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Purpose of accounting

The purpose of accounting is to accumulate and report on financial information about

the performance, financial position, and cash flows of a business. This information is
then used to reach decisions about how to manage the business, or invest in it, or lend
money to it. This information is accumulated in accounting records with accounting
transactions, which are recorded either through such standardized business
transactions as customer invoicing or supplier invoices, or through more specialized
transactions, known as journal entries.

Once this financial information has been stored in the accounting records, it is usually
compiled into financial statements, which include the following documents:

 Income statement
 Balance sheet
 Statement of cash flows
 Statement of retained earnings
 Disclosures that accompany the financial statements

Financial statements are assembled under certain sets of rules, known as accounting
frameworks, of which the best known are Generally Accepted Accounting Principles
(GAAP) and International Financial Reporting Standards (IFRS). The results shown in
financial statements can vary somewhat, depending on the framework used. The
framework that a business uses depends upon which one the recipient of the financial
statements wants. Thus, a European investor might want to see financial statements
based on IFRS, while an American investor might want to see statements that comply
with GAAP.

The accountant may generate additional reports for special purposes, such as
determining the profit on sale of a product, or the revenues generated from a particular
sales region. These are usually considered to be managerial reports, rather than the
financial reports issued to outsiders.

Thus, the purpose of accounting centers on the collection and subsequent reporting of
financial information.

What is 'Accounting'
Accounting is the systematic and comprehensive recording of financial transactions
pertaining to a business, and it also refers to the process of summarizing, analyzing
and reporting these transactions to oversight agencies and tax collection entities.
Accounting is one of the key functions for almost any business; it may be handled by a
bookkeeper and accountant at small firms or by sizable finance departments with
dozens of employees at large companies.

Read more: Accounting

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A number of basic accounting principles have been developed through common

usage. They form the basis upon which modern accounting is based. The best-known
of these principles are as follows:

 Accrual principle. This is the concept that accounting transactions should be

recorded in the accounting periods when they actually occur, rather than in the
periods when there are cash flows associated with them. This is the foundation of
the accrual basis of accounting. It is important for the construction of financial
statements that show what actually happened in an accounting period, rather
than being artificially delayed or accelerated by the associated cash flows. For
example, if you ignored the accrual principle, you would record an expense only
when you paid for it, which might incorporate a lengthy delay caused by the
payment terms for the associated supplier invoice.
 Conservatism principle. This is the concept that you should record expenses and
liabilities as soon as possible, but to record revenues and assets only when you
are sure that they will occur. This introduces a conservative slant to the financial
statements that may yield lower reported profits, since revenue and asset
recognition may be delayed for some time. Conversely, this principle tends to
encourage the recordation of losses earlier, rather than later. This concept can
be taken too far, where a business persistently misstates its results to be worse
than is realistically the case.
 Consistency principle. This is the concept that, once you adopt an accounting
principle or method, you should continue to use it until a demonstrably better
principle or method comes along. Not following the consistency principle means
that a business could continually jump between different accounting treatments
of its transactions that makes its long-term financial results extremely difficult to
discern.
 Cost principle. This is the concept that a business should only record its assets,
liabilities, and equity investments at their original purchase costs. This principle is
becoming less valid, as a host of accounting standards are heading in the
direction of adjusting assets and liabilities to their fair values.
 Economic entity principle. This is the concept that the transactions of a business
should be kept separate from those of its owners and other businesses. This
prevents intermingling of assets and liabilities among multiple entities, which can
cause considerable difficulties when the financial statements of a fledgling
business are first audited.
 Full disclosure principle. This is the concept that you should include in or
alongside the financial statements of a business all of the information that may
impact a reader's understanding of those financial statements. The accounting
standards have greatly amplified upon this concept in specifying an enormous
number of informational disclosures.
 Going concern principle. This is the concept that a business will remain in
operation for the foreseeable future. This means that you would be justified in
deferring the recognition of some expenses, such as depreciation, until later
periods. Otherwise, you would have to recognize all expenses at once and not
defer any of them.
 Matching principle. This is the concept that, when you record revenue, you
should record all related expenses at the same time. Thus, you charge inventory
to the cost of goods sold at the same time that you record revenue from the sale
of those inventory items. This is a cornerstone of the accrual basis of accounting.
The cash basis of accounting does not use the matching the principle.
 Materiality principle. This is the concept that you should record a transaction in
the accounting records if not doing so might have altered the decision making
process of someone reading the company's financial statements. This is quite a
vague concept that is difficult to quantify, which has led some of the more
picayune controllers to record even the smallest transactions.
 Monetary unit principle. This is the concept that a business should only record
transactions that can be stated in terms of a unit of currency. Thus, it is easy
enough to record the purchase of a fixed asset, since it was bought for a specific
price, whereas the value of the quality control system of a business is not
recorded. This concept keeps a business from engaging in an excessive level of
estimation in deriving the value of its assets and liabilities.
 Reliability principle. This is the concept that only those transactions that can be
proven should be recorded. For example, a supplier invoice is solid evidence that
an expense has been recorded. This concept is of prime interest to auditors, who
are constantly in search of the evidence supporting transactions.
  Revenue recognition principle. This is the concept that you should only recognize
revenue when the business has substantially completed the earnings process.
So many people have skirted around the fringes of this concept to commit
reporting fraud that a variety of standard-setting bodies have developed a
massive amount of information about what constitutes proper revenue
recognition.
 Time period principle. This is the concept that a business should report the
results of its operations over a standard period of time. This may qualify as the
most glaringly obvious of all accounting principles, but is intended to create a
standard set of comparable periods, which is useful for trend analysis.

These principles are incorporated into a number of accounting frameworks, from which
accounting standards govern the treatment and reporting of business transactions.

Business Types of Ownership

The pros and cons of different business types of
ownership, including sole proprietorship, partnering,
corporations, and limited liability companies.
One of the first decisions that you will have to make as a business owner is how the
company should be
structured. This decision will have long-term implications, so consult with an
accountant and attorney to help you
select the form of ownership that is right for you. In making a choice, you will want to
take into account the
following:

 Your vision regarding the size and nature of your business.

 The level of control you wish to have.
 The level of structure you are willing to deal with.
 The business' vulnerability to lawsuits.
 Tax implications of the different ownership structures.
 Expected profit (or loss) of the business.
 Whether or not you need to reinvest earnings into the business.
 Your need for access to cash out of the business for yourself.

Sole Proprietorships
The vast majority of small businesses start out as sole proprietorships. These firms are
owned by one person,
usually the individual who has day-to-day responsibilities for running the business.
Sole proprietors own all the
assets of the business and the profits generated by it. They also assume complete
responsibility for any of its
liabilities or debts. In the eyes of the law and the public, you are one in the same with
the business.

Advantages of a Sole Proprietorship:

 Easiest and least expensive form of ownership to organize.

 Sole proprietors are in complete control, and within the parameters of the law,
may make decisions as they
see fit.
 Sole proprietors receive all income generated by the business to keep or
reinvest.
 Profits from the business flow directly to the owner's personal tax return.
 The business is easy to dissolve, if desired.

Disadvantages of a Sole Proprietorship:

 Sole proprietors have unlimited liability and are legally responsible for all debts
against the business. Their
business and personal assets are at risk.
 May be at a disadvantage in raising funds and are often limited to using funds
from personal savings or
consumer loans.
 May have a hard time attracting high-caliber employees or those that are
motivated by the opportunity to
own a part of the business.
 Some employee benefits such as owner's medical insurance premiums are not
directly deductible from
business income (only partially deductible as an adjustment to income).

Federal Tax Forms for Sole Proprietorship:

(only a partial list and some may not apply)
  Form 1040: Individual Income Tax Return
 Schedule C: Profit or Loss from Business (or Schedule C-EZ)
 Schedule SE: Self-Employment Tax
 Form 1040-ES: Estimated Tax for Individuals
 Form 4562: Depreciation and Amortization

 Form 8829: Expenses for Business Use of your Home

 Employment Tax Forms

Partnerships

In a Partnership, two or more people share ownership of a single business. Like

proprietorships, the law does not
distinguish between the business and its owners. The partners should have a legal
agreement that sets forth how
decisions will be made, profits will be shared, disputes will be resolved, how future
partners will be admitted to the
partnership, how partners can be bought out, and what steps will be taken to dissolve
the partnership when
needed. Yes, it's hard to think about a breakup when the business is just getting
started, but many partnerships
split up at crisis times, and unless there is a defined process, there will be even greater
problems. They also must
decide up-front how much time and capital each will contribute, etc.

Advantages of a Partnership:

 Partnerships are relatively easy to establish; however time should be invested in

developing the partnership agreement.

 With more than one owner, the ability to raise funds may be increased.
 The profits from the business flow directly through to the partners' personal tax
returns.

 Prospective employees may be attracted to the business if given the incentive to

become a partner.

 The business usually will benefit from partners who have complementary skills.
Disadvantages of a Partnership:

 Partners are jointly and individually liable for the actions of the other partners.
 Profits must be shared with others.
 Since decisions are shared, disagreements can occur.
 Some employee benefits are not deductible from business income on tax returns.

 The partnership may have a limited life; it may end upon the withdrawal or death
of a partner.

Types of Partnerships that should be considered:

1. General Partnership
Partners divide responsibility for management and liability as well as the shares
of
profit or loss according to their internal agreement. Equal shares are assumed
unless there is a written agreement that states differently.

2. Limited Partnership and Partnership with limited liability

Limited means that most of the partners have limited liability (to the extent of their
investment) as well as limited input regarding management decisions, which
generally encourages investors for short-term projects or for investing in capital
assets. This form of ownership is not often used for operating retail or service
businesses. Forming a limited partnership is more complex and formal than that
of a
general partnership.

3. Joint Venture
Acts like a general partnership, but is clearly for a limited period of time or a
single project. If the partners in a
joint venture repeat the activity, they will be recognized as an ongoing
partnership and will have to file as such as
well as distribute accumulated partnership assets upon dissolution of the entity.

Federal Tax Forms for Partnerships:

(only a partial list and some may not apply)

 Form 1065: Partnership Return of Income

  Form 1065 K-1: Partner's Share of Income, Credit, Deductions
 Form 4562: Depreciation
 Form 1040: Individual Income Tax Return
 Schedule E: Supplemental Income and Loss
 Schedule SE: Self-Employment Tax
 Form 1040-ES: Estimated Tax for Individuals
 Employment Tax Forms

Corporations

A corporation chartered by the state in which it is headquartered is considered by law

to be a unique entity,
separate and apart from those who own it. A corporation can be taxed, it can be sued,
and it can enter into
contractual agreements. The owners of a corporation are its shareholders. The
shareholders elect a board of
directors to oversee the major policies and decisions. The corporation has a life of its
own and does not dissolve
when ownership changes.

Advantages of a Corporation:

 Shareholders have limited liability for the corporation's debts or judgments

against the corporations.
 Generally, shareholders can only be held accountable for their investment in
stock of the company. (Note
however, that officers can be held personally liable for their actions, such as the
failure to withhold and pay
employment taxes.)
 Corporations can raise additional funds through the sale of stock.
 A corporation may deduct the cost of benefits it provides to officers and
employees.
 Can elect S corporation status if certain requirements are met. This election
enables company to be taxed
similar to a partnership.

Disadvantages of a Corporation:
  The process of incorporation requires more time and money than other forms of
organization.
 Corporations are monitored by federal, state and some local agencies, and as a
result may have more
paperwork to comply with regulations.
 Incorporating may result in higher overall taxes. Dividends paid to shareholders
are not deductible from
business income; thus it can be taxed twice.

Federal Tax Forms for Regular or "C" Corporations:

(only a partial list and some may not apply)

 Form 1120 or 1120-A: Corporation Income Tax Return

 Form 1120-W Estimated Tax for Corporation
 Form 8109-B Deposit Coupon
 Form 4625 Depreciation
 Employment Tax Forms
 Other forms as needed for capital gains, sale of assets, alternative minimum tax,
etc.

Subchapter S Corporations

A tax election only; this election enables the shareholder to treat the earnings and
profits as distributions and
have them pass through directly to their personal tax return. The catch here is that the
shareholder, if working for
the company, and if there is a profit, must pay him/herself wages, and must meet
standards of "reasonable
compensation". This can vary by geographical region as well as occupation, but the
basic rule is to pay yourself
what you would have to pay someone to do your job, as long as there is enough profit.
If you do not do this, the
IRS can reclassify all of the earnings and profit as wages, and you will be liable for all
of the payroll taxes on the
total amount.
Federal Tax Forms for Subchapter S Corporations:
(only a partial list and some may not apply)

 Form 1120S: Income Tax Return for S Corporation

 1120S K-1: Shareholder's Share of Income, Credit, Deductions
 Form 4625 Depreciation
 Employment Tax Forms
 Form 1040: Individual Income Tax Return
 Schedule E: Supplemental Income and Loss
 Schedule SE: Self-Employment Tax
 Form 1040-ES: Estimated Tax for Individuals
 Other forms as needed for capital gains, sale of assets, alternative minimum tax,
etc.

Limited Liability Company (LLC)

The LLC is a relatively new type of hybrid business structure that is now permissible in
most states. It is designed
to provide the limited liability features of a corporation and the tax efficiencies and
operational flexibility of a
partnership. Formation is more complex and formal than that of a general partnership.

The owners are members, and the duration of the LLC is usually determined when the
organization papers are
filed. The time limit can be continued, if desired, by a vote of the members at the time
of expiration. LLCs must not
have more than two of the four characteristics that define corporations: Limited liability
to the extent of assets,
continuity of life, centralization of management, and free transferability of ownership
interests.

Federal Tax Forms for LLC:

Taxed as partnership in most cases; corporation forms must be used if there are more
than 2 of the 4 corporate
characteristics, as described above.

In summary, deciding the form of ownership that best suits your business venture
should be given careful
consideration. Use your key advisers to assist you in the process.

Courtesy of the U.S. Small Business Administration.

Types of Business Operations

There are three (3) different nature and types of businesses that are operated with the
purpose of earning profit. Each type of business has distinctive features.

1. Service Business

This type of business operation provides services, instead of product, to its customers.
It includes, but not limited, to the following:

 Professionals such Lawyers, Doctors, Accountant, Engineer, etc.

 Consultation
 Hospital
 Hotel and Lodging
 Restaurant
 Transportation
 Entertainment
 Banking and Financial

2. Merchandising Business

This type of business operation sells products to its customers. However, they don’t
make the products they sell; instead, they buy or purchase it from other business. It
includes, but not limited, to the following:

 General merchandise such as grocery store and retail business

 Toy stores
 Electronic stores
 Apparel stores
 Online stores such as Amazon.com, iTunes.com, Audible.com, eBay, etc.
3. Manufacturing Business

This type of business operation converts basic inputs, such as materials, labor and
overhead, into finished products which are sold to customers. It includes, but not
limited, to the following:

 Computer and electronic manufacturer

 Car, trucks and vans manufacturer
 Shoe and clothes manufacturer
 Canned goods manufacturer
 Soda or beverage manufacturer

Types of Business Organizations

Once you’ve identified the nature and type of operation the business runs, the next
thing you need to know is what type of organization the business was formed.

Manufacturing, merchandising and service businesses are commonly organized and

formed as either of the following:

1. Proprietorship

It’s a type of business organization that is owned by a single individual. The individual
or person who owns this type of business is referred to as Proprietor.

It is the most common and popular type of business organization because it is easier
and cheaper to organize. However, the primary disadvantage of proprietorship is that
the business resources are limited to the single owner’s resources. Also, the owner
assumes all the risk, liability and decision making of the business.

Small businesses like repair shops, laundries, restaurants, and professional services
are organized as proprietorship.

2. Partnership

As a business grows bigger, it needs more financial, people and managerial resources.
Two or more individuals may join together and form a business called partnership. The
group of individuals who own the partnership business is referred to as Partners.

Partnership is a type of business organization that is owned by two or more individuals.

It is a little harder and more expensive to organize than the proprietorship. The benefit,
however, is that the risk, liability and management is shared by group of individuals,
depending on the percentage of ownership agreed upon.

There are many small and medium-size businesses such as repair shops, laundries,
and professional firms that are organized as partnership. The difference it has from
proprietorship is that it is owned by more than one individual and the requirements of
organizing a partnership is more tedious than a proprietorship.

3. Corporation

It’s a type of business organization that is owned by shareholders and it is structured

as a separate legal entity under the operation of law. The ownership of a corporation is
divided into shares of stock. A corporation issues the stock to individuals or other
businesses, who then become owners or stockholders, of the corporation.

The benefit of the corporation is that the risk and liability is not shouldered by the
owners called as stockholders. And the management or decision making is shared by
the board of directors. Also, it is easier to increase resources of the business by means
of issuing stock.
Large size businesses usually form a corporation because of its complexity and high
need of resources.

I hope this article has been helpful for you to learn and understand the different types
of business operations and organizations. You may share your thoughts, additional
knowledge, questions or concerns via comment box below.

1. Service Business

A Service Business revolves around the idea of a company providing its customers
with intangible goods. An Intangible good is something that does not have a physical
nature like transportation, consultation, repair, and professional services from lawyers,
doctors, financial analysts and accountants.
If you might have guessed already, service businesses doesn’t have any inventory to
take into account when computing for financials. You will not have a lot of expense
accounts so there are a lot more room for gray areas that you can be flexible with.

2. Merchandising Business
Merchandising Business Operations is the complete opposite of a Service Business;
where you are selling tangible goods. Common businesses who sells tangible products
are grocery stores, hardware supplies, and clothing. Merchandising operations
however only involves purchasing goods that are ready for sale and reselling it for a
certain amount of profit.

Unlike Service Business, expect to have more expense accounts. There are a lot more
to manage but everything is straight forward. You need to record wages and inventory
accounts.

3. Manufacturing Business

A Manufacturing Business operations concerns with manipulating resources like raw

materials, labor, machine and transforming them into finished products that are ready
to be sold to customers. This is the major difference of a Manufacturing Business to a
Merchandising Business. A Manufacturer buys goods for the purpose of making new
products and selling them, while a Merchandiser buys goods for the sole purpose of
selling it right away. Popular examples of Manufacturing Businesses are big
companies who makes Vehicles, Soft Drinks, and Canned Goods. But small
businesses like Water refilling Stations, Bead Necklaces and Bracelets, Dried Fruits
Production and Ice production are considered manufacturers also.

Manufacturing Business opens up a new world of accounting approach as you also

need to consider the additional expense of your raw materials and your cost of goods
sold.

What’s best for you?

On paper, you can pick any Business Operation, and that is the beauty of starting your
own business. You can even choose to have a combination of the operations; it
depends entirely to you and the nature of the business that you envision. This is just a
friendly reminder to guide you about the things that you might encounter if you either
choose to have a service, merchandising, or manufacturing business.
The crucial part of the choices that you make is having the right accounting knowledge
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