Financial Accounting for Companies - Coursework Example

Accounting for Companies Name Institution Accounting for Companies Introduction Accounting is an important field especially for businesses since it provides a way in which the financial performance of the businesses can be determined. Accounting can be defined as the practice through which financial information is identified, measured and communicated to allow users of the information to make informed decisions and judgments (Horngren, 2013). The definition suggests that accounting involving providing information to others. This information is economic information, and it is about the economic or financial activities of an organization or business. The definition also suggests that there is need for identification and measurement of the accounting information. The identification of accounting information is done through the use of a company’s financial transactions and activities. Measurement involves making judgments on the value of assets that are owned by an organization or the liabilities that the business owes to other people or organizations (Kolitz, Quinn & Mcallister, 2009). Accounting is about accountability. Most companies are accountable to external players or stakeholders for their activities and actions. The need to be answerable for their activities, therefore, compels to produce reports about their activities and actions. For instance, private or public companies are accountable to shareholders, charities are accountable to charity commissioners and donors, local authorities are accountable to the local electorate and government departments, public services are accountable to government ministers and consumers and quasi-governmental agencies are accountable to government ministers and consumers. This, therefore, provides a need for these organizations to prepare accounting information to provide to the stakeholders to whom they are accountable (Kolitz, Quinn & Mcallister, 2009). Financial Accounting For companies, the most important part of accounting is financial accounting. Financial accounting is a branch of accounting that deals with tracking the financial transactions of the company (Kolitz, Quinn & Mcallister, 2009). Using certain set guidelines, transactions in companies are recorded and presented in financial reports or financial statements for example, the statement of financial position or statement of comprehensive income. Companies communicate their performance through such financial reports or statements. The financial statements are normally issued on routine schedules. The statements are regarded as external because they are normally issued to people outside the company. The primary recipients of financial statements or reports are owners or stockholders and certain lenders. However, in situations where a company’s stock is publicly traded, the financial statements and any other financial report of the company tend to circulate widely, and information contained in the statements is likely to reach secondary recipients like customers, competitors, employees, investment analysts and labor organizations. The purpose of financial accounting is therefore to provide information about a company so that the concerned people can assess its value (Horngren, 2013). Since financial statements are used differently by different people, financial accounting has certain common rules otherwise known as accounting standards. These standards are applied at any time a transaction is recorded. Double Entry At the heart of accounting is the double entry system. The double entry system is normally applied in recording each financial transaction made by a company. Double entry means that each single transaction made by a company affects two accounts on the least. For instance, if a company borrows 50,000 dollars from a bank, the cash account belonging to the company increases by the said amount and creditors or notes payable account in the company also increases. This means that the transaction has to be recorded in the two accounts, therefore, fulfilling the double entry requirement (Horngren, 2013). The double entry requirement also means that one account must have an amount entered as a debit and the other account have the amount entered as the credit. In addition, the debit amount for any given transaction must be equal to the credit amount. The double entry system has one main advantage: the system allows for a balance in the company’s assets, owner’s equity and liabilities in the sense that at any given time, a company’s asset accounts are equal to its owner’s equity and liabilities (Kolitz, Quinn & Mcallister, 2009). Accrual Basis of Accounting Another guideline that is applied to financial accounting is the accrual basis. Under this guideline, revenue in a company is reported at the time it is earned and not at the time the money is received (Kolitz, Quinn & Mcallister, 2009). Likewise, expenses in a company are reported at the time they are incurred and not at the time they are paid. For instance, a magazine publisher who receives a 24 dollar check for an annual subscription from a customer reports monthly revenue of 2 dollars even if the check has not matured, and the cash received. The accrual basis enables the profitability, liabilities, assets as well as any other financial information of the company to be in line with the economic reality. Accounting Principles In order for financial accounting to be useful, financial reports of a company need to easy to understand, credible, and easy to compare with those from other companies. To achieve this, financial accounting uses a set of rules known as accepted accounting principles (GAAP) or accounting standards. GAAP is based on basic underlying concepts and principles such as the matching principle, the cost principle, full disclosure, the economic entity, going concern, relevance, conservatism and reliability (Horngren, 2013). However, GAAP is not static. Apart from the basic principles, it also includes complex standards that are applied to complicated business transactions carried out by companies or traders. GAAP also takes care of accounting practices which may be unique to certain specific industries such as the banking, insurance and utility industries. The unique practices in these industries are normally due to changes in regulations imposed by governments on the industries. GAAP includes many explicit pronouncements which are normally issued by FASB (Financial Accounting Standards Board). FASB is a non-governmental group which researches about current economic and financial needs and establishes accounting rules and regulations to meet the emerging needs. Companies are supposed to follow the rules and regulations set in GAAP in all their business transactions (Kolitz, Quinn & Mcallister, 2009). Apart from following rules set in GAAP, any company that trades its stock publicly is also liable to the requirements of SEC (Securities and Exchange Commission). The requirements state that a company should provide an annual report to SEC as well as to stockholders. The report submitted to SEC should include a report of independent public accountants. SEC requires independent certified accountants to carry out the auditing of financial statements of companies to ensure that GAAP has been followed. That is why the annual report must include the auditing report from an independent certified accountant (Horngren, 2013). Financial Statements There are a number of overall purpose and external financial statements that are generated by financial accounting. They include an income statement or known as a profit and loss statement, the statement of financial position, also known as the statement of financial position, cash flow statement and statement of stockholders. These statements are used to provide all information about the company’s financial performance as well as financial position (Kolitz, Quinn & Mcallister, 2009). Income Statement The income statement is used to report the effectiveness of a company during a certain period. The duration could 13 weeks, one month, three months, one year or any other duration or time interval that a company chooses to use. The main elements of the income statement include the revenues, gains, losses, and expenses. Revenues are things such as sales revenue, interest revenue and service revenues (Kolitz, Quinn & Mcallister, 2009). Expenses include operating expenses such as rent, salaries, advertising and utilities, cost of goods sold, and non-operating expenses such as the interest expenses. In case a company engages in public trading of its stock, the earnings per share on the common stock are included in the income statement. Balance Sheet According to Horngren (2013), the balance sheet just like the income statement, also has components. The main mechanisms of a balance sheet are assets, liabilities and stockholders’ equity. The balance sheet has normally a date, and the three parts are reported in the balance sheet at a specified date. Normally, the date of reporting in the balance sheet is the last day of a financial or accounting period. The asset section of the balance sheet provides information about the assets owned by a company. Assets include things such as cash, inventory, accounts receivable, buildings, equipment, and prepaid insurance. The liability section in the balance indicates the obligations of the company to outsiders that are due at the reporting date on the balance sheet. They include notes payable, wages payable, accounts payable, and interest payable. The stockholders’ equity section shows the owners’ worth in the company. It is normally the difference between the assets and liabilities in the company. The balance sheet is normally used to show the financial position of the company (Kolitz, Quinn & Mcallister, 2009). Statement of Cash Flows This financial statement explains the change in the asset cash and cash equivalents in a company during the time interval provided in the statement. The change in cash and cash equivalents is divided into three parts. The parts are operating activities, the investing activities and the financing activities. The investing activities section shows the amount of cash received or spent in transactions that involve long-term assets. The operating activities part explains how the cash and cash equivalents in a company have changed because of operations. The financing activities part provides a report about things such as money spent to settle long-term liabilities, the issuance of stock, or money received due to the issuance of long-term debt (Kolitz, Quinn & Mcallister, 2009). Statement of Stockholders’ Equity The statement of stockholders’ or shareholders’ equity highlights the changes in the stockholders’ equity during the accounting period. The changes include a change in net income, dividends, other comprehensive income, the exercise of stock options, and the repurchase of common stock (Horngren, 2013). Management Accounting Apart from financial accounting, there is a management or the managerial accounting in business accounting. Management accounting is meant to provide financial information to the management of the company. Management accounting can be defined as a means through which financial and non-financial information is provided to the management of a company to aid in decision making (Horngren, 2013). Management accounting extends to three areas: strategic management, performance management, and risk management. Strategic management involves extending the function of the management to include that of a strategic partner in the company in the sense that the management accountant takes part in the decision making by the management (Kolitz, Quinn & Mcallister, 2009). The performance management involves managing the performance of the company as well as developing the practice of decision making in the business. Risk management, on the other hand, involves contributing to practices and frameworks for identifying, managing, measuring and reporting risks that might hamper the achievement of the company’s objectives (Horngren, 2013). Role within a Company Management accounting plays a crucial role in companies today. Management accountants have a double reporting relationship. As providers of decision based operational and financial information as well as working as strategic partners, management accounts have the responsibility of managing the business team as well as having to report responsibilities and relationships to the finance organization in the company. The actions provided by management accountants include projecting and planning, reviewing and monitoring costs that are inherent to the company and performing variance analysis (Kolitz, Quinn & Mcallister, 2009). In companies that derive most of their revenues and profits from the information market such as publishing houses, banks, defense contractors and telecommunications companies, IT costs are one of the significant sources of uncontrollable spending (Horngren, 2013). IT costs in such sectors are normally the greatest corporate costs after property related costs and total compensation costs. The work of management accounting in these organizations is therefore to work closely with IT departments in order to provide cost transparency in the department. Management accounting is, therefore, used to help in driving the success of a business while financial accounting is more about compliance. Specific Methodologies Used in Management Accounting Just the principles used in financial accounting, management accounting has a number of methodologies that are applied in this field. They include activity-based costing, Grenzplankostenrechnung (GPK), lean accounting, resource ingestion accounting, throughput accounting, and allocation pricing. Activity-based Costing Activity-based costing is a costing approach which identifies a company’s activities and assigns indirect costs to the company’s products. This approach recognizes the relationship between activities, costs and products and its uses this relationship to assign indirect costs to products. To assign overhead costs to products more correctly, the activity-based costing system puts activities into four categories (Horngren, 2013). They are unit-level activities, batch-level activities, product-line activities and facility support activities. Unit level activities are activities that occur each time there is the performance of a service or production of a product. The cost of direct labor, machine maintenance and direct materials are among the examples of unit-level activities. Batch-level activities include costs that are incurred each time a group or batch of units is produced. Examples of such activities include purchase orders, quality tests and machine setup (Kolitz, Quinn & Mcallister, 2009). Product-line activities are the activities that support the whole product line. Examples of such activities include engineering changes to the assembly line, warehousing and storage costs, and product design changes. Facility support activities are essential for production and development to take place. The costs involved support activities are administrative in nature. They include property taxes, building depreciation, and plant security, accounting, and insurance, maintenance, outside landscape, plant management and support staff salaries (Horngren, 2013). Grenz plan kostenrechnung (GPK) GPK is a German costing methodology which is intended to deliver an accurate and constant application of how to calculate and assign managerial costs to products or services. The objective of this methodology is to deliver meaningful analysis and insight of accounting information which benefits internal users like project managers, controllers, and plant managers. GPK consists of four elements (Kolitz, Quinn & Mcallister, 2009). They are cost-type accounting, cost center accounting, product cost accounting and contribution margin accounting. Cost-type accounting separates costs such as labor, depreciation and materials. Then each cost account is broken down into proportional and fixed costs. Cost center accounting involves assigning an area of responsibility to a manager. Product cost accounting involves assigning costs that are product related. Such costs are then collected in costing model. Lean Accounting Lean accounting involves applying lean methods to accounting, measurement processes and control in the company (Horngren, 2013). The main of lean accounting is to eliminate waste, speed up the process, free up capacity, make the process clear and eliminate errors and defects. Another aim of lean accounting in management accounting is to change the accounting, measurement processes and control so that they motivate improvement, provide an understanding of the value of the customer and provide information that is suitable for decision making. The vision of lean accounting is to provide accurate, understandable, and timely information in order to motivate lean transformation in an organization to achieve increased customer value, profitability, growth and cash flow; use lean tools to get rid of waste from accounting processes while maintaining financial control; fully comply with GAAP, internal reporting requirements and external reporting regulations; and support the lean culture through motivating investment in people, empowering continuous improvement in the organization and providing relevant and actionable information (Horngren, 2013). Resource Consumption Accounting Resource consumption accounting approach is a management accounting approach which provides managers with information to help them in decision making in order to achieve enterprise optimization. It is largely based on GPK. The core elements of resource consumption accounting are the review of resources; quantity based modeling, and cost behavior. In the view of resources, resources and the costs of such resources are regarded as foundational to decision support and proper cost modeling. In quantity-based modeling, the whole model is established using operational quantities (Kolitz, Quinn & Mcallister, 2009). Throughput Accounting This is a management accounting approach which recognizes the interdependencies of production processes. This approach looks at the contribution of each process in production to the cost and revenue generation and tries to adjust each part to achieve efficient production. Transfer Pricing This is a managerial accounting approach that assigns a price to transactions taking place between different divisions in an organization. This approach is used to determine the operational cost of an organization (Kolitz, Quinn & Mcallister, 2009). Conclusion Accounting is an important field especially for businesses because it provides a way in which the financial performance of the businesses can be determined. It also allows for accountability to be exercised in companies. Accounting for companies involves two main accounting sectors: financial accounting and managerial accounting. Financial accounting involves providing financial information to various stakeholders. This information is used to control how the company is performing. Financial information is provided through financial statements such as the balance sheet, the income statement and the statement of cash flows. Management accounting, on the other hand, involves providing information to the management in a company to aid in decision making. Both these sections have underlying principles and methodologies that are required to be applied in order to ensure consistence and transparency. Bibliography Top of Form Kolitz, D. L., Quinn, A. B., & Mcallister, G 2009, A concepts-based introduction to financial accounting, Lansdowne, Juta. Horngren, C. T.,2013, Introduction to financial accounting. Upper Saddle River, N.J., Prentice Hall.Bottom of Form Bottom of Form Read More