This method is used particularly for short-term decision-making. Its principal tenets are:
Revenue (per product) - Variable Costs (per product) = Contribution (per product)
Total Contribution - Total Fixed Costs = Total Profit or (Total Loss)
Thus it does not attempt to allocate fixed costs in an arbitrary manner to different products. The short-term objective is to maximize contribution per unit. If constraints exist on resources, then Managerial Accounting dictates that marginal cost analysis be employed to maximize contribution per unit of the constrained resource (see Development of Throughput Accounting, above).
Tuesday, July 21, 2009
Lean Accounting
Lean accounting [1] has developed in recent years to provide the accounting, control, and measurement methods supporting lean manufacturing and other applications of lean thinking such as healthcare, construction, insurance, banking, education, government, and other industries.
There are two main thrusts for Lean Accounting. The first is the application of lean methods to the company's accounting, control, and measurement processes. This is no different than applying lean methods to any other processes. The objective is to eliminate waste, free up capacity, speed up the process, eliminate errors & defects, and make the process clear and understandable.
The second (and more important) thrust of Lean Accounting is to fundamentally change the accounting, control, and measurement processes so they motivate lean change & improvement, provide information that is suitable for control and decision-making, provide an understanding of customer value, correctly assess the financial impact of lean improvement, and are themselves simple, visual, and low-waste. Lean Accounting does not require the traditional management accounting methods like standard costing, activity-based costing, variance reporting, cost-plus pricing, complex transactional control systems, and untimely & confusing financial reports. These are replaced by
lean-focused performance measurements
simple summary direct costing of the value streams
decision-making and reporting using a box score
financial reports that are timely and presented in "plain English" that everyone can understand
radical simplification and elimination of transactional control systems by eliminating the need for them
driving lean changes from a deep understanding of the value created for the customers
eliminating traditional budgeting through monthly sales, operations, and financial planning processes (SOFP)
value-based pricing
correct understanding of the financial impact of lean change
As an organization becomes more mature with lean thinking and methods, they recognize that the combined methods of Lean Accounting in fact creates a Lean Management System (LMS) designed to provide the planning, the operational and financial reporting, and the motivation for change required to prosper the company's on-going lean transformation
There are two main thrusts for Lean Accounting. The first is the application of lean methods to the company's accounting, control, and measurement processes. This is no different than applying lean methods to any other processes. The objective is to eliminate waste, free up capacity, speed up the process, eliminate errors & defects, and make the process clear and understandable.
The second (and more important) thrust of Lean Accounting is to fundamentally change the accounting, control, and measurement processes so they motivate lean change & improvement, provide information that is suitable for control and decision-making, provide an understanding of customer value, correctly assess the financial impact of lean improvement, and are themselves simple, visual, and low-waste. Lean Accounting does not require the traditional management accounting methods like standard costing, activity-based costing, variance reporting, cost-plus pricing, complex transactional control systems, and untimely & confusing financial reports. These are replaced by
lean-focused performance measurements
simple summary direct costing of the value streams
decision-making and reporting using a box score
financial reports that are timely and presented in "plain English" that everyone can understand
radical simplification and elimination of transactional control systems by eliminating the need for them
driving lean changes from a deep understanding of the value created for the customers
eliminating traditional budgeting through monthly sales, operations, and financial planning processes (SOFP)
value-based pricing
correct understanding of the financial impact of lean change
As an organization becomes more mature with lean thinking and methods, they recognize that the combined methods of Lean Accounting in fact creates a Lean Management System (LMS) designed to provide the planning, the operational and financial reporting, and the motivation for change required to prosper the company's on-going lean transformation
Activity-based costing
Activity-based costing (ABC) is a system for assigning costs to products based on the activities they require. In this case, activities are those regular actions performed inside a company. "Talking with customer regarding invoice questions" is an example of an activity performed inside most companies.
Accountants assign 100% of each employee's time to the different activities performed inside a company (many will use surveys to have the workers themselves assign their time to the different activities). The accountant then can determine the total cost spent on each activity by summing up the percentage of each worker's salary spent on that activity.
A company can use the resulting activity cost data to determine where to focus their operational improvements. For example, a job-based manufacturer may find that a high percentage of its workers are spending their time trying to figure out a hastily written customer order. Via ABC, the accountants now have a currency amount pegged to the activity of "Researching Customer Work Order Specifications". Senior management can now decide how much focus or money to budget for resolving this process deficiency. Activity-based management includes (but is not restricted to) the use of activity-based costing to manage a business.
While ABC may be able to pinpoint the cost of each activity and resources into the ultimate product, the process could be tedious, costly and subject to errors.
As it is a tool for a more accurate way of allocating fixed costs into product, these fixed costs do not vary according to each month's production volume. For example, an elimination of one product would not eliminate the overhead or even direct labor cost assigned to it. ABC better identifies product costing in the long run, but may not be too helpful in day-to-day decision-making.
Accountants assign 100% of each employee's time to the different activities performed inside a company (many will use surveys to have the workers themselves assign their time to the different activities). The accountant then can determine the total cost spent on each activity by summing up the percentage of each worker's salary spent on that activity.
A company can use the resulting activity cost data to determine where to focus their operational improvements. For example, a job-based manufacturer may find that a high percentage of its workers are spending their time trying to figure out a hastily written customer order. Via ABC, the accountants now have a currency amount pegged to the activity of "Researching Customer Work Order Specifications". Senior management can now decide how much focus or money to budget for resolving this process deficiency. Activity-based management includes (but is not restricted to) the use of activity-based costing to manage a business.
While ABC may be able to pinpoint the cost of each activity and resources into the ultimate product, the process could be tedious, costly and subject to errors.
As it is a tool for a more accurate way of allocating fixed costs into product, these fixed costs do not vary according to each month's production volume. For example, an elimination of one product would not eliminate the overhead or even direct labor cost assigned to it. ABC better identifies product costing in the long run, but may not be too helpful in day-to-day decision-making.
Standard Cost Accounting
In modern cost accounting, the concept of recording historical costs was taken further, by allocating the company's fixed costs over a given period of time to the items produced during that period, and recording the result as the total cost of production. This allowed the full cost of products that were not sold in the period they were produced to be recorded in inventory using a variety of complex accounting methods, which was consistent with the principles of GAAP (Generally Accepted Accounting Principles). It also essentially enabled managers to ignore the fixed costs, and look at the results of each period in relation to the "standard cost" for any given product.
For example: if the railway coach company normally produced 40 coaches per month, and the fixed costs were still $1000/month, then each coach could be said to incur an overhead of $25 ($1000/40). Adding this to the variable costs of $300 per coach produced a full cost of $325 per coach.
This method tended to slightly distort the resulting unit cost, but in mass-production industries that made one product line, and where the fixed costs were relatively low, the distortion was very minor.
For example: if the railway coach company made 100 coaches one month, then the unit cost would become $310 per coach ($300 + ($1000/100)). If the next month the company made 50 coaches, then the unit cost = $320 per coach ($300 + ($1000/50)), a relatively minor difference.
An important part of standard cost accounting is a variance analysis which breaks down the variation between actual cost and standard costs into various components (volume variation, material cost variation, labor cost variation, etc.) so managers can understand why costs were different from what was planned and take appropriate action to correct the situation
For example: if the railway coach company normally produced 40 coaches per month, and the fixed costs were still $1000/month, then each coach could be said to incur an overhead of $25 ($1000/40). Adding this to the variable costs of $300 per coach produced a full cost of $325 per coach.
This method tended to slightly distort the resulting unit cost, but in mass-production industries that made one product line, and where the fixed costs were relatively low, the distortion was very minor.
For example: if the railway coach company made 100 coaches one month, then the unit cost would become $310 per coach ($300 + ($1000/100)). If the next month the company made 50 coaches, then the unit cost = $320 per coach ($300 + ($1000/50)), a relatively minor difference.
An important part of standard cost accounting is a variance analysis which breaks down the variation between actual cost and standard costs into various components (volume variation, material cost variation, labor cost variation, etc.) so managers can understand why costs were different from what was planned and take appropriate action to correct the situation
Origin Of Cost Accounting
Cost accounting has long been used to help managers understand the costs of running a business. Modern cost accounting originated during the industrial revolution, when the complexities of running a large scale business led to the development of systems for recording and tracking costs to help business owners and managers make decisions.
In the early industrial age, most of the costs incurred by a business were what modern accountants call "variable costs" because they varied directly with the amount of production. Money was spent on labor, raw materials, power to run a factory, etc. in direct proportion to production. Managers could simply total the variable costs for a product and use this as a rough guide for decision-making processes.
Some costs tend to remain the same even during busy periods, unlike variable costs which rise and fall with volume of work. Over time, the importance of these "fixed costs" has become more important to managers. Examples of fixed costs include the depreciation of plant and equipment, and the cost of departments such as maintenance, tooling, production control, purchasing, quality control, storage and handling, plant supervision and engineering. In the early twentieth century, these costs were of little importance to most businesses. However, in the twenty-first century, these costs are often more important than the variable cost of a product, and allocating them to a broad range of products can lead to bad decision making. Managers must understand fixed costs in order to make decisions about products and pricing.
For example: A company produced railway coaches and had only one product. To make each coach, the company needed to purchase $60 of raw materials and components, and pay 6 laborers $40 each. Therefore, total variable cost for each coach was $300. Knowing that making a coach required spending $300, managers knew they couldn't sell below that price without losing money on each coach. Any price above $300 became a contribution to the fixed costs of the company. If the fixed costs were, say, $1000 per month for rent, insurance and owner's salary, the company could therefore sell 5 coaches per month for a total of $3000 (priced at $600 each), or 10 coaches for a total of $4500 (priced at $450 each), and make a profit of $500 in both cases.
In the early industrial age, most of the costs incurred by a business were what modern accountants call "variable costs" because they varied directly with the amount of production. Money was spent on labor, raw materials, power to run a factory, etc. in direct proportion to production. Managers could simply total the variable costs for a product and use this as a rough guide for decision-making processes.
Some costs tend to remain the same even during busy periods, unlike variable costs which rise and fall with volume of work. Over time, the importance of these "fixed costs" has become more important to managers. Examples of fixed costs include the depreciation of plant and equipment, and the cost of departments such as maintenance, tooling, production control, purchasing, quality control, storage and handling, plant supervision and engineering. In the early twentieth century, these costs were of little importance to most businesses. However, in the twenty-first century, these costs are often more important than the variable cost of a product, and allocating them to a broad range of products can lead to bad decision making. Managers must understand fixed costs in order to make decisions about products and pricing.
For example: A company produced railway coaches and had only one product. To make each coach, the company needed to purchase $60 of raw materials and components, and pay 6 laborers $40 each. Therefore, total variable cost for each coach was $300. Knowing that making a coach required spending $300, managers knew they couldn't sell below that price without losing money on each coach. Any price above $300 became a contribution to the fixed costs of the company. If the fixed costs were, say, $1000 per month for rent, insurance and owner's salary, the company could therefore sell 5 coaches per month for a total of $3000 (priced at $600 each), or 10 coaches for a total of $4500 (priced at $450 each), and make a profit of $500 in both cases.
History
Early history
Accountancy's infancy dates back to the earliest days of human agriculture and civilization (the Sumerians in Mesopotamia, and the Egyptian Old Kingdom). Ancient economic thought of the Near East facilitated the creation of accurate records of the quantities and relative values of agricultural products, methods that were formalized in trading and monetary systems by 2000 B.C. Simple accounting is mentioned in the Christian Bible (New Testament) in the Book of Matthew, in the Parable of the Talents.[4] The Islamic Quran also mentions simple accounting for trade and credit arrangements.[5]
In the twelfth-century A.D., the Arab writer, Ibn Taymiyyah, mentioned in his book Hisba (literally, "verification" or "calculation") detailed accounting systems used by Muslims as early as in the mid-seventh century A.D. These accounting practices were influenced by the Roman and the Persian civilizations that Muslims interacted with. The most detailed example Ibn Taymiyyah provides of a complex governmental accounting system is the Divan of Umar, the second Caliph of Islam, in which all revenues and disbursements were recorded. The Divan of Umar has been described in detail by various Islamic historians and was used by Muslim rulers in the Middle East with modifications and enhancements until the fall of the Ottoman Empire.
The development of mathematics and accounting were intertwined during the Renaissance. Mathematics was in the midst of a period of significant development in the late-15th century. Hindu-Arabic numerals and algebra were introduced to Europe from Arab mathematics at the end of the 10th century by the Benedictine monk Gerbert of Aurillac, but it was only after Leonardo Pisano (also known as Fibonacci) put commercial arithmetic, Hindu-Arabic numerals, and the rules of algebra together in his Liber Abaci in 1202 that Hindu-Arabic numerals became widely used in Italy.[6]
[edit] Luca Pacioli and the birth of modern accountancy
Pacioli's portrait, a painting by Jacopo de' Barbari, 1495, (Museo di Capodimonte).[7]Luca Pacioli’s mathematics compendium, "Summa de Arithmetica, Geometria, Proportioni et Proportionalità" (trans. Review of Arithmetic, Geometry, Ratio and Proportion) was first printed and published in Venice in 1494. It included a 27-page treatise on bookkeeping, "Particularis de Computis et Scripturis" (trans. Details of Accounting and Recording). It was written primarily for, and sold mainly to, merchants who used the book as a reference text, as a source of pleasure from the mathematical puzzles it contained, and to aid the education of their sons. It represents the first known printed treatise on bookkeeping; and it is widely believed to be the forerunner of modern bookkeeping practice. In Summa Arithmetica, Pacioli introduced symbols for plus and minus for the first time in a printed book, symbols that became standard notation in Italian Renaissance mathematics. Summa Arithmetica was also the first known book printed in Italy to contain algebra.[8]
Double-entry is defined as any bookkeeping system in which there was a debit and credit entry for each transaction, or for which the majority of transactions were intended to be of this form.[9] Pacioli's 27-page treatise on bookkeeping contained the first known published work on that topic, and is said to have laid the foundation for double-entry bookkeeping as it is practiced today.[10]
[edit] Post-Pacioli
The first known book in the English language on accounting was published in London, England by John Gouge (or Gough) in 1543. It is described as A Profitable Treatyce called the Instrument or Boke to learn to know the good order of the kepyng of the famous reconynge, called in Latin, Dare and Habere, and, in English, debtor and Creditor.[citation needed]
A short book of instructions was also published in 1588 by John Mellis of Southwark, England, in which he says, "I am but the renuer and reviver of an ancient old copies printed here in London the 14 of August 1543: collected, published, made, and set forth by one Hugh Oldcastle, Schoolmaster, who, as reappeared by his treatise, then taught Arithmetics, and this booke in Saint Ollaves parish in Marko Lane." Mellis refers to the fact that the principle of accounts he explains (which is a simple system of double entry) is "after the former of Venice".
A book described as The Merchants Mirrour, or directions for the perfect ordering and keeping of his accounts formed by way of Debtor and Creditor, after the (so termed) Italian manner, by Richard Dafforne, accountant, published in 1635, contains many references to early books on the science of accountancy. In a chapter in this book, headed "Opinion of Book-keeping's Antiquity," the author states, on the authority of another writer, that the form of book-keeping referred to had then been in use in Italy about two hundred years, "but that the same, or one in many parts very like this, was used in the time of Julius Caesar, and in Rome long before." He gives quotations of Latin book-keeping terms in use in ancient times, and refers to "ex Oratione Ciceronis pro Roscio Comaedo"; and he adds:
"That the one side of their booke was used for Debitor, the other for Creditor, is manifest in a certain place, Naturalis Historiae Plinii, lib. 2, cap. 7, where hee, speaking of Fortune, saith thus:
Huic Omnia Expensa.
Huic Omnia Feruntur accepta et in tota Ratione mortalium sola.
Utramque Paginam facit."
An early Dutch writer appears to have suggested that double-entry book-keeping was even in existence among the Greeks, pointing to scientific accountancy having been invented in remote times.
There were several editions of Richard Dafforne's book - the second edition in 1636, the third in 1656, and another in 1684. The book is a very complete treatise on scientific accountancy, beautifully prepared and containing elaborate explanations. The numerous editions tend to prove that the science was highly appreciated in the 17th century. From this time on, there has been a continuous supply of literature on the subject, many of the authors styling themselves accountants and teachers of the art, and thus proving that the professional accountant was then known and employed.
Accountancy's infancy dates back to the earliest days of human agriculture and civilization (the Sumerians in Mesopotamia, and the Egyptian Old Kingdom). Ancient economic thought of the Near East facilitated the creation of accurate records of the quantities and relative values of agricultural products, methods that were formalized in trading and monetary systems by 2000 B.C. Simple accounting is mentioned in the Christian Bible (New Testament) in the Book of Matthew, in the Parable of the Talents.[4] The Islamic Quran also mentions simple accounting for trade and credit arrangements.[5]
In the twelfth-century A.D., the Arab writer, Ibn Taymiyyah, mentioned in his book Hisba (literally, "verification" or "calculation") detailed accounting systems used by Muslims as early as in the mid-seventh century A.D. These accounting practices were influenced by the Roman and the Persian civilizations that Muslims interacted with. The most detailed example Ibn Taymiyyah provides of a complex governmental accounting system is the Divan of Umar, the second Caliph of Islam, in which all revenues and disbursements were recorded. The Divan of Umar has been described in detail by various Islamic historians and was used by Muslim rulers in the Middle East with modifications and enhancements until the fall of the Ottoman Empire.
The development of mathematics and accounting were intertwined during the Renaissance. Mathematics was in the midst of a period of significant development in the late-15th century. Hindu-Arabic numerals and algebra were introduced to Europe from Arab mathematics at the end of the 10th century by the Benedictine monk Gerbert of Aurillac, but it was only after Leonardo Pisano (also known as Fibonacci) put commercial arithmetic, Hindu-Arabic numerals, and the rules of algebra together in his Liber Abaci in 1202 that Hindu-Arabic numerals became widely used in Italy.[6]
[edit] Luca Pacioli and the birth of modern accountancy
Pacioli's portrait, a painting by Jacopo de' Barbari, 1495, (Museo di Capodimonte).[7]Luca Pacioli’s mathematics compendium, "Summa de Arithmetica, Geometria, Proportioni et Proportionalità" (trans. Review of Arithmetic, Geometry, Ratio and Proportion) was first printed and published in Venice in 1494. It included a 27-page treatise on bookkeeping, "Particularis de Computis et Scripturis" (trans. Details of Accounting and Recording). It was written primarily for, and sold mainly to, merchants who used the book as a reference text, as a source of pleasure from the mathematical puzzles it contained, and to aid the education of their sons. It represents the first known printed treatise on bookkeeping; and it is widely believed to be the forerunner of modern bookkeeping practice. In Summa Arithmetica, Pacioli introduced symbols for plus and minus for the first time in a printed book, symbols that became standard notation in Italian Renaissance mathematics. Summa Arithmetica was also the first known book printed in Italy to contain algebra.[8]
Double-entry is defined as any bookkeeping system in which there was a debit and credit entry for each transaction, or for which the majority of transactions were intended to be of this form.[9] Pacioli's 27-page treatise on bookkeeping contained the first known published work on that topic, and is said to have laid the foundation for double-entry bookkeeping as it is practiced today.[10]
[edit] Post-Pacioli
The first known book in the English language on accounting was published in London, England by John Gouge (or Gough) in 1543. It is described as A Profitable Treatyce called the Instrument or Boke to learn to know the good order of the kepyng of the famous reconynge, called in Latin, Dare and Habere, and, in English, debtor and Creditor.[citation needed]
A short book of instructions was also published in 1588 by John Mellis of Southwark, England, in which he says, "I am but the renuer and reviver of an ancient old copies printed here in London the 14 of August 1543: collected, published, made, and set forth by one Hugh Oldcastle, Schoolmaster, who, as reappeared by his treatise, then taught Arithmetics, and this booke in Saint Ollaves parish in Marko Lane." Mellis refers to the fact that the principle of accounts he explains (which is a simple system of double entry) is "after the former of Venice".
A book described as The Merchants Mirrour, or directions for the perfect ordering and keeping of his accounts formed by way of Debtor and Creditor, after the (so termed) Italian manner, by Richard Dafforne, accountant, published in 1635, contains many references to early books on the science of accountancy. In a chapter in this book, headed "Opinion of Book-keeping's Antiquity," the author states, on the authority of another writer, that the form of book-keeping referred to had then been in use in Italy about two hundred years, "but that the same, or one in many parts very like this, was used in the time of Julius Caesar, and in Rome long before." He gives quotations of Latin book-keeping terms in use in ancient times, and refers to "ex Oratione Ciceronis pro Roscio Comaedo"; and he adds:
"That the one side of their booke was used for Debitor, the other for Creditor, is manifest in a certain place, Naturalis Historiae Plinii, lib. 2, cap. 7, where hee, speaking of Fortune, saith thus:
Huic Omnia Expensa.
Huic Omnia Feruntur accepta et in tota Ratione mortalium sola.
Utramque Paginam facit."
An early Dutch writer appears to have suggested that double-entry book-keeping was even in existence among the Greeks, pointing to scientific accountancy having been invented in remote times.
There were several editions of Richard Dafforne's book - the second edition in 1636, the third in 1656, and another in 1684. The book is a very complete treatise on scientific accountancy, beautifully prepared and containing elaborate explanations. The numerous editions tend to prove that the science was highly appreciated in the 17th century. From this time on, there has been a continuous supply of literature on the subject, many of the authors styling themselves accountants and teachers of the art, and thus proving that the professional accountant was then known and employed.
Types of accounting
Financial accounting is "a major branch of accounting involving the collection, recording and extraction of financial information, and the summary of it in the form of a periodic profit and loss account, a balance sheet and a cash flow statement in accordance with legal, professional, and capital market requirements".[11]
Management accounting is another branch of accounting performed within an organization to provide information only accessible to its decision-makers.
Open-book accounting is an accounting principle that aims to improve accounting transparency of organizations.
Tax accounting is the accounting needed to comply with jurisdictional tax regulations.
Accounting scholarship is the academic discipline which studies the theory of accountancy.
The related, but separate financial audit comprises internal audit and external audit. External audit—carried out by independent auditors—examines the financial statements and accounting records in order to express an opinion as to the truth and fairness and adherence to Generally Accepted Accounting Principles (GAAP). Commonly used GAAP include the US Financial Accounting Standards Board (FASB), which issues FASB Pronouncements including Statements of Accounting Standards, and the International Accounting Standards Board (IASB), which issues International Financial Reporting Standards (IFRS). Many other countries have instituted local standards resulting in a local country GAAP. Internal audit aims at providing information for management usage, and is typically carried out by employees.
Management accounting is another branch of accounting performed within an organization to provide information only accessible to its decision-makers.
Open-book accounting is an accounting principle that aims to improve accounting transparency of organizations.
Tax accounting is the accounting needed to comply with jurisdictional tax regulations.
Accounting scholarship is the academic discipline which studies the theory of accountancy.
The related, but separate financial audit comprises internal audit and external audit. External audit—carried out by independent auditors—examines the financial statements and accounting records in order to express an opinion as to the truth and fairness and adherence to Generally Accepted Accounting Principles (GAAP). Commonly used GAAP include the US Financial Accounting Standards Board (FASB), which issues FASB Pronouncements including Statements of Accounting Standards, and the International Accounting Standards Board (IASB), which issues International Financial Reporting Standards (IFRS). Many other countries have instituted local standards resulting in a local country GAAP. Internal audit aims at providing information for management usage, and is typically carried out by employees.
acccounting scandals
The year 2001 witnessed a series of financial information frauds involving Enron Corporation, auditing firm Arthur Andersen, the telecommunications company WorldCom, Qwest and Sunbeam, among other well-known corporations. These problems highlighted the need to review the effectiveness of accounting standards, auditing regulations and corporate governance principles. In some cases, management manipulated the figures shown in financial reports to indicate a better economic performance. In others, tax and regulatory incentives encouraged over-leveraging of companies and decisions to bear extraordinary and unjustified risk.[12]
The Enron scandal deeply influenced the development of new regulations to improve the reliability of financial reporting, and increased public awareness about the importance of having accounting standards that show the financial reality of companies and the objectivity and independence of auditing firms.[13]
In addition to being the largest bankruptcy reorganization in American history, the Enron scandal undoubtedly is the biggest audit failure.[14] The scandal caused the dissolution of Arthur Andersen, which at the time was one of the five largest accounting firms in the world.It involved a financial scandal of Enron Corporation and their auditors Arthur Andersen, which was revealed in late 2001. After a series of revelations involving irregular accounting procedures conducted throughout the 1990s, Enron filed for Chapter 11 bankruptcy protection in December 2001[15].
One consequence of these events was the passage of Sarbanes-Oxley Act in 2002, as a result of the first admissions of fraudulent behavior made by Enron. The act significantly raises criminal penalties for securities fraud, for destroying, altering or fabricating records in federal investigations or any scheme or attempt to defraud shareholders.[16]
The Enron scandal deeply influenced the development of new regulations to improve the reliability of financial reporting, and increased public awareness about the importance of having accounting standards that show the financial reality of companies and the objectivity and independence of auditing firms.[13]
In addition to being the largest bankruptcy reorganization in American history, the Enron scandal undoubtedly is the biggest audit failure.[14] The scandal caused the dissolution of Arthur Andersen, which at the time was one of the five largest accounting firms in the world.It involved a financial scandal of Enron Corporation and their auditors Arthur Andersen, which was revealed in late 2001. After a series of revelations involving irregular accounting procedures conducted throughout the 1990s, Enron filed for Chapter 11 bankruptcy protection in December 2001[15].
One consequence of these events was the passage of Sarbanes-Oxley Act in 2002, as a result of the first admissions of fraudulent behavior made by Enron. The act significantly raises criminal penalties for securities fraud, for destroying, altering or fabricating records in federal investigations or any scheme or attempt to defraud shareholders.[16]
Monday, July 20, 2009
The philosophy of accounting
The philosophy of accounting is the conceptual framework for the professional preparation and auditing of financial statements and accounts. The issues which arise include the difficulty of establishing a true and fair value of an enterprise and its assets; the moral basis of disclosure and discretion; the standards and laws required to satisfy the political needs of investors, employees and other stakeholders.
accounting principles
Financial accounting is information that must be assembled and reported objectively. Third-parties who must rely on such information have a right to be assured that the data are free from bias and inconsistency, whether deliberate or not. For this reason, financial accounting relies on certain standards or guides that are called "Generally Accepted Accounting Principles" (GAAP).
Principles derive from tradition, such as the concept of matching. In any report of financial statements (audit, compilation, review, etc.), the preparer/auditor must indicate to the reader whether or not the information contained within the statements complies with GAAP.
Principle of regularity: Regularity can be defined as conformity to enforced rules and laws.
Principle of consistency: The consistency principle requires accountants to apply the same methods and procedures from period to period.
Principle of sincerity: According to this principle, the accounting unit should reflect in good faith the reality of the company's financial status.
Principle of the permanence of methods: This principle aims at allowing the coherence and comparison of the financial information published by the company.
Principle of non-compensation: One should show the full details of the financial information and not seek to compensate a debt with an asset, a revenue with an expense, etc.
Principle of prudence: This principle aims at showing the reality "as is" : one should not try to make things look prettier than they are. Typically, a revenue should be recorded only when it is certain and a provision should be entered for an expense which is probable.
Principle of continuity: When stating financial information, one should assume that the business will not be interrupted. This principle mitigates the principle of prudence: assets do not have to be accounted at their disposable value, but it is accepted that they are at their historical value (see depreciation).
Principle of periodicity: Each accounting entry should be allocated to a given period, and split accordingly if it covers several periods. If a client pre-pays a subscription (or lease, etc.), the given revenue should be split to the entire time-span and not counted for entirely on the date of the transaction.
Principle of Full Disclosure/Materiality: All information and values pertaining to the financial position of a business must be disclosed in the records.
Principles derive from tradition, such as the concept of matching. In any report of financial statements (audit, compilation, review, etc.), the preparer/auditor must indicate to the reader whether or not the information contained within the statements complies with GAAP.
Principle of regularity: Regularity can be defined as conformity to enforced rules and laws.
Principle of consistency: The consistency principle requires accountants to apply the same methods and procedures from period to period.
Principle of sincerity: According to this principle, the accounting unit should reflect in good faith the reality of the company's financial status.
Principle of the permanence of methods: This principle aims at allowing the coherence and comparison of the financial information published by the company.
Principle of non-compensation: One should show the full details of the financial information and not seek to compensate a debt with an asset, a revenue with an expense, etc.
Principle of prudence: This principle aims at showing the reality "as is" : one should not try to make things look prettier than they are. Typically, a revenue should be recorded only when it is certain and a provision should be entered for an expense which is probable.
Principle of continuity: When stating financial information, one should assume that the business will not be interrupted. This principle mitigates the principle of prudence: assets do not have to be accounted at their disposable value, but it is accepted that they are at their historical value (see depreciation).
Principle of periodicity: Each accounting entry should be allocated to a given period, and split accordingly if it covers several periods. If a client pre-pays a subscription (or lease, etc.), the given revenue should be split to the entire time-span and not counted for entirely on the date of the transaction.
Principle of Full Disclosure/Materiality: All information and values pertaining to the financial position of a business must be disclosed in the records.
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