Corporate accounting is the measurement, summary, and interpretation of financial information and events pertaining to a company or organization. More than just bookkeeping, the key word in corporate accounting is the account of the name—the tale it tells, the explanation of the numbers.
The core of accounting is the double-entry bookkeeping system, which originated with Luca Pacioli, a Franciscan friar in 15th-century Venice who taught mathematics to Leonardo da Vinci. Pacioli streamlined the system in use among Italian merchants, and included it in his seminal mathematics textbook, from which it was quickly adopted across Europe. In double-entry bookkeeping, every transaction leaves a record in two (or more) accounts—the debit account from which money is leaving, and the credit account to which it is going. Balancing a personal checkbook, by contrast, is usually done according to a single-entry bookkeeping system.
Double-entry bookkeeping involves multiple copies of the same information. Sales transactions generate receipts for both parties. Deposit slips are collected after making bank deposits. These source documents are saved, with their information recorded into daybooks, of which there are usually multiple types for different types of data—a sales journal, a tax journal, and so on. After a set period of time—usually monthly, weekly, or quarterly—the figures from each journal are tallied to provide a financial picture of the period. Those tallies are further recorded—a process called posting, in accounting terminology—in the book of accounts (or ledger), and balanced to make sure that debits and credits are equal.
Double-checking the ledger is done by producing an unadjusted trial balance, an accounting document usually made in three columns, the first of which contains the names of accounts with non-zero balances. Debit balances are recorded in column two, credit balances in column three. If the respective totals of the two columns aren’t the same, an error has either been made during the posting process or revealed by it. Once any such errors have been taken care of, the balance is adjusted according to the needs of the business—typically correcting for inventory amounts— and an adjusted trial balance is produced and used as the basis for a variety of financial statements. Those statements include the P&L—the profit and loss statement—the statement of retained earnings, the balance sheet, and the cash flow statement.
In preparing financial statements, accountants in the United States are bound by Generally Accepted Accounting Principles (GAAP); other countries have other terms for their standards, and an international set of standards is of increasing importance. Common law countries—like the United States and the United Kingdom—do not specifically set their standards in law, though there is growing sentiment that they would benefit from doing so. It is part of the body of common law, required of publicly traded companies by the SEC, set by the Governmental Accounting Standards Board and the Financial Accounting Standards Board according to the type of accounting. The SEC has announced that by 2016, it expects the accounting standards followed by public companies to adhere to those of the International Accounting Standards Board (IASB), reflecting the increasingly global nature of doing business.
The objectives of GAAP are to ensure that financial statements are useful to investors and creditors both actual and potential, in order to help them make financial decisions in which the company is involved. GAAP is organized into four “basic assumptions,” four basic principles, and four basic constraints. The assumptions are that the company is a business entity, with a financial identity independent of its owners; that it is a “going concern,” expected to remain in business indefinitely; that a stable currency such as the dollar will be the unit used in financial statements; and that the company’s economic activities transpire over a time period that can be divided up for the purpose of preparing reports.
The four principles are the cost principle (companies report their actual costs, not the fair market value of their assets), the revenue principle (companies record when revenue is realized or earned, not when cash is received), the matching principle (expenses have to be matched with revenue), and the disclosure principle (sufficient information should be disclosed to allow the readers of financial statements to make informed decisions). The constraints are the objectivity principle (financial statements should be based on objective evidence), the materiality principle (that which would impact a decision is significant and material), the consistency principle (the same accounting methods should be used year to year), and the prudent principle (err on the side of understating the company’s success, not overstating it). In the unlikely event that adhering to GAAP would create a misleading financial statement, the accountant is ethically bound to depart from GAAP practices and explicitly note the departure and the nature of the misapprehension that would have resulted.
International standards differ not so much in their objectives as in their specifics; the International Financial Reporting Standards (IFRS) adopted by the IASB specifically lay out the financial statements and documents that are to be produced for a variety of situations and uses. IFRS also explicitly calls for comparability as a qualitative characteristic of a standards-compliant financial statement: the statements produced for any two companies should be similar enough in structure and type of content that it is easy for potential investors to compare the two companies without having to do any “translation.” In general, the IFRS reflect the specificity and tendencies of code-law countries such as much of western Europe and Asia. Regardless of the set of accounting standards adhered to, separate standards—again, more specific than GAAP—obtain when preparing reports for tax purposes, where very specific information needs to be identified.
One reason for the switch to IFRS is because of growing dissatisfaction with American corporate accounting practices, as a result of recent accounting scandals. 2002 saw every major accounting firm—Arthur Andersen, Deloitte & Touche, Ernst & Young, KPMG, and PricewaterhouseCoopers—charged with negligence or admitting to other forms of wrongdoing, amid the indictment of Arthur Andersen over the Enron scandal, the bankruptcy of WorldCom only weeks later, and a stock market downturn credited in part to the failure of investor confidence in the accurate reporting of the companies in which they were expected to invest.
- Troy Adair, Corporate Finance Demystified (McGraw-Hill, 2005);
- John R. Emshwiller and Rebecca Smith, 24 Days: How Two Wall Street Journal Reporters Uncovered the Lies that Destroyed Faith in Corporate America or Infectious Greed (HarperInformation, 2003);
- Bethany McLean and Peter Elkind, The Smartest Guys in the Room: The Amazing Rise and Scandalous Fall of Enron (Portfolio, 2004).
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