Types of Accounting Systems

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Under cash based accounting revenue is recorded when cash is received, and expensed is recorded when cash if paid (Weygant, et. al. 2002, pg.89). The use cash based accounting is suitable for small businesses that deal primary in cash such as a hot dog vendor or a pizza cart. The use of cash based accounting is not in compliance with the generally accepted accounting principles, thus public companies cannot utilize this method of accounting because it would violate GAAP and SEC mandates. It is easier to implement a cash based accounting when the firm does not have account receivables or account payables. It is possible for accountants to convert a system from a cash basis accounting to an accrued basis accounting. The process is time consuming due to the fact that the accountant must use a lot of adjusting entries. The users of financial statement or stakeholders require precise and accurate financial statements that are free of fraud and materials errors. The major stakeholders groups that use often use financial information of companies to make decisions include the employees, lenders, shareholders, board of directors, suppliers, managerial staff, governmental institutions, and the community. The employees need information regarding the financial activity of the company they work for to provide them with security that the company is aligned with the going concern principle. The lenders evaluate the financial statements of companies to determine whether to lend them money or not. Banks and others rely on the accuracy of the financial statements to make decisions worth thousands or millions of dollars. Suppliers often extend credit lines to corporate customers based on their evaluation of the financial performance of an enterprise. The general public expects corporations to act in a socially responsible manner at all times. The shareholders make buy and sell decisions based on the results of the financial statements. Wall Street would collapse if investors stop believing in the accuracy of financial statements. Back at the turn of the century a series of financial scandals caused investors in the US to lose confidence in the accuracy of financial statements released by public companies. The US Congress reacted by passing the Sarbanes-Oxley Act of 2002. The Sarbanes-Oxley Act raised the consumer confidence, overall accountability, accuracy, and it imposed severe penalties for white collar crimes. Executive managers such as CEOs found of fraudulent financial activity can receive penalties of up to 20 years in prison. The CEO now has to sign the financial statements prior to being release to certify that they are free of fraud and material error. Accountants utilized a concept knows as depreciation to reflect the loss in value of an equipment or machinery as time passes. The most common depreciation method used by accountants in the United States is straight line depreciation. Straight line depreciation is calculated by diving price minus salvage value by lifetime in years (price – salvage value) / (years). Depreciation helps adjust the value of an asset. Companies that depreciate its assets receive a tax benefit because depreciation is categorized as an expense the lowers the net earning of the company. Three additions depreciation methods are LIFO, FIFO, and weighted average. The MACRS depreciation method is one of the best methods to reduce taxes in the short