Abstract
The paper gives an account of the importance of accounting. It provides information about the increasing importance of accounting in the recent years and the entities that pay attention to the information provided by the accounting system. The paper also describes about how each party makes use of accounting and its role in the process of decision-making. It also explains the need for recording and analyzing the transactions through the accounting system. Most importantly, the paper asserts the importance of accounting in assessing the performance of firms. The paper also provides a great deal of information about the role of GAAP in influencing the accounting system. Furthermore, it explains how GAAP acts as a guide in the preparation of financial standards and the way it influences the auditing standards of various organizations. The paper describes the importance of income statements in analyzing the profitability of firms. It also informs as to how the two kinds of income statements, namely comparative and common-size income statements affect the efficiency of organizations. The paper determines the importance of raw income statement in influencing the profitability and cost structure of firms. Finally, the paper concludes by summarizing the contents mentioned altogether.
Accounting is an information system, which measures, processes and communicates financial information about an economic entity, such as a business or a government body . More people than ever have recognized the importance of accounting and the effect that unethical and misleading financial reports have on the businesses and financial markets. Various organizations feel the need and importance of accounting whether they are trading or non-trading organizations. Furthermore, accounting information is often a major input to pricing decisions. Since business organizations run with the objective of earning profit, without a proper record of all the business transactions, it is difficult to know the true result of the business. A proper record of all assets and liabilities are essential to prepare the financial position of a business, which is possible only through accounting.
The government, which is one of the biggest forms of organization, also makes use of accounting. Budgeting is a significant aspect of accounting made by every state and central government. Every government has a keen interest in knowing the total revenue and expenditure as well as the total amount available in the treasury. For this purpose, a new branch of accounting known as government accounting plays an important role. Accounting facilitates the management of business organizations in planning, decision-making and controlling . It also enables a comparative study of the efficiency of the business. Accounting is important as it helps to know whether there is any leakage of revenue or misappropriation of property of the business. It assists in performing various functions through collecting, analyzing, interpreting and presenting all accounting information useful to the management. Accounting also plays a crucial role in taking decisions about investment, insurance, business expansion and many others .
Accounting provides an independent and reliable check on the accuracy of financial accounts. It helps in creating a competitive spirit among organizations through a comparative study of accounting information. The analysis of the causes of unsatisfactory results indicates immediate remedial action. Accounting is necessary not only from an owner’s point of view, but also from the view point of creditors, investors, government and the society at large . While creditors have a keen interest in the solvency of the business, government determines the economic policies, such as taxation through accounting. The purpose of accounting is not only recording the transactions, but also analyzing and interpreting data for future forecasting. Accounting is also important for those who have a direct interest in business. They depend on accounting to measure and report information about the performance of a business.
Accounting plays a crucial role in raising funds from investors, creditors, taxpayers, donors and deploying scarce resources. It aids in the allocation of efficient allocation of resources in capital markets. Accounting is also important because it is dynamic in nature and operates in a rapidly changing environment. Globalization has led accounting to adapt a number of ways by increasing the harmonization of accounting reporting across not only national, but also international boundaries . Although accounting is a series of figures, which gives the impression that it is a form of commercial arithmetic, it is merely a convenient way of summarizing and reporting information, which is indigestible in narrative form. The role of accounting within an organization is at the very core of running a successful and effective organization. Although most of the information generated by accounting relates to financial performance of the organizations, it also contains information related to other areas, such as governance.
Accounting system frames various strategies, which suggest the organizations in shaping the profitability of recommended transformations in the business. The implementation of an efficient accounting system is essential as it looks into the fraud and manipulation of records. Accounting also aids in the rendering of accurate and reliable information to the management as well as many others interested in the organization. Accounting also helps to identify the profitable as well as non-profitable actions of the management. In other words, it helps the management in distinguishing between the areas, which earn profits and those that incur losses to the organizations . Accounting is also important as it helps to establish an enhanced functioning efficiency of the organizations through the implementation of reliable accounting standards and the resultant analysis of the existent performance of organizations with the instituted rules and standards.
The practice of accounting takes place through an implicit framework known as Generally Accepted Accounting Principles (GAAP). According to the Accounting Principles Board of the American institute of Certified Public Accountants (AICPA), GAAP is a practical necessity, which consists of certain conventions, rules and procedures that are essential to define the accounting practices accepted at any point of time . GAAP acts as a guide to the profession of accounting and helps in the preparation of financial statements. There are different types of GAAP for regulated business enterprises, government organizations, non-profit organizations, investment companies and banks. The Financial Accounting Standards Board (FASB) plays a lead role in establishing GAAP . The research bulletins, audits and accounting guides, statements of position and practice bulletins when approved by FASB become GAAP. Furthermore, GAAP clarifies the compliance issues incorporated into the annual reports of organizations.
Although there is no standard set of policies and procedures related to GAAP, there are sample policies and procedures for generic company operations. GAAP applicable for state and local governments are fundamentally different from those applicable to non-government entities. The principles of GAAP resemble laws and rules, which are a mandate in financial reporting . GAAP involves several accounting policy-making bodies and determines the procedures for recording transactions. The changes involved in GAAP have a profound impact on the auditing standards of various organizations. There are various reports published annually to identify the consensus about GAAP for a particular issue or methods of disclosure. GAAP is a matured level of approach and consists of a large body of interpretation, which increases the comparability. In spite of various differences in terms of complexity of businesses, GAAP provides a sophisticated framework of rules and procedures . GAAP is all about measuring the success or failure of an entity in the language of accounting.
The income statement is one of the significant components of the accounting system. The techniques of analysis used in the income statement provide a great deal of information about the revenue, expenses and earnings of firms. Such a deeper level of scrutiny provided by the income statement requires an awareness of the imperfections in the accounting system, which can distort the economic reality . By observing an income statement in its raw form, firms make useful observations regarding their profitability and cost structure. Depreciation is a larger component of the income statements of heavy manufacturing companies with huge production facilities, such as steel mills and automobile plants. Income statement also helps to detect artificial expansion of revenues. A firm’s income statement from the preceding year is primarily a basis for forecasting future earnings.
The income statement communicates how much revenue a company generated during a period and what costs it incurred in connection with generating that revenue. Also known as the statement of operations or profit and loss statement, the income statement is a separate section gives an account of comprehensive income. Fixed-income analysts examine the components of income statements, past as well as projected for information on the companies’ abilities in making promised payments on their debt over the course of the business cycle . Corporate financial announcements frequently emphasize the information reported in the income statements, especially earnings, more than the information reported in the other financial statements. Common-size analysis is one of the major components of the income statement. The common-size statement divides each income statement item by revenue or total assets. On the other hand, comparative income statement gives an account of the absolute and percentage changes in gross profit, operating profit, net profit and many others .
Creating more favorable expectations about the future from the income statement helps to not only raise the stock, but also lower the borrowing cost of the firms. In order to create the desired impression that a loss was alien to the company’s normal pattern of behavior, the income statement shows the loss in a separate line with the label ‘extraordinary item’. Such a representation creates the strongest possible impression that the loss was outside the ordinary course of business, thereby maximizing the profitability of the firm . A pro forma income statement shows the levels of sales, expenses and earnings a company would have achieved in a span of a year. A systematic maintenance of income statements not only enables intra-firm comparison, but also inter-firms comparison. However, one of the major disadvantages of the income statement is that it provides only a limited insight into its operating leverage or the rate at which the net income escalates as soon as sales volumes rise above the breakeven rate.
Works Cited
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Weygandt, J. J., Kimmel, P. D., & Kieso, D. E. (2009). Financial Accounting. New York, NY: John Wiley & Sons.
