Accounting is the systematic process of recording, storing and presenting company financial data. Accountants maintain complex records of all financial transactions, including things like sales revenue and expenses in addition to costs such as payrolls and taxes. The accounting cycle begins with transaction receipts and other original financial documents. Accountants make entries for all financial events in individual accounts, most often using a software accounting program. Using the information stored in company accounts, accountants routinely construct financial statements, such as balance sheets and income statements, to provide internal and external stakeholders with insightful glimpses into a company's financial situation.
Accounting and auditing are both essential business functions which, while distinctly different concepts, can interrelate at times. Small business owners must set up an accounting system before they open their doors to manage and record financial data, but auditing is generally reserved for larger or more established businesses. Understanding the definitions of accounting and auditing, as well as the correlation between the two, is vital to understanding business finance.
Accounting is the systematic process of recording, storing and presenting company financial data. Accountants maintain complex records of all financial transactions, including things like sales revenue and expenses in addition to costs such as payrolls and taxes. The accounting cycle begins with transaction receipts and other original financial documents. Accountants make entries for all financial events in individual accounts, most often using a software accounting program. Using the information stored in company accounts, accountants routinely construct financial statements, such as balance sheets and income statements, to provide internal and external stakeholders with insightful glimpses into a company's financial situation.
Auditing is the process of reviewing and investigating any aspect of a business, whether financial or nonfinancial. Auditors are fully trained to spot areas of needed improvement, potential dangers and incidents of unethical conduct in their area of expertise. Audits can disrupt the normal flow of business in a company, but the ability to spot and address potential weaknesses can outweigh any temporary losses of productivity. Among the range of issues audits can review are human resources policies, operational procedures, quality or safety policies and, of course, accounting audits.
Accounting audits bring these two distinct concepts together and can convey significant benefits to small and large businesses alike. An accounting audit by definition is a systematic review and investigation of the policies, procedures and systems put in place to record, store and present financial data within a company. Accounting audits cover the full range of the accounting cycle, looking for inconsistencies, inefficiencies, errors and incidents of unethical conduct at all steps in the process. Audits begin by analyzing the systems put in place to ensure that the accounting department receives all transaction documents in a timely manner. Audits review the accounting system in depth to ensure that all necessary accounts are present and maintained accurately. Accounting audits also review financial statements and the processes used to prepare financial statements.
Businesses can depend on themselves or seek outside guidance when performing either the accounting or auditing function. Small businesses can often benefit from relying on a third-party accounting firm to set up their accounts and handle their accounting needs. Even large businesses can benefit from hiring an outside auditing firm, and publicly traded corporations are actually required by law to obtain third-party audits on a regular basis. While accounting activities are always initiated from within, companies can be subjected to external audits from government agencies at any time. Government accounting audits are normal for corporate businesses, but a government audit for a private business can be a sign of impending legal trouble
A BALANCE SHEET IS A FINANCIAL STATEMENT THAT SUMMARIZES A COMPANY'S ASSETS, LIABILITIES AND SHAREHOLDERS' EQUITY AT A SPECIFIC POINT IN TIME. THESE THREE BALANCE SHEET SEGMENTS GIVE INVESTORS AN IDEA AS TO WHAT THE COMPANY OWNS AND OWES, AS WELL AS THE AMOUNT INVESTED BY SHAREHOLDERS. THE BALANCE SHEET ADHERES TO THE FOLLOWING FORMULA: ASSETS = LIABILITIES + SHAREHOLDERS' EQUITY
THE BALANCE SHEETS GETS ITS NAME FROM THE FACT THAT THE TWO SIDES OF THE EQUATION ABOVE – ASSETS ON THE ONE SIDE AND LIABILITIES PLUS SHAREHOLDERS' EQUITY ON THE OTHER – MUST BALANCE OUT. THIS IS INTUITIVE: A COMPANY HAS TO PAY FOR ALL THE THINGS IT OWNS (ASSETS) BY EITHER BORROWING MONEY (TAKING ON LIABILITIES) OR TAKING IT FROM INVESTORS (ISSUING SHAREHOLDERS' EQUITY). \
FOR EXAMPLE, IF A COMPANY TAKES OUT A FIVE-YEAR, $4,000 LOAN FROM A BANK, ITS ASSETS – SPECIFICALLY THE CASH ACCOUNT – WILL INCREASE BY $4,000; ITS LIABILITIES – SPECIFICALLY THE LONG-TERM DEBT ACCOUNT – WILL ALSO INCREASE BY $4,000, BALANCING THE TWO SIDES OF THE EQUATION. IF THE COMPANY TAKES $8,000 FROM INVESTORS, ITS ASSETS WILL INCREASE BY THAT AMOUNT, AS WILL ITS SHAREHOLDERS' EQUITY. ALL REVENUES THE COMPANY GENERATES IN EXCESS OF ITS LIABILITIES WILL GO INTO THE SHAREHOLDERS' EQUITY ACCOUNT, REPRESENTING THE NET ASSETS HELD BY THE OWNERS. THESE REVENUES WILL BE BALANCED ON THE ASSETS SIDE, APPEARING AS CASH, INVESTMENTS, INVENTORY, OR SOME OTHER ASSET.
ASSETS, LIABILITIES AND SHAREHOLDERS' EQUITY ARE EACH COMPRISED OF SEVERAL SMALLER ACCOUNTS THAT BREAK DOWN THE SPECIFICS OF A COMPANY'S FINANCES. THESE ACCOUNTS VARY WIDELY BY INDUSTRY, AND THE SAME TERMS CAN HAVE DIFFERENT IMPLICATIONS DEPENDING ON THE NATURE OF THE BUSINESS. BROADLY, HOWEVER, THERE ARE A FEW COMMON COMPONENTS INVESTORS ARE LIKELY TO COME ACROSS.
WITHIN THE ASSETS SEGMENT, ACCOUNTS ARE LISTED FROM TOP TO BOTTOM IN ORDER OF THEIR LIQUIDITY, THAT IS, THE EASE WITH WHICH THEY CAN BE CONVERTED INTO CASH. THEY ARE DIVIDED INTO CURRENT ASSETS, THOSE WHICH CAN BE CONVERTED TO CASH IN ONE YEAR OR LESS; AND NON-CURRENT OR LONG-TERM ASSETS, WHICH CANNOT.
HERE IS THE GENERAL ORDER OF ACCOUNTS WITHIN CURRENT ASSETS:
CASH AND CASH EQUIVALENTS: THE MOST LIQUID ASSETS, THESE CAN INCLUDE TREASURY BILLS AND SHORT-TERM CERTIFICATES OF DEPOSIT, AS WELL AS HARD CURRENCY
MARKETABLE SECURITIES: EQUITY AND DEBT SECURITIES FOR WHICH THERE IS A LIQUID MARKET
ACCOUNTS RECEIVABLE: MONEY WHICH CUSTOMERS OWE THE COMPANY, PERHAPS INCLUDING AN ALLOWANCE FOR DOUBTFUL ACCOUNTS (AN EXAMPLE OF A CONTRA ACCOUNT), SINCE A CERTAIN PROPORTION OF CUSTOMERS CAN BE EXPECTED NOT TO PAY
INVENTORY: GOODS AVAILABLE FOR SALE, VALUED AT THE LOWER OF THE COST OR MARKET PRICE
PREPAID EXPENSES: REPRESENTING VALUE THAT HAS ALREADY BEEN PAID FOR, SUCH AS INSURANCE, ADVERTISING CONTRACTS OR RENT
LONG-TERM ASSETS INCLUDE THE FOLLOWING:
LONG-TERM INVESTMENTS: SECURITIES THAT WILL NOT OR CANNOT BE LIQUIDATED IN THE NEXT YEAR
FIXED ASSETS: THESE INCLUDE LAND, MACHINERY, EQUIPMENT, BUILDINGS AND OTHER DURABLE, GENERALLY CAPITAL-INTENSIVE ASSETS
INTANGIBLE ASSETS: THESE INCLUDE NON-PHYSICAL, BUT STILL VALUABLE, ASSETS SUCH AS INTELLECTUAL PROPERTY AND GOODWILL; IN GENERAL, INTANGIBLE ASSETS ARE ONLY LISTED ON THE BALANCE SHEET IF THEY ARE ACQUIRED, RATHER THAN DEVELOPED IN-HOUSE; THEIR VALUE MAY THEREFORE BE WILDLY UNDERSTATED—BY NOT INCLUDING A GLOBALLY RECOGNIZED LOGO, FOR EXAMPLE—OR JUST AS WILDLY OVERSTATED
LIABILITIES ARE THE MONEY THAT A COMPANY OWES TO OUTSIDE PARTIES, FROM BILLS IT HAS TO PAY TO SUPPLIERS TO INTEREST ON BONDS IT HAS ISSUED TO CREDITORS TO RENT, UTILITIES AND SALARIES. CURRENT LIABILITIES ARE THOSE THAT ARE DUE WITHIN ONE YEAR AND ARE LISTED IN ORDER OF THEIR DUE DATE. LONG-TERM LIABILITIES ARE DUE AT ANY POINT AFTER ONE YEAR.
CURRENT LIABILITIES ACCOUNTS MIGHT INCLUDE:
CURRENT PORTION OF LONG-TERM DEBT
BANK INDEBTEDNESS
INTEREST PAYABLE
RENT, TAX, UTILITIES
WAGES PAYABLE
CUSTOMER PREPAYMENTS
DIVIDENDS PAYABLE AND OTHERS
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