Inconsistencies in the way accounts are prepared can lead to financial accounting problems.
There are several issues that can lead to financial accounting problems. This includes the elements of financial performance that a business tracks, the basis on which it records transactions, and how it handles depreciation. By contrast, math errors are unlikely to cause major problems thanks to double-entry bookkeeping’s built-in checkpoints.
One of the simplest sources of financial accounting problems is a lack of coverage of the three main types of financial documents. The first is a simple transaction record, which is added to a profit and loss account. The second is a cash flow record, which does not always match transactions due to credit arrangements and late payments; Cash flow forecasts are also important. The third is a balance sheet, which lists a company’s overall assets and liabilities, effectively measuring its financial health. Not having these three documents can reduce opportunities to identify problems with a company’s finances and possible solutions.
Some financial accounting problems can be caused by inconsistencies in the basis on which the accounts are prepared. One such area is the decision to record transactions at the time of payment or at the time the goods or services are physically delivered. Not using the same basis for all transactions can cause confusion. This is particularly true when payment occurs in one accounting period and delivery in another.
Depreciation is another source of financial accounting problems. It is the accounting process used to account for the fact that an asset loses value over time, such as the time it takes for it to physically wear out. Since depreciation must be fixed in advance, it is effectively an estimate. Different methods may vary in the length of the depreciation period, the rate and pace of depreciation, and the final value placed on the asset, if any. A company deciding on a depreciation method will often have to comply with statutory accounting requirements and standards set by tax officials.
Perhaps surprisingly, math errors are not the main source of financial accounting problems. This is due to the use of double-entry accounting, in which each transaction is recorded twice, once as a debit and once as a credit. This involves looking at both sides of a transaction; For example, a store that is making a sale increases its cash balance but sees a corresponding decrease in the value of its unsold inventory. The double entry system implies that, in any period of time, the total value of the entries in the credit column and in the debit column must be identical. Checking for disparities on a regular basis can quickly uncover errors before they cause major problems.