Accounting procedure

What Is Accounting Procedure?

An accounting procedure is a defined sequence of steps and guidelines that an organization follows to record, classify, summarize, and report its financial transactions. These procedures are fundamental to financial accounting, ensuring consistency, accuracy, and compliance with established accounting standards. By standardizing how financial data is handled, accounting procedures provide a structured framework for managing a company's financial operations, from routine transactions to complex financial reporting. The systematic application of an accounting procedure helps maintain the integrity of financial records and facilitates the creation of reliable financial statements.

History and Origin

The evolution of accounting procedures is deeply intertwined with the development of commerce and the need for organized record-keeping. Early forms of accounting date back thousands of years, with double-entry bookkeeping, a foundational accounting procedure, emerging during the Renaissance in Italy. Luca Pacioli, often considered the "Father of Accounting," codified this system in his 1494 treatise, Summa de Arithmetica, Geometria, Proportioni et Proportionalita. His work detailed the principles of debits and credits, which form the bedrock of many modern accounting procedures. Over centuries, as businesses grew in complexity and economies became more interconnected, the need for standardized financial reporting became paramount. In the United States, significant developments in accounting procedures were driven by market events, such as the Great Depression, which led to the establishment of regulatory bodies like the Securities and Exchange Commission (SEC). The SEC's mandate includes ensuring transparent financial reporting for public companies, thereby influencing and often prescribing specific accounting procedures to protect investors. For instance, the SEC provides comprehensive resources, such as its Beginners' Guide to Financial Statement, which outlines the outputs of these procedures⁴.

Key Takeaways

• An accounting procedure is a systematic set of steps for handling financial transactions.
• It ensures consistency, accuracy, and compliance in financial record-keeping.
• Accounting procedures are crucial for generating reliable financial statements.
• They provide a structured framework for recording, classifying, summarizing, and reporting financial data.
• Effective accounting procedures support strong internal controls and sound financial management.

Formula and Calculation

While "accounting procedure" itself does not have a single formula, it encompasses the methodologies used to calculate various financial metrics and prepare financial statements. For example, a common accounting procedure involves the calculation of depreciation expense. Depreciation is the process of allocating the cost of a tangible asset over its useful life. One widely used method is the straight-line method, which follows this formula:

Where:

• Cost of Asset: The original purchase price of the asset.
• Salvage Value: The estimated residual value of the asset at the end of its useful life.
• Useful Life in Years: The estimated number of years the asset will be used in the business.

This formula is applied as part of an accounting procedure to regularly expense a portion of an asset's cost, impacting the income statement and balance sheet.

Interpreting the Accounting Procedure

Interpreting an accounting procedure involves understanding its purpose, the specific steps involved, and how it contributes to the overall financial reporting process. For instance, an accounting procedure for revenue recognition dictates when and how revenue is recorded, which directly impacts the accuracy of a company's financial performance. A clear understanding of the accounting procedure for expense classification helps in correctly categorizing expenses and assessing operational efficiency. Proper interpretation also extends to understanding how different procedures interact, ensuring that the fundamental accounting equation—Assets = Liabilities + Equity—remains balanced throughout the accounting cycle.

Hypothetical Example

Consider a small manufacturing company, "Widgets Inc.," that purchases new machinery for $50,000. This machinery has an estimated useful life of 10 years and a salvage value of $0. Widgets Inc. uses the straight-line depreciation method as its accounting procedure for fixed assets.

Step-by-step application of the accounting procedure:

1. Determine Depreciable Amount: Cost of Asset ($50,000) - Salvage Value ($0) = $50,000.
2. Calculate Annual Depreciation Expense: $50,000 / 10 years = $5,000 per year.
3. Record Journal Entry Annually:
   • Debit: Depreciation Expense $5,000
   • Credit: Accumulated Depreciation $5,000

This accounting procedure ensures that the cost of the machinery is systematically allocated over its useful life, reflecting its wear and tear. The annual depreciation expense is reported on the company's income statement, while accumulated depreciation, a contra-asset account, reduces the book value of the machinery on the balance sheet.

Practical Applications

Accounting procedures are ubiquitous across all financial domains, from individual financial planning to multinational corporate finance and government operations. They are integral to the preparation of a company's balance sheet, income statement, and cash flow statement, providing the structure for accurate financial reporting. In the realm of taxation, specific accounting procedures dictated by tax authorities ensure compliance and proper calculation of tax implications. For example, the Internal Revenue Service (IRS) outlines detailed accounting procedures for various tax deductions in its publications, such as Publication 946, "How To Depreciate Property", which provides comprehensive guidance on claiming depreciation deductions. Fu³rthermore, governmental entities, like the Federal Reserve Banks, adhere to their own set of specialized accounting procedures, documented in manuals such as the Financial Accounting Manual for Federal Reserve Banks. Th²ese procedures ensure consistency in the financial reporting of critical economic institutions.

Limitations and Criticisms

While essential for financial order, accounting procedures are not without limitations. Their rigid nature can sometimes struggle to capture the full economic reality of complex transactions, particularly in rapidly evolving industries. One significant criticism relates to the use of accounting estimates, which are inherent in many procedures (e.g., estimating bad debt or asset useful lives). These estimates introduce subjectivity and can be a source of error or even manipulation, as auditors have noted. A report by Thomson Reuters discusses how auditors can avoid pitfalls related to common deficiencies in accounting and reporting, highlighting the challenges in ensuring accuracy. Ad¹ditionally, the reliance on historical cost in certain accounting procedures may not always reflect the current market value of assets or liabilities, potentially limiting the relevance of financial statements for decision-making. The "one-size-fits-all" approach that some standardized accounting procedures may imply can also be critiqued for not fully accommodating the unique operational nuances of diverse businesses.

Accounting Procedure vs. Accounting Standard

While often used interchangeably by non-experts, "accounting procedure" and "accounting standard" refer to distinct concepts in financial reporting. An accounting procedure is a specific, step-by-step method or routine for performing an accounting task, such as recording a sales transaction, processing payroll, or calculating depreciation. Procedures are the "how-to" guidelines that ensure consistency and accuracy in daily operations.

In contrast, an accounting standard is a set of authoritative rules and guidelines that dictate what financial information must be reported and how it should be presented in financial statements. Standards, such as Generally Accepted Accounting Principles (GAAP) in the U.S. or International Financial Reporting Standards (IFRS) globally, provide the overarching principles and framework. For example, an accounting standard might require companies to use accrual accounting for revenue recognition, while the accounting procedure would detail the specific steps an accountant takes to apply that accrual method within the company's system. Essentially, standards establish the "what" and "why," while procedures define the "how."

FAQs

Why are accounting procedures important?

Accounting procedures are critical because they ensure consistency, accuracy, and reliability in financial record-keeping and reporting. They help companies comply with accounting standards, facilitate auditing, and provide a clear trail for financial transactions, which is essential for informed decision-making and regulatory compliance.

Who sets accounting procedures?

While overarching accounting standards are set by bodies like the Financial Accounting Standards Board (FASB) or the International Accounting Standards Board (IASB), individual organizations develop specific accounting procedures to implement these standards. Companies tailor their procedures to their unique operations while adhering to the broader principles. Regulatory bodies, such as the SEC or IRS, also set mandatory procedures for areas under their jurisdiction.

Can accounting procedures change?

Yes, accounting procedures can and do change. They may be updated to reflect new accounting standards, changes in technology, shifts in business operations, or to improve efficiency and accuracy. Regulatory changes, such as new tax laws, also necessitate adjustments to accounting procedures to ensure ongoing compliance.

How do accounting procedures impact financial statements?

Accounting procedures directly impact the accuracy and completeness of financial statements. Every transaction recorded through an accounting procedure ultimately flows into the balance sheet, income statement, and cash flow statement. Proper procedures ensure that assets, liabilities, revenues, and expenses are correctly recognized, measured, and presented, providing a true and fair view of a company's financial health.