Tag Archives | GAAP

You Can’t Afford Not to Spend Money on the Accounting Department

As a former CEO to some CEOs, this Blog is to my counterparts that “don’t know what you don’t know.”  I have seen time and time again closely held businesses that have experienced growth make the same mistakes over and over again. To the CEO that believes bookkeeping is a necessary fixed cost that should be minimized, here is a money making tip. You can’t afford not to spend money on the accounting department if you want to be successful.

The Big Mistake

Your company has grown over the years; you have experienced good times and maybe some bad times. Additionally, you have taken a nice paycheck and sometimes, some nice bonuses.  You got used to a certain life style. And you did all of this with a bookkeeper that does not cost you much.  But your company has grown. Still in the back of your mind, you know something tells you that you are not comfortable with your accounting records. But you elected to keep cost down for the bookkeeper and you do not spend much on accounting.

You Can't Afford Not to Spend Money on the Accounting Department

My Tax CPA Does It All

Maybe until now, some of you have your outside CPA that prepares your tax return also prepare year-end financials. This is not a knock-on tax preparers, but your CPA that prepares your tax return is an expert in one of many fields CPAs work in. For example, I am a CPA, but there is no way I would prepare my own tax return. Tax laws change way too often. I just want to maximize my deductions and pay my fair share of tax, but not more than that. That is why I have my tax CPA prepare the tax return.

But over the course of my career, I have found that most tax CPAs do not have operational expertise. They have not run a manufacturing or service business, nor have they had any P&L responsibility. The Tax CPA is considering accelerated depreciation, maximize expenses, etc. This is quite the opposite from a management set of financial statements. The role of the CPA Tax preparer is totally different from a “operational” CPA, Controller or even CFO.

Minimizing the Back Office For the Wrong Reasons

Most CEOs that I have worked with argue to minimize the cost of the back office. That includes the cost of preparing financial and accounting records. But think about this… The Securities and Exchange Commission (SEC) does not require public companies to prepare their financial statements according to Generally Accepted Accounting Principles (GAAP) because they pulled this out of thin air as another way to regulate.  The SEC requires public companies to prepare their accounting records and financial statements based on GAAP because it is the best way to present fairly the results of your financial operations to third parties reading your financial statements.  In other words, It’s the RIGHT way to keep your books!

In some cases where there is significant debt and exposure, some banks also require that the company present your accounting records based on GAAP – regardless of whether it is a Public or Private company.  Some debt situations even require an audit. The banks simply make it one of the covenants related to your debt. When you present your books and records per GAAP, you have accurate financial statements, everyone is assured your accounting is correct.

The Importance of Using GAAP

So, if a lot of brain power has been put into coming up with GAAP, and the general consensus is that GAAP is the right way to present your financials and accounting records.  Why would you as CEO not require that your financial statements be presented per GAAP?

I have been an “operational” type CPA for over 27 years now. In addition, I have held the office of CEO twice. I have used my expertise in public company environments and private companies both as an employee and as a consultant in the U.S. and in other countries. I have seen many very successful small, medium and large private companies and they were all keeping their financial records per GAAP. Yet, I have NEVER seen a significant company (not a micro or small business) be successful and properly run without keeping their books and records per GAAP.

So why is it that CEO’s of closely held (private) business still permit their accounting records to be kept some other way?   The answer: they do not want to spend money on a fixed cost such as accounting. But they will spend money on the sales team, hunting leases, extravagant meals or parties.

Not getting the basics down – such as GAAP – leaves money on the table when you are exiting the company. Increase value with our Top 10 Destroyers of Value whitepaper.

You Can't Afford Not to Spend Money on the Accounting Department

You Can’t Afford Not to Spend Money on the Accounting Department

These are real life examples and outcomes of minimizing the cost of your accounting department that I have lived…

The service company incorrectly books gains on U.S. dollar receivables. In conclusion, they had to reverse $8 million from earnings.

I have seen this one several times. The company does not have some large assets on the balance sheet, because their tax preparer said they used accelerated depreciation. As a result, the balance sheet assets are severely understated. Hint: your value is understated. IT’S ABOUT THE MONEY DUDE!

The manufacturing facility does not properly accrue costs. As a result, their margins are way off, and the CEO wondered why they were always short on cash.

The company did not properly reconcile accounts including cash. This led to fraud.

The company did not properly recognize revenue. In conclusion, the company was understating revenue by millions of dollars.

I can go on and on with more real-life examples.

If you do not have your financial statements presented per GAAP, how are they prepared and presented? Do you really know your margins in your P&L. Do you really have all your assets, liabilities and equity presented correctly? Is your P&L, Balance Sheet and Cash Flow statement presented correctly? Guess what? Your ratios that your controller or CFO should be analyzing are not correct.

Leadership Needs to Believe in GAAP

Why do you think Exxon, Walmart and all other public company CEO’s believe in GAAP?  I have also seen many small, medium and large closely held private companies keep their accounting records per GAAP.  These are all successful companies. They know their margins, they know where cash is, they know their ratios and guess what, they know how to forecast!

I have also seen time and time again good companies that have been around a while and have experienced growth, and NOT prepare their financials per GAAP.  And every one of these CEO’s and companies has the exact same issues.

  • They really don’t know their margins in their P&L
  • Some companies don’t even really know their actual revenue
  • There is always that doubt in the CEO’s mind as to what is really going on in the business
  • The CEO lives a stressful life
  • Every time there is even the slightest decrease in margins, there is even a bigger disproportionate stress on cash
  • If your books are not per GAAP, then most likely they are not on the accrual basis; if that is the case, then you are 60-90 days behind your business
  • Having your books on an accrual basis is just the first step. There are many other accounting rules, procedures and pronouncements to get your books per GAAP. Just because they are on accrual basis, does not mean they are per GAAP. GAAP “rules” actually change frequently

You Can't Afford Not to Spend Money on the Accounting Department

In Summary

In my consulting business, I have seen CEOs that are “smart” as in they know what they don’t know. They bring us in to get the problem fixed. Although it takes time and money, the CEO is fully supportive and we get it done. These are the companies that grow and ultimately have a successful liquidation event. Or they leave a well-run machine to their family or employees.

But it shocks me to continue to see companies as large as $120 million in revenue, with a couple hundred employees that have not professionalized their accounting department. No one knows the true margins. Everyone stresses out about the “accounting records.” There are no correct historical financials, and most certainly, there are no forecasts. Unfortunately, there is no analysis of the business at all. In some high margin “hot” industries, this works for a while. The sins are buried. But millions of dollars are lost without knowing it. But, since ultimately everything ends up in cash, when that “hot” industry has even a slight downturn, the CEO feels the cash crunch.

Whether you are trying to increase the value of your company or positioning it for sale, this issue of unknowingly leaking cash is a destroyer. Learn how to tighten your belts and increase value with our Top 10 Destroyers of Value whitepaper.

Don’t be Cheap

Don’t be cheap. Spend the money (which is usually less than the hunting lease) to get your books and records based on GAAP basis.  Get your priorities straight.  Continue to have a professional accounting department in your business. YES, you will spend more than you are currently spending. But you can’t afford not to spend money on the accounting department!

Consider this… I had one investment banker with a very large firm tell me the difference in a valuation of an acquisition target from a company that has accounting records per GAAP and solid accounting department versus one that does not have a professional accounting department and accounting records not per GAAP is a difference of 20%-30%.  I had another investment banker tell me the difference in valuation is “one turn of EBITDA”. The use of EBITDA and multipliers is often used in valuation.

So if your company generates $2 million EBITDA and the multiple used is a 5, then your value would be $10 million with a professional accounting department and books per GAAP. In comparison, your value is $8 million with an unsophisticated accounting department and accounting records not per GAAP. I don’t think your professional accounting department will ever cost you $2 million per year! But not having it will.

Not having your financial records per GAAP is one of the destroyers of value. If you want to protect the value of your company, download the free Top 10 Destroyers of Value whitepaper to learn how to maximize your value.

You Can't Afford Not to Spend Money on the Accounting Department

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You Can't Afford Not to Spend Money on the Accounting Department

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Securities Act of 1933

See Also:
Primary Market
Securities Exchange Act of 1934
Investment Banks
Secondary Market
Initial Public Offering (IPO)

Securities Act of 1933

The Securities Act of 1933 was a landmark decision in the United States to regulate the issuance of newly issued shares into the market – an initial public offering. The act is also there for companies to register before the issuance as to ensure reliability.

Securities Act of 1933 Meaning

The Securities Act of 1933 followed the stock market crash in 1929. It was a movement to regulate the markets as to not mislead investors. Furthermore, the idea requires due diligence so that the best possible information would hit the market. The 1933 Securities Act was also meant to do away with insider information. By requiring this information to be provided pre-issuance investors presented with the opportunity to buy shares of the firm, during the investment banker’s road show, can make well informed decisions. The due diligence required by the 1933 Securities Act is to have a full audit and compliance with Generally Accepted Accounting Principles (GAAP). Without registration and a following of the 1933 Securities Act rules a firm cannot be listed on a U.S. stock exchange until the requirements are satisfied.

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securities act of 1933

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American Institute of Certified Public Accountants – AICPA

American Institute of Certified Public Accountants (AICPA) Definition

The American Institute of Certified Public Accountants (AICPA) is a professional organization for Certified Public Accountants (CPAs) in the United States. The organization dates back to 1887.

The AICPA creates and grades the CPA examination. In addition, it is also the organization that authored many of the original financial accounting and reporting standards included in GAAP –  though FASB is now responsible for GAAP.

The AICPA’s primary objectives include the following: advocacy on behalf of members, certification and licensing of new members, promoting public awareness of CPA professionalism, recruiting and educating prospective CPAs, and establishing professional standards.

To learn more financial leadership skills , download the free 7 Habits of Highly Effective CFOs. Find out how you can become a more valuable financial leader.

american institute of certified public accountants

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american institute of certified public accountants

AICPA Website

For more information on the AICPA, go to: AICPA.org

See Also:
Statement of Financial Accounting Standards – SFAS
Sensitivity Analysis Definition
Standard Chart of Accounts
Problems in Chart of Accounts Design
Future of the Accounting Workforce

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Accounting Income vs Economic Income

See Also:
Economic Income
Accounting Income Definition
Income Statement
Operating Income
Net Income
Future of the Accounting Workforce
Variance Analysis

Accounting Income vs Economic Income Definition

Accounting income or loss recognizes realized gains and losses, and does not recognize unrealized gains and losses. Economic income or loss recognizes all gains and losses, whether realized or unrealized.

When the related transaction is settled or completed, gains and losses are realized. Until a transaction is completed, any gains or losses related to that transaction are considered unrealized. Unrealized gains and losses are also called paper gains or paper losses, because the nominal value of the asset or liability has changed, but the cash has not actually changed hands.

Accounting Conservatism

Accounting income or loss does not incorporate unrealized gains and losses because of the convention of conservatism. When accountants confront uncertainty in regard to method or procedure, they conventionally choose the option that is least likely to overstate income or asset value. In the case of realized versus unrealized gains and losses, it is more conservative to exclude increases or decreases in value that have not yet been actualized.

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Accounting Income vs Economic Income Example

Here is a simple example dealing with an individual regarding accounting income vs economic income. Imagine Ralph earns $50,000 dollars per year salary, after tax, and has $10,000 dollars invested in the stock market. At the end of the year, his stock market investment is worth $15,000.

Because Ralph has not yet sold his stock and collected the profits, the increase in value of the investment is considered unrealized. Consequently, it is a paper profit. At the end of the year Ralph has a realized income of $50,000 from his salary. His total realized income is $50,000. He has unrealized profits of $5,000 dollars. His combined realized and unrealized incomes equal $55,000.

In this example, Ralph’s accounting income would be $50,000 and his economic income would be $55,000. According to accounting income, the increased value of the stock investments do not count as actual income because the investor has not actually sold the stock, completed the transaction, and collected the profits.

According to economic income, the increased value of the stock investments to count as actual income because the real value of the assets has gone up. The assets are worth more now then they were at the beginning of the year. In this sense, Ralph has earned the full $55,000 income.

Mark to Market Accounting Income

There are exceptions to the methodology of reporting net income, based solely on the historical cost of acquired assets. US GAAP includes the principle of “Mark to Market Accounting.” Under this accounting principle, valuation of commodities, securities and other financial instruments on a company’s balance sheet are based on the market values of such assets.

For example, if the cost of a precious metal acquired by a company for use in its production process, such as using silver to produce a catalyst used by the petrochemical industries was $10 per troy ounce and the market value of silver increases to $ 15 per troy ounce, the company would value the silver on its balance sheet at $15 per troy ounce. It would also report the increase in inventory value as an element of its net income for the period being reported.

GAAP vs IFRS

Another development in the financial arena is the move towards “IFRS” or International Financial Reporting Standards, which have been adopted by European companies, and which US companies will move to, in order to provide a common measuring stick when comparing earnings per share of publicly traded companies. IFRS mandates adjustment of many assets to a market value, which adjustments would be/ are included in the calculation of accounting income.

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Accounting Income vs Economic Income

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Accounting Income vs Economic Income

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Accounting Income Definition

See Also:
Accounting Income vs. Economic Income
Accrual Based Accounting
Financial Ratios
Comprehensive Income
Financial Accounting Standards Board (FASB)

Accounting Income Definition

Accounting income is an estimate of performance in the operations of a company. It is influenced by financing and investing decisions. Accounting income or loss generally recognizes realized gains and losses, and does not recognize unrealized gains and losses.

For income to be realized it must be related to actual business transactions; in effect, the cash you have must increase or decrease. A change in market value rather than cash received is not an accounting income; it is an economic income. Economic income or loss recognizes all gains and losses whether realized or unrealized.

Whether a gain or loss is realized or unrealized, it is central to the accounting profits definition. It becomes an income suitable for accounting when a gain or loss is realized. The accounting value for this asset is generally listed at the historical value of the transaction selling it. When a gain or loss is unrealized, you may or may not be account for it in general. This depends on the placement of the gaining or losing asset in the balance sheet. Despite that this gain or loss may be accounted for, the fact that it is unrealized makes it an economic income or loss. The accrual accounting income statement will look very different from the fair value accounting statement.

Essentially, accounting income defined the ways companies evaluate their cash standing after the sale of an asset. This, once again, differs from economic income in that economic income is the way for companies to account for changes in the value of a given asset in the market. The deciding factor is whether or not a transaction takes place.

Accounting income is a critical part of knowing your economics. If you’re struggling to identify your company’s economics, download the free Know Your Economics Worksheet

Accounting Conservatism

Accounting income or loss does not incorporate unrealized gains and losses because of the convention of accounting conservatism. When accountants confront uncertainty in regard to method or procedure, they conventionally choose the option that is least likely to overstate income or asset value. In the case of realized versus unrealized gains and losses, it is more conservative from an accounting perspective to exclude increases or decreases in value that have not yet been actualized.

Accounting Profit Example

A perfect example of accounting profit occurs every day in the stock market. Investco is a company which invests in market securities. Investco currently owns a share of Google stock worth $600. The following week Investco notices the share of Google stock has increased in value from $600 to $650. Investco sells this share of Google stock and receives $650 from the sale of one share of Google stock. What is Investco’s accounting income? Accounting profit and economic profit demonstrate two different principles.

Investco experienced an accounting income: their share of Google stock was sold for $50 more than it was initially worth. Thus, Investco has a realized accounting gain of $50. The accounting income calculation is $650 – $600 = $50.

If Investco never sold the share of Google stock it would have experienced an economic gain of $50. Investco did not have a transaction in which cash increased by $50.

Accounting Income vs Taxable Income

The treatment of accounting income and taxable income is different. The inclusion of tax accounting confuses the matter. Under GAAP, income and expenses are matched to the period in which they are incurred. As a result, the accounting income received was incurred on the specific day that it sold the share of Google stock. With tax accounting, however, match taxable income and expenses to the period upon which the I.R.S. decides. Investco may or may not incur an increase in taxable income based on I.R.S. regulations. It has incurred this potential increase in the accounting period the I.R.S. chooses. Do not consider accounting income under GAAP an accounting profit under I.R.S. tax rules. Want to check if your unit economics are sound?  Download your free guide here.

accounting income definition

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Compare IFRS vs US GAAP for SME’s

Do you want to know what is going to change when the new international standards are adopted? The AICPA has now created a wiki comparing the streamlined and complete version of the international standards using IFRS vs US GAAP for SME’s (Small and Medium Sized Entities). All of the sections of the IFRS will be updated in a wiki format on a go forward basis.

Compare IFRS vs US GAAP for SME’s

You can now see how the new rules will apply to private companies. As the rules become evident and adoption more likely, this site will be a great resource for navigating change. To see the comparison go to the new site at wiki.ifrs.com.

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