A business has to prepare and show its financial results. The size of your business and its financial success will determine where you have to file your accounts and what certain formats to have to comply with. If your business is a limited company, plc or LLP then you will need to file accounts with Companies House. Only companies with a certain turnover figure or above need to have their accounts audited. The turnover figure is not the same as the profit figure. However, if you are a sole trader or partnership, you do not have to submit accounts to Companies House (the agency who monitor and register businesses under the current Government regulations). H M Revenue & Customs do require that partnerships and sole traders do report and follow their legislation and therefore have to report their profit or loss to them, the same as limited companies, plc’s and LLP’s have to. To be in a position to report to the Revenue and complete their required returns, you will need to have basic accounts prepared which will include a profit and loss account. This can then be sent with your tax return to support any entries on your tax return. Profit and loss accounts are also used by banks and financial companies if you are applying for any form of credit and they normally would like to see your last three years accounts and/or tax returns. What does a profit and loss account show?
The profit and loss account brings together your business’ financial transactions and summarises them into useful categories which can be reviewed. They also summarise these to show if a profit or loss has been made. They will cover a given time period, your accounting period, which is usually a year but can at times be longer or shorter, for example when you are just starting or ceasing a business. You can create your own profit and loss account. To start with you will want to simply split it into two halves with the top half being your income and the bottom half showing your expenditure.
The income figures are then further analysed by showing your turnover figure and other income. Turnover or business sales is the total amount of your product sales or services in your financial year or period. How you record this information will vary depending on the type and size of your business but you could use a simple listing in a book, or a computer spreadsheet or a computer software program.
As well as the business’ main income, it may also receive income from any property which it owns, sale of any assets including equipment, any additional cash or bank loans and bank interest and this is all classed as other income.
Business expenses which are spent in connection with the production or creation of your product of service you sell are called cost of sales. Business expenses are the costs incurred enabling you to carry out your business such as rent, travel and motor expenses, administration and stationery, interest and advertising. Any expenses relating to any equipment your business has or uses is classified under cost of equipment. This can include vehicles and any equipment which is leased or bought on hire purchase. Only expenditure relating to the business should be included in your profit and loss account and any personal expenditure should be taken out from the figures in your accounts.
When choosing your accounting period being a self employed or a partnership it is easier if you produce your accounts on a yearly basis with the year ending either on 31 March or 5 April. This will mean your accounts will fall in line with the information and figures needed for your tax return and will make the process of completing your tax return easier. If your year end is out of sync with these dates, you can produce a set of accounts for a specific date period and then start again with yearly accounts. By choosing a new date for your accounts to run too which might be more beneficial, then you can produce a set of accounts to that month end date from your year end and produce a period set of accounts instead of yearly accounts. These accounts will cover a set number of months. You will now have a new year end date and will produce yearly accounts from this date forward.
You must ensure that you keep all receipts and records supporting your income and expenditure. This needs to be retained for a minimum of six years.
You should now be in a position to understand any profit and loss accounts that you review and understand the figures contained within them. Many bookkeepers, financial and administrative assistants understanding profit and loss accounts are women bringing a range of experience and glamour to a business.
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Is there such thing as accounting police?
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This interesting article addresses some of the key issues regarding accounting. A careful reading of this material could make a big difference in how you think about accounting.
You can see that there’s practical value in learning more about accounting. Can you think of ways to apply what’s been covered so far?
Who created accounting principles? Who sets and revises accounting standards? What if you don’t follow all the rules, do you go to jail? Is there an accounting police force that investigates and arrests violators? It would seem that there must be some regulatory force to make sure that providers of financial statements conform to the rules. There is, up to a point, and here is how it works:
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Mainly, it’s all voluntary and it works pretty well. First, double-entry accounting originated in Italy in the 1400’s, so its been around awhile. Accounting principles have evolved over the years just as have accounting standards. The reason why the system works is that the business community could not function if there was not commonality and consistency in financial statement reporting. It would be chaos, much like if there were no driving rules of the road.
Therefore, in the United States, a body of experts known as the Financial Accounting Standards Board (FASB pronounced Fasbee) was established in 1973, which superseded another board called the Accounting Principles Board (APB). The FASB members go through a lengthy process of analyzing and reviewing problems in the accounting field that are brought to them. After much thought, they will make a pronouncement as to what they think the new or revised way of approaching the treatment of an accounting issue should be.
They are a non-governmental organization that has private financing. A big supporter of FASB is the American Institute of Certified Public Accountants (AICPA). Many Certified Public Accountants (CPAs) belong to this prestigious organization and are obligated to abide by its guidelines and principles of behavior. Other countries no doubt have similar organizations that require high levels of accounting professional conduct.
FASB established an accounting code called “Generally Accepted Accounting Principles” or (GAAP). The assumption is that if a business financial statement is prepared according to GAAP, then the user of that financial statement could rely on or trust the information more readily than if not prepared according to GAAP. Those businesses that deviate from GAAP, and many smaller businesses do, cannot say that their statements are prepared under GAAP; in fact, they should inform the reader that they are not. However, let the buyer beware.
One governmental body that has a policing function is the Securities Exchange Commission (SEC). It is primarily concerned with public companies because their job is to protect investors from unscrupulous acts. Recently, the SEC has gotten into the act of establishing accounting standards. It has its hands full today.
Since most businesses use their financial statements to prepare their required income tax returns, the Internal Revenue Service (IRS) may audit those tax returns and review the financial statements upon which the tax returns are based. Not following the rules can get you in trouble with this governmental body.
You can see that in many ways compliance to the principles and standards is a mixture of voluntary and regulatory behavior. Currently, there is an effort underway to set international accounting standards due to the inexorable globalization process. This is a massive undertaking that will take years, but it is obviously necessary and inevitable.
Hopefully the sections above have contributed to your understanding of accounting. Share your new understanding about accounting with others. They’ll thank you for it.
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