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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What is GAAP?

What is GAAP?

GAAP stands for Generally Accepted Accounting Principles. It is the set of rules and guidelines for U.S. companies to follow. GAAP regulates financial reporting for public companies, private businesses, non-profits, and government authorities. This means that GAAP outlines the procedures to make sure that businesses are recording their financials in the same way.

GAAP Principles

The principles in GAAP ensure transparency and consistency. This includes the following topics:

The overall philosophy behind these principles is to prevent deceptive recording.

What is IRFS?

While the United States follows the GAAP, most of the developed world follows the International Financial Reporting Standards (IFRS.) In 2008, the United States decided to move towards adopting the IFRS to be more consistent with the rest of the world. While the long term effects are only speculative, the short term changes will have an immediate impact on accountants, managers, and investors.

IFRS vs GAAP

What is the benefit of following the same set of guidelines as the rest of the world? One major advantage of having the same international financial reporting guidelines is the effect on investors. Investors will be able to compare and contrast investments between nations more accurately.

For example, if there is one startup in the United States and one in London, then they will likely use different methods for financial reporting. This could make the investor’s decision very difficult. If inventory and depreciation are valued differently, then the investor might not fully understand the true standing of these startups.

What is GAAP

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Generally Accepted Accounting Principles (GAAP)

Generally Accepted Accounting Principles (GAAP) Definition

Generally Accepted Accounting Principles (GAAP) are a set of standards, guidelines, and regulations for financial accounting. Companies should follow GAAP rules when preparing financial statements.

GAAP rules were established to provide consistency in financial reporting and accounting practices. The rules evolve over time. Therefore, they reflect the most relevant and applicable accounting practices.

GAAP Meaning

Generally Accepted Accounting Principles (GAAP), in short, means the rules which provide the basis of all accounting decisions for financial institutions, businesses, and organizations. In the U.S., several organizations influence what GAAP rules, including the Financial Accounting Standards Board (FASB), the American Institute of Certified Public Accountants (AICPA), the Securities and Exchange Commission (SEC), and the Internal Revenue Service (IRS). U.S. GAAP differs from other international accounting standards, but organizations like FASB and the International Accounting Standards Board (IASB) are working to establish acceptable international accounting standards.

Overall, accountants calculate in two ways: for a financially stable or financially instable company. This is referred to as the Going Concern; unstable companies calculate assets by estimated value of the item when liquidated.

GAAP Standards

Generally Accepted Accounting Principles (GAAP) uses many standards and protective measures to ensure reliable and useful accounting statements. For example, accounting is done in fiscal periods which may not coincide with actual calendar periods. They instead coincide with the relevant events that happen to the company with respect to accounting standards.

Worst Case Scenario

Many GAAP standards account for the worst-case scenario. When you record past events in their value at the given time, call this the historical monetary unit. Additionally, subtractions from company cash are made when possible whereas additions are made only when the product is sent and cash is received.

Do Not Consider Intangibles

Under GAAP, do not consider intangible values, such as workforce knowledge or brand goodwill, an asset. Do not record these in the balance sheet. Furthermore, always make an effort towards consistency. Expectations like depreciation or inventory are accounted for in the same way across all periods which they occur. You must make any changes to one period, under this concept, to all periods past. Also, make these changes completely clear to the reader of the statement, providing the necessary background to understand the true meaning of the document.

Lastly, the scope of the company comes into play. An example of this would be a laptop computer: the accidental destruction of a single laptop means much more to a small business than a multinational one. The company scope is essential to relevant and readable financials.

GAAP Example

For example, Natalie is the CFO at a large, multinational corporation. Her work, hard and crucial, effects the decisions of the entire company. She must use Generally Accepted Accounting Principles (GAAP) to reflect company accounts very carefully to ensure the success of her employer.

Natalie begins her process of creating GAAP compliant statements. First, she looks at past records. These provide the crucial understanding of where her company has been. From here she can expand her accounting to meet the current and future needs of the company.

Nataile makes sure to to keep statements consistent. With the recent change in company policy from LIFO to FIFO, she has a lot of work ahead to correct past balances as well as make the change clear in the body text of the document.

When Natalie creates financials she ignores the value of the company name and brand, despite the fact that they sell a product which is in many ways a commodity. Her concern is tangible rather than intangible assets.

Bad News

Finally, the executive salesperson enters her office with the bad news that he has been in a car accident with the company car. The accident destroyed the vehicle beyond repair. Though Natalie is concerned for the health of her co-worker she is not concerned with the value of the vehicle: with a vehicle fleet valued at over $25 million a single car is not the concern of Natalie.

Natalie finally completes her assignment. She has faith in her work due to her training and expertise in her field. She has confidence that she has prepared sound GAAP complaint statements.

If you want to add more value to your organization, then click here to download the Know Your Economics Worksheet.

generally accepted accounting principles (gaap)

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generally accepted accounting principles (gaap)

See Also:
Accrual Based Accounting
Modified Accelerated Cost Recovery System MACRS
10 Q
Asset
History of Accounting
Full Disclosure Principle

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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.

If you want to overcome obstacles and prepare how your company is going to react to external factors, then download your free External Analysis whitepaper.

securities act of 1933

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securities act of 1933

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Statement of Financial Accounting Standards (SFAS)

The Statement of Financial Accounting Standards (SFAS) describes standards for professional accounting practices and procedures in the United States. Furthermore, it is published by the Financial Accounting Standards Board (FASB). The document lists standard rules and regulations – including many from GAAP – for preparing financial statements. In addition, the FASB intended for these standards to promote uniformity and transparency of corporate accounting practices. In conclusion, all publicly traded companies in the United States must adhere to the rules and regulations described in Statement of Financial Accounting Standards (SFAS).

Statement of Financial Accounting Standards (SFAS) Online

If you want to see the Statement of Financial Accounting Standards, then go to: fasb.org

When accounting standards change, they have the opportunity to change how your company accounts – resulting in disruptions. If you want to overcome obstacles and prepare how your company is going to react to external factors, then download your free External Analysis whitepaper.

Statement of Financial Accounting Standards

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Statement of Financial Accounting Standards

See Also:
Accrual Based Accounting
Accounting Income vs Economic Income
Chart of Accounts (COA)
The Future of the Accounting Workforce
Accounting for Factored Receivables

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Scrap Value

Scrap Value Definition

Scrap value, defined also as salvage value, is the value of an asset after it is fully depreciated. Once an asset reaches the point where it is fully depreciated, has lost the vast majority of production efficiency due to use, and is ready to be resold, it has reached the scrap value. At this point, managers must make the decision of whether to sell the asset for it’s material, or recyclable value, continue using it despite the fact that it is no longer in good operating condition, or trash the asset.

Scrap Value Explanation

Scrap value, explained as the value an asset has on the open market after it has surpassed it’s useful lifetime, is very important in the eyes of accountants and CFO’s. Because financial planners in a company deal closely with assets and their depreciation schedules, they are the main monitoring body which decides when a piece of equipment has reached it’s scrap value in accounting. These financial managers, working with GAAP and any government requirements placed upon them, decide the amount of use an item can take before it becomes useless. With this they decide how much of this use happens per year, known as depreciation, and when a piece of equipment can no longer be used.

Final Scrap Value

Once an item reaches it’s final scrap value, accounting professionals see several available options. First, the item can be sold to another company which can still make use of the asset, despite the less-than-optimal condition it is in. This depends on the chosen depreciation schedule and whether the item can still operate, in some ways, as designed.

Second, the item can be sold for it’s value in raw materials. For example, a large printing press can be sold for it’s metal content to a recycling facility after it is no longer able to be used for printing purposes. Though this item will be sold for a relatively small amount of money it will still create some value for the company.

Third, the item can be trashed if it has no real scrap value. In this scenario, the item has such little value that it creates more cost in resale than it does when thrown away. An example of this would be an old computer: the man hours spent to resell the computer often outweigh the income gained from selling it.

Only material assets have a scrap value. To simplify, if an asset does not depreciate it does not have a scrap value. For example, this scrap value wiki will never depreciate and thus has no scrap value in accounting.

Scrap Value Calculation

There is no simple method for scrap value calculation. More, scrap value is a result of market factors. On one hand, one must figure out the market value for an almost useless asset. This will provide the scrap value if it is sold for use.

On the other hand, one must also figure out the total value of the raw materials contained in the asset. This will lead to the value of the asset if it is recycled.

Whichever of these values is greater will become the scrap value for the asset. The reasoning behind this is simple: company controllers will, obviously, choose to sell the item for more rather than less money.

Scrap Value Example

For example, Leo is the head accountant at a company which prints marketing messages on common items: hats, cups, silverware, and other items designed to attract attention for a business when they are used. Leo likes his work because it allows him to bring value to his company through the decisions and analysis he performs.

Then, Leo, performing his monthly tasks, notices that one of the company assets is nearing the end of it’s depreciation schedule. Once it reaches the end of this schedule it will be at scrap value. Leo, the ever-active analyst, must make the decision of how to gain maximum value from the scrapped piece of equipment.

Leo notices that he recorded a market value for the scrapped piece of equipment in recycling. He notes this value as he moves forward with his work. Leo explores other options before he makes a decision.

Leo does a bit of networking and finds a potential buyer for the scrapped printer which is nearing the end of it’s lifetime. This buyer, knowing that the item will not be able to perform some of the functions it was originally designed for, is willing to offer $5,000.

Next, Leo talks with a decision maker at a local scrap metal company. The item is found to have $2,500 in value for the metal it is made of. The scrap metal company, however, can not pick up the item. It will have to be shipped to their headquarters. This salvage value is less than Leo initially found. He attributes this difference to changes in the market value for metals.

Calculate Total Cost

Leo calculates the total cost for his company to sell the item. What he finds is shocking. The company will gain more monetary value from trashing the item than it will selling it. The math is simple: disassembling and shipping the item to his buyer will cost $5,015. Though his company only saves $15, Leo knows that “a penny saved is a penny earned”.

Conversely, to disassemble and ship the large printer to the scrap metal company will be slightly less than this. This, combined with the negotiating time spent at the scrap metal company will result in a loss of $5. Once again, Leo will make the prudent financial decision even if it is a small one.

Leo completes his decision. He is happy that he did the proper research. His work results in a greater company value than if he had not. Leo loves his work for this very reason: he can make a difference in the lives of the company employees and shareholders.

Don’t leave any value on the table! Download the Top 10 Destroyers of Value whitepaper.

scrap value

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scrap value

See Also:
Adjusted Present Value (APV)
Asset Market Value vs Asset Book Value
Future Value
Going Concern Value
Customer Analysis

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Proforma Earnings

See Also:
Pro-Forma Financial Statements
Retained Earnings
EBITDA
Operating Income (EBIT)
Financial Ratios

Proforma Earnings Definition

Pro forma earnings are a company’s earnings that exclude rare, extraordinary, or nonrecurring items. Companies may incur expenses that do not reflect typical operating expenses. These expenses, which must be disclosed in financial statements in accordance with GAAP standards, can impact a company’s financial performance in a given accounting period. Proforma earnings exclude these extraordinary expenses in order to provide a clearer picture of the company’s financial performance. You can also call proforma earnings core earnings, operating earnings, or ongoing earnings.

A company’s earnings are a key measure of its financial performance. Creditors and investors examine a company’s earnings to evaluate its financial performance when deciding whether or not to lend to or invest in the company. Compare current period earnings to prior period earnings of the same company to gauge progress over time. Or compare current period earnings to industry peers and competitors to assess the company’s competitive position in the marketplace.

Earnings According to the SEC and GAAP

The SEC requires publicly traded companies to report net income and operating income in financial statements prepared according to GAAP regulations and procedural standards. The investing public scrutinizes these measures of financial performance. However, some businesspeople often consider these income measures to be inaccurate to some degree.

GAAP standards require businesses to include rare, extraordinary, or nonrecurring items in their financial statements. But company executives believe that including these rare, extraordinary, and nonrecurring items in the financial statements obscures the true picture of the company’s financial performance. Therefore, some companies prefer to publish pro forma earnings in their financial statements along with their SEC-required GAAP-standardized earnings.

Proforma Earnings – Explanation

These pro forma earnings, or hypothetical earnings that exclude items deemed rare, extraordinary, or nonrecurring by the individuals preparing the pro forma financial statements, are considered to provide a clearer and more accurate picture of the company’s financial performance for the relevant accounting period. For example, when prepared in accordance with GAAP regulations, a company may show a loss for a given accounting period. However, during that same period, a company can show a profit in its pro forma earnings.

If you want to increase the value of your organization, then click here to download the Know Your Economics Worksheet.

Proforma Earnings

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Proforma Earnings

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