Office Standard 2007 Key Understanding Accounting

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Comprehending Accounting Strategies
Officially, there are two varieties of accounting techniques, which dictate how the company's transactions are recorded inside the company's financial publications: cash-basis accounting and accrual accounting. The main element distinction between the two types is how the company data funds coming into and going out of the business. Inside that easy variation lies a lot of area for error — or manipulation. In fact,microsoft Office 2010 License, many of your major corporations involved in economic scandals have gotten in trouble because they played games with the nuts and bolts of their accounting method.
Cash-basis accounting
In cash-basis accounting, companies record expenses in monetary accounts when the cash is actually laid out, and they book revenue when they actually hold the funds in their hot little hands or,Office Pro Plus 2010 Key, more likely, in a bank account. For example, if a painter completed a project on December 30, 2003, but doesn't get paid for it until the owner inspects it on January 10, 2004, the painter reports those funds earnings on her 2004 tax report. In cash-basis accounting, dollars earnings include checks, credit-card receipts, or any other form of revenue from customers.

Smaller companies that haven't formally incorporated and most sole proprietors use cash-basis accounting because the system is easier for them to use on their own, meaning they don't have to hire a large accounting staff.
Accrual accounting
If a company uses accrual accounting, it data revenue when the actual transaction is completed (such as the completion of work specified in a contract agreement amongst the organization and its customer), not when it receives the money. That is, the company records revenue when it earns it,Office Standard 2007 Key, even if the customer hasn't paid yet. For example, a carpentry contractor who uses accrual accounting data the revenue earned when he completes the job, even if the customer hasn't paid the final bill yet.

Expenses are handled from the same way. The company data any expenses when they're incurred, even if it hasn't paid for the supplies yet. For example, when a carpenter buys lumber for a job, he may very likely do so on account and not actually lay out the cash for the lumber until a month or so later when he gets the bill.

All incorporated companies must use accrual accounting according to the generally accepted accounting principles (GAAP). If you're reading a corporation's financial reports, what you see is based on accrual accounting.
Why method matters
The accounting method a organization uses can have a major impact on the total revenue the business reports as well as on the expenses that it subtracts from the revenue to get the bottom line. Here's how:
Cash-basis accounting: Expenses and revenues aren't carefully matched on a month-to-month foundation. Expenses aren't recognized until the money is actually paid out, even if the expenses are incurred in previous months, and revenues earned in previous months aren't recognized until the money is actually received. However, cash-basis accounting excels in tracking the actual funds available.
Accrual accounting: Expenses and revenue are matched, providing a organization with a better idea of how much it's spending to operate each month and how much profit it's making. Expenses are recorded (or accrued) inside the month incurred, even if the cash isn't paid out until the next month. Revenues are recorded within the month the project is complete or the product is shipped, even if the organization hasn't yet received the dollars from the customer.
The way a organization data payment of payroll taxes,Office 2007 Pro Plus Key, for example, differs with these two methods. In accrual accounting, each month a organization sets aside the amount it expects to pay toward its quarterly tax bills for employee taxes using an accrual (paper transaction in which no money changes hands, which is called an accrual). The entry goes into a tax liability account (an account for tracking tax payments that have been made or must still be made). If the company incurs $1,000 of tax liabilities in March, that amount is entered from the tax liability account even if it hasn't yet paid out the cash. That way, the expense is matched to the month it is incurred.

In cash accounting, the organization doesn't record the liability until it actually pays the government the cash. Although the organization incurs tax expenses each month, the company using funds accounting shows a higher profit during two months every quarter and possibly even shows a loss in the third month when the taxes are paid.

To see how these two approaches can result in totally different financial statements, imagine that a carpenter contracts a job with a total cost to the customer of $2,000. The carpenter's expected expenses for the supplies, labor, and other necessities are $1,200, so his expected profit is $800. He contracts the work on December 23, 2004, and completes the job on December 31, 2004. But he isn't paid until January 3, 2005. The contractor takes no dollars upfront and instead agrees to be paid in full at completion.

If he uses the cash-basis accounting method,Microsoft Office Standard 2007, because no cash changes hands, the carpenter doesn't have to report any revenues from this transaction in 2004. But say he lays out the cash for his expenses in 2004. In this case, his bottom line is $1,200 less with no revenue to offset it, and his net profit (the amount of money the organization earned, minus its expenses) for the organization in 2004 is lower. This scenario may not necessarily be a bad thing if he's trying to reduce his tax hit for 2004.

If you're a small-business owner looking to manage your tax bill and you use cash-basis accounting, you can ask vendors to hold off payments until the beginning of the next year to reduce your net income, if you want to lower your tax payments for the year.

If the same carpenter uses accrual accounting, his bottom line is different. In this case, he books his expenses when they're actually incurred. He also records the income when he completes the job on December 31, 2004, even though he doesn't get the funds payment until 2005. His net income is increased by this job, and so is his tax hit.