Accounting For Dummies. John A. Tracy

First of all, a business needs a good bookkeeping system simply to operate day to day. An army marches on its stomach. A business marches on data and information, without which it literally couldn’t make it through the day.

In addition to facilitating day-to-day operations, a company’s bookkeeping system serves as the source of information for preparing its periodic financial statements, tax returns, reports to managers, and a variety of other demands. The completeness, accuracy, reliability, and timeliness (the acronym CART that you see referenced time and again throughout this book) of these reports is critical to the business’s survival. If its accounting records are incomplete or inaccurate, its financial statements, tax returns, and management reports are incomplete or inaccurate. And inaccuracy simply won’t do. In fact, inaccurate and incomplete bookkeeping records could be construed as evidence of deliberate fraud (or at least of incompetence). Suppose, for instance, that the Internal Revenue Service decides to audit a business. The business won’t get very far with the excuse that it doesn’t have records to back up the deductions in its tax returns.

      Obviously, then, business management has to be sure that their company’s bookkeeping and accounting system is dependable and up to snuff. This chapter shows you what bookkeepers and accountants do, mainly so you have a clear idea of what it takes to be sure that the information coming out of the accounting system is complete, accurate, reliable, and timely for all the demands on the system. We stress that strong internal accounting controls are absolutely necessary.

Separating the Duties of Bookkeepers and Accountants

      

It’s useful to distinguish between bookkeeping and accounting because they aren’t completely interchangeable:

       Bookkeeping refers mainly to the recordkeeping aspects of accounting and is heavily weighted toward processing transactions (for example, billing a customer, paying a vendor, and so on); it’s essentially the process (some would say the drudgery) of preparing documents or managing computer-based digital data entries for recording all the detailed information regarding the transactions and other activities of a business (or other organization, venture, or project).

       The term accounting is much broader, going into the realm of designing the bookkeeping system, establishing controls to make sure the system is working well, and analyzing and verifying the recorded information. Accountants give orders; bookkeepers follow them. And we might add that accountants are paid better than bookkeepers.

Bookkeepers spend most of their work time keeping the recordkeeping process running smoothly according to the system established by the business — and they also spend a fair amount of time dealing with problems that inevitably arise in recording so much information. Accountants, on the other hand, have a different focus. You can think of accounting as what goes on before and after bookkeeping. Accountants are in charge of preparing reports based on the information accumulated by the bookkeeping process: financial statements, tax returns, and various confidential reports to managers.

      

Measuring profit performance is a critical task for accountants — a task that depends on the accuracy and completeness of the information recorded by the bookkeeper. The accountant decides how to measure sales revenue and expenses (as well as any special gains and losses) to determine the profit or loss for the period. The tough questions about profit — how to measure it in our complex and advanced economic environment — can’t be answered through bookkeeping alone. We discuss accounting problems in Chapter 9.

      These are the important differences between bookkeeping and accounting. Bookkeeping has two main jobs:

       Recording the financial effects and other relevant details of the wide variety of transactions and other activities of the entity

       Generating a constant stream of documents and electronic interactions and outputs to keep the business operating every day

      Bookkeeping builds up the financial database of the entity. This is a perpetual, nonstop process for a business of any size. A business does bookkeeping every day.

      Accounting, on the other hand, focuses on the periodic preparation of three main types of output: reports to managers, tax returns (income tax, sales tax, payroll tax, and so on), and financial statements and reports. These outputs are done according to established timetables. For example, external financial reports are prepared every quarter (3 months) and at the end of the year (12 months). Tax returns have their own timetables, as dictated by the tax laws and regulations. Accountants have much more choice in deciding how often to prepare financial reports to managers. The managers of some businesses require daily or even hourly financial reports; in other businesses, quarterly reports are adequate to keep on top of things.

In this book, we explain the fundamentals of financial reporting to the “outside,” or non-management creditors and investors of a business. The main focus is on the financial statements sent to them (see Chapters 6 through 10). This field of accounting is referred to as financial accounting (although it might be better called external financial accounting). The externally reported financial statements are useful to managers as well, but managers need considerably more detailed information than is reported in the external financial statements of a business. Much of this management information is confidential and not for circulation outside the business. We offer a limited discussion of accounting to managers in Part 4.

Pedaling through the Bookkeeping Cycle

      If anything, bookkeeping is a very repetitive process. Certain basic steps are done in virtually every bookkeeping system. The steps are done in a certain order, although the specific methods and procedures of each step vary from business to business. For example, entering the data for a sale could be done by scanning bar codes in a grocery store, or it could require an in-depth legal interpretation for a complex order from a customer for an expensive piece of equipment. We briefly explain the basic steps in this section. (See also the later section “Double-Entry Accounting,” which explains how the books are kept in balance by using debits and credits for recording transactions.)

      Getting to the end of the period

      Although the means and specific procedures regarding how the bookkeeping process is carried out vary from business to business, all businesses walk through the following steps during the accounting period. These basic four steps take up most of the time spent on recordkeeping:

      1 Prepare original source documents or electronic references for all transactions, operations, and other events of the business.When buying products, a business gets a purchase invoice (or its electronic equivalent) from the supplier. When borrowing money from the bank, a business signs a note payable, a copy of which the business keeps. When a customer uses a credit card to buy a retailer’s product, the business gets the credit card receipt (or an electronic alternative) as evidence of the transaction. When preparing payroll, a business depends on salary rosters and time tracking systems. All these key business forms serve as sources of information for the bookkeeping system — in other words, information the bookkeeper uses in recording the financial effects of the activities of the business.

      2 Determine the financial effects of the transactions, operations, and other events of the business.The activities of the business have financial effects that must be recorded: The business is better off, worse off, or at least “different