Business Accounting Essay

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Business accounting refers to the financial management of a company, whether a small neighborhood grocery store or a huge multinational corporation. The  focus  of business  accounting is on the economic comings and goings of the firm— each time money goes in or out, the business accountant must keep track of what has happened and why, to be able to predict what will happen  in the future  and prepare  for it. Business accounting, thus, has three major functions: (1) identifying financial     transactions    by     the     company, (2) recording  those  transactions in a manner  that makes   it   easy   to   keep   them   up-to-date,  and (3) reporting the  transactions to  stakeholders in the business  so that  they can use the information to steer the business into the future.

Depending   on   the   physical   location   of  the business, there  are different  sets of standards that must  be followed  by business  accountants. These standards are  known  as GAAP, which  stands  for Generally  Accepted  Accounting  Principles.  GAAP is essentially a collection of best practices followed by  most  practitioners in  a  particular area.  Not surprisingly, this method of following only local standards has encountered difficulty because of the pressures  of  globalization for  companies  located far  apart   to  trade  with  one  another. More  and more,  companies  are  turning  for  guidance  to  the

International Financial  Reporting Standards produced  by the  International Accounting  Standards organizations in an effort to keep their  records  in formats   that   are  not  only  useful  to  their  own decision makers but also organized according to standards that  will be readily  comprehensible the world  over.

Common  Tasks

Business  accounting  has  the  goal  of  providing reports  that are reliable, informative, timely, and of good  value—that is, saving  more  than  they  cost. The information reported must be reliable because decision makers  will use it to determine  the future course   the   company   should   take.   The   reports need to be informative by presenting  complex information in straightforward ways that highlight important trends  in ways  that  do  not  require  an accountant’s knowledge to comprehend. Timeliness is critical because in the modern world the economic landscape can change from moment to moment; depending   on  the  sector   of  the  market,  status reports  on the state of the market  and the company’s performance may be needed  weekly, daily, or even several times a day. Finally, accounting systems and  software  come  in  all  shapes  and  sizes, so  a company  must be careful to choose ones that are a good fit for its culture  and budget.

Within the larger categories of transaction identification,  recording,   and   reporting  are   a number  of more  specific tasks  common  to  most businesses.  The  most  obvious  of  these  are  cash inflow  and  outflow—that is, sales and  payments. Another  major  task  is payroll;  to  issue employee paychecks,  the company  must  use many  different kinds of financial  information in its files: salaries, personal   deductions, taxes  to  be  withheld,   and retirement withholdings, to name only a few.

One  of the  more  complicated  tasks  is keeping track of capital accounting, which requires records to be kept not of financial  transactions but for the value of assets such as machinery  and equipment, office furniture and  supplies,  real  estate,  vehicles for  personal   transportation and  for  shipping  of goods, tools and computers, and many other items. These assets are not  as fungible  as cash or investments,  but  they  are  still assets  the  company  has control over, and therefore their value must be accounted for. This is also true  for the company’s unsold   stock   of  products—the  accounting  unit must  monitor  inventory   for  insurance   purposes and   as  part   of  its  responsibility  for   tracking purchase   orders   received   from   customers   and making  sure that  the orders  are filled in a timely manner.

In most cases, a business accountant will conduct these common  tasks  according  to a regular  cycle, moving  through each  task  and  generating   each report  until  the end of the cycle is reached  at the end  of  the  fiscal  year.  The  cycle starts  with  the receipt  of source  documents such as invoices and purchase  orders;  these are then  posted  as journal entries, which are later posted to ledgers; periodically, the ledger is used to generate trial balances,  and  ultimately, the cycle concludes  with the production of financial  statements. At the end of the  fiscal year,  the  ledger  for  the  past  year  is closed,  and  a new  ledger  for  the  coming  year  is created.

Constituencies

Businesses  also  work   with   different   groups   of people,  and  each  of  these  constituencies has  its own  record-keeping requirements. To begin with, there are the employees of the business itself, whose salaries, benefits, and retirement packages  all have an impact on the finances of the company, and this impact  must  be recorded.  The  company  also  has customers, and  each  time  there  is an  interaction between  a  customer   and  the  company,   there  is likely to be a need for documentation, whether  it takes the form of a receipt for a simple cash transaction or a purchase order received for a huge shipment  of goods  to be delivered.  In addition to having  customers  of its own,  the typical  business will also find itself in the role of customer  when it interacts  with  its  own  vendors  to  purchase  supplies, raw materials,  and services.

There are also several groups that produce accounting records related to the business through means  other  than  day-to-day buying  and  selling. The government is one such body, because its role in collecting taxes and providing  funding  through grants  requires  a large amount of documentation. Another  group consists of those who provide capital to the company  by investing their own money, in the hope that they will eventually realize a profit on their investment,  in the form of dividends; such investors   are   sometimes   known   as  sources   of equity capital. There are also debt sources of capital,  but   instead   of  investing   their   funds,   these sources  lend  money  to  a  company   and  charge interest  on  the  loan  until  it has  been  repaid.  All three  of  these  groups—government agencies  and regulators, investors,  and  creditors—demand precise records  of the transactions that  the company conducts  with them, to ensure that their own goals remain  well aligned with those of the company.

Identifying Transactions

Business  accounting involves  a  number   of  tasks that occur cyclically in what is known  as the accounting cycle or  bookkeeping cycle. The  first part of the accounting cycle is focused on the need to identify the transactions that need to be recorded. Usually, a transaction will be documented in some form that leaves behind a paper trail; this could be a purchase order that was generated as part of obtaining goods  or services from  an outside  vendor,   a  receipt   from   a  purchase,  or  an  invoice received from a vendor after submitting  a purchase order.

Whatever   the   nature   of  the   document  that records  the  transaction, the  business  accountant must review that document and decide which accounting category  it belongs  to. The  categories that  are traditionally used in business  accounting are  assets,  liabilities,  expenses,  and  revenue.  An asset is something  that  the company  or the other business entity owns or has control  over as a result of  a  previous   transaction  and   that   the  owner expects  to  produce  further  income  or  benefits  in the future.  Examples  of assets include stocks,  real estate,  patent  rights,  and  so forth.  Liabilities  are the opposite  of assets—they come from past transactions,  just  like assets,  but  instead  of expecting additional income  from  them, the company  bears an  obligation  related   to  them.  This  obligation could take the form of a monetary debt that  must be  repaid,  a  service  that  must  be  performed for another party,  or some other  duty to be fulfilled.

Somewhat  related  to liabilities are another category of business accounting transactions— expenses.  Expenses  are  caused  when  funds  flow from   the   company   or   individual   outward  to another entity,  usually  in  payment   for  goods  or services.  Examples  of  expenses  that   a  company might incur include costs of advertising  in various media  outlets,  salaries  paid  to the employees  and contractors of the company  in exchange  for their labor,   and   money   paid   for   the   raw   materials needed to produce  the company’s products for sale to  customers. An  expense  can  take  one  of  two forms:  Either  the company  pays the expense  with cash  that  it has  on  hand,  or  it takes  on  debt  by promising  to pay the expense  in the future.  Thus, when  a business  incurs  an  expense,  it either  uses up  an  asset  (e.g.,  cash)  or  takes  on  a  liability (debt—an  obligation to pay the expense later).

The  fourth   and  final  category  of  transaction entry in business  accounting is that  of revenue. In some parts of the world, revenue is known  as “turnover,” but  regardless  of  what  term  is used, revenue   refers   to   the   income   that   a  business receives from customers  in exchange  for the goods or services that  the business has provided  to them. It is also  possible  for  businesses  to  earn  revenue from  sources  other  than  direct  payments  by customers,  for example,  royalties  and  interest  earned on existing assets. By tradition, accounting ledgers usually place revenue near the top  of the page on an income statement, so revenue is sometimes referred  to as the “top  line,” meaning  that  it is the amount  of  money   flowing  in  to  the  company, before deducting  expenses from it.

Recording Transactions

Keeping  an  accurate  and  complete  record  of the financial transactions of a business is a highly complex task—far  more  complicated  than  the  simple balancing   of  a  checkbook, which  is  the  closest analogy most people are familiar with. Unlike a system  of personal  accounting, business  accounting must keep track of transactions made by many different  entities—individuals, departments, work groups,  and so forth—each of which may have its own types of transactions and processes for completing  them.  Recording  of transactions for a business  must  also  be done  in multiple  ways,  so that  different  kinds of reports  can be generated.  It is  not  enough   to  simply  have  one  long  list  of credits  and  debits  leading  to  a  bottom line;  the company’s   decision   makers   need   to   know   the date  and  time  of  each  transaction, whether  it  is income  or  an  expense,  whether  it  is a  one-time event or part of a recurring  series, and many other points  of  data.  With  such  information recorded, the  company   can  analyze   its  performance  and make    projections   about    future    performance and  levels of  demand. For  example,  a  company that manufactures school supplies might review its past sales figures and note that each year in August sales of pencils go up an average of 3 percent compared with sales at the same time the previous year, occasionally leading to shortages when the company  runs out of pencils to sell. This information could be used to increase pencil production in advance  of August  in order  to take  advantage of the  traditionally higher  demand—but only  if the information had  been captured in the accounting system in the first place.

To make  sure that  all information is recorded, rather  than  being misplaced  or forgotten, business accountants use several strategies to preserve information. One strategy is to record the information  more  than  once—when  this  is made  into  a standard practice,  it increases the chances that  the transaction information will be preserved  and not lost.  Transactions  are  first  recorded   in  a  prime entry  record  (sometimes  the  prime  entry  records are referred  to collectively as the books  of prime entry).  Then,  sometime  later,  the  transactions are also entered in the company’s ledger. Recording transactions first in the books  of prime  entry  is a precaution to make sure that  they are entered into the  ledger,  which  is  the  most  important  set  of records  in business accounting.

The books  of prime entry have several different categories,  each  with  their  own  types  of  entries. There is a cash book, which is used to record payments   made  to  and  from  the  company’s   bank account;  there is also a petty cash book  to record smaller purchases;  usually, these are for things like office   supplies.   Other    types   of   transactions are  recorded   in  what  are  known   as  day  books. There is a purchases  day book, where invoices received for purchases  the company  has made are recorded,  and  a sales day book,  which  is used to record invoices that the company  sends to customers  when  it  makes  a  sale.  Finally,  the  books  of prime entry also include a journal, which is used to record annotations and corrections to other entries.

The ledger takes its name from the type of book that was used to record financial information, long before  the  arrival  of  computers and  accounting software.  Much  like the books  of prime entry, the ledger  has  several  parts  to  it. The  general  ledger records information such as payables and receivables,  wages,  utilities,  sales,  assets  that  are not  current, and  purchases.  The  general  ledger  is sometimes called the nominal ledger, and it includes entries  for  cash  and  for  bank  accounts.  There  is also a receivables ledger, separate  from the general ledger. The receivables ledger includes information about  what  is owed  to  the  company  by  various customers. This  information also  appears   in  the general  ledger, but  in the receivables  ledger, there may be additional details recorded  about  the circumstances of the transaction: Perhaps a customer   purchased  an   item   but   received   the wrong   item  in  the  mail  and  had  to  return   it, generating a credit; this could be entered in the receivables ledger. Each of the company’s customers will have  its own  account  within  the  receivables ledger,  to  make  it  easier  to  locate  information about   that   customer’s   orders.   The   receivables ledger is also sometimes  called the sales ledger or the debtors’ ledger (this term was more common in the  past).  Finally,  there  is also  a payables  ledger, which is the complement  to the receivables ledger. The  payables  ledger  records  what  the  company owes   to   others,   and   each   payee   has   its  own account, as in the receivables ledger. The calculations in the receivables and payables ledgers should  tally with those in the general ledger.

Reporting  Transactions

Business accountants generate reports  for a variety of reasons, so the contents  of the reports  tend to be driven by the information needs of the business at the moment. Typical functions  of a financial report include determining if the business reinvested all of its profit for a given period, explaining  the sources of the business’s capital, comparing assets with liabilities, estimating whether the business has adequate capital  reserves  to  permit  it to  grow  in the future,  and  describing  whether  the business  is currently  generating  a profit or operating at a loss.

One  basic  report  is the  determination of total profits and losses within a given period of time, to show   how   well   or   how   poorly   the   business performed within that period. Many businesses prepare  these profit-and-loss statements on a quarterly   basis,   having   found   that   reviewing   such figures annually  often  does not  allow  a company to  identify  problems   quickly  enough  to  address them  before they spiral  out  of control. For example,  if  a  company’s   research   and   development division  was  spending  far  beyond  its  budget  to meet a deadline, the company would want to know about  this sooner rather  than  later so it could take corrective  action  to adjust  the deadline,  adjust  the budget, or postpone the project  altogether.

Another  type  of  reporting focuses  not  on  the inflow  and  outflow  of cash during  a fixed period but  on  the  overall  financial  position  of the  company until the present moment. This type of report is similar to a “state  of the union” address given by a governmental figure—it tells decision  makers  in the  company  how  things  stand,  so that  they  can determine  what  actions  to take  next.  Having  this type  of  information readily  available   is  crucial, especially in high-stakes  situations, such  as when the company  is deciding whether  or not  to merge with  another entity.  In that  case, both  companies will  want  to  know  what  they  are  getting  themselves  into,  and  the  best  way  to  tell  this  is  by reviewing   each   other’s   balance   sheets  (another term for a statement or report of financial position). The balance sheet lists liabilities, ownership equity, and  assets as of a fixed date  and  is often  called a “snapshot” of the company’s financial  health.

While reports such as those describing the company’s  financial  position  are essential,  there  is also a need for reports  that  focus on more specific issues. One  of these is the statement of changes  in equity.  Equity  is, put  simply, ownership interest  in an asset after the debts related to that asset are accounted for. In finance, equity is usually the sum of the funds that have been contributed by the owners and the earnings of the company. The statement of changes in equity, then, is a report  that  covers a fixed time period and explains how and why equity changed  during  that  period.  For  example,  a company that  paid out a large amount of money in the spring quarter to settle a lawsuit would show a corresponding  reduction  in  equity  for  that   period. Some of the information available  in the statement of changes  in equity  is not  available  elsewhere  in the   company’s   financial   records,   and   this   can include  changes  in  reserves  of  capital  shares,  net profits   and   losses  stemming   from   shareholder actions  during the reporting period, equity changes due to changes in accounting policies, and changes due to the correction of errors in previous reports.

Changes  in equity are often  related  to the cash flow of the business, so a separate report documents changes in cash flow. Like the report  on changes in equity,  the statement of cash flows covers a fixed period, and as its name suggests, its emphasis is on how much money came in during  the period,  how much went out, and how much there was at the beginning   of  the  period   (the  opening   balance). With  these three  pieces of information, the report can  calculate   the  amount  of  cash  on  hand   at the  end  of the  period.  This  is done  by adding  to the initial cash on hand the cash earned during the period  and  subtracting the  amount of cash  spent during  the period.  The result of this calculation is called the closing balance.

Given the amount of detail in these reports, it is not  uncommon for  additional explanation to  be necessary,  especially when  there  are discrepancies in the data or changes that have been implemented to the accounting processes  used. For this reason, another form of reporting used in business accounting  is the  presentation of  notes  to  the  financial statements. While  these  notes  may  or  may  not contain  actual  figures and calculations, their main purpose  is to  provide  additional details  that  the formats  of the other reports  cannot  accommodate. In some cases, the notes also provide an interpretation of certain aspects of the reports  that might not be immediately  apparent to those  unfamiliar with their purpose.

Security

The  security  of business  accounting processes  and the  computer systems  used  to  maintain them  has gained  a significant  amount of attention in recent years.  Companies must  be  wary  of  threats   from within  and  without. Threats  from  within  can take forms ranging  from simple fraud  to rogue employees manipulating the accounting system to conceal illegal or  unethical  activity,  as happened with  the Enron  scandal of the early 2000s, which resulted  in the  demise  of  the  world  famous  accounting firm Arthur  Andersen.  The  best  way  to  mitigate  these threats   is  to  distribute  responsibility for  various functions   across  different   people  or  departments and  to require  multiple  internal  reviews of records from each accounting department on a regular basis.

In recent years, external  threats  have taken  the form of online attacks directed against the company’s network. While the company’s accounting system is not  always  the  specific  target  of  such  attacks, it remains just as vulnerable  to them as other network resources.  The danger  of being hacked  is especially troubling because it is damaging  in two  ways: Not only may the attack  interrupt the normal  operation of the business by making  data  temporarily or even permanently unavailable, but the company may also be held liable if its customers’ financial information, such as credit card numbers or personal information, is compromised during  an  attack.  To  avoid  such liability, business accounting departments must consider  options  for increasing  the security of their computer networks, and many firms also choose to purchase  insurance  policies to reduce their potential liability in case of a successful attack.

Bibliography:

  1. Berman, Karen, Joe Knight, and John Case. Financial Intelligence for Entrepreneurs: What  You  Really Need to Know  About the Numbers. Boston: Harvard Business Press, 2008.
  2. Biondi, Yuri. “Should Business and Non-Business Accounting  Be Different? A Comparative Perspective Applied to the French Central  Government Accounting  ” International Journal of Public Administration, v.35/9 (2012).
  3. Clikeman, Paul M. Called to Account:  Fourteen Financial Frauds That  Shaped the American  Accounting Profession.  New York: Routledge, 2009.
  4. Farmer, Roger E. A. How the Economy Works: Confidence, Crashes and Self-Fulfilling Prophecies. Oxford: Oxford University Press, 2010.
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  7. Lindgreen, Adam. A Stakeholder Approach to Corporate Social Responsibility: Pressures, Conflicts, and Reconciliation. Burlington, VT: Gower,
  8. McGuckin, Frances. Business for Beginners: From Research and Business Plans to Money, Marketing and the Law. Naperville, IL: Sourcebooks, 2005.

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