Fundamentals Of Accounting
- The Problem with Cash Basis Accounting
- The Benefits of Cash Basis Accounting
- Ensuring Financial Report Standards through Outsourcing
- Myths About Accounting: The Question of Audits and Reasonable Assurance
- Making Hay by Making Pay(roll)
- The Big 3 Errors of Accounting: Commission, Omission and Principle
- How Cost Accounting Can Help a Business
- The Limitations of Cost Accounting
- Tax Havens vs. Doing Foreign Business Legally
- Qualifying Company Cars for the Alternative Fuel Motor Vehicle Credit
- What Is Accrual Basis Accounting?
- The Challenges Inherent in Accrual Basis Accounting
- Constant Change, and the Question of Cost
- Putting LIFO on Life Support
The Problem with Cash Basis Accounting
There are a good number of businesses that, through the methods they employ in their accounting procedures, are effectively placing their necks within a hair's breadth of the chopping block. And the worst part? Most of them know they're doing it, yet do little or nothing to lower their risk level. What we're talking about here are companies that use cash basis accounting as their primary method of tracking their day to day financial dealings.
This can develop into a serious problem. Cash basis accounting doesn't comply with GAAP principles. If you're surprised to learn that, you might want to continue reading. The fact is, even though there are companies to whom a cash accounting method makes practical sense, the significant gaps in time between recording profit and expense can cause havoc—especially when it comes to prolonged jobs. A company can appear to be earning great profit one year, resulting in far higher tax liabilities. In order to combat this, many companies spend those revenues elsewhere to reduce their tax liability, but inadvertently put themselves in the position of having short cash flow when the time comes to foot the bill to complete a job.
So why do so many businesses still operate using cash basis accounting? In a word, simplicity. Far more straightforward than the method of accrual basis accounting, where income is recorded when it's earned and expenses are recorded when they're incurred, a cash accounting method is just simpler. But simple doesn't always mean better.
The Benefits of Cash Basis Accounting
If it seems like extolling the virtues of cash basis accounting at the same time as discussing its equally profound problems is a bit schizophrenic, welcome to the wonderful world of accounting. Here, one company's liability can be another company's saving grace. And although cash basis accounting fails to meet basic GAAP principles, there are some companies that can benefit.
The problem is, those companies might be few and far between with respect to the commercial landscape. If your company falls into any of the categories below, cash basis accounting might be for you:
If your company doesn't fit the description above, a cash accounting method is something you should steer far and clear of.
The bottom line: accrual basis accounting gives a company the ability to take an accurate financial snapshot at any given time. With a cash accounting method, that picture is not as clear. Its outcome depends on at what point the snapshot is taken, once again proving that the path of least resistance is not always the best path to take.
Ensuring Financial Report Standards through Outsourcing
As a result of the financial scandals of 2001 (anyone remember Enron?), Congress passed legislation that severely impacted publicly held companies. It required them to implement stringent internal auditing controls. Although the Sarbanes-Oxley Act (SOX) only applies to publicly held companies, the ramifications of these financial meltdowns resulted in many private companies ramping up their own accounting standards. In short, most are figuring that it's not a bad idea to cover all bases.
Having an in-house accounting department or controller is essential for the accurate preparation of company financial reports. But any time the words "in house" and "accounting" appear in the same sentence people begin to get a little nervous. And rightly so. The fact is, not everyone is a criminal—but when there are too many hands in the proverbial pie, and all those hands just so happen to work for the same company, the fraud risk always exists.
For this reason, many businesses are opting to outsource their accounting to third party companies that balance books and compile financial statements at a reasonable cost. Not only does this eliminate the potential for fraudulent activity, but also saves the cost of hiring a dedicated controller and caring for all the intricacies that have to be considered with internal audits.
Myths About Accounting: The Question of Audits and Reasonable Assurance
One of the most common misconceptions that exists about auditors and company financial reports is that once audited, the financial statements are guaranteed to be accurate. In reality, there are no such guarantees. There are only "reasonable assurances" that vouch for, but stop short of officially certifying, the accuracy of the statements.
The fact is, it would be economically infeasible for a company—not to mention unrealistic time wise for any auditor—to review every single monetary transaction reported on a business's financial statements. As an alternative, an auditor "spot checks" particular transactions. These are frequently done at random, but are sometimes chosen due to inordinate characteristics like high dollar amounts and other transactions that appear to be out of the ordinary.
For this reason, once company financial reports have been audited, a company is required to sign a letter stating that they accept full responsibility for the accounting standards contained within the report.
In the end, all an auditor's letter can offer is added credibility to the information contained in the company's financial statements. However, when an auditor provides their "unqualified opinion" it doesn't mean that they've vetted the company's internal controls. They're basically stating that, to the best of their knowledge, the financial statements don't appear to be wrong.
Making Hay by Making Pay(roll)
SMBs without adequate business accounting support (and sometimes even those operating under the assumption that their accounting is up to snuff) are constantly in the precarious situation of fumbling when it comes to payroll. Needless to say, a company's ability to process payroll in an accurate and timely manner is of immeasurable importance. Without that, the reputation of the company can seriously degrade from within. Here's an important tip to help ensure you're keeping your employees happily paid, while continuing to maintain established GAAP accounting practices.
Establish Lag Time
A Caveat: Check Your State
The Big 3 Errors of Accounting: Commission, Omission and Principle
In the hierarchy of common business accounting errors, there are three distinct designations. Although often times it's impossible to expect absolute perfection, adherence to GAAP accounting principles requires steadfast vigilance in the pursuit of that all-elusive "numerical perfection" goal.
Errors of Commission
Errors of Omission
Errors of Principle
How Cost Accounting Can Help a Business
Cost accounting is the method by which all actual operating costs of a business are gathered and reviewed to determine profitability. In other words, it helps shed light on what's making money and what's not. Standard cost accounting takes a far simpler view of a company's performance and boils it down to dollars spent versus dollars earned. Job costing also comes in handy in day to day business operations, such as:
The Limitations of Cost Accounting
In the day-to-day operation of a business, standard cost accounting is viewed as a practical method of gauging financial performance. It offers a solid, mathematical method of being able to take a snapshot of where a company is financially so that decisions can be made to increase efficiency and cut cost. Cost accounting is seen as a foolproof method—but that doesn't mean it's free from limitations and drawbacks.
Limitation #1: Timeliness = Accuracy
Limitation #2: Final Numbers Can Be Deceiving
Tax Havens vs. Doing Foreign Business Legally
Corporations who either purposefully or unknowingly participate in shenanigans aimed at tax avoidance can find themselves in serious hot water with the Internal Revenue Service. And that's stating it mildly. Although tax accountants and tax accounting firms are not responsible for policing these situations, they are given the resources that allow them to spot some of the most common tax avoidance schemes.
Creating Offshore Tax Havens
This isn't to say that every company that has operations outside of the U.S. is involved in some sort of tax evasion plot. There are plenty of perfectly legitimate legal circumstances, such as establishing a company in a foreign country in order to be able to do business there legally. A certified tax accountant experienced in SMBs will be versed enough to provide knowledgeable counsel on these types of issues.
Qualifying Company Cars for the Alternative Fuel Motor Vehicle Credit
Experienced tax accountants skilled in the preparation of corporate tax returns are aware that businesses in the practice of providing company cars to certain employees can take advantage of the Alternative Fuel Motor Vehicle Credit. These credits were enacted in 2005 as a part of the Energy Policy Act, and have the potential of bringing considerable tax savings and valuable write-offs to many SMBs. There are four specific categories of vehicles that fall under this umbrella.
Tax credit amounts vary depending on the type of vehicle, and the number of vehicles eligible for the credits may be limited. Any certified tax accountant or tax accounting firm can offer their corporate clients detailed information on the specific requirements needed to qualify for these tax incentives.
What Is Accrual Basis Accounting?
In the business world, there are two methods of accounting that, both in practice and theory, separate the sole proprietorships from the SMBs of the world. The two specific methods are:
Accrual basis accounting is the only of the above listed techniques for reporting business financial activity that adheres to GAAP accounting standards. GAAP standards are set in place to prevent companies from taking part in "creative" and deceiving practices that paint unrealistic pictures of how a company is performing. These conventions are set in place to protect the interests of both lenders and financial investors.
Although generally accepted accounting principles are in place throughout a majority of large industrial nations, the fact remains that each of these countries have sometimes substantial differences in standards that are "generally accepted."
The Challenges Inherent in Accrual Basis Accounting
Accrual basis accounting is required for all medium to large sized businesses that want to ensure compliance with GAAP accounting standards. But that doesn't mean doing so is a simple task, or that it doesn't have its drawbacks and challenges.
Time and Effort
Cash Flow Inaccuracies
Constant Change, and the Question of Cost
Constant change has come to be an accepted fact of life when it comes to compliance with accounting standards -- begrudgingly by some, casually accepting by others. Yet both share one main concern: cost. Put simply, companies are becoming increasingly concerned with the ability of their CPAs to adapt in the face of ever changing requirements. Many have found themselves facing tough decisions about how best to handle the ever evolving landscape of business accounting.
A Silver Lining
There's Always Time
Putting LIFO on Life Support
Once conversion to the international accounting standards set forth by IFRS is complete, U.S. companies will face major changes in inventory accounting procedures. The fact that the last in, first out (LIFO) method is not an allowed practice in IFRS—only the FIFO method is allowable—will have a serious impact on businesses that rely on it as a method of lowering their income tax liability.
The Potential Repercussions
Tips for a World After LIFO