William A Paton, Professor of Accounting at the University of Michigan, states that accounting has one basic function, namely facilitating the administration of economic activity, which can be divided into two closely related phases:
1) measuring and arraying economic data; and
2) communicating the results of this process to interested parties.
For instance, a company’s accountants periodically measure the profit and loss for a month, a quarter or a fiscal year and publish these results in a statement of profit and loss which is also known as an income statement. These statements include two big types of elements: accounts receivable (what’s owed to the company) and accounts payable (what the company owes). At the higher levels of accounting and in the organization, it can also contain other sophisticated things like retained earnings and accelerated depreciation.
To a great extent, accounting also relates to basic bookkeeping, which is defined as the process that records every transaction; every bill paid, every dime owed, every dollar and cent spent and accumulated.
But usually, the owners of the company, which can be individual owners or millions of shareholders, are most concerned with the totals of these transactions, contained in the financial statement. The aim of the financial statement is to summarize a company’s assets. A value of an asset equals the amount of money paid for it when it was first acquired. The financial statement also includes the sources of the assets. Assets may be of different form, for example, loans that have to be paid back. Another type of business asset is profits.
Bookkeeping may be performed in the way called double-entry bookkeeping, where the liabilities are also summarized. It is done by companies to show higher amounts of assets in order to offset the liabilities and show a profit. Accounting itself represents the management of these two elements.
Of course, nowadays there is a definite system for accounting. It is not the case that every company or individual use their own accounting systems but keep to some approved one; otherwise this could lead us to chaos!
Its obvious that financial statement has a lot of numbers in them. To compute ratios is one way to interpret a financial report, which means, divide a particular number in the financial report by another. Financial statement ratios are also useful because they enable the reader to compare a business’s current performance with its past performance. In other words, using ratios can cancel out difference in company sizes.
There aren’t many ratios in financial reports. Publicly owned businesses are required to report just one ratio (earnings per share, or EPS) and privately-owned businesses generally don’t report any ratios. Generally accepted accounting principles (GAAP) don’t require that any ratios be reported, except EPS for publicly owned companies.
Ratios don’t provide definitive answers. They’re useful indicators, but aren’t the only factor in gauging the profitability and effectiveness of a company.
One ratio that’s a useful indicator of a company’s profitability is the gross margin ratio. This is the gross margin divided by the sales revenue. Businesses do not disclose margin information in their external financial reports.
In analyzing the bottom-line of a company the profit ratio is very important. A profit ratio of 5 to 10 percent is common in most industries.
Auditors and accountants help to ensure that the Nation’s firms are run efficiently, and its taxes paid on time and properly. They perform these vital functions by offering an increasingly wide array of business and accounting services, government accounting and management, as well as internal auditing, to their clients. Accountants and auditors are broadening the services they offer to include budget analysis, investment planning and financial and information technology consulting.
Specific job duties vary among the four major fields of accounting: public, management, and government accounting and internal auditing.
Internal auditors verify the accuracy of their organization’s internal records and check for mismanagement, waste, or fraud. Internal auditing is an increasingly important area of accounting and auditing. Internal auditors examine and evaluate their firms’ financial and information systems, management procedures, and internal controls to ensure that records are accurate and controls are adequate to protect against fraud and waste.
They also review company operations, evaluating their efficiency, effectiveness, and compliance with corporate policies and procedures, laws, and government regulations. There are lots types of highly specialized auditors, such as electronic data-processing, environmental, legal, bank, and health care auditors.
As computer systems make information timelier, internal auditors help managers to base their decisions on actual data, rather than personal observation. Internal auditors also may recommend controls for their organization’s computer system, to ensure the reliability of the system and the integrity of the data.
Government auditors and accountants work in the public sector, maintaining and examining the records of government agencies and auditing private businesses and individuals whose activities are subject to government regulations or taxation. Accountants employed by Federal, State, and local governments guarantee. Those employed by the Federal Government may work as Internal Revenue Service agents or in financial management or budget administration and analysis.
It could be perfect if business and life were as simple as producing goods, recording the profits and selling them. Anyway there are often circumstances that disrupt the cycle, and it’s part of the accountants job. Changes in the business climate or cost of goods can lead to exceptional or extraordinary gains and losses in a business.
Some things that can alter the income statement can include downsizing or restructuring the business. This used to be a rare thing in the business environment, but is now fairly commonplace. It’s done to offset losses in other areas and to decrease the cost of employees’ salaries and benefits. Anyway, there are costs involved with this as well, such as severance pay, outplacement services, and retirement costs.
In other circumstances, a business might decide to discontinue certain product lines. Western Union recently delivered its very last telegram. The nature of communication has changed with email, cell phones and other forms that telegrams have been rendered obsolete. It’s time to change your product mix when you no longer sell enough of a product at a high enough profit to make the costs of manufacturing it worthwhile.
Lawsuits and other legal actions can cause extraordinary losses or gains as well. If you win damages in a lawsuit against others, then you’ve incurred an extraordinary gain. If your own legal fees and damages or fines are excessive, then these can significantly impact the income statement.
Business would need to correct any errors or change accounting methods that had been made in previous financial reports. Accepted Accounting Procedures (GAAP) requires that businesses make any one-time losses or gains very visible in their income statement.
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