The Differences in Accounting Processes between Partnerships and Corporations - Case Study Example

Running Head: ACCOUNTING II Accounting II Accounting II  How do partnerships and corporationsdiffer in accounting processes? Reporting? Financial statements? What are the benefits of each? How would one select one from another? Partnerships v/s Corporations Companies exist under different forms which include partnerships and corporations. A partnership exists when two or more individuals or associates carryout a non-corporate business for profit. Partnerships could be limited liability partnerships or companies where owners have limited liability for business debts and in most cases at least one partner is liable for partnership debts. Examples could include KPMG and Ernst & Young which are LLPs. Corporations on the other hand are authorized and formed by state laws and have separate identity from their owners and managers. This form of company typically have unlimited life and ease of ownership transferability in addition to owners limited liability. Examples of such companies are Microsoft and HP (Brigham & Ehrhardt, 2008). The accounting treatment of partnership takes company as an entity which is separate from partners’ personal affairs (Horngren, Bamber, & Harrison, 2005). The major difference in the accounting of corporations and partnership is the calculation and disclosure of the capital of the organization. Corporations are required to prepare and publish audited annual and quarterly reports which could be accessed by shareholders. These annual reports contains statements including income statement, balance sheet, cash flow and changes in shareholders’ equity. Financial reports are not published for external users by partnership and tax return is submitted as part of individual tax forms. There are different ways of identifying whether a company is a partnership or corporation. Firstly, partnerships and corporations fall in different tax regimes. In partnership entity is not liable for tax and it is deducted from owner’s personal income. IRS has set out guidelines for distinguishing between partnership and corporation. In addition to the characteristics discussed above if one partner has the power to dissolve company then the characteristics of corporation is absent. Shareholders of corporations can sell their stock to third party however in partnerships there is general lack of transferability. There is also centralization of management in partnership whereas in corporations there is a board of directors which comprise of company’s shareholders (Brickman, 1991).  What does a statement of cash flows tell us about the short and long term prospects of the firm? How does an outside review use a statement of cash flows and other financial statements to assess the viability of the firm? Companies prepare cash flow statement on a periodic basis for both internal and external users. Companies need to assess their cash flow which is the net of receipts and payments. Cash flow statements provide a summary of actual or anticipated cash flows under three categories of business activities including operating, investment and financing activities over a period of time. Investors and lenders evaluate companies’ financial performance by examining different elements of cash flow statements. Emphasis on preparing cash flow by different regulatory bodies is due to its more relevance to the current cash position of the company instead of taking account of payments and receipts on credit. Therefore, cash flow statements could be used by its users for determining both short and long term prospects of the firm. In order to assess companies’ short term and long term prospects it is more important to determine company’s ability to generate cash than profitability. Therefore, cash flow statement provides detailed information which investors, analysts and other users can actually use to determine both short and long terms opinion about the company. Cash Flow Statement takes into account elements of both income statement and balance sheet which could have impact on the financial position of the company. From a short term perspective changes in working capital that is current asset less current liabilities are reflected in cash flow from operating activities suggest the net position of the company and its ability to meet its current liabilities. From another perspective an increase in long term loan commitments and raise of capital suggests that company is not able to generate enough cash to finance its operations. In addition to this investment in fixed assets and early repayment of loan can give out positive signals regarding company’s expansion plans and its ability to generate funds thus reducing company’s reliance on external debt. This thus requires further investigation. From shareholders perspective the company’s ability to pay dividend is reflected in statement of cash flow. Cash flows provided can be used to develop budgeted cash flows which are subject to discounting techniques to evaluate a company’s or a project’s long term feasibility. If discounted cash flows over a period of time exceed initial investment then a project should be accepted and should be rejected if otherwise (Fridson & Álvarez, 2002). In addition to this various cash flow ratios evaluate financial strength and profitability of the company. EPS has been manipulated unjustifiably by companies to attract investments and cash flows analysis provides a much better view of the company’s ability to survive and do well for shareholders. External users including investors, creditors and others could use statement of cash flow for assessing the company’s ability to remain a viable entity by generating future cash flows, generate sufficient cash to meet its interest expense and principal repayment, its ability to pay dividends, assess company’s free cash flow which could be invested back in the company and also determine effect on financial position of a company from its non cash activities. By far statement of cash flow is considered to be most relevant for carrying out financial analysis however other financial statements including income statement and balance sheet can also be used to evaluate the company’s financial position. Financial statement analysis is common tool used by users of financial information to evaluate company’s financial standing and its ability to remain as a going concern. Horizontal and vertical analyses use totals from income statement and balance sheet to provide year on year comparison and also as proportion of an element used for basis of comparison respectively. One criticism that covers all statements is that the information provided in the annual reports is historical data (Carmichael, Whittington, & Graham, 2007). Forecasted financial statements can overcome some of the issues but still have issues of subjectivity and relevance.  Why is cost accounting so important to the success of the firm? What are the various methods of cost accounting and how are they used? Cost Accounting is the process of identifying costs associated with business activities and developing and implementing controls to manage costs. Cost accounting procedures involves ascertaining costs of products, services and other procedures and identifying flaws in the business procedures contributing to increase in the costs of production. Cost accounting encompasses various steps which assist companies to prepare periodic reports on costs related to different business components which are consolidated to ascertain the overall profitability of the company or a business line. Cost accounting is an important accounting procedure which is the responsibility of company’s cost accountants however the extent of its implementation depends upon the nature and size of the business and produces information which covers both internal and external transactions. Cost accounting establishes responsibilities for individuals and departments which are involved in different business processes. The information provided by cost accounting function enables management to undertake decision making. Companies use cost estimates to decide which product or service they should produce, which equipment should be retained or disposed off, whether to expand or retract operations or even decide about the selling price. Thus, it contributes to important business decisions which could eventually determine the success of business operations. In contrast to financial accounting cost accounting focuses upon the present and future data using both historical and forecasted data. This suggests planning role of cost accounting which allows companies to prepare estimates and identify any variations between the actual and budgeted costs. This allows companies to devise their overall budgets and their strategies and procedures to achieve the corporate objectives. If cost data suggests unfavorable conditions then companies can undertake corrective actions to solve problems in particular to material loss, machinery and labor idleness (Weil & Maher, 2005). Different methods could be applied for costing of products and services under cost accounting. These include job costing and product costing and are differentiated on the basis of calculation. Job costing is a method which is commonly used where products or services are prepared according to the order and according to customers’ specifications. Since products manufacturer or services offered are unique from others therefore companies perform costing on specific job basis. There are three sub-categories of job costing which are batch costing, terminal costing and composite costing. Process costing is usually used where same or similar products or services are prepared on a continuous basis. The rationale for this method is that it is difficult to trace costs to individual unit being produced and therefore the total cost is calculated and average based on the number of units produced. There are three variants of process costing which are single output costing, operating costing and operation costing. Furthermore, four different techniques are used for costing which include historical costing, standard costing, absorption costing, marginal costing and uniform costing (Lal, 2002). All these techniques result in different cost estimates.  How does an operating budget work to discipline a firm’s management? What are the elements of a budget? How are budgets constructed? What is budget variance? Operating budget is a comparatively short term projection of all estimated income and expenses based on the projected levels of sales. This type of budget is related to the operating activities of a company and therefore excludes estimates regarding financing and capital layout. Budgeting process is not simply about presenting future estimates but also to provide basis for assessing management’s performance. Inputs to operation budget are made from managers of different business functions and their performance is measured against targets set out in operating budget. However, there are some flaws in preparation of operating budgets such as managers willingly setting lower targets for themselves or setting them very high which are unachievable. In both circumstances businesses could be adversely affected from missed opportunities. Therefore, it is vital that targets set out are reasonable and managers are held responsible for their business functions. Operating budget can be used to evaluate management performance using ratio analysis to provide financial measure. Operating budget comprises of elements affecting income statement of a company hence assists in determining profit levels of a company at different expected levels of sales. These elements include sales revenue, variable costs, fixed / administrative costs, depreciation and interest cost. Fixed costs also include unexpected costs which companies ascertain based on previous years and foreseeable difficulties in the future periods (Weil & Maher, 2005). This implies that depending on the expected sales companies need to plan ahead regarding their business operations. Budgets are very crucial in any business and different approaches have been developed and used frequently by different companies to arrive more realistic and achievable targets. Two approaches include top down budgeting and bottom up budgeting. In the earlier approach targets are set from the top management and guidelines are trickled down to lower management through different levels of hierarchy. This approach is most common in self proprietary business where owners use estimates for their own projections and set targets for their employees who are considered to lack skills and experience. Also this approach lacks commitment and sense of ownership of given tasks by the lower management and employees. On the other hand bottom up budgeting involves gathering relevant information from the lower management and is compiled together using sophisticated budgeting software to develop overall budget and individual departmental budgets. This approach has the advantages of more relevance and responsibility assignment (Horngren & Harrison, 2007). Budget variance is an analysis of difference between budgeted amount and actual figures. The result is the positive or negative impact on net income of the company. This analysis is used to determine the differences between estimated costs of inputs and actual costs both variable and fixed overheads. This analysis helps management to identify variables which shows greater variations thus allows management to revise their estimates for future budgeting (Horngren & Harrison, 2007).  What is management accounting? What are the sources of data? How are the data used to make management decisions? Management accounting is defined as the ‘process of identification, measurement, accumulation, analysis, preparation, interpretation and communication of financial information’ (AllBusiness, 2009). This information is prepared for the use of management and assists them in planning, evaluating performance of internal departments and developing controls within an organization. The management is primarily concerned with information that would help them in decision making and management accounting systems serve this objective. However, the information produced by management accounting is to be used with other relevant information to ensure successful decision making. The information produced through management accounting is not subjected to regulatory frameworks as the information is produced for internal users (Smith, 2007). However, it is important for companies to have reliable framework and systems for gathering such information from different elements of the business and reporting to the management for their decision making process. The scope and frequency of information is not limited in anyway and can be drafted by altering data variables. As mentioned management accounting is typically carried by companies using sophisticated management accounting software. Inputs to this system are made by authorized individuals constituting of tasks information and typically different business functions are interconnected and information submitted by one department is transferred to other department which adds its input. Thus, the content of management information evolves from inputs made in the system by different users. In addition inputs regarding financing and capital layouts are also made to the system which evaluates this information to assist decisions by the management. There is a major difference between management accounting and cost accounting as the later only focuses on the costs incurred by business and controls to limit these costs whereas management accounting is not limited to determining cost variance it is beyond that it covers other information related to revenue cycle, production cycle, expense cycle, reporting cycle in addition to investment appraisals, tax calculation and payment and selection between financing choices (Weil & Maher, 2005). All the data processed by the management accounting system is presented in a suitable form for managements understanding and use. Keeping in mind the management requires simple and understandable reports the information summary presented to them is kept to its fundamentals rather than technical details. References AllBusiness. (2009). Business Glossary. Retrieved July 22, 2009, from AllBusiness: http://www.allbusiness.com/glossaries/management-accounting/4944842-1.html Brickman, D. S. (1991, January 1). Partnership or Corporation? Meeting the IRS Requirements. Retrieved July 22, 2009, from AllBusiness: http://www.allbusiness.com/accounting-reporting/corporate-taxes-joint/150926-1.html Brigham, E. F. & Ehrhardt, M. C. (2008). Financial Management: Theory and Practice. Mason: Thomson South-Western. Carmichael, D. R., Whittington, R. & Graham, L. (2007). Accountants Handbook . New Jersey: John Wiley & Sons . Fridson, M. S. & Álvarez, F. (2002). Financial Statement Analysis . New Jersey: John Wiley & Sons. Horngren, C. T. & Harrison, W. T. (2007). Accounting. New Jersey: Prentice Hall. Horngren, C. T., Bamber, L. S. & Harrison, W. T. (2005). Accounting = Kuai Ji Xue. New Jersey: Pearson Prentice Hall. Lal, J. (2002). Cost Accounting. Noida: Tata McGraw-Hiill . Smith, J. A. (2007). Handbook of Management Accounting. Oxford: Elsevier. Weil, R. L. & Maher, M. (2005). Handbook of Cost Management. New Jersey: John Wiley & Sons. Read More