Read Understanding Business Accounting For Dummies, 2nd Edition Online
Authors: Colin Barrow,John A. Tracy
Tags: #Finance, #Business
Understanding Business Accounting For Dummies, 2nd Edition (123 page)
Partnerships are
pass-through
tax entities. A pass-through business entity pays no tax on its taxable income but passes the obligation to its owners, who pick up their shares of the total taxable income in their individual income tax returns. In contrast, the individual shareholders of companies pay tax only on the amount of actual cash dividends from profit distributed by the company. Keep in mind here that the company pays corporation tax based on its taxable income. Except for very small and very large businesses, the main corporation tax rate in 2008/9 is 28 per cent of taxable income. Factors other than tax affect the choice of ownership structure. You need the advice of tax professionals and financial consultants.
Regardless of the ownership structure, you should understand how accounting methods determine taxable income. Basically, the choice of accounting methods enables you to shift the timing of expenses - such as depreciation and cost of goods sold - between early years and later years. Do you want more expense deductions this year? Then choose the last-in, first-out (LIFO) method for cost-of-goods-sold expense and an accelerated method for depreciation. But keep in mind that what you gain today, you lose tomorrow. Higher expense deductions in early years cause lower deductions in later years. Also, these income-tax-driven accounting choices make the stock and fixed assets in your balance sheet look anaemic. Remember that expenses are asset decreases. You want more expense? Then lower asset values as reported in your balance sheet.
Think twice before jumping on the tax minimisation bandwagon. Knowing about accounting methods and their effects in both the profit and loss account and the balance sheet helps you make these important decisions.
Explain Your Financial Statements to Others
On many occasions, as a business manager you have to explain your financial statements to others:
When applying for a loan
Knowledge of financial statement reporting and accounting methods is also extremely useful when you sit on a bank's board of directors, or a hospital board, or any of several other types of oversight boards. In the preceding list, you're the explainer, the one who has to do the explaining. As a board member, you're the explainee, the person who has to make sense of the financial statements and accounting methods being presented. A good accounting foundation is invaluable.
A short word on massaging the numbers: Don't!
I (John) taught accounting to future business managers and accountants. I didn't encourage profit smoothing, window dressing, and other techniques for manipulating accounting numbers to make a company's financial statements look better - no more than my marketing professor colleagues encouraged their students to engage in deceptive advertising tactics. Yet these things go on, and I felt obligated to expose my students to these practices as a warning that accountants face difficult moral decisions. In a similar vein, I caution you, a business manager, that you will surely face pressures from time to time to massage the accounting numbers - to make profit look smoother from year to year, or to make the short-term solvency of the business look better (by window dressing). Don't!
