Sunday, May 8, 2011

Phil Mickelson & KPMG

Golfers today display as many advertisements as race cars. Tiger Woods wears a Nike Swoosh, and other players were sporting good related images.

Phil Mickelson prominently displayed KPMG on his hat at the Masters. KPMG LLC is a major accounting firm, one of the so-called Big 4 firms.

They are:

Deloitte & Touche
Price Waterhouse Cooper
Ernst & Young

There are thousands of other firms, but these are generally considered to the largest and most prominent. There was originally a Big 8, but with consolidation and the implosion of Arthur Andersen in the Enron scandal, the number has been reduced to four.

One thing I don’t understand is the value for KPMG to advertise on Phil’s hat. How many people watching have the ability to engage KPMG? Everyone can buy a pair of shoes or a golf, a Srixon golf ball (advertised on Jim Furyk’s hat.) But an accounting firm? It’s their money, but it seems a waste

The Difference Between Cash and Accrual Accounting

One of the main goals of accounting is to be able to fairly measure the value of a business at any given point in time. Bookkeepers can use a check book to keep track of all the bills they pay and any deposits they receive.

Accountants, on the other hand, need to know more than just what checks have been written. They have to know what the company is responsible for paying, even if they haven’t cut the checks yet. So, a system was developed for tracking everything, even stuff that hasn’t been paid for. This system is called accrual accounting

Cash Based Accounting

A cash system is what most individuals use. Deposits are recorded in the checkbook when the money is received. Checks are recorded when they are written.

If things are properly recorded, a person can look at the checkbook at any time and know how much cash they have. This is usually good enough for most people, but not for large businesses.

Accrual Accounting Systems

Accrual accounting looks at more than just the cash position, and attempts to determine where the business would be if everything that was owed had been paid as of a particular date. Most businesses of any size use accrual accounting.

The technical terminology is that revenues and expenses should be recorded in the period that they are incurred (not necessarily when they are paid.)

Example of Accrual Accounting

Let’s use the example of buying furniture:

In a cash accounting system, if you buy a couch and have it delivered in January, but the bill is due in February, you record the amount in your checkbook in February.

In an accrual system, the accountant would record the expense for the couch in January, even if they paid the bill in February. Why? Because it doesn’t matter when the bill is paid. The company knows they owe the money in January. So that’s when they book it.

Individuals can get away with using cash basis because they usually keep track of how much they have spent each month fairly easily. Businesses need to have a good handle how much they owe for things that haven’t been paid yet. Accountants work each month to make sure they record all the revenue and expense each month on an accrual basis.

Month End Close

Much of the attention in the accounting profession is focused on public accounting, which is responsible for auditing financial statements and producing audit reports.

However, I suspect that most of the accountants are engaged in financial or management accounting, who prepare the monthly financial statements presented management long before they audited by outsiders.

These accountants design the spreadsheets and book the journal entries so management can see what the profitability of the company is, and so that the auditors have something to audit.

Month End Again?

Most companies issue financial statements monthly, so that these accountants have a routine. The last few days of the month involve getting ready for close, and then the next five to ten days are a furious race to close the books accurately.

The next few weeks are spent working on other projects or preparing reconciliations, and then the process begins all over again.

I knew one accountant that counted the number of month ends to retirement. So, if you desire an unpredictable job, with varied responsibilities, never knowing what is going to face you each day, don’t go into accounting.

What is Accounting?

Webster’s Dictionary defines Accounting as

> the system of recording and summarizing business and financial transactions and analyzing, verifying, and reporting the results;

The goal of this website is to take complicated statements like the above and convert to easy, understandable language.

Therefore, Easy Basic Accounting’s definition of accounting is:

A way to know how much money a company makes, and
how much it can spend before it runs out of money.

A good accounting system does both of these things.

What is Bookkeeping?

Again, to Webster:

>a person who records the accounts or transactions of a business

That’s pretty simple already, isn’t it? A person that keeps the books. Remember, to spell bookkeeping, use two ‘k’s.

The Difference Between Bookkeeping and Accounting

The simple answer, based on the above definitions, is that the Accountant designs the system, and the bookkeeper enters the transactions, and then the Accountant verifies and produces the reports, or statements based on what the bookkeeper has entered.

It can get a lot more complicated, but the goal here at EBA is to keep things understandable.

Thursday, May 5, 2011

Financial Statements

Accountants keep track of the transactions for a business and load each of the transactions in a ledger. At the end of a time period, usually at the end of each month, the accountant or bookkeeper pulls the data out of the ledger and prepares financial statements.

There are three main financial statements that are required for public companies.

1. Income Statement
2. Balance Sheet
3. Statement of Changes in Cash

Each of these statements deserves their own page, and multiple pages, but this chapter will describe them briefly and highlight key differences.

Income Statement

The income statement shows the revenues the company generates and expenses it incurs, and then compares the two to show how much money the company made or lost. The income statement covers a time period, usually a month, quarter (three month period) or year.

Balance Sheet

The balance sheet shows the financial position of a company at a point in time. It does not cover a month, but instead shows the company’s assets and liabilities at a specific date, usually the end of a month, quarter or year.

Statement of Changes in Cash

This statement, like the income statement, covers the company activities over a time period. Unlike the income statement, this statement covers all transactions that impact the company’s cash position.

Investments in fixed assets, also known as capital expenditures, are shown here, since they are uses of cash, but they are not shown on the income statement until they are depreciated.

Using Financial Statements

These statements are all related, and when viewed together, provide important facts about a company to management and outside investors.

What is a General Ledger?

Accountants need to keep track of every transaction a business might make. In order to accomplish this, the accountant will develop a ledger.

The ledger consists of accounts. Each account represents something that a business needs to keep track of. Types of accounts include cash, debts, expenses or revenues. A good accounting system will contain accounts for every type of transaction a business needs.

An Example of a Simple General Ledger:

Accounts Receivable
Accounts Payable
Long term debt
Owners Capital
Salary expense
Rent expense

A larger business may have hundreds of different accounts if they are needed to keep track of a business.

The ledger will be used to record each transaction. If money comes into the business, cash increases. If money goes out, cash decreases. Cash can also be broken out into different pieces, and these accounts are added to the general ledger.

Cash- Checking account
Cash – Savings account
Cash – money market account

There can also be the same accounts with different banks.

Using Subsidiary Ledgers

As you can see, ledgers could become very cluttered for larger businesses, with many different accounts, particularly in different locations. Therefore, many companies use subsidiary ledgers.

These are similar in concept but focused on one topic. All the cash accounts above could be kept in one subsidiary ledger, and the total of the subsidiary cash accounts would equal one cash account on the general ledger.
The concept of subsidiary ledgers was very important when ledgers were kept by hand on paper. With computer systems, adding accounts to the general ledger is not as difficult, and space restricted. Still, subsidiary ledgers make it easier to balance the general ledger when financial statements are being produced.

A word of warning: always make sure the subsidiary ledgers balance to their corresponding accounts on the general ledger.

Once all the transactions are entered into the ledger, the accountant can use the information to create financial statements.