. Typically, the major direct costs include cost of goods sold, salary and wage labor, and specific operating supplies. After direct costs are determined, they are deducted from sales revenue to isolate contributory income, which represents the department’s or division’s contribution to support undistributed indirect costs of the whole operation. Indirect costs are not easily traceable to a department or division. Generally, no attempt is made at this stage of the evaluation to allocate indirect costs to the department or divisions. Managers review operating results to ensure that contributory income from all departments or divisions is sufficient to cover total indirect costs for the overall hospitality operation and provide excess funds to meet the desired level of profit.

Essentially, financial accounting, developed by accountants over time, “defines the principles, concepts, procedures, and broad rules necessary for management’s use in a viable accounting system for making decisions and maintaining an efficient, effective, and profitable business.” Each type of asset, liability, owners’ equity, sales revenue, and expense is kept. The balance is the current status of an account at a specific point in time detailing information regarding each categories while governing recording, reporting, and preparing financial statements. This information should demonstrate the financial condition of a business entity during an accounting period which is the time period covered by the financial statements.

Accounting has two major financial reports. The balance sheet provides a composite look of a business’ financial outlook by listing its assets, liabilities, and ownership equities on the last date of an operating period. The balance sheet provides an easier basis for understanding double-entry accounting. The balance sheet, as an equation represents an entities assets, equal to liabilities and ownership equity. Assets are defined as resources of value used by a business entity to create sales revenue, which increase assets. Liabilities are essentially debt obligations owed to creditors accrued during operations in the hopes of generating sales revenue to be paid in the near future from assets. Liabilities represent creditor equity or claims against the assets of the business entity. Lastly, ownership equity represents claims to assets of a business entity. There are three basic forms of ownership equity which provide financing by a sole owner, partnership or corporation with ownership represented by shares of corporate stock. Each share of stock represents one ownership claim to retained earnings after dividends are paid.

As the equation stated above, there is an absolute necessity to maintain the same on both sides of the equation. When a transaction affects both sides of the equation, equality of the equation must be maintained. One side of the equation cannot increase or decrease without the other side increasing or decreasing by the same amount. If a transaction occurs that affects only one side of the equation, total increases must equal total decreases. This “double-entry accrual accounting” requires that at least one element of the balance sheet equation or the income statement elements must be created or changed. A transaction is defined as an exchange between a business entity where services are rendered or goods are sold to an external entity for cash or on credit, or where services are received or goods are purchased creates a transaction. Following the transaction, adjusting entries must be made to adjust the operating accounts of the business entity at the end of an operating period; the entry is made on both sides of the equation, thus the term double-entry accounting.

The income statement reports the economic results of the business entity by matching sales revenue inflows, and expense outflows to show the results of operations, its net income or net loss. The income statement is generally considered the more important because it reports the results of operations, thus clearly identifying the relationship of sales revenue inflows and the cost outflows to produce sales revenue. “The income statement equation consists of three basic elements that produce three possible outcomes in for-profit operations.” First, sales revenue is produced from the sale of goods and/or services. Second, the cost of sales reflects the cost of inventories purchased for resale that were sold. When total sales revenue equals the total cost of producing the revenue, there is no profit or loss exists, thus establishing the breakeven point. If total sales revenue exceeds total cost of producing the revenue, then a profit exists. If total sales revenue is less than the total cost of producing the revenue, a loss exists. The income statement shows the ending results of operations as of a specific date for a specific period.

In conclusion, accounting is not a static system but rather a dynamic process that incorporates generally accepted accounting principles (GAAP) that “evolve to suit the needs of financial statement readers, such as business managers, equity owners, creditors, and governmental agencies with meaningful, dependable information.”

Sources

BASIC FINANCIAL ACCOUNTING REVIEW: media.wiley.com/product

Smith; Outlines & Highlights for Financial Accounting Basics. AIPI; 3 edition (October 19, 2006).

Stickney, Clyde P., Weil, Roman L.; Financial Accounting: An Introduction to Concepts Methods, and Uses. South-Western College Pub; 10 edition (July 2, 2002).

Maher, Michael W., Stickney, Clyde P., Weil, Roman L.; Managerial Accounting: An Introduction to Concepts, Methods and Uses. South-Western College Pub; 10 edition (March 13, 2007)

Roman L. Weil (Author)

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