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Classification: Genpact Internal

Indeed, this is one of good area, where most of techies have lot of confusion and illusion about when accounting comes. Many of consultant came from Technical background and gradually moved into doing some techno -functional role or pure functional role, thus it is essestintial to understand the basic accounting and Guided principal .

Normally, there are two basic accounting methods available in the business world:

Cash Accrual

And most of the ERP accounting products weather its SUN system, Oracle financial or SAP have functionality to capture on the basis of set up.

Then want is the difference:

Cash Basis AccountingThis is what “Based on Realization“

We Most of us use the cash method to keep track of our personal financial activities.

The cash method recognizes revenue when payment is received, and recognizes expenses when cash is paid out.

For example, our local grocery store’s record is based on the cash method. Expenses are recorded when cash is paid out and revenue is recorded when cash or check deposits are received

If we summarize, under the cash basis accounting, revenues and expenses are recognized as follows:

Revenue recognition: Revenue is recognized when cash is received. Expense recognition: Expense is recognized when cash is paid.

Take a note the word “cash” is not meant literally - it also covers payments by check, credit card, barter, etc.

Moreover it is not standard method in compliance with accountings matching principle.

Classification: Genpact Internal

Accrual Basis AccountingThis is what “Based on Recognition“

The accrual method of accounting requires that revenue be recognized and assigned to the accounting period in which it is earned. Similarly, expenses must be recognized and assigned to the accounting period in which they are incurred.

Then the underline question is what is accounting Period, Let explain like this normally a company tracks the summary of the accounting activity in time intervals, which we normally called as Accounting periods. These periods are usually a month long. It is also common for a company to create an annual statement of records. This annual period is also called a Fiscal or an Accounting Year.

In the accrual method relies on the principle of matching revenues and expenses. This principle says that the expenses for a period, which are the costs of doing business to earn income, should be compared to the revenues for the period, which are the income earned as the result of those expenses. In other words, the expenses for the period should accurately match up with the costs of producing revenue for the period.

Take a case:Company is doing a business and they have to pay sales commissions expense, so sales commissions expense should be reported in the period when the sales were made (and not reported in the period when the commissions were paid). Similarly, Salary/Wage to employees are reported as an expense in the week/month when the employees worked and not in the week/month when the employees are paid. If a company agrees to give its employees 2-month equivalent salary of its 2006 revenues as a bonus on January 25, 2007, the company should report the bonus as an expense in 2006 and the amount unpaid at December 31, 2006 as a liability. This is most simple kind of matching principal normally has.

In general, there are two types of adjustments that need to be made at the end of the accounting period.

1. The first type of adjustment arises when more expense has been recorded than was actually incurred or earned during the accounting period.

2. Similarly, there may be revenue that was received but not actually earned during the accounting period. Also known as Un-earned Revenue.

The accrual method generates tax obligations before the cash has been collected (because revenue leads to tax and revenue is recognized against receivable and not against receipt of money).

If we summarize, under the accrual basis accounting, revenues and expenses are recognized as follows:

Classification: Genpact Internal

Revenue recognition: Revenue is recognized when both of the following conditions are met:

o Revenue is earned i.e. when products are delivered or services are provided.

o Revenue is realized or realizable. i.e. either cash is received or it is reasonable to expect that cash

will be received in the future. Expense recognition: Expense is recognized in the period in which related

revenue is recognized (Matching Principle).

Timing differences in recognizing revenues and expensesVarious accounting books did mention four potential timing differences in recognizing revenues and expenses between these of two. Just to recap of those:

a. Accrued Revenue: Revenue is recognized before cash is received.b. Accrued Expense: Expense is recognized before cash is paid.c. Deferred Revenue: Revenue is recognized after cash is received.d. Deferred Expense: Expense is recognized after cash is paid.

Compare with a Case to explain these two methods

Your company purchase a new Laptop on credit in May 2007 and pay $1,500 for it in July 2007, two months later.

Under the both case see how this makes a difference:

Using the cash method accounting, you would record a $1,500 payment for the month of July, the month when the money is actually paid.

Under the accrual method, you would record the $1,500 payment in May, when you take the Laptop and become obligated to pay for it.

Pros and cons of these Two accounting methodMaintence: The cash method is easier to maintain because you don’t record income until you receive the cash, and you don’t record an expense until the cash is paid, where as in the accrual method, you will typically record more transactions.

Cash-basis accounting defers all credit transactions to a later date. It is more conservative for the seller in that it does not record revenue until cash receipt. In a growing company, this results in a lower income compared to accrual-basis accounting.

Do you what is meant by GAAP?No, I don’t know, but knows most of ERP follows these. Lets explain this way:The word”generally accepted accounting principles” (or “GAAP”) consists of three important sets of rules:(1) The basic accounting principles and guidelines,(2) The detailed rules and standards issued by FASB(Financial Accounting Standards

Classification: Genpact Internal

Board and its predecessor the Accounting Principles Board (APB)(3) The generally accepted industry practices.

Normally Standard GAAP will have various guided Principal, such as

Economic Entity Assumption Time Period Assumption Cost Principle Matching Principle Revenue Recognition Principle

Will take a seprate case of some of them to understand in better way.

If you want to know more about GAAP, weather US-GAAP, UK-GAAP , refer wikipedia

ERP/Oracle FinancialsOracle Financials have been developed to meet GAAP requirements as well as the special needs of different countries. For example, in Oracle Payables you can choose whether to record journal entries for invoices and payments on an accrual basis, a cash basis, or a combined basis where accrual journal entries are posted to one set of books and cash basis journal entries are sent to a second set of books.

Will continue with some additional accounting stuff, keep reading and commenting.

PROFIT AND LOSS

In accounting world, an Income Statement is called as “Profit and Loss Report”. In addition, the word Revenue is often used in place of the word Income. An Income Statement is used to inform you about the income earned, expenses incurred, and the total profit or loss in a particular period. Two common periods for creating an income statement are monthly and annually.

This report summarizes all Income (or sales), the amounts that have been or will be received from customers for goods delivered or services rendered to them, and all expenses, the costs that have arisen in generating revenues.

Normally Income Accounts accounts are used to track income earned during the process of operating your business. The income of a business comes from sales to customers or fees for services or both. Some of the common names for income accounts are: Income from Sales, Income from Freight, Income from misc. sources as property, shares.

As discussed in last post Balance Sheet is a ‘position’ statement whereas Profit & Loss Account is a ‘flow’ statement.

The need of P & L report is enforced because of companies Act, which enforce to produce Balance sheet and P&L account.

Classification: Genpact Internal

A Balance Sheet as on the last day of the financial year A Profit & Loss Account for the financial year.

Profit and Loss A/C

What you suppose to remeber is :

P&L A/c is also called ‘Income Statement’. Income is calculated as the difference between revenues and expenses.

o Revenues: from operationso Expenses: specific product/service/period

Accountants have agreed to use the accrual basis of accounting rather than the cash basis

The term Revenue and expense

Revenues - gross increases in owners’ equity arising from business operations/delivery goods-services to customers

Expenses - decreases in owners’ equity that arise because goods or services are delivered to customers

In term of accounting, this can be described as:

Revenue Account :This is the income account. Whenever a revenue account balance is changed, it leads to a change in the Assets / Liabilities account. Revenue account is not a control account, it’s treated as an operative account. At the beginning of a new accounting cycle, this account is turned to zero. Entire balance is transferred to the retained earnings account.

Classification: Genpact Internal

Expense Account : This is the operations expenditure account. Whenever an expenditure account balance is changed, it leads to a change in the Assets / Liabilities account. This account behaves just like the Owner’s equity account as an increase in this account essentially means a decrease in owner’s equity. Expense account is not a control account, it’s treated as an operative account. At the beginning of a new accounting cycle, this account is turned to zero. Entire balance is transferred to the retained earnings account.

Spliting the above , the balance sheet can be drived on the basis of these. You can see the details in one of last post.

BALANCE SHEET

Do you know one of Key Financial Report aka Balance Sheet is a basically ‘position’ statement, which describes the financial position of assets & liabilities of

your company/firm as on a particular date

If you take any accounting book, this can be best defined as “a statement of the financial position of an enterprise as at a given date, which exhibits assets, liabilities, capital, etc.”

Why Balance Sheet Required?

Obvious question why this is required? the Only reason is because the the legal rules (Companies Act) enforce companies to publish such report.

A Balance Sheet as on the last day of the financial year A Profit & Loss Account for the financial year.

In accounting world , balance sheet should reflect ‘true and fair view’ in term of shareholder equity .

Balance sheet - techies definition

Assets and Liabilities are continuously changing with Business activity. To understand the financial position of the Business, it is necessary to ‘FREEZE’ the values of financial components at a certain point in time. These values, or Balances, are used to construct a

Classification: Genpact Internal

balance sheet which shows how the owner’s equity is represented by the various categories of assets and liabilities.

Do this have any Structure?

Yes, If you see different accounting book, we will find two different form of Balance sheet,

Horizontal Vertical

The only difference between these two are required to give the corresponding amounts for the preceding financial year (‘Comparatives’) for all the items shown in the balance sheet.

A typical Balance sheet can be best represented as:

Classification: Genpact Internal

This is based out of accounting equation, which I have discussed in one of old post :

Assets = Owner’s Equity + Outside Liabilities

A = OE + OL

in the world of double entry system, the rule of thumb is “In the double-entry accounting system, every transaction is recorded by equal amounts of debits and credits”

A (DEBIT)= OE + OL(CREDIT)

Classification: Genpact Internal

If you analyze the above sheet in term of accounting equation , this can be best understood as:

Is there any limitation for Balance sheet?

Yes, there are (adopted from Jep Robertson Notes)

As most most assets and liabilities are based out of historical cost. Judgments and estimates are used in determining many of the items. The balance sheet does not report items that can not be objectively determined. It does not report information regarding off-balance sheet financing.

Where is my Balance sheet report within Oracle

Classification: Genpact Internal

Balance sheet reports in Oracle are one of the FSG report which need to fine tune base out of the customer requirement, and this can be executed from the report section within GL responsibility.

Classification: Genpact Internal