Financial Accounting For Dummies. Maire Loughran

can’t be done willy-nilly whenever the business feels like it. I provide the whole scoop on changes in accounting treatment in Chapter 20. Also, the company has to disclose this change in its footnotes to the financial statements; see Chapter 15.

      SEEING HOW DEPRECIATION AFFECTS THE BOTTOM LINE

      Depreciation is the process of systematically reclassifying the cost of an asset from the balance sheet to the income statement over its useful life — a topic I discuss at length in Chapter 12. A few different methods of depreciation are allowed by GAAP, so unless you know which method the company is using, you can’t effectively compare one company to another.

      Consider an example. For the same asset, here is the amount of depreciation a company can take for the asset’s first year of use depending on which commonly used depreciation method it employs:

       Straight-line depreciation: $54,000

       Double-declining balance depreciation: $120,000

      The difference between the two methods is a whopping $66,000 ($120,000 – $54,000)! Now imagine depreciating equipment that costs in the millions of dollars; the effect on the company’s bottom line net income of choosing one depreciation method versus another would be even more astonishing.

      Luckily for the financial statement users, to aid in comparability, the depreciation method in use by a company must be disclosed in the notes to the financial statements. For much more info about depreciation, jump to Chapter 12. For the scoop on what financial statement notes are, head to Chapter 15.

Consistency is crucial when it comes to depreciation. If the company lacks consistency —for example, it uses different depreciation methods when accounting for the same asset in different years — you cannot create truly useful financial statements.

Accepting Financial Accounting Constraints

      While preparing financial statements, accountants realize that time is money and there is a limit to the amount of cost that should be incurred for any reporting benefit. The agencies that set the standards for accounting practices (which I introduce in Chapter 4) always perform a cost/benefit analysis before finalizing any reporting requirements. Associated with this financial accounting constraint is the concept of materiality.

      

Materiality is the importance you place on an area of financial reporting based upon its overall significance. What is material for one business may not be material for another. You have to consider the size of the company, the size of the financial statement transaction, the particular circumstances in which the transaction occurred, and any other factors that can help you judge whether the issue is truly significant to the financial statement users.

      COST/BENEFIT LOST IN THE WOODS

      Years ago, the bookkeeper at one of my client companies spent five hours tracking down the reason why the company bank reconciliation was off by $2 to make sure the bank hadn’t made a mistake. (Preparing a bank reconciliation means you take the balance in the bank account per the bank as of a certain date, add in any deposits that got to the bank too late to hit the statement, and subtract any checks the company has written that have not yet cleared.) Yikes!

      Now, was this an effective and efficient use of that bookkeeper’s time and salary expense? No, of course not. Say she was paid $10 per hour. It cost the company $50 for her to confirm that the operating account bank balance was indeed off by $2, and it wasn’t just an inadvertent mistake on the part of the bank.

For example, an expense totaling $10,000 would be material if the total expense amount is $50,000 but would likely be immaterial if the total expense was $500,000. But the nature of the transaction may make the difference material even if the comparative size is immaterial. For example, $10,000 that is deliberately — not accidentally — excluded from income may be material even if the amount is a small percentage of overall income. That’s because the deliberate exclusion may be an attempt by the owner of the company to avoid paying taxes on the income.

      

Conservatism is very important in financial accounting. It means that when in doubt, the financial accountant should choose the financial accounting treatment that will cause the least favorable effect on revenue or expenses.

Considering Your Ethical Responsibilities

      Every professional — and, frankly, every individual — should operate using a code of conduct. This means you should always attempt to act in an ethical manner and do the right thing, regardless of whether doing the right thing is the best choice for you personally.

      In this section, I give you the nuts and bolts of the code of conduct that financial accountants must follow. Plus, you find out about the goals toward which financial accountants strive: integrity, objectivity, and independence.

      Following the accountant’s code of conduct

      In a financial accounting class, you learn about different employment and licensing options available to financial accountants — a topic I discuss in Chapter 22. Financial accountants who are serious about their profession normally become certified public accountants (CPAs), which means they have to take a certain number of accounting and auditing classes, pass a four-part exam, and comply with any other requirements of their state’s licensing board.

      Working as a financial accountant doesn’t require any special licensing, but a lack of licensing may limit your career options. Thinking that after graduation taking another test is a big no-no? As Chapter 22 points out, many interesting and exciting accounting careers do not require licensure.

CPAs have to abide by their state’s code of conduct and also follow the code of conduct established by the American Institute of Certified Public Accountants (AICPA) — the national professional organization for all CPAs. The AICPA is responsible for establishing accounting, auditing, and attestation standards for private companies in the United States, as well as for enforcing a code of professional conduct for its members. (Attestation involves generating reports on subjects that are the responsibility of another person or business.) In Chapter 4, I outline that code of conduct in detail.

      But what if you’re a financial accountant who isn’t a CPA or a member of the AICPA? Do you still have to worry about abiding by a code of conduct? Of course, you do! Any profession lacking ethical behavior descends into chaos. Financial accountants must have high professional standards, a strict code of professional ethics, and a commitment to serving the public interest. They achieve these goals through their integrity, objectivity, and independence.

      Having integrity

      In the world of financial accounting, integrity means you act according to a code or standard of values. You demonstrate integrity when you do the right thing, regardless of whether doing so is best for you personally.

      Specifically, having integrity means that you serve, to the best of your ability, your employer and/or