Tag Archives | financial statements

Accounting Cycle

See Also:
Account Reconciliation
Account Reconcilement Definition
Accrual Based Accounting
Financial Accounting Standards Board (FASB)
Generally Accepted Accounting Principles (GAAP)
Thirteen Week Cash Flow Report

Accounting Cycle Definition

The accounting cycle, defined as the process taken by prudent accountants which leads to sensible accounting records, is part of the general best practices of accountancy. During the accounting cycle, controllers assure the quality of work with 3 main phases: analysis, record keeping, and adjustment.

Accounting Cycle Meaning

The term accounting cycle means the procedure accountants follow which eventually leads to representative financial statements for a company. Over time, an accounting cycle sequence has emerged from the successes and failures of the accountants who walked before. These, eventually, were assembled and accepted as a formal system to assure that records are kept relevant.


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Accounting Cycle Process

The accounting cycle process created is now widely accepted as a set of best practices. The value of these is that they account for quantitative as well as qualitative analysis, provides a framework of records as a foundation for statements, and allow for changes to occur which are then included in the statements. Find the accounting cycle process below:

1. Identify the Transaction

This part of the qualitative analysis assures that a transaction is important to the accountant and her work. Invoices and other documents allow this to occur.

2. Analyze the Transaction

When analyzing the transaction, the accountant relies on their expertise to decide what accounts and statements are effected by the transaction and in what way.

3. Record the Transaction as a Journal Entry

In this stage, the transaction is placed where it belongs in the transaction journal.

4. Post the Transaction to the Ledger

Here, the above journal entries are then included in T-accounts where they belong in the ledger.

5. Create a Trial balance

This stage assures that all existing credits and debits balance in their respective accounts.

6. Adjust Entries

Include accrued and deferred entries. Include these entries in the period which they effect. These entries are included, here, in the journal and T-accounts

7. Calculate the Adjusted Trial Balance

Create a new trial balance, after you adjust the entries for accrued and deferred entries.

8. Create Financial Statements

Here, financial statements are created from the adjusted trial balance.

9. Closing Entries

In this stage of the accounting cycle, temporary accounts are finally included in the Owner’s Equity section of financial statements. Call these the closing entries.

At this stage, the accountant can pass off the final accounting statements to their supervisors. Sometimes, a new trial balance is created here before sharing financials with company controllers. As with other stages of the process, the accountant will use their best judgement to decide what the next course of action will be.

Accounting Cycle and Operating Cycle

The accounting cycle and operating cycle are very closely related. These ties become more obvious when working in either department. With cash cycles, capital investments, permanent or seasonal hiring, and other needs that the operations department has the accounting department must be well informed in order to meet the needs of an ever-changing business. In many minds, the ties between the accounting and operations department may even be stronger than others. Most businesses will want to ensure regular communications between all departments, but most of all these.

Accounting Cycle Example

For example, John is the head accountant for a merchandising company. In truth, his side of retail may be the most important because nothing happens with a business until he makes a sale. John is an expert when it comes to the accounting cycle for a merchandising company. He has earned this through the constant struggles that he faces in his daily work.

John has to face one such struggle today. A deferred entry, in the form of an account payable with terms will effect the current period, has come up. He prepare financials, at his level of expertise. But the company has not informed John of this expense yet.

Luckily, John is at the adjust entries phase of his work. This is the perfect place to receive this information. Now, John can adjust entries to include the new expense. This will include additional information which was not otherwise in the statements. John loves to place as much useful information as possible in his statements. He is happy to do the extra work.

Conclusion

In conclusion, John receives a hail of praise when he finally presents the statements to the board of directors. For his continued attention to detail while still monitoring the big picture, he receives a large raise. His company wants to make sure they retain his expertise. John is happy for his success and thanks the accountants who first conceived of the accounting cycle transactions.

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New Financial Reporting Framework for Small Businesses

The AICPA just released a new financial reporting framework for small businesses. It aims to save small business owners both time and money. According to aicpa.org, the FRF for SMEs (Financial Reporting Framework for Small to Medium Sized Entities) is “a new accounting option for preparing streamlined, relevant financial statements for privately held owner-managed businesses that are not required to use GAAP.  The FRF for SMEs framework draws upon a blend of traditional methods of accounting with some accrual income tax methods.”

Financial Reporting Framework for Small Businesses

Examples of how the new framework reduces the complexity and cost of financial reporting for small businesses include the following:

  • The use of historical cost rather than the onerous fair value measurement basis
  • No requirement for complicated accounting for derivatives, hedging or stock compensation
  • Targeted disclosure requirements, providing users of financial statements with the relevant information they need while recognizing that those users can obtain additional information from management if they desire

Definition of SME

So what is the definition of a SME? A standard definition doesn’t exist in the United States. According to the AICPA, “the term is intuitive, widely recognized, and effectively descriptive of the scope of entities for which the FRF for SMEs accounting framework is intended.”

FRF for SMEs Accounting Framework

The task force and staff deliberately did not develop quantified size criteria for determining what is a small-and medium-sized entity. They decided that developing quantified size tests is not feasible. It is also not an effective way of describing the kinds of entities the framework is intended for. Rather, the AICPA has developed a list of characteristics of SMEs to guide companies in determining whether to adopt the new framework.

Excerpt of FRF for SMEs Report

Here is the list excerpted from the FRF for SMEs report:

  • The entity does not have regulatory reporting requirements that essentially require it to use GAAP-based financial statements.
  • A majority of the owners and management of the entity have no intention of going public.
  • The entity is for-profit.
  • The entity may be managed by the owner; owner-managed is a closely held company where the people who own a controlling ownership interest in the entity are substantially the same set of people who run the company.
  • Management and owners of the entity rely on a set of financial statements to confirm their assessments of performance, cash flows, and of what they own and what they owe. vii FRF-SME
  • The entity does not operate in an industry where the entity is involved in transactions that require highly-specialized accounting guidance, such as financial institutions and governmental entities.
  • The entity does not engage in overly complicated transactions.
  • Key users of the entity’s financial statements have direct access to the entity’s management.
  • The entity does not have significant foreign operations.
  • Users of the entity’s financial statements may have greater interest in cash flows, liquidity, statement of financial position strength, and interest coverage.
  • The entity’s financial statements support applications for bank financing when the banker does not base a lending decision solely on the financial statements but also on available collateral or other evaluation mechanisms not directly related to the financial statements.

Conclusion

Since the use of the framework is optional, there is no effective date. So, businesses can use the framework immediately.

While the framework should simplify the financial reporting process for small businesses, only time will determine the ripple effect. How will this affect the learning curve for CFOs changing jobs between companies reporting under different frameworks? Furthermore, will lenders accept financial statements prepared under the new framework? How will CPA firms deal with the cost of educating staff on the auditing standards for the new framework?

Here’s a link to the full FRF for SMEs report.

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Financial Reporting Framework for Small Businesses

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How to Control Annual Audit Fees

Partnership, loan or other agreements may require the annual audit of a company’s financial statements.

How to Control Annual Audit Fees

The cost of this audit can constitute a significant administrative expense. Therefore, your company’s financial staff needs to properly manage the audit fees. Although the independent accountant has the responsibility of establishing the scope of the audit required in order for him to issue an opinion on the financial statements, the company can limit the involvement of the independent accountant’s staff, in order to keep the audit fee at appropriate levels.

Adopt the following procedures to minimize annual fees. Also, assure appropriate cooperation between the company’s financial staff and the independent accountant…

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FASB Chief to Propose Accounting Rule Change

In this blog, we look at how the FASB Chief to propose accounting rule change will impact your business.

FASB Chief to Propose Accounting Rule Change

The Chairman of FASB is set to propose that bank regulators be allowed to make adjustments to the financial statements of banks in order to determine whether those banks have met capital requirements, while requiring that those banks report to the investing public according to GAAP.

Naturally, the banks are in favor of this, yet investors should pay attention to the financial statements and not the pronouncement of regulators that a given bank has met its capital requirements through some “adjustments” to its loan portfolio.

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FASB Chief to Propose Accounting Rule Change

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FASB Chief to Propose Accounting Rule Change

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Don’t Let Tax Strategies Drive Financial Performance

With most young companies cash is king. As a company grows managing the cash available to finance that grow is crucial to sustaining the growth rate. Minimizing the cash expenses of the company is an entrepreneurs and CFO’s primary job. One of the main cash expenses is federal income taxes.

Don’t Let Tax Strategies Drive Financial Performance

During this start up and growth phase (which can last 10 years or more) the entrepreneur is focused on minimizing the cash payments for federal income taxes. He will work closely with his tax CPA to aggressively take financial positions that minimize taxes.

Somewhere along the line this strategy begins to lose its effectiveness. It generally happens when outside bank financing is obtained to fuel the growth of the company. As larger and larger amounts of outside debt is obtained the financial reporting needs of the company changes. The financial statements must now be presented to new users (i.e. the bank). The banks are seeking a clearing picture of the financial position of the company on an accrual basis. Often they want to know the true equity available from the company so they can establish the leverage of the company.

But maximizing the equity value of the company often is at odds with minimizing federal income taxes. To minimize taxes you typically end up either taking deductions sooner, deferring the recognition of income or valuing assets more conservatively. Taking these positions is fine until you want to borrow money.

Most entrepreneurs want to borrow as much as they can to fuel growth. However, by presenting there financial statements on a tax basis they minimize the amount that lenders will advance.

Conclusion on Tax Strategies Driving Financial Performance

The answer is that just as no strategy works in every situation, neither does one strategy work forever. The goal of the CFO should be to educate the owner to the needs of the other users of the financial statements. Often the benefits of paying higher income taxes is offset by the increased growth rate of the company.

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