Accounting For Dummies. John A. Tracy

to know what’s going on. Therefore, we need to have a good grip on the financial statements included in the financial reports. For all practical purposes, financial reports are the only source of financial information we get directly from a business or other organization.

      By the way, the employees of a business — even though they obviously have a stake in the success of the business — don’t necessarily receive its financial reports. Only the investors in the business and its lenders are entitled to receive the financial reports. Of course, a business could provide this information to employees who aren’t shareowners, but generally speaking, most businesses do not. The financial reports of public businesses are in the public domain, so their employees can easily secure a copy. However, most businesses don’t automatically mail financial reports to all employees.

      In your personal financial life, a little accounting knowledge is a big help for understanding investing in general, how investment performance is measured, and many other important financial topics. With some basic accounting knowledge, you’ll sound much more sophisticated when speaking with your banker or broker. We can’t promise you that learning accounting will save you big bucks on your income taxes, but it can’t hurt and will definitely help you understand what your tax preparer is talking about.

This is not a book on bookkeeping and recordkeeping systems. We offer a brief explanation of procedures for capturing, processing, and storing accounting information in Chapter 3. Even experienced bookkeepers and accountants should find some useful nuggets in that chapter. However, this book is directed to users of accounting information. We focus on the end products of accounting, particularly financial statements, and not on how information is accumulated. When buying a new car, you’re interested in the finished product, not details of the manufacturing process that produced it.

      Using accounting in your personal financial life

      We’re sure you know the value of learning personal finance and investing fundamentals. (Given the big push these days on improving financial literacy, we recommend Personal Finance For Dummies and Investing For Dummies by Eric Tyson, MBA, both published by Wiley.) A great deal of the information you use in making personal finance and investment decisions is accounting information. However, we do have one knock on books in these areas: They don’t make clear that you need a solid understanding of financial statements to make good use of the financial information.

      

We’ve noticed that a sizable percent of the populace bash the profit motive and seem to think businesses should not make a profit. We would remind you, however, that you have a stake in the financial performance of the business you work for, the government entities you pay taxes to, the churches and charitable organizations you donate money to, the retirement plan you participate in, the businesses you buy from, and the healthcare providers you depend on. The financial performance and viability of these entities has a direct bearing on your personal financial life and well-being.

      We’re all affected by the profit performance of businesses, even though we may not be fully aware of just how their profit performance affects our jobs, investments, and taxes. For example, as an employee, your job security and your next raise depend on the business’s making a profit. If the business suffers a loss, you may be laid off or asked to take a reduction in pay or benefits. Business managers get paid to make profit happen. If the business fails to meet its profit objectives or suffers a loss, its managers may be replaced (or at least not get their bonuses). As authors, we hope our publisher continues to make a profit so we can keep receiving our royalty checks.

      Your investments in businesses, whether direct or through retirement accounts and mutual funds, suffer if the businesses don’t turn a profit. We hope the stores we trade with make profit and continue in business. The federal government and most states depend on businesses making profit so they can collect income taxes from them.

Accounting extends into many nooks and crannies of your life. You’re doing accounting when you make entries in your checkbook and when you fill out your federal income tax return. When you sign a mortgage on your home, you should understand the accounting method the lender uses to calculate the interest amount charged on your loan each period. Individual investors need to understand accounting basics in order to figure their return on invested capital. And it goes without saying that every organization, profit-motivated or not, needs to know how it stands financially.

      Seeing accounting at work

      Accounting methods must fit the nature of the entity being accounted for and how the entity carries out its purpose. Accounting is not a case of one size fits all. Here’s a quick sweep of the radar screen to give you an idea of different types of entities that accounting methods are adapted to:

       Accounting for profit-motivated businesses and accounting for nonprofit organizations (such as hospitals, homeowners’ associations, churches, credit unions, and colleges)

       Income tax accounting while you’re living and estate tax accounting after you die

       Accounting for farmers who grow their products, accounting for miners who extract their products from the earth, accounting for producers who manufacture products, and accounting for retailers who sell products that others make

       Accounting for businesses and professional firms that sell services rather than products, such as the entertainment, transportation, and healthcare industries

       Accounting where periodic financial statements are legally mandated (public companies are the primary example) and accounting where such formal accounting reports are not legally required

       Accounting that mainly adheres to historical cost (businesses) and accounting that records changes in market value (mutual funds, for example)

       Accounting in the private sector of the economy and accounting in the public (government) sector

       Accounting for going-concern businesses that will be around for some time and accounting for businesses in bankruptcy that may not be around tomorrow

      Accounting is necessary in a free-market capitalist economic system. It’s equally necessary in a centralized, government-controlled socialist economic system. All economic activity requires information. The more developed the economic system, the more the system depends on information. Much of the information comes from the accounting systems used by the businesses, institutions, individuals, and other players in the economic system.

Some of the earliest records of history are the accounts of wealth and trading activity. The need for accounting information was a main incentive in the development of the number system we use today. The history of accounting is quite interesting (but beyond the scope of this book).

Accounting’s Two Primary Roles

      

We aim to make this section of the book as easy to understand as possible by stating what should be obvious. That is, the accounting function in most businesses has two primary purposes:

       First, the accounting function and systems established must be able to produce complete, accurate, reliable, and timely (“CART”) financial information on which businesses can base sound decisions.In today’s intensely competitive global economy that is now supported by a broad ranging technology infrastructure that delivers information in split seconds, it has never been more important for accounting systems and the entire accounting function to produce and deliver vital financial information on a timely basis for review and management action.

       Second,