Types of Accounts Maintained by a Business Essay Example

Introduction

The three types of accounts maintained by a business are nominal, real, and personal accounts ("What Are the Three Types of Accounts?," 2010) . A real account refers to a record of the assets, liabilities, and capital at a particular moment in time while nominal accounts give a summary of the business expense and revenue within a particular period, for instance a year. On the other hand, personal accounts are based upon personal relationships and hence are related to firms and its stakeholders (persons). For instance, personal accounts include debtors, prepaid and outstanding accounts, drawings, capital, and banks.

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Personal accounts are classified into natural, artificial, and representative personal accounts. Natural personal accounts involve God's creations which essentially refers to people while artificial personal accounts are established by law, and include, limited liability companies, Faviar Ltd account, school accounts, among others. The last account is referred to as a representative personal account which represents a group of individuals either directly or indirectly such as salaries paid in advance which are drafted in a wages prepaid account, which is indirectly attached to the individual.

Real accounts are reported in a balance sheet as they summarize assets, equity, and liabilities. There are also two classifications of real accounts which are tangible and intangible real accounts. The former refers to all business components that can be physically felt or are touchable. For instance, stock, land, buildings, machinery, and vehicles are real tangible accounts. Intangible real accounts include matter that one cannot feel via touch such as trademarks, goodwills, and patents for businesses.

Nominal accounts are annual such that they are closed at the end of the trading period, as their role is to accumulate expenses and sales annually, when balances close, and are hence reset to zero to pave way for the annually accumulated expenses and sales.

What is double-entry accounting?

Using a double-entry system requires at least some level of formal training in accounting. Two characteristics of double-entry bookkeeping are that each account has two columns and that each transaction is located in two accounts. Two entries are made for each transaction - a debit in one account and a credit in another (Sangster, 2015).

Accounting attempts to record both effects of a transaction or event on the entity's financial statement. The double entry system of accounting or bookkeeping means that every business transaction will be entered into two accounts (or more). For example, when a company borrows money from its bank, the company's Cash account will increase and its liability account Loans Payable will increase.

Double entry also allows for the accounting equation (assets = liabilities + owner's equity) to always be in balance. In our example above, the asset Cash decreased and the owner's capital account within owner's equity also decreased.

Why is double-entry accounting the only way to provide the most accurate financial information for business managers?

The majority of business firms worldwide, big or small use the double-entry approach, despite the fact that it is more complicated and more difficult to use than the more straightforward alternative, single-entry accounting. They make this choice because it is almost impossible for them to comply with government and regulatory requirements for reporting and record-keeping using a single-entry system. Furthermore, with a single-entry system alone, large corporations cannot accurately track their assets, liabilities, equities, revenues, and expenses (Yamey, 2008). Single-entry accounting has a downside in that; the owners receive a very limited view of their business (Sangster, 2015). A list of incomes and expenses can only go so far in helping the owners understand their business - particularly because a company's finances involve more than just incomes and expenses. Assets such as equipment, property and machinery may not generate "income" like cash, but these assets are integral to the owners' equity and to understanding the company's overall net worth. That's why double-entry accounting, giving you a more complete balance sheet, provides a much better option.

The advantages that double-entry bookkeeping has over single-entry bookkeeping are that errors or fraud are easy to detect, proper financial statements can be prepared directly from the books, and the owners can accurately calculate profit and loss in complex organizations.

Describe the accounting process used by a business manager to forecast the firm's financial performance and financial needs over the next five years?

As a business manager, important decisions need to be made on a regular basis. The accuracy and correctness of the manager's decisions are largely dependent on his true understanding of the firm's business position. Strong accounting records, proper management accounting and accurate financial forecasts ensure that a company stays fully aware of its business position (Kaplan & Atkinson, 2015). This allows the managers to make informed decisions that will benefit the business both now and in the long run.

A forecast is essentially a prediction concerning future business conditions that are likely to affect a company, organization, or country. In forecasting a company's financial performance, a business manager identifies trends in external and internal historical data and projects those trends in order to provide decision-makers with information about what the financial status of the company is likely to be at some point in the future.

The first step usually is to review/reexamine the key financial statements within the context of the relevant accounting standards. The balance sheet is reassessed to ascertain whether it is a complete representation of the firm's economic position. The income statement on the other hand is reexamined to properly assess the quality of earnings as a complete representation of the firm's economic performance. The statement of cash flows helps in understanding the impact of the firm's liquidity position from its operations, investments and financial activities over the period i.e. where funds came from, where they went, and how the overall liquidity of the company was affected.

The next step is to compute key financial statement ratios relating to liquidity, asset management, profitability, debt management/coverage and risk/market valuation. These ratios are then analyzed comparatively, looking at the current ratios in relation to those from earlier periods or relative to other firms or industry averages (Sonnerup & Scheible, 1998).

A budget provides a roadmap of what a business is aiming to achieve and how it intends to get there. It provides a lot of insight as to the resource requirements and milestones a company needs to reach its goals.

A business manager will make reasonable assumptions about the future of the firm (and its industry) and determine how these assumptions will impact both its cash flows and the funding. This could take the form of pro-forma financial statements, where techniques such as the percent of sales method are employed.

The manager will then compare the budget results against the actual results and monitor the variances, which provide him with the feedback needed to take corrective action (Sonnerup & Scheible, 1998). This analysis provides a monthly/yearly yardstick against which managers can measure the company's actual performance via the feedback loop, identify variances from the plan and inform managers on areas corrective action is required to get back on track, or hopefully improve on the plan.

If a manager is working with accurate forecasts, he will be able to learn from the past and more accurately predict the future. Forecasts also keep the manager looking ahead, making him more likely to forestall market changes and competitive challenges.

References

Elliott, G., & Timmermann, A. (Eds.). (2013). Handbook of economic forecasting. Elsevier.Horngren, C. T., Bhimani, A., Datar, S. M., Foster, G., & Horngren, C. T. (2002). Management and cost accounting. Harlow: Financial Times/Prentice Hall.

Kaplan, R. S., & Atkinson, A. A. (2015). Advanced management accounting. PHI Learning.Sangster, A. (2015). The genesis of double entry bookkeeping. The Accounting Review, 91(1), 299-315.

Sonnerup, B. U., & Scheible, M. (1998). Minimum and maximum variance analysis. Analysis methods for multi-spacecraft data, 185-220.Yamey, B. S. (2008). Double-entry bookkeeping. The New Palgrave Dictionary of Economics: Volume 1-8, 1432-1435.

"What Are the Three Types of Accounts?" AccountingCapital, 2010, www.accountingcapital.com/books-and-accounts/three-type-of-accounts-in-accounting/Accessed 9 Nov. 2018.