Free Custom «Methods of Accounting» Essay Paper

An accounting method is any given set of rules used in determining the appropriate time and technique to report income and expenses in a firm’s books of records and also in its income tax returns. The most widespread methods of accounting globally are cash and accrual accounting methods of accounting. Cash accounting system reports income and expenses in the financial year that they are received and paid.  However, the accrual accounting system of accounting reports income and expenses in the year they are earned and incurred respectively. Choosing the most suitable and suiting method of accounting is fundamental, as the choice may have major consequences on the amount of taxes a firm or business entity pays to the government, and also it determines how much finances a business may acquire.

In cash basis method of accounting, a firm record expenses in financial accounts when cash is actually laid out, and they book revenue when they actually hold the cash or when it gets in a bank account. For example, if a plumber working inside a firm completed a project in December 15, 2011, but receives payment in January 10, 2012, the plumber reports those cash earnings on his 2012 tax report. In the system of cash-basis accounting, cash income is included among other cheques, receipts from credit-cards, or any other available forms of revenue earnings from customers (Whittington, 2010). Small entrepreneurial firms that are yet to fully establish or incorporate, mostly use cash-basis accounting because the system is quite easy for them to use on their own, meaning they don't have to hire a large number of accounting employees to perform the work. This reduces cost of running their business.

 

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When a firm opts to use accrual system of accounting, it records revenue earned when the real transaction is concluded (for example, the conclusion of work specified in the contract agreement between the customer and the company), not when the cash is received. That means that, the company records revenue when it earns it, even if the customer has not paid yet, therefore, it is a premature transaction. For example, a contractor who uses accrual accounting records the revenue earned when he/she completes the job, even if the customer hasn't paid the final invoice yet. The same happens to expenses. The firm records any expenses when they're incurred, even if it hasn't paid for the supplies yet. For instance, when a plumber buys pipes for a job, he/she most likely buys on account and not actually lay out the cash for the pipes until when he/she gets the bill. All incorporated companies must use accrual accounting, according to the generally accepted accounting principles (GAAP) (Deloitte, 2008). An incorporated firm’s financial report is based on accrual accounting.

There exist general rules and concepts that govern the accounting sector. These general rules are commonly referred to as basic accounting principles. They form the basis on which more accounting rules are based (Arnould, 1972). The generally accepted accounting principles (GAAP) contain a number of imperative sets of rules and regulations: the fundamental accounting principles and course of action, the detailed rules and principles issued by FASB and its forerunner the Accounting Principles Board (APB), and the Generally Accepted Industry Practices (GAIP). If a firm distributes its financial statements to the public, it is required to follow Generally Accepted Accounting Principles in the preparation of those financial statements. Furthermore, if a company's stock is publicly traded, federal law requires the company's financial statements to be audited by independent public accountants. Both parties (i.e. the company's management and the independent accountants) must confirm that the financial statements and the associated notes to the financial statements have been organized in accordance with GAAP (Whittington, 2010).

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History of Accounting

Unlike how most other modern professions in the world today are defined, accounting has a history that is usually discussed in terms of one seminal event that is the discovery and propagation of the double entry bookkeeping system of accounting (Arnould, 1972). About 5000 years previous to the emergence of double entry, the Assyrian, Babylonian and Sumerian civilizations were thriving in the MesopotamianValley, producing some of the oldest known records of business and accounting. As farmers thrived, service businesses and small industries emerged in the environment in and around the MesopotamianValley. Mesopotamia began employing standard measures of gold and silver, and extending credit in some transactions.

Around the 11^th through 13^th centuries (AD) after the crusades, there was a dramatic increase in trade between Europe and the Middle East. Italy became the centre/intersection for this trade. Business or corporate owners needed to know how well their business supervisors were managing (Armstrong, 1985).  They had to rely on written records. There was a dire need for better account keeping. This was escalated by the fact that businesses were expanding drastically in size and distance and therefore, owners could no longer control everything by themselves. This led to the first major advancement in accounting. The Modern accounting (“double-entry” system) was developed in the Italian city-states. In Genoa, the Genoese system assumed the concept of a “business entity” which used “money” to record transactions, so unlike items, could be compared in common terms. It distinguished between capitals (owner’s investment) profits (earnings of the business). In Florence, gold florin was accepted as a standard coin across Europe. Large associations and partnerships were developed that pooled capital and distinguished between individual partner’s capital accounts. In addition, it allocated profits and losses between partners. Venice perfected double-entry accounting system. “The Summa” written by Luca Pacioli in 1494 publicized the Method of Venice and helped to spread literacy in the middle class. Luca Pacioli did not invent double-entry accounting but assisted in spreading the knowledge. The double accounting system, a binary method for recording economic events, invented the “debit” and “credit” concepts. This allowed for much easier addition and subtraction before invention of calculators. As businesses expanded in physical size, degree of mechanization, and number of employees, firms began operating as corporations to bring in funds from outsiders in form of stocks and bonds.Double-entry accounting spread throughout the world and accountants in each country adapted accounting practices to suit the cultures, laws & regulations of the particular country. The final development was the creation of international accounting standards and harmonization of accounting and reporting that is effective up to date (Whittington, 2010).