Accounting Principles and Practices: What You Need to Know in Six Scenarios

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Accountants are almost always in high demand, both for business and individuals. For anyone who wants to enter this field, it’s important to understand the principles and practices of the profession. Accountants must be familiar with several different fields, including auditing, analysis, dynamics of acquisitions and mergers, financial reporting, risk management, and taxation.

Here are some of the most important things to understand in these areas of discipline for individuals considering an accounting career:

Protecting Businesses’ Finances with Risk Management Policies

Understanding risk management procedures and policies is an important component of a career in accounting. Basically, an organization sets risk management policies to give itself boundaries and to limit its risk exposure. Effective risk management policies can help an organization to reduce certain expenditures.

Every risk management policy will need to cover several different topics, almost all of which are related to an organization’s finances. For example, most policies will put limitations on the financial risk that an organization can take on safely. Limiting third-party financial guarantees is another important component of risk management. Other topics that can be covered by a risk management policy include an insurance provider’s minimum acceptable credit rating and if there will be any limits on self-insurance amounts.

Ineffective risk management policies can result in severe financial harm for an organization, including large losses. In terms of investment, risk generally means analyzing the expected outcome of an investment and determining the likelihood of experiencing a deviation from this outcome.

Accountants can use several different methods to detect and manage risk. Measuring standard deviation is the most common method for ascertaining risk. Basically, the accountant would research a particular investment’s average return and then determine how often there were deviations from this return.

Untangling the Complicated Issues Surrounding Tax Accounting

While working toward a Master of Science in Accounting online, students will learn a variety of principles related to taxation. Whether working for an individual or a business, tax accounting is the practice of maintaining financial records for the purpose of preparing tax returns. The rules for tax accounting are covered in the Internal Revenue Code, and every tax accountant must fully understand these rules.

Once a student learns the ins and outs of tax accounting, they will have the ability to help others with their tax returns. They will also understand how to prepare tax returns so that they are free from error and will also be able to give their clients advice for maintaining future financial records so subsequent tax returns are easier to handle.

One of the most important things to understand is the difference between tax accounting and generally accepted accounting principles (GAAP). With tax accounting, the focus is on tracing any transactions that would affect a business’s or person’s tax burden. GAAP, on the other hand, are accounting rules that dictate how an organization tracks all of its financial transactions.

Tax accounting for an individual is focused on several different items, including the following:

  • Taxable income
  • Available deductions
  • Losses and gains from investments

When tax accounting for a business, a large volume of information must be analyzed. For instance, in addition to monitoring how much income the organization has earned, a tax accountant must also keep track of money spent on business obligations, such as money distributed to shareholders and the cost of regular business expenses.

Tax-exempt organizations also require tax accounting, even though they don’t actually have to pay any taxes. Filing an annual return is required of all tax-exempt organizations, and these returns must include information related to any funds earned by the organization and how the organization makes use of those funds.

Putting Companies on Solid Footing with Financial Analysis

Accounting analysis, commonly referred to as financial statement analysis, involves examining a business’s finances to determine the following:

  • Stability
  • Profitability
  • Viability

Analyzing financial statements for a company requires keeping track of several different issues. For instance, an accountant may look at records to see when a company is generating profits and when it is experiencing losses. With this information, the accountant may be able to detect trends that could help the company mitigate losses and maximize profits.

Accounting analysis is also focused on helping a company understand its finances. An accountant can use analysis to help a business decide if it is carrying too much debt compared to its assets. Analysis can also involve comparing different business accounts to each other to get a sense of a business’s financial health.

Businesses can make use of financial statement analysis in several ways. Effective analysis may make it easier to obtain a loan or to attract investors to the company. Analysis can also be a good way to decide how well a company is performing and if any improvements could be made.

Financial statement analysis, while beneficial in many regards, isn’t without its problems:

  • It can be difficult to accurately compare statements from different reporting periods.
  • Comparing two companies can be challenging, because not every business will use the same accounting methods.
  • This analysis only covers a company’s finances, not how it operates, meaning important details that indicate performance in the future may be missed.

Keeping Finances Transparent with Financial Reporting

Financial reporting is the practice of creating financial statements for a company. When preparing financial statements, it is crucial that an organization follow the same format used by other companies in its field. It is for this reason that successful financial reporting requires drafting financial statements based on GAAP. For instance, the GAAP requires that all transactions are recorded in U.S. dollars.

If a transaction cannot be recorded in dollars, it cannot be included on a financial statement. Financial statements must also include the reporting period based on GAAP rules. Finally, financial statements prepared based on the GAAP must be for a going concern. Basically, this means that the business with finances described in the report can’t be in the process of liquidating or considering liquidation.

A number of efforts to codify accounting standards have been undertaken in the United States, with the GAAP serving as the most current iteration. The GAAP include accounting rules from multiple previous efforts to set standards and are based in large part on the methods adopted by the Financial Accounting Standards Board in 1972.

Financial reporting can also be referred to as accounting disclosure. As the name suggests, this means revealing important information about a company’s finances. Financial reporting can involve an array of company documents:

  • Balance sheets
  • Cash flow statements
  • Profit and loss statements

Parentheses are commonly used in financial reporting to indicate important information. Information that can be revealed in these parentheses can include the number of authorized shares and how much common stock has actually been issued.

Footnotes are another useful tool in financial reporting. These notes will typically be added to the end of a financial statement, and it’s common for statements to include numerous footnotes. The purpose of footnotes in a financial statement is to give the reader an idea of the company’s financial standing. Some of the information that one might find in these footnotes includes the following:

  • How much debt the company holds
  • The securities owned by the company
  • Pension plans maintained by the organization

The SEC requires some companies to make further financial disclosures.

The Do’s and Don’ts of Auditing Accounting

Auditing is another important part of accounting and involves reviewing a company’s or individual’s financial statements to guarantee their accuracy. When auditing financial statements, the goal is to look for any errors in the statement and to determine how the error may have been made. In addition to checking for accuracy, auditing requires the accountant to make sure that the financial statements follow any applicable reporting standards.

Unlike other accounting issues that can be handled internally, auditing requires that an accountant not affiliated with the company review financial records. Having financial statements externally audited is a legal requirement for public companies, and the reason for this rule is to make sure that the auditing process is transparent and that the company cannot hide any inaccuracies or legal violations.

Private companies will frequently use an internal auditor to make sure they are following proper accounting standards and that their financial statements are accurate. Internal auditors can be beneficial to private and public companies in several regards:

  • Identifying areas of risk and helping to develop risk management policy
  • Determining operational areas that can be improved
  • Finding errors in accounting standards and fixing these problems

When a public company is audited, the process must follow the rules of the Public Company Accounting Oversight Board (PCAOB). These rules apply to all companies that have registered with the SEC. Internal auditors can follow the International Professional Practices Framework (IPPF). The rules of this framework are not legally required but are recommended.

Seamlessly Handling Acquisition Dynamics

Accounting for mergers and acquisitions can be very complex, particularly because these transactions require tracking a variety of moving parts. However, understanding the dynamics involved in mergers and acquisitions is important for anyone interested in a job in the field of accounting.

Accounting for an acquisition requires following a two-step process. The first step is something known as pushdown accounting. The main part of this step is writing up the liabilities and assets of the company that is being acquired. This write-up will determine how much the company will be purchased for.

When writing up assets and liabilities, it is important to keep in mind their fair market value and mark them up or down accordingly. The purchase price of one company becomes the equity of the other if the purchase prices exceeds the fair market value of assets and liabilities.

Consolidation is the second step of acquisition accounting. In some acquisitions, shareholders of the company being purchased become shareholders of the acquiring company. The reason for this is that acquisitions can be financed in several ways. Some companies choose to use cash in an acquisition, while others use debt. It’s also common to use a mixture. The important thing to remember in consolidation is that the equity of the purchased company is eliminated.

Making Mergers Painless
Handling a merger can be just as difficult as an acquisition. When two companies combine forces, many factors must be considered, which is why businesses interested in merging will typically employ a team of accountants to help with the process.

Keeping lines of communication open between the two companies is of the utmost importance in a merger. Both companies need to be transparent about their assets and liabilities to make sure the merger can be completed successfully. If one company is dishonest about a financial issue, for instance, it can cause big headaches for the accountants and may hold up the merger.

One important decision that must be made in a merger is which staff members from each company will be retained and which will be let go. A merger creates a new company, and it is unlikely that all employees from each company involved will be able to keep their job. A good accountant may be able to help decide which employees to retain and which to let go by analyzing how much an employee is paid versus how much revenue they generate. If an employee is costing a business money, the accountant can advise that he or she be let go after the merger.

If you are interested in an accounting career and want to learn more about the principles and practices of accounting, visit the Master of Science in Accounting online degree program at New England College. Students take classes related to these six important areas of accounting, preparing them for a career in this field.

 

Sources:

Risk Management Policies

Risk Management

Tax Accounting

Tax Accounting

Accounting Analysis

Financial Statement Analysis

Overview of GAAP Rules for Financial Statements

Accounting Basics: Financial Reporting

What is Auditing?

M&A Accounting in Simple English

Tips for Successfully Managing Mergers Successfully