Accounting Tools



Part1: Definition of terms

GAAP(GenerallyAccepted Accounting Principles) refer to the accounting rules andstandards, which every firm should adhere to in financial reporting.According to Edwards &amp Hermanson (2007), GAAP stipulations aremade up of descriptions of theories and values. The major purpose ofGAAP is to ensure financial reporting is transparent and consistentacross all organizations. In the United States, there is a commissionput in place to ensure all firms adhere to GAAP rules. However, it isimportant to point out that GAAP standards are not universal. Thestandards vary from one geographic location or industry to another.

InternationalFinancial Accounting Standards (IFRS) is a single set of accountingstandards, which are designed and intended to be consistent globally. The major role of IFRS is to provide an inclusive framework to showhow public firms prepare and reveal their financial statements(Gangwar S &amp and Gangwar D, 2009). IFRS has been adopted by bothdeveloped and developing economies to enable investors, and otherusers of financial statements compare the performance of public firmsand make good decisions about where to invest.

TheU.S. SEC is a U.S. government agency that is in charge of supervisingfinancial transactions and activities of accounting firms to preventfraud and intentional deception (U.S. Securities and ExchangeCommission, 2007). It has four leading units: Division of CorporationFinance (discloses corporate information to the inspecting public),Trading, and Markets (guarantees parity, capability, and order inmarket-related activities), Division of Investment Management(safeguards stakeholders and enhances the formation of capital), andEnforcement (deals with securities law and applies actions againstillegal activities).

Anannual report is an inclusive report on a company’s financialactivities throughout the previous year (Smith, 2010). The major roleof annual reports is to give investors and other interested peoplefacts about company’s activities and financial performance. 10-Q isa report that a company is required to prepare quarterly. Thequarterly report contains less detail than the annual report. It is arequirement that companies file the 10-Q report within 35 days of theend of their quarter. 10-K is the annual report prepared by a companyyearly. It is highly detailed and enables investors to know all thevital finical information about a company. 8-K is a form that isfiled by companies to update their investors of any importantupcoming events (Smith, 2010). The 10-Q, 10-K, and 8-K reports arevery important to a company since allows the investors to obtainimperative information about the firm and build strong relations toenhance the company’s image and boost its performance.

Theimportance of the above concepts to financial statements

Theabove-described reports are highly important to financial statementssince they provide adequate information that every investor islooking for. They enable the financial statements to reflect theactual financial position of the company. For instance, IFRS ensurethat a company prepares financial statements based on facts to avoiddeception and potential fraud. The quarterly, half-yearly and yearlyreports are all important since they enable a company boosts thequality and transparency of their financial statements hence buildinggood corporate image (GangwarS &amp Gangwar D, 2009). Reports such as the 10-Q and the 10Kcontain critical information that helps to build up financialstatements and guide the company in decision making regardingfinancial activities. The financial statement such as the balancesheet, income statement, and cash flows rely on the informationcontained in reports such as the 10-Q, 10K, 8K and annual reports.

PartII: The basic formats of the financial statements


Theincome statement reports the accountant`s primary measure of abusiness`s performance regarding profit made. Net income is arrivedat by calculating the revenues or incomes and then deducting expensesduring an accounting period.

Thebalance sheet

Abalance sheet main objective is to report the monetary state of afirm during a particular period in time (Smith, 2010). One determinesthe financial position of an entity by calculating assets bysubtracting stockholders` equity from the total liabilities.

Thestatement of cash flow

Inany typical business, the Statement of Cash Flow categorizes cashinflows and outflows into 3 classes of cash flows. The cash flows arefrom the operating, investing and financing activities. It isimportant to point out that the stated incomes do not continuouslyrepresent the cash inflow since some firms may make sales on creditterms (Smith, 2010). Similarly, the calculated expenditures may notrepresent the cash outflow since a firm may incur expenses in thecurrent financial period but pay them in the next period. Because thestatement does not offer adequate evidence about cash flows, auditorsformulate the report to show clearly how cash flows in and out. Theequations used to come up with statement of cash flows are asfollows:

“+/-Cash Flows from Operating Activities (CFO), +/- Cash Flows fromInvesting Activities CFI), +/- Cash Flows from Financing Activities(CFF) = Change in Cash.”

Statementfor retained earnings

TheStatement of Retained Earnings, which usually provides informationfor a specific financial period enables the company to measures theimpact of dividends’ distribution on the firm’s financialposition. Companies with high net income in a period, have highretained earnings. The report shows the connection between the IncomeStatement and the Balance Sheet (U.S. Securities and ExchangeCommission, 2007). In the same breadth, the provision of bonuses ordividends diminishes retained earnings, calculated as.

“BeginningRetained Earnings + Net Income – Dividends = Ending RetainedEarnings.”


Aspectsof Accounting naturally falls into one of three classes, asdemonstrated by the Accounting Equation.

Assets= Liabilities + Equity

Eachof the three classes making up the accounting equation falls intoseveral accounts. The table below classifies several accounts undereach category of the Accounting equation with total assets of $559,000.




Cash = $222,000

Accounts payable = $25,000

Owner’s equity = $56,000

Accounts receivable = $ 60,000

Rent payable = $10,000

Owner’s withdrawal = $32,000

Property and equipment = $45,000

Salaries payable = $55,000

Common shares = $48,000

Buildings = $119, 000

Dividends payable = $76,000

Retained earnings = $ 56,000

Goodwill= $78,000

Tax payable = $ 56,000

Dividends = $76,000

Merchandise inventory = $ 35,000

Long term liabilities = $15,000

Preferred shares = $54,000

TheAccounting Equation therefore, becomes:

Assets= Liabilities + Equity

$557,000= $237,000 + $322,000


Edwards,J.D. &amp Hermanson, R.H. (2007). FinancialAccounting.In Accounting Principles: A Business Perspective. First Global TextEdition, pp. 6-37. Retrieved 18, November 2015 from

Gangwar,S., &amp Gangwar, D. K. (2009). FundamentalPrinciples of Accounting,Global Media, Himalaya Pub. House, Mumbai.

Smith,B. (2010). IntroductoryFinancial Accounting,Open University Press.

U.S.Securities and Exchange Commission. (2007). Beginner`sGuide to Financial Statements.Retrieved 18, November 2015