Bond Engineering should report its financial performance periodically. To achieve this, the company needs to keep an up to date financial records of all the transactions that take place during the entire life of the business. These transactions are recorded in various ledger accounts. At the end of a financial year, the books of accounts are closed and the final reports are prepared. Further, a business needs to prepare the books of accounts and the financial statement using a stipulated set of accounting standards. Basically, financial reporting is the language that communicates the financial standing of a company. The three main aspects of reporting are financial position, results of operations, and disclosures. Therefore, Steve, the owner of the company, prepares the financial statements for Bond Engineering periodically. The paper seeks to discuss the various aspects of accounting for a new business.
Role of GAAP in accounting
The Financial Accounting and Standards Board (FASB) develops the Generally Accepted Accounting Principles (GAAP). GAAP gives directions on how entities should prepare and present their financial statements (Kieso, Weygandt & Warfield 2011). Specifically, it provides information on how various transactions are recognized in the financial statements, the amounts to be reported, the line items in the financial statements, subtotals, and totals to be shown in the financial statements and the information to be disclosed. Companies are required to use GAAP so that the stakeholders of an organization can find it easy to compare the results of various entities and to monitor results over a period of time. Besides, it enables the management team to monitor the performance of various divisions in a company (DuBrin 2008).
Purpose of trial balance
The trial balance is a statement that shows a summary of all ledger account balances at the end of a financial period. The main role of a trial balance is to check the correctness of entries made. If the debit and the credit entries do not match, then it implies that there is an error with the ledger accounts. This may create a problem when preparing the final statements. Therefore, it is not an account or a report that must be prepared. Besides, accounting software has eliminated the use of a trial balance as a bookkeeping tool (Williams, Haka, Bettner & Carcello 2010).
Capital and revenue expenditure
The amount spent on fixed assets can either be classified into capital or revenue expenditure. The separation of these two aids in knowing the correct amount that should be capitalized. Capital expenditure represents amounts that are spent on the purchase of a fixed asset. It also comprises the amounts spent subsequently with an aim of increasing the earning capacity of an asset. It is worth mentioning that the cost of an asset does not only include the purchase price, but it also contains other additional amounts spent on bringing an asset to a condition that it can be used to generate revenue. Further, a capital expenditure is incurred by a business once and it is expected that a stream of revenue will be generated from this expenditure. Examples of capital expenditures are net purchase price (less discount received), installation costs, legal charges, up-gradation costs, replacement costs, and delivery costs among others (Wood & Sangster 2008). The accounting entry for capital expenditure is to debit the fixed asset account and to credit the cash account (if the asset is bought on cash) or accounts payable (if the asset is bought on credit). Capital expenditures are recorded property, plant, and equipment in a statement of financial position. On the other hand, revenue expenditures are expensed straightaway (Weygandt, Kimmel & Kieso 2012). This is based on the fact that they need to match the revenue for the respective accounting period. The revenue expenditures are incurred on a regular basis. For instance, regular repairs on property, plant, and equipment are treated as revenue expenditure. Other items that are treated as revenue items are renewal expenses, insurance premiums, salaries, and office supplies among others. Revenue items are not supposed to be capitalized. Instead, they are recorded in the income statement in the same period they are incurred. The accounting entries for revenue expenditure is to debit the expense account and credit the cash account (if the expense is paid for using cash) or accounts payable (if payment for the expense is not made by the end of the financial year) (Abraham, Glynn, Murphy & Wilkinson 2010).
Depreciation and purpose
An asset that is purchased does not maintain the same value throughout the entire life of the business. It can either increase the value (when major renovations are done to it) or lose value. The loss in value is normal and can be caused by a number of factors such as wear and tear (Vance 2008). Thus, depreciation is a provision made by a business against the loss of value of an item of property, plant, and equipment while taking into account the useful life of an asset (Collier 2009). From a different perspective, depreciation is based on the accrual concept. Based on the accrual and matching concept, revenue should be matched with expenses for a specific period. Thus, the main purpose of depreciation is to allocate costs over a fixed period. Depreciation affects both the income statement and the financial standing of the business.
Working capital and its importance
Working capital is important for all businesses irrespective of size because it gives information on the liquidity of an entity. It shows the ability of the company to settle the short-term obligations using current assets (Siddiqui 2005). Working capital has a number of advantages. First, it strengthens the liquidity and solvency of a company. Secondly, it enhances the goodwill of a company (Collier 2009). The ability to make prompt payments creates and maintains the goodwill of a company. The third importance is that it facilitates the ability of a company to obtain a loan. Also, it enables a business to have a steady supply of raw materials. Finally, it maintains a smooth flow of operations and it enables a business to survive during crises such as during an economic meltdown (Brigham & Michael 2009).
Accruals and prepayments in accounting
“Financial statements are prepared based on the accrual basis of accounting” (Abraham, Glynn, Murphy & Wilkinson 2010). “This requires income and expenses to be recorded in the accounting period in which they relate” (Petty, Titman, Keown, Martin, Martin, Burrow & Nguyen 2012). Thus, adjustments need to be made for accruals and prepayments because accruals are expenses that have been incurred but payments have not been made. Thus, the expenses need to be recorded in the income statement while the amount owing will be treated as a liability in the balance sheet. On the other hand, prepayments are amounts paid for expenses that have not been incurred. Accruals and prepayments also apply in the case of income. Therefore, adjustments need to be made for these items because based on the accrual and matching principle they create current liabilities and assets. Accrual is different from the cash basis of accounting (Clarke 2012).
Dual aspect concept
The duality principle is the foundation of accounting. This principle accounts for the entire aspects of a transaction. It provides a basis for recording transactions in the books of account. The concept outlines that any type of transaction has a dual effect. This implies that a transaction should be recorded in two accounts. Thus, every debit entry has a corresponding and an equivalent credit entry (Horngren, Harrison, Oliver, Best, Fraser, Tan & Willett 2012). For instance, the double entry for the purchase of an asset for cash is to debit the asset account and credit the cash accounting with the same amount. Thus, “the principle is the basis of the double entry system in accounting” (Horngren, Harrison, Oliver, Best, Fraser, Tan & Willett 2012). Therefore, dual aspect theory enables accountants to detect errors and complete accounts. It also gives confirmation to accountants to record accounting entries in the opposite direction. Finally, the principle indicates that all financial transactions touch the accounting equation (Holmes, Sugden & Gee 2005).
Prudence is a concept that ensures that the correct amount of assets, income, and liabilities are recorded. The books of account can be inflated by overstating the assets and income and understating the expenses and liabilities. Even though there are uncertainties that surround business transactions, the prudence concept requires that all transactions should be recorded in time. Further, sound and prudent judgment should be made to counter the uncertainties. Examples of uncertain transactions are bad debts, contingent liabilities, and impairment of fixed assets, among others (Block & Hirt 2007).
Purpose of the journal and the use of suspense account
A journal is used to record the financial transactions of a business. It is known as a book of original entries because it captures all transactions. The transactions are recorded in the order of date. Transactions are often being recorded in journals before being posted to the ledger accounts. Examples of journals are cash receipts, cash payments, sales, general, and a purchase journals (Head & Watson 2009). In recent years, the use of computers has eliminated journals because transactions are recorded into accounts directly. The only journal that is still commonly being used is a general journal and it is used to record adjusting entries. A suspense account is used to provisionally record various transactions. This occurs when the correct account where such amounts can be recorded has not been established. Such amounts are moved from the suspense account once the correct account had been established. Also, a suspense account is used to balance a trial balance in case the debit and the credit side fail to agree. Once the error has been established and corrected, the trial balance is done away with (Arnold 2008).
Conclusion, recommendation, and suggestions
In the paper, various aspects of accounting were discussed. However, accounting is a broad subject and other important areas in accounting have not been discussed above. Steve needs to prepare the books of accounts and the financial results by the guidelines provided in the US GAAP. This will facilitate the comparison of performance with other companies and monitor the results over some time. As a recommendation, Steve needs to engage a professional in accounting matters to enable him to realize the benefits of accounting.
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