Explaining Basic Accounting Concepts and Business Structures
ACT/537
March 12, 2012
Del Roberts
Explaining Basic Accounting Concepts and Business Structures
The three most authoritative sources of Generally Accepted Accounting Principles (GAAP) include FASB Standards, Interpretations, and Staff Positions; APB Opinions; and AICAP Accounting Research Bulletins (ARP) (Kieso, Weygandt, & Warfield, Chapter 1, Pg. 12, 2007). The FASB Standards, Interpretation, and Staff Positions issued are automatically GAAP. The APB Opinions and ARB standards were issued prior to 1973. These standards are considered binding by the FASB until they are either modified or replaced by new standards issued by the FASB.
Source Hierarchy
Source hierarchy is a standard created by the FASB to allow users alternative resources in regard to their specific needs for accounting methods. The hierarchy categorizes sources from most authoritative to least authoritative. The hierarchy sources are formed by other professional organizations that use due process similar to the FASB. The remaining hierarchy sources in order of authority include the FASB Technical Bulletins, AICPA Industry Audit and Accounting Guidelines, AICPA Statement of Position, FASB Emerging Issue Task Force, AICPA AcSEC Practice Bulletins, AICPA Accounting Interpretations, FASB Implementation Guides, and widely recognized and prevalent industry practices.
The GAAP hierarchy is important because not all accounting transactions and the method for reporting these transactions are covered by the three major sources of GAAP. Accountants may need to do further research to find the best accounting procedure for their application.
Effective Accounting Information
Internal and external users utilize accounting information in their decision-making processes. For the accounting information to be useful and understood, it must contain four basic qualities: relevance, reliability, comparability, and consistency.
Relevant information must pertain to the decision at hand and be reported in the time period in which it occurs. The information must offer predictive value and feedback value.
Reliability depends on if the user can verify the information. Various users arriving at the same conclusion by implementing similar methods determine verifiability. It is imperative that the information presented is true to the transactions that actually occurred.
Comparability occurs when either the same company uses similar accounting methods across different periods or separate companies use the same method. Similarities, differences, and trends among various companies or periods will be determined from the financial data if the same methods are used.
Consistency occurs when the same accounting method is used over multiple periods of time. This increases the validity of the financial statements in the eyes of the user. A change in methods requires the auditor or accountant to give a report to explain the reason and justification for the change.
Accrual and Cash-Based Accounting
The accrual based accounting system is when a company recognizes revenue when realized or earned and expenses when incurred. Accrual based accounting supports the revenue recognition and matching principle, which are standards of GAAP. Accrual based accounting requires adjusting entries to be made and establishes an accurate income statement at the end of each period.
The cash basis of accounting occurs when a company recognizes revenue when it is received not earned and when expenses are paid for not used. GAAP prohibits cash basis of accounting, however; companies not publicly traded often use this method of accounting. The cash basis of accounting misrepresents the income statement at the end of each period by overstating revenue or understating expenses.
Business Structures
Sole proprietorship, partnerships, and corporations are the three types of business structures. Sole proprietorships have one owner who assumes full control and is responsible for all liabilities. Sole proprietorships are very easy to form and have minimal governmental control.
A Partnership is formed when two or more individuals establish a business and equally assume the liabilities of the company. There is no maximum for the number of persons who can form a partnership. Advantages of a partnership are that they are relatively easy to form and partners gain additional resources, skills, and investment capital.
Corporations are legal entities separate from its owners. Ownership is attained through transferable shares of stock. Owners have limited liability and can easily sell their position. An advantage of a corporation is the ease of raising capital. A disadvantage is the amount of tax liability and government regulations.
Works Cited
Kieso, D. E., Weygandt, J. J., and Warfield, T. D. (2007). Financial Accounting (4th ed.). Retrieved from the University of Phoenix eBook Collection database.
Kimmel, P. D. (2007). Financial Accounting and Accounting Standards (12th ed.). Retrieved from the University of Phoenix eBook Collection database. 