Financial Statements

Financial Statements

The world of accounting can often times confuse many people as they attempt to decipher information contained within an organizations financial reports. The federal government has established guidelines for all organizations to operate under in an attempt to standardize reporting procedures and ensure standardization across all genres of business. The following paper will provide background information of several widely used accounting terms .

Clarification of Terms

General Accepted Accounting Principles (GAAP) are a set of policies, procedures and standards that are used by companies to assemble financial reports (Investopedia, 2011). GAAP were established by the Financial Accounting Standards Board (FASB) so that companies had a set standard in which to follow. Developing a standard provides consistency for potential investors. Investing in a company requires a large amount research that must be conducted so that poor decisions are not made. The financial livelihood of an investor can be adversely affected if sound and timely financial decisions are not made. Financial statements submitted to the Securities Exchange Commission (SEC) by publicly traded companies are required to meet GAAP standards (glossary). The information that is covered under GAAP includes such things as revenue recognition, balance sheet item classification and outstanding share measurements (Investopedia, 2011). GAAP are a great tool for conformity, but they are not a guarantee that everything reported is credible. There is plenty of room within GAAP for unscrupulous accountants to distort figures. So, even when a company uses GAAP, the financial statements still need to be scrutinized (Investopedia, 2011).

Another term that exists in the accounting world that can cause confusion is contra asset account. This concept seems to cancel one another out. Contra refers to a negative connotation, but asset is believed to be a positive entity for any organization. A contra asset account is an account that is expected to have a credit (negative) balance (Accounting Coach, 2011). Since a credit balance in an asset account is contrary to the normal or expected debit balance the account is referred to as a contra asset account (Accounting Coach, 2011). An example of this type of account can include anything dealing with property and depreciation value. Recording the credits in the Accumulated Depreciation means that the cost of the property, plant and equipment will continue to be reported (Accounting Coach, 2011). This practice would serve usefulness over a period of time to determine how much a property has depreciated compared to its value.

Historical cost accounting is an accounting principle that uses the value of assets based on the actually cost paid at the time of purchase without adjustments made for inflation (Money Terms, 2011). Historical cost accounting basically states that if an asset is purchased for one dollar, than the asset is worth one dollar. Inflation along with other market factors influences the worth of an item over a period of time. Historical cost can cause problems if it is used to make decisions based upon past costs. Historical cost is useful to see where an organization has come from, but not useful to base future decisions upon outdated information. Current factors such as inflation and market stability must be taken into account when making financial decisions within an organization.

Accrual Basis and Cash Basis Accounting are two different types of accounting principles that keep track of an organization's assets and expenses. The two systems are basically the same, but differ in one aspect of calculating assets. Cash basis accounting is the most commonly accepted accounting principle, and when operating under the cash basis method, income is not counted until cash (or a check) is actually received, and expenses are not counted until they are actually paid (Nolo Law for All, 2011). Accrual basis accounting on the other hand calculates transactions differently. Under the accrual method, transactions are counted when the order is made, the item is delivered, or the services occur, regardless of when the money for them (receivables) is actually received or paid (Nolo Law for All, 2011). Basically, income is counted when a sale is made, and expenses are recorded when the good or service is received. The accrual basis is most common for individuals when they manage their own personal checking account and therefore is probably the most easily understood accounting principle for all to understand.

Accounting Standards Codification (ASC) was established in an attempt to simplify reporting procedures. ASC is a major restructuring of accounting and reporting standards designed to simplify user access to all authoritative U.S. GAAP by