The Benefits Of An Accounting System Accounting Essay

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This essay is to help Mr. Peter Anderson, who has gone on retirement last year, on his project of investing 3,000,000 RM in the bottled water business in Malaysia. This paper gives an overview of the accounting science, and presents the benefits of having an accounting system which might help Mr. Anderson in running his business, along with illustrations and explanations of some of the financial statements needed to be declared by him for the benefits of his business various stakeholders.

2.0 Defining Accounting:

Accounting as defined by Weygandt, Kimmel, & Kieso (2010) Accounting Principles (9th ed.) consists of three basic activities-it identifies, records, and communicates the economic events of an organization to interested users [1] .

Identifying business events: A company selects the economic events relevant to its business. For example the sales of "Spritzer" bottled water by "Spritzer Bhd", or providing internet services by "Maxis Communication Bhd".

Recording events: Once a company like "Spritzer Bhd" has identified its business events, it should record them in order to provide the history of its financial events or activities. "Spritzer Bhd" arranges chronologically its relevant economic events, summarizes them and then classifies them accordingly.

Communicating: In the end the company should communicate the collected information for various users by providing them with financial statements.

Businessdictionary.com also gives a similar definition for accounting: "Accounting is a practice and body of knowledge concerned primarily with (1) methods for recording transactions, (2) keeping financial records, (3) performing internal audits, (4) reporting and analyzing financial information to the management, and (5) advising on taxation matters. It is a systematic process of identifying, recording, measuring, classifying, verifying, summarizing, interpreting and communicating financial information. It reveals profit or loss for a given period, and the value and nature of a firm's assets, liabilities and owners' equity. Accounting provides information on the (1) resources available to a firm, (2) the means employed to finance those resources, and (3) the results achieved through their use." [2] 

3.0 Business Entity:

According to this assumption, which is one of many other accounting principles, business is treated as a unit or entity apart from its owners, creditors, debtors and others. In other words, Mr. Anderson will always be considered separate from the business which he controls. All the business events and financial transactions are recorded in the books of accounts from the view point of the business. Even the proprietor is treated as a creditor to the extent of his capital. Generally there are three forms of business entities [3] .

3.1 Sole proprietorship:

It is the simplest form of business organization because it is run by just one person (the owner). There is little difficulty or complexity in starting up a sole proprietorship as it may involve just getting a license and finding some premises. This is why most of the businesses around the world are in this form. It is normally feasible for service providers such as physicians, freelancers, lawyers, etc. [4] 

Advantages of Sole proprietorship [5] :

The owner gets and keeps all the profits from the revenue.

There is little hardship or difficulty in starting up a sole proprietorship.

A small capital is relatively enough for setting up this form of business.

Disadvantages of Sole proprietorship [6] :

Sole proprietorship has unlimited liability of business debts. That means that the debts that the owner makes for the benefit of his business are recovered from his personal assets if the business assets are not enough or insufficient to discharge them.

The income of such a business is taxed collectively with the owner's revenue and income from other sources. This may make Mr. Anderson pay taxes at a higher rate.

The life of a sole proprietorship is restricted with the owner's life span.

Sole proprietorship's capital raising opportunity is restricted mostly with the resources of the owner. This makes the growth of this form of companies harder.

Ownership of a sole proprietorship may be hard to transfer due to the requirements of selling the whole business to a new owner.

3.2 Partnership:

Partnership is a form of an organization or a business in which two or more persons mutually own, run the business, and agree to share profits according to profit sharing ratio or sometimes equally. It is similar to sole proprietorship in many ways [7] . Thus as Mr. Anderson has no experience in the bottled water market in Malaysia, I would suggest for him to partner up with an investor who has the needed information to run the prospected business.

Advantages of Partnership [8] :

Due to the nature of the business, partners usually fund this form of business with a startup capital together. This means that the more partners there are, the more money they can put into their business.

They are less strictly regulated than corporations, in terms of the laws framing the formation and because the partners control how the business is run (without interference by shareholders) they are far more flexible in terms of management, as long as all the partners can agree.

Partners mutually share the responsibility of the running of the business. This allows them to make the most of their skills knowledge and abilities. Instead of splitting the management and taking an equal share of each business task, they could split the work according to their skills.

More partners means more brains that can work on business ideas and for solving the problems that the business encounters.

Disadvantages of Partnership [9] :

The danger or risk of disagreements between the partners.

Partnerships are subject to unlimited liability, which means that each of the partners shares the liability and financial risks of the business with their own personal assets.

The allocation of profits between partners can lead to unfairness where one or more partners aren't putting a fair share of effort into the management of the business, but still getting the rewards.

3.3 Corporation:

Corporation is a type of business which is registered as a public owned company it is recognized as a separate entity from its owners and which has its ownership divided into transferable shares of stock [10] . In my opinion when Mr. Anderson gains enough experience and earns a relative success in the bottled water market, he might consider changing his business entity structure into corporation.

Advantages of a Corporation [11] :

The liability of the owners towards the creditors is limited to their investment in the company.

The corporation exists until it is liquidated which means that death or change in ownership has no effect on the corporation.

Additional capital can be raised easily through stock markets.

The transfer of ownership is relatively easy as it is represented by the number of share certificates held by a person (shareholder).

Disadvantages of a Corporation [12] :

Establishing a corporation is a complex process

Shareholders delegate the governance function to the board of directors which hires management to look after the day to day affairs of the corporation. It is possible that the management acts to its own interests rather than the interest of the owners of the corporation.

Double taxation: First the corporate income is taxed at a flat rate and then the dividends paid to the shareholders are also taxed.

4.0 Benefits of an Accounting System:

First it is important to show the accounting cycle [13] :

Identify the Transaction: Understand the event as a transaction and release the source document.

Analyze the Transaction: Determine the amount of the transaction, which accounts are related, and in which direction.

Journal Entries: The transaction is recorded in the journal in the accounts as a debit or a credit.

Post to Ledger: The journal entries are transferred to the related T-accounts in the ledger.

Trial Balance: This balance is calculated to ensure that the sum of the debits the same as in the credits.

Adjusting Entries: They are made for accrued and deferred items. The entries are journalized and posted to the T-accounts in the ledger.

Adjusted Trial Balance: A new trial balance is calculated after the adjusting entries.

Financial Statements: Financial statements are generated.

Closing Entries: Transfer the balances of the temporary accounts (e.g. revenues and expenses) to owner's equity.

After-Closing Trial Balance: A final trial balance is made after the closing entries are calculated.

This process used to be manual; however today with the introduction of IT and the Accounting Information System things are much easier and more efficient. An accounting system will show Mr. Anderson if his business is really making a profit or loss; it will help him to predict cash flow shortages; and enables him in accurately keeping track of those slow paying customers, or those who are not paying and result in bad debts [14] .

An accounting system also helps the business in [15] :

Precisely reporting business transactions. 

Simplifying access to financial information.

Updating reports different debit or credit accounts.

Reducing problems with tax departments.

Satisfying various users of accounting information and providing them with the relevant statements.

5.0 Financial Statements:

The goal of the financial statements is to report the organization's financial performance and position to external and internal users of accounting information. It is important that these statements reflect the transactions of the business, and not the transactions of its owners [16] .

5.1 Balance Sheet (BS):

The (BS) shows [17] :

The net worth of a business at a specific moment, which is the difference between business's assets and business's liabilities.

The owners' equity, which is the capital of the business, invested by the owners. Equity consists of the original capital invested in the business, and all other profits or losses that the business has made in the past and which have been reinvested in the business.

Because the BS 'balances', the net worth and the owners' equity should be equal. This is known as the balance sheet equation:

Net Worth = Owners' Equity

We can rewrite this equation as follows:

Assets - Liabilities = Capital + Reserves

The following table illustrates the Annual Balance Sheet of Spritzer Bhd in 2011

Source: Spritzer Bhd_Annual Report 2011

The balance sheet is important for investors and managers to understand how wealthy the organization is, and helps them in calculation of various ratios which help in better decision making.

5.2 Income Statement:

The income statement or also known as (The Statement of Financial Performance) shows the income (revenues) and expenditure of the business over a year or any other accounting period. It is a statement of the business transactions in the accounting period.

The difference between the revenue and expenses of the business is called profit. To understand how the business makes profits, the revenue and expenses are split into different categories and different profit figures are reported in the income statement. The income statement shows [18] :

Gross profit is the difference between sales revenue (income) and cost of sales. Cost of sales is calculated as opening stock (at the beginning of the accounting period) adding purchases of goods (or production costs if the business is a manufacturer), deducting closing stock (at the end of the accounting period).

Net profit is the profit that the business gets after adding any other supplementary income (such as interest receivable) and after removing further business expenditures (such as wages, rent and salaries, or lighting and heating costs), or any other form of administrative costs.

Retained profit for the accounting period is the final profit figure, after giving away distributions to owners. These Distributions are called either drawings if the business is a sole trader or partnership, or dividends if the business is a corporation. The retained profit is then added to reserves in owners' equity in the Balance Sheet.

The following table is an example of the Income statement of Spritzer Bhd annual report in 2011:

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Source: Spritzer Bhd_Annual Report 2011

The income statement shows the profitability of the company over a period of time. The managers of the company can determine the major revenues it earned through this income. Secondly, an income statement is significant because it is based on the matching principal and it shows the expense incurred by a company to earn the revenues. Shareholders of a company are interested in this statement because the dividends are paid out of the total income. Moreover, income statement also helps the directors to analyze their expenses, calculate their taxes, and to take into account the major streams of operating revenues of the company [19] .

6.0 Users of Accounting Information:

Accounting is usually classified into two categories [20] :

Managerial Accounting: which satisfies the needs of internal users such as:

Management: for analyzing the organization's performance and position which helps in taking appropriate measures in improving the company's results.

Employees: for assessing company's profitability and its consequence on their future salaries or wages and job security.

Owners: for assessing the viability and profitability of their investment and determining long term course of action.

Financial Accounting: which satisfies the needs of external users such as:

Creditors: for determining the credit worthiness or the value of an organization. Terms of credit are set according to the assessment of their customers' financial health.

Tax Authorities: for determining the credibility of the tax returns filed on behalf of the company.

Investors: for analyzing the feasibility of investing in the company. Investors want to be sure they can earn a relative return on their investment before they put any financial resources to the company.

Customers: for assessing the financial position of its supplier which is necessary for a stable source of supply in the long term.

Regulatory Authorities: for ensuring that the company's disclosure of accounting information is according to rules and regulations set in order to protect the interests of the stakeholders who use such information in forming their decisions.

7.0 Conclusion:

As Mr. Anderson is willing to establish bottled water business in Malaysia, with a startup capital of 3,000,000 RM, it is important for him to clearly understand the advantages of accounting statements, accounting systems, and the differences between business entities. I would suggest for him to partner up with experienced partners who might drive his business forward, and to study the financial statements and financial ratios of other companies which are related to bottled water production and trading in Malaysia so that he would have an overview of the market situation and market demand in this region.

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