Accounting For Dummies. John A. Tracy

presentation styles for their financial statements? Putting it in such a stark manner makes us suck in our breath a little. The ideal answer is that all businesses should use the same rulebook of GAAP. However, the rulebook permits alternative accounting methods for some transactions. Furthermore, accountants have to interpret the rules as they apply GAAP in actual situations. The devil is in the detail.

      

In the United States, GAAP constitute the gold standard for preparing financial statements of business entities. The presumption is that any deviations from GAAP would cause misleading financial statements. If a business honestly thinks it should deviate from GAAP — in order to better reflect the economic reality of its transactions or situation — it should make very clear that it has not complied with GAAP in one or more respects. If deviations from GAAP are not disclosed, the business may have legal exposure to those who relied on the information in its financial report and suffered a loss attributable to the misleading nature of the information.

      GAAP also include requirements for disclosure, which refers to the following:

       The types of information that have to be included with the financial statements

       How information is classified and presented in financial statements (mainly in the form of footnotes)

The SEC makes the disclosure rules for public companies. Disclosure rules for private companies are controlled by GAAP. Chapter 10 explains the disclosures that are required in addition to the three primary financial statements of a business (the income statement, balance sheet, and statement of cash flows).

      Divorcing public and private companies

      Traditionally, GAAP and financial reporting standards were viewed as equally applicable to public companies (generally large corporations) and private companies (generally smaller). For some time, private companies have argued that some of the standards issued by the FASB are too complex and burdensome for private companies to apply. Although most accountants don’t like to admit it, there’s always been a de facto divergence in actual financial reporting practices by private companies compared with the more rigorously enforced standards for public companies. For example, a surprising number of private companies still do not include a statement of cash flows in their financial reports, even though this has been a GAAP requirement for 30 years.

      

Although it’s hard to prove one way or the other, our view is that the financial reports of private businesses generally measure up to GAAP standards in all significant respects. At the same time, however, there’s little doubt that the financial reports of some private companies fall short. In fact, in the invitation to comment on the proposal to establish an advisory committee for private company accounting standards, the FASB said, “Compliance with GAAP standards for many for-profit private companies is a choice rather than a requirement because private companies can often control who receives their financial information.” Recently, a Private Company Council (PCC) was established; it’s separate from the FASB but subject to oversight by the FASB.

      Private companies do not have many of the accounting problems of large, public companies. For example, many public companies deal in complex derivative instruments, issue stock options to managers, provide highly developed defined-benefit retirement and health benefit plans for their employees, enter into complicated intercompany investment and joint venture operations, have complex organizational structures, and so on. Most private companies don’t have to deal with these issues.

      Finally, we should mention in passing that the AICPA, the national association of CPAs, has started a project to develop an Other Comprehensive Basis of Accounting for privately held small and medium-sized entities. Oh my! What a time we live in regarding accounting standards. The upshot seems to be that we’re drifting toward separate accounting standards for larger public companies versus smaller private companies — and maybe even a third branch of standards for small and medium-sized companies.

      Following the rules and bending the rules

      An often-repeated story concerns three persons interviewing for an important accounting position. They’re asked one key question: “What’s 2 plus 2?” The first candidate answers, “It’s 4,” and is told, “Don’t call us. We’ll call you.” The second candidate answers, “Well, most of the time the answer is 4, but sometimes it’s 3, and sometimes it’s 5.” The third candidate answers, “What do you want the answer to be?” Guess who gets the job. This story exaggerates, of course, but it does have an element of truth.

      The point is that interpreting GAAP is not cut-and-dried. Many accounting standards leave lots of wiggle room for interpretation. Guidelines would be a better word to describe many accounting rules. Deciding how to account for certain transactions and situations requires seasoned judgment and careful analysis of the rules. Furthermore, many estimates have to be made. Deciding on accounting methods requires, above all else, good faith.

      

A business may resort to “creative” accounting to make profit for the period look better or to make its year-to-year profit less erratic than it really is (which is called income smoothing). Like lawyers who know where to find loopholes, accountants can come up with inventive interpretations that stay within the boundaries of GAAP. We warn you about these creative accounting techniques — also called massaging the numbers — at various points in this book. Massaging the numbers can get out of hand and become accounting fraud, also called cooking the books. Massaging the numbers has some basis in honest differences for interpreting the facts. Cooking the books goes way beyond interpreting facts; this fraud consists of inventing facts and good old-fashioned chicanery.

Chapter 3

      Safeguarding Company Assets

      IN THIS CHAPTER

      

Distinguishing between bookkeeping and accounting

      

Getting to know the bookkeeping cycle

      

Making sure your bookkeeping and accounting systems are rock solid

      

Doing a double take on double-entry accounting

      

Protecting against innocent errors and cunning fraud

      We think it’s safe to say that most folks are not enthusiastic bookkeepers. Let’s hope you reconcile or balance your checkbook against your bank statement every month (most likely electronically these days) and somehow manage to pull together all the records you need for your annual federal income tax return. But if you’re like us, you stuff your bills in a drawer or bury them in your cellphone somewhere, and just drag them out once a month when you pay them. And when’s the last time you prepared a detailed listing of all your assets and liabilities (even though a listing of assets is a good idea for fire insurance purposes)? Personal computer programs are available to make bookkeeping for individuals more organized, but you still have to enter lots of data into the program, and in our experience, most people don’t put forth the effort.

      Individuals can get along quite well without much bookkeeping