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Objectives of Accounting System. Timely and accurate picture of performance Generate financial reports for management, lenders, creditors Facilitate filing of tax returns (sales and payroll taxes more important than income tax) Prevent and detect fraud, waste and theft.

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objectives of accounting system
Objectives of Accounting System
  • Timely and accurate picture of performance
  • Generate financial reports for management, lenders, creditors
  • Facilitate filing of tax returns
    • (sales and payroll taxes more important than income tax)
  • Prevent and detect fraud, waste and theft
methods of accounting
Methods of Accounting
  • Types of methods
    • Cash basis
    • Accrual basis
    • Hybrid (modified cash or accrual)
choice of method
Choice of Method
  • Tax Requirements
    • In general, cash basis is preferable for tax purposes
    • Accrual required for tax if significant:
      • Inventory
      • Account receivable
tax vs book accounting
Tax Vs. Book Accounting
  • Different overall accounting methods can be used for tax and financial reporting purposes
  • Even if same overall method used, different specific methods can be used (i.e., depreciation)
    • Exception is LIFO inventory
cash basis accounting
Cash Basis Accounting
  • Simplest Method
    • Appropriate for many small businesses
    • Not allowed for tax if significance inventories, or gross receipts exceed 5 million
    • Cash can be used internally, and adjusted to accrual for year-end reporting
accrual basis accounting
Accrual Basis Accounting
  • When significant receivables and inventory exist, cash basis accounting will not accurately reflect income
    • Accrual accounting does not accurately capture cash flow
    • However, income is best predictor of future cash flows
comparison of cash vs accrual
Comparison of Cash vs. Accrual

Cash Accrual

Beg. A/R 20,000 -

Sales for month 120,000 120,000

Ending A/R (40,000) -

Reported Sales 100,000 120,000

different tax and reporting methods
Different Tax and Reporting Methods

Financial Tax

Sales 500,000 500,000

Other exp. (480,000) (480,000)

Depr. ( 2,000)

Sec. 179 (10,000)

Net Income 18,000 10,000

lifo inventory last in first out
LIFO Inventory(Last-In, First-Out)
  • LIFO inventory reduces taxes when inventory prices are rising
    • Must also be used for financial statements (FIFO usually disclosed)
  • Provides additional deferral timing option
    • Taxes can be affected by timing of inventory purchases
lifo inventory
LIFO Inventory
  • LIFO Pitfalls
    • Write-offs for obsolescence not allowed
    • Unplanned inventory liquidation can result in large tax bill by including old, “cheap” inventory in cost of goods sold
value of lifo
Value of LIFO

Inventory Value in Yr. 1 $ 1,000,000

(LIFO value)

Inflation 5%

FIFO value in 10 years

(1.05)10 x 1,000,000 1,628,900

Difference 628,900

Tax Rate 40%

Cumulative Tax Deferral $ 251,560

accounting systems
Accounting Systems
  • Integrated with inventory, accounts receivable
  • Payroll - almost always better to use service bureau
    • don’t have to worry about changes in law, rates

Don’t get behind on payroll taxes!

various taxes
Various Taxes

Tax Form Rate

Sales Tax State 7% (NY)

Withheld taxes

FICA&Med. 941Varies

Federal

State

Employer

FICA 6.2%

Medicare 9412.45%

FUTA 940 0.8%

State State

external reporting
External Reporting

Type of Level of Est. Est.

Report Assurance Cost Loan Size

Audit Positive Expen. $1 mill +

Review Limited 1/2 audit < $1 mill.

Compilation None Minimal < $200k

accountant reports
Accountant Reports
  • Type of report may be negotiable with bank
  • CPA reports can also be issued for forecasts and projections included in business plans or loan applications
  • Don’t place undue reliance on an audit report when evaluating a buyout candidate