Profitability of individual processes summary

profession give some right ideas and some wrong ideas. Accounting is a process through which persons come to know the state of the business. It is used by the owners to find out their own performance in the activity they have taken up, by the government to collect the amount of taxes that are due by the investors in order to decide as to whether they should invest in the business, by the lenders to find out whether it is safe and secure to give the business credit, and many others for various needs or purposes. At the same time, it is not essential that all accounts give the right ideas as we can see many big businesses being penalized for wrong statements and manipulating their own accounts. Ultimately they have an objective — pay as low a figure of taxes as you can. The government also tries to catch them through the accounts, and sometimes, there are different accounts brought out for different audiences. For all the concerned persons, accounts are the beginning and not the end. Accounts are also not the complete truth.

Question 2

The two main types of accounting are financial accounts and cost accounts. Financial accounts are for determining the performance of the company, whereas cost accounts are to determine profitability of individual processes, products or any other activities of the particular organization. The utility of this process is to determine whether the company should continue on that particular activity. This is required as some activities of every organization have to change as the organization develops. This happens as the costs of the organization and the dreams of the entrepreneurs, as also investors have to change. It is cost accounting which tells them the direction to go. Even for maintaining the basic books of accounts, there are two common forms of accounts — cash or accrual. The first method is permitted for businesses which have a turnover of less than $5 million, but the moment the turnover goes above that, accrual method of accounting has to be used — at least for the purpose of reporting to the government. (Basic Accounting Principles)

Question 3

Designing of accounting systems can be done by any person who is competent to do it. For the purpose of filing tax returns, asking for loans from banks, and other similar activities the accounts have to be prepared in the required manner by chartered accountants, who are the professionals. At the same time, they are not necessarily the best for designing the original system of accounting in the organization as the systems can be designed to give a lot of information about the efficiency and quality of activities of the company. For example, for any service organization it is possible to take each contract separately and determine the earnings/losses on that contract. This will be summed up in the final accounts that are presented, but the individual account will tell the managers about profitable and loss making contracts that they have undertaken. Similarly, it is possible to have sales revenue and cost account for each item sold by a trading organization. That will tell the managers about profits and sales from each, individual product. In a way this will also direct them to losses and possible misuse of individual items. This has become very simple now with computers maintaining records. These decisions have to be taken by the owners/managers of the organization. However, if they are not able to do it, the design of the system may be left to a professional accountant. He will probably design a system that will satisfy statutory requirements. (Bookkeeping and Accounting – From Start to Finish)

Question 4

The question of users of any information comes from the recipients of the information. Again, accounts are information that can be tailored to the way in which it will look at its best to the person who is looking at it. The first set of external persons who have to look at accounts of a company are the income tax authorities and for them the accounts will have to be prepared in a manner that is specified under the income tax laws. These differ from country to country as also the type of organization and the level of turnover. The next set is the shareholders of a limited company. These persons have to be supplied a set of accounts of the company and the rule generally states that they are given the set of accounts that are presented for income tax. Along with that there are statements by different management staff within the company who try to convince them through the interpretation of the accounts that the future of the company is excellent. If the company is a public limited company, then it has to go to the stock exchange as per laws of the stock exchange. Apart from that are the banks and other authorities who have given loans to the organization and they use the set of accounts to convince themselves that their investment is safe. (Bookkeeping and Accounting)

There are also company law authorities in every country and depending up on the country, the accounts have to reach them as per laws for getting permission from them to continue business. There are no laws to send it to the ‘experts’ who write their comments on performance of companies in different magazines, or e-magazines, but they are generally able to collect it anyhow. It may be better to send them official copies so that misinterpretation will be less. Of course there are generally other requirements for stopping misinterpretations. There may be laws for having annual accounts published in newspapers also. In that case, it will have to them for that purpose. All these persons get the accounts and the manner of usage depends on each individual. Some shareholders are generally happy if they get a good dividend and just ignore the accounts. Some are not even able to interpret it. The income tax authorities require it to calculate whether due taxes have been paid, and since the annual accounts have to be certified by chartered accountants, this is generally done. If taxes are not paid, then the concerned managers are liable to severe penalties. The experts use it as is their personal and organizational want. Some are critical of all performances, some criticize those organizations from whom they do not get enough advertising, some feel that they can get all indications from accounts and that is not true, etc.

Question 5

The meaning of cash flow prospects is whether the company has a positive cash flow or a negative cash flow. A positive cash flow means that the organization is collecting more money than what it is using. (Accounting Terminology Guide) This should be the normal situation or condition as some of the items or products in prices are inclusive of factors like depreciation which do not have to be paid in cash if the plant or machinery has been purchased for cash earlier. At the same time, positive cash flow can also be achieved by delaying payments to suppliers and other means. In general when a company has a positive cash flow, it means that the company is not in cash troubles, or should be able to function well in future. This is important to both investors and creditors who are going to invest their own funds in the organization.

Question 6

The meaning of the term ‘operating profitably’ means that there are profits for the business entity in the course of its operations. Here the course of business operations means that the revenue from sales that it has earned. The term sales here means earnings from whatever are the products of the business entity — products, services, time for advertising in operations of media organizations, contracts that have been executed by a contracting organization, etc. From this the deductions would be the costs of operation and that means cost of materials it has purchased, staff salaries it has paid or are due for the period under consideration, interest costs for all loans it has taken for the purpose of operations for the period or on basis of actual depending on the contract, rents and similar charges of all types that it has paid or are to be paid, commissions that have been paid or are due, costs for machine servicing and operations, etc. It is difficult to make any general statement on this as the situation varies from organization to organization and the type of service or goods that it produces.

It could be better to view and analyze at it from the other way round — it does not contain any elements of depreciation, it does not include any dividends that are paid or which are to be paid, costs for the purpose of construction or development of facilities for future use that are being built for the growth and progress of the organization, costs for investment made in other organizations or institutions, income taxes paid or which are remaining, etc. In short the objective of making this statement is to say that the business entity is not in an operation that is causing direct losses. That does not however mean that operations can continue, or even that management would be interested in continuing operation. There are many instances where some activities of organizations that are operating profitably have been sold out to other organizations. In some instances this is due to the judgment about future of that business, or change of policies of the organization. It may even be that the particular operation is not making enough money as per the aims of the business entity.

Question 7

Revenue reflects earning of the company. The revenue does not have to be in cash, but may be in the form of checks, credit given, and set off against dues of the organization. Even the cash received by a business entity may be for other reasons like sale of assets, or facilities available with the business entity. The explanation of the two terms by New York State Society of CPAs is given – Revenues occur from sales of products, merchandise, and services; and earning by means of interest, dividend, rents. And Cash Basis is the method of bookkeeping by which revenues and expenditures are being recorded when they are received and paid for. (Accounting terminology guide) Thus it is clear that cash received is a part of revenue, but revenue is not all earned in cash, or even reflected in cash.

Question 8

Let us go back to the same source of definitions taken. There the answer is Expenditure which is “payment, either in terms of cash, by assuming a liability, or by surrendering assets.” (Accounting terminology guide) Thus it is clear that expenditure may be paid in terms of cash, but all expenditure is not reflected in terms of cash. Again, the payment by means of cash does not entail that expense has been incurred. This means that the cash payment may have to be made to satisfy the dividend payments which are not part of the expenses for the business entity.

Question 9a

The normal steps would be to journalize transactions, post transaction data to the ledger, prepare a trial balance, make end of period adjustments, journalize and post the closing entries, prepare an adjusted trial balance, prepare financial statements and then prepare an after closing trial balance. The use of trial balance is basically to see that all debits are equal to credits as without that no set of accounts will balance.

Question 9b

The definition of an accounting cycle is quite complicated as many business entities review their position at least once every three months now. However, the end of cycle information does not reach completely to everybody. Employees are in different levels of the organization and in different functions. All of them contribute to sales or costs. The sales and marketing personnel are informed when their performance is below targets and then they must try their best to reach targets. Production staff is more connected to costs, and they may be able to use the information to reduce costs to targeted levels. Anyway, in different stages of the year also comparative studies to previous years are useful as it will let them decide on methods to reach targets. Regarding managers, the information is generally more complete, and often the targets are different, but the purpose is the same.

Question 10

The methods of recognizing revenues are generally fair, but for the end of year settlement, even the sales on credit should be recognized as revenue. “Morris family’s weekly grocery and dry cleaning bills” are certainly not part of expenses for business. The salaries paid by Morris to her husband and each of her two teenaged children are not fair, as they are not working in the operation. They may be paid for the period during which they work on a reasonable basis. Income taxes paid by Morris and her family are not an expense for the enterprise and naturally should not be included in the same. Further, even income taxes for the organization are not an expense as it is only charged on profits. The amount of $150,000 paid for the equipment paid by Morris to Stanley is an investment and not an expense. The charges for that can be depreciation that is felt to be reasonable or permitted.

It is thus clear from the above that certain items which have been taken as relating to expenses of the organization when they are not expenses namely — Morris family’s weekly grocery and dry cleaning bills, full or major part of the salaries paid to her husband and of the two children by Morris, income taxes paid for Morris and her family members, full costs of the equipment. The recognized revenues are also lower as credit sales have not been recognized. When all these factors are taken into account, the revenue collected, or collectable should have been much higher. That has to form the basis for payment by Morris to Stanley. Whether the payment can be paid in cash or not is a matter to be settled between them.

REFERENCES

“Accounting Terminology Guide” Retrieved from http://www.nysscpa.org/prof_library/guide.htm Accessed on 22 July, 2005

“Basic Accounting Principles” Retrieved from http://www.entrepreneur.com/article/0,4621,265198,00.html Accessed on 22 July, 2005

“Bookkeeping and Accounting – From Start to Finish” Retrieved from http://www.onlinewbc.gov/docs/finance/bkpg_basic1.html Accessed on 22 July, 2005

“Bookkeeping and Accounting” Retrieved from http://www.onlinewbc.gov/docs/finance/bkpg_acct.html Accessed on 22 July, 2005

“Simple production shop chart of accounts” Retrieved from http://www.onlinewbc.gov/docs/finance/bkpg_basic1.html Accessed on 22 July, 2005


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