Accounting

Limitations of Financial Accounting

Financial accounting permits alternative treatmentsAccounting is based on concepts and it follows ” generally accepted principles” but there exist more than one principle for the treatment of any one item. This permits alternative treatments with in the framework of generally accepted principles. For example, the closing stock of a business may be valued by anyone of the following methods: FIFO (First-in- First-out), LIFO (Last-in-First-out), Average Price, Standard Price etc., but the results are not comparable.

Financial accounting does not provide timely information

It is not a limitation when high powered software application like HiTech Financial Accenting are used to keep online and concurrent accounts where the balance sheet is made available almost instantaneously. However, manual accounting does have this shortcoming.

Financial accounting is designed to supply information in the form of statements (Balance Sheet and Profit and Loss Account) for a period normally one year. So the information is, at best, of historical interest and only ‘post-mortem’ analysis of the past can be conducted. The business requires timely information at frequent intervals to enable the management to plan and take corrective action. For example, if a business has budgeted that during the current year sales should be $ 12,00,000 then it requires information whether the sales in the first month of the year amounted to $ 10,00,000 or less or more?

Traditionally, financial accounting is not supposed to supply information at shorter interval less than one year. With the advent of computerized accounting now a software like HiTech Financial Accounting displays monthly profit and loss account and balance sheet to overcome this limitation. Financial accounting is influenced by personal judgments’Convention of objectivity’ is respected in accounting but to record certain events estimates have to be made which requires personal judgment. It is very difficult to expect accuracy in future estimates and objectivity suffers. For example, in order to determine the amount of depreciation to be charged every year for the use of fixed asset it is required estimation and the income disclosed by accounting is not authoritative but ‘approximation’.

Financial accounting ignores important non-monetary information

Financial accounting does not consider those transactions of non- monetary in nature. For example, extent of competition faced by the business, technical innovations possessed by the business, loyalty and efficiency of the employees; changes in the value of money etc. are the important matters in which management of the business is highly interested but accounting is not tailored to take note of such matters. Thus any user of financial information is, naturally, deprived of vital information which is of non-monetary character. In modern times a good accounting software with MIS and CRM can be most useful to overcome this limitation partially.

 

Major Limitations of Financial Accounting

Supplies Insufficient Information:

Financial accounting provides the information about the financial activities as a whole and not individual-wise, i.e., it does not record information relating to product-wise, department-wise etc.

Controlling Cost not Possible:

In financial accounting control of cost is not possible since the costs are known at the end of the financial year or a specified period of time whether the expense or cost has already been incurred, i.e., nothing can be done to control either the account of expense or the cost. In other words, if it is even found that a particular cost is more, it is not possible to control it.

But the same is possible only when the cost accounting system is being introduced.

Historic in Nature:

Since the financial accounting records all transactions relating to a particular period, it is rather historic in nature. In short, present financial information relating to a past period and not for the future although all financial decisions are taken on the basis of past financial data.

Recording Actual Cost:

The financial accounting records the actual cost only, the historical cost of the assets. The value of assets may be changed, but record only the cost of acquisitions of such assets. In other words, financial accounting does not record the price fluctuations or change in price level. As a result it does not present the correct information.

 

Measurability

One of the biggest limitations of accounting is that it cannot measure things/events that do not have a monetary value. If a certain factor, no matter how important, cannot be expressed in money it finds no place in accounting. Some very important qualities like management, loyalty, reputation, etc find no place on the balance sheet or the income statement.

No Future Assesment

The financial statements show the financial position of the firm on the date of preparation. The users of the statement are more interested in the future of the company in the short term and long term. However, accounting does not make any such estimates.

And due to the dynamic nature of the business environment, a lot can change between such dates. Auditors sometimes do disclose the important events occurring after the balance sheet date to rectify these limitations of accounting.

Historical Costs

Accounting often uses historical costs to measure the values. This fails to take into consideration factors such as inflation, price changes, etc. This skews the relevance of such accounting records and information. This is one of the major limitations of accounting.

Accounting Policies

There is no global standard in accounting policies. In India, we follow the Accounting Standards. Americans follow the GAAP and then there are the international standards, namely the IFRS. And if a global company operates in more than one country, there may be confusion.

Not all accounting policies follow the same line of thinking, and conflicts may arise due to this. It has long been said that the whole world must agree on uniform accounting policies but this has not happened yet.

 

Time Value of Money

Under the accounting system, money value is treated constantly. But the value of money always changes due to inflation. Under existing accounting systems, accounts are maintained considering historical cost ignoring current changed value. As a result, the accounts maintained fail to exhibit the exact financial position of a business concern.

Recommendation of alternative methods

There exists an application of alternative methods in determining depreciation of assets and valuation of stock etc. Information regarding the activities of the business is expressed in a misleading way if an alternative method is used to achieve a particular object.

Importance of form over substance

At the time of preparing accounts for a particular period, the emphasis is laid on the form, table, etc. instead of giving importance to an exhibition of substantial information. As per Company Act, preparation of the balance sheet in the prescribed form is mandatory.

Although there are some limitations in the present accounting system, accounting in the present-day world has generally been accepted as a recognized profession. Efforts are on throughout the world to overcome these limitations. Economic activities of any society without accounting are neither possible nor legal.

 

Overall Performance:

Financial accounting discloses and reports profitability or otherwise of the business as a whole. Since it does not classify accounts on the basis of departments or segments, products, processes and sales territories, it fails to provide information about costs and profit of these sub-divisions of the organisation.

No Objective Classification:

In financial accounting, accounts are classified under two major groups, viz., and personal and impersonal. Such a primary classification made subjectively, is of little use to management to ascertain costs by products, jobs and processes.

What are the functions of bookkeeping?

Bookkeeping is the activities concerned with the systematic recording and classification of financial data of an organization in an orderly manner. It is essentially a record-keeping function done to assist in the process of accounting. It is a key component in forming the financial statements of the organization at the end of the financial year.

Bookkeeping also concerns itself with the classification of financial transactions and events. Such classification of transactions is essential to maintain proper financial accounts. It also involves preparing source documents for the financial transactions and other business operations being carried out.

There are many methods of book-keeping. The most common ones are the double-entry system and the single-entry system. But even methods other than these, which involves the process of recording financial transactions in any manner are acceptable book-keeping systems or processes.

 

The function of bookkeeping

Bookkeeping is the process of recording daily transactions in a consistent way, and is a key component to building a financially successful business.

Bookkeeping is comprised of:

• Recording financial transactions
• Posting debits and credits
• Producing invoices
• Maintaining and balancing subsidiaries, general ledgers, and historical accounts
• Completing payroll

Maintaining a general ledger is one of the main components of bookkeeping. The general ledger is a basic document where a bookkeeper records the amounts from sale and expense receipts. This is referred to as posting and the more sales that are completed, the more often the ledger is posted. A ledger can be created with specialized software, a computer spreadsheet, or simply a lined sheet of paper.

The complexity of a bookkeeping system often depends on the the size of the business and the number of transactions that are completed daily, weekly, and monthly. All sales and purchases made by your business need to be recorded in the ledger, and certain items need supporting documents. The IRS lays out which business transactions require supporting documents on their website.

 

Other Tasks

Bookkeepers often develop a skill set and specialized knowledge particular to the company for which they are employed. They may utilize specialized coding procedures to maintain records of debits and credits, create unique functions in computer programs to meet the accounting needs of the business and develop or adjust procedures for keeping track of finances. Bookkeepers have to stay informed inside the business to ensure that all money is accounted for. They must create or use systems for communicating with employees to track expenses or payments are crucial. In many businesses, bookkeepers are also responsible for making sure that taxes are paid to local, federal and state governments. They must submit tax documents to the appropriate offices, ensure that employees have proper documentation and identification on file, and calculate estimated taxes when necessary.

 

Produce Financial Reports

Ask any bookkeeper there most valuable trait, and they’ll tell you their ability to produce financial reports. The financial reports give a detailed account of how the business is performing; there are three main reports that every business needs.

Balance Sheet

The balance sheet is a collection of all the assets and liabilities of a business, it’s used to determine how much a business is worth. If a business owner ever wants to sell his business the first thing a potential buyers will ask for is the balance sheet. The balance sheet also tells us how much owner’s equity there is, If there are multiple partners it can be used to determine each person’s individual stake. Also remember that the accounting equation Liabilities + Owners Equity = Assets.  Must be true for every balance sheet.

Cash Flow Statement

Cash is king. You’ve probably heard this quote a thousand times in your life and for good reason because if a business wants to stay in business they need cash. In Fact not being able to generate a positive cash flow every month is one of the biggest reasons why businesses fail. Now that you are aware of how important cash is to a business, you can see why there is such a high need to monitor cash flow.The cash flow statement makes it easy to do this and combines all the data to give you your net cash flow for the month. The cash flow statement also shows you where all the money is coming from, so you can focus more on high cash producing projects, while also showing you areas in your business where your losing money so you can better manage them.

The Profit and Loss

The profit and loss statement accumulates all of the expenses and income for a business. Like the name suggest this statement lets business owners know if there profitable or not. Producing an accurate profit and loss statement can only be done, if the other 3 functions of bookkeeping where done properly, because every mistake in not recording an expense, or mistakes made in accounts receivable/payable will show up in your profit and loss statement. The goal of every business is to make money and be profitable, so if you produce an inaccurate profit and loss statement it can give the owner the wrong information about his business, which can lead to making wrong decisions.

 

The bookkeeper’s role

Is to keep his accounts according not only to basic bookkeeping principles but also with regard to the company’s rules and specifications and most importantly following legal requirements. If in doubt the bookkeeper should refer to HMRC or his local tax consultant. A bookkeeper will need to bring to light any practices which could lead to errors in the business books and then work with the business managers to rectify the system and update any official bodies and so on. Mistakes need to be put right as soon as possible to avoid penalties which could further impact company finances.

The bookkeeper will need to have great data entry skills and thoroughness. She will need to have a head for figures and double check her work at all times. She will know what is happening in the monetary core of the company and be discrete and keep the information safe and away from third parties. Confidentiality will be maintained in everything she does. Her filing systems will be orderly and also updated as and when for instance when data needs be destroyed once it has served its purpose. She will also make sure that the relevant information is never deleted or corrupted.

The function of the bookkeeper could also involve recording the value of property and other financial fixed assets. He or she may also take on further responsibilities such as chasing up late payments, purchasing (buying) and generally constantly working to become increasingly efficient so helping to improve the profit of the business and contribute to the net income or the ‘bottom line’ (the actual money made after all the sales and expenses have been calculated).

tax preparation

Types of Tax Return Pros

You can have anyone—your uncle, your neighbor, or your best friend—prepare your tax return. But if you’re paying for this service, the person must be registered with the IRS and have a current preparer tax identification number (PTIN), which is an IRS number issued annually to eligible preparers.

What Will You Pay?

The more credentialed the person who prepares your return is, the more you can expect to pay. As a general rule, you’ll pay the highest fees to attorneys, followed by CPAs and then enrolled agents. The lowest fees are charged by annual filing season program participants and preparers without any special designation.

Who’s Best for What?

Cost is only one factor in choosing a preparer. Depending on your situation, certain other considerations may be important. That includes whether you might want the preparer to represent you if the IRS raises any questions concerning your return. These are some general guidelines, for each type of preparer.

Red Flags to Watch For

Once you’ve decided what type of preparer to use, make sure you steer clear of anyone who may be unscrupulous or could create problems for you. (If the IRS suspects that a preparer’s actions are shady, their clients’ returns may be subject to special review.) Some tipoffs of suspicious behavior.

Some Final Advice

To make the best use of your preparer’s time—and keep your bill to a minimum—be sure to gather all the information you need and make a list of your questions before you meet.

 

How To Get Your Money’s Worth and Choose The Right Tax Preparer

Free File through the IRS – Anyone can use free file and e-file their federal tax return at no cost.  This is due to a public-private partnership between the IRS and tax preparation software companies called Free File Alliance.   You can simply fill out the forms online and e-file.  For example, this would have been perfect when I helped my mother-in-law with her simple tax return; she only had income from Social Security and some investment income.  That was it.  Free e-file is a perfect fit for very simple returns.

Do-it-yourself with tax preparation software – Tax software programs are popular for a reason: they are easy to use.  The program walks you through every section of your return, highlights deductions you might not have caught, provides red flag audit alerts and to top it off are inexpensive.  Three popular tax software programs are TurboTax, H&R Block at home, and TaxAct.  They range from $10 (Tax Act) to $45 (H&R Block at home) for the deluxe home version.

Use a storefront tax service – People with relatively basic returns who don’t want to do it themselves may want to consider a storefront tax service.  The tax code is complex and constantly changing. In fact in April 2011, IRS Commissioner Douglas Shulman reported that there had been about 3,500 tax changes since 2000, and that doesn’t even include the latest changes in the fiscal cliff negotiations.  It makes sense that most people want face-to-face help where they can get their questions answered and receive personalized guidance from a tax preparer.

Getting help with an Enrolled Agent – The IRS does not currently have any guidelines on who can prepare your tax return (although some states such as California do).  This makes it a challenge to find out if someone is competent with even basic tax preparation.  Instead of just choosing any tax preparer, consider working with an Enrolled Agent.  According to the National Association of Enrolled Agents, they are required to demonstrate competency in all areas of taxation, representation and ethics before they are given unlimited representation rights before the IRS.  An Enrolled Agent is a tax specialist for people who are looking specifically for tax return preparation, tax advice, and audit representation.

Hiring a Certified Public Accountant – As mentioned in a previous blog, the services of a Certified Public Accountant may be somewhat more expensive, but in many cases well worth the money spent.  People who need strategic tax planning such as small business owners or individuals with complex returns, those who pay high income taxes, or have unusual circumstances appreciate the services of a CPA over an enrolled agent or general tax preparer.  You would think that filing your taxes would be very black and white, but where CPAs really provide value is in grey areas.  They give advice on which tax strategies to take or not to take based on their interpretation of IRS rulings and past experience.

 

Questions To Ask When Choosing A Tax Preparer

How do you determine your fees? Note the wording on this one. I didn’t say ask how much the fees would be but how the fees are determined. Prices may vary based on the complexity of your return, whether you require additional schedules (such as dividend and interest on Schedule B, business information on Schedule C, capital gains and losses on Schedule D and/or rental income and losses on Schedule E); supporting forms (such as those for the child tax credit or additional charitable donation information); or whether your return has out of the ordinary line items (like Roth IRA conversions). Some preparers offer reduced costs for federal return but add on for state and local returns: make sure you understand the total cost. Finally, be wary of preparers who base their fee on a percentage of your anticipated refund: they have a financial incentive to encourage inappropriate credits and deductions.

What about the extras? There’s nothing wrong with paying for the extras: just make sure that you know what those might be ahead of time. When asking about fees (see #6), be sure to ask about the cost of extra services, like the cost to fix any mistakes or to file electronically (see #7). A tax preparer should not charge you extra for a copy of your return when the return is prepared (though charging you extra for additional copies may be appropriate).

Can I file electronically? More than 1 billion individual tax returns have been processed since the debut of electronic filing in 1990. It’s the fastest way to get your refund and tends to result in fewer math errors. It may also be required: a paid preparer who prepares and files more than ten client returns must generally file returns electronically unless the client opts out.

Who will sign my return? Remember that your preparer must have a PTIN (see again #1). The PTIN and the preparer’s signature need to appear on your tax return. Don’t trust a preparer who refuses to sign a return or asks you to sign as self-prepared.

When will I receive a copy of my return? It’s not unreasonable to leave your preparer’s office without a copy of your completed return; assembly may be required. However, you should receive a complete copy of your return within a reasonable amount of time following your appointment. If your preparer can’t offer a window of time to expect the copy, it might be indicative of a time management problem. If your preparer can’t promise you a copy at all, run, don’t walk away: you will need a copy for your own records.

 

How to Choose a Tax Preparer

• Review the tax preparer’s credentials. EAs, CPAs, and tax attorneys are all qualified to represent their clients to the IRS on all matters. Other preparers can help you with forms and basic matters, but cannot represent you in case of an audit. Don’t be afraid to ask about these or other qualifications before you hire someone.
• Be wary of spectacular promises. If a tax preparer promises you larger refunds than the competition, this is a red flag. Many such tax preparers base their fees on the amount of your return and may be likely to use shady tax preparation tactics. In addition, it’s wise to avoid tax preparers who offer “refund anticipation loans” as you’ll probably lose a large percentage of your return to commission fees.
• Get referrals from friends and family. One of the best ways to find a trustworthy tax preparer is to ask your loved ones for recommendations. Once you have a few options, check the BBB.org, paying careful attention to other consumers’ reviews or complaint details. This will give you a clear view about what you can expect.
• Think about availability. If the IRS finds errors in your tax forms or decides to perform an audit, will your tax preparer be available to help you with the details? Find out whether you can contact the tax preparer all year long or only during tax season.
• Ask about fees ahead of time. Before you agree to any services, read contracts carefully and understand how much the tax preparer charges for their services. Ask about extra fees for e-filing state, federal, and local returns, as well as fees for any unexpected complications.
• If things don’t add up, find someone else. If a tax preparer can’t verify their credentials, has a record of bad reviews from previous clients, or their business practices don’t seem convincing, don’t do business with them. Keep in mind that if you hire them, this individual will handle your sensitive personal information – information you need to keep safe from corrupt or fraudulent tax preparers.

 

Checklist for Selecting the Best Accountant

Check the Preparer’s Qualifications. Use the IRS Directory of Federal Tax Return Preparers with Credentials and Select Qualifications. This tool helps taxpayers find a tax return preparer with the qualifications that they prefer. The Directory is a searchable and sortable listing of preparers with a credentials or filing season qualifications.

Check the Preparer’s History. Ask the Better Business Bureau about the preparer. Check for disciplinary actions and the license status for credentialed preparers. For CPAs, check with the State Board of Accountancy. For attorneys, check with the State Bar Association. For Enrolled Agents, go to IRS.gov and search for “verify enrolled agent status” or check the Directory.

Ask about Service Fees. Avoid preparers who base fees on a percentage of the refund or who boast bigger refunds than their competition. When inquiring about a preparer’s services and fees, don’t give them tax documents, Social Security numbers and other information. Some preparers have improperly used this information to file returns without the taxpayer’s permission.

Ask to e-file. Taxpayers should make sure their preparer offers IRS e-file. Paid preparers who do taxes for more than 10 clients generally must file electronically. The IRS has safely processed billions of e-filed tax returns

Make Sure the Preparer is Available. Taxpayers may want to contact their preparer after this year’s April 18 due date. Avoid fly-by-night preparers.