Federal agencies are required by law to follow

June 4, 2018 Law

Generally accepted accounting principles (GAAP) include the standards, conventions, and rules accountants must follow in recording and summarizing transactions and financial statements.  While for private companies, it is not law that they must follow GAAP when preparing their statements, it does provide a certain level of credibility to the reports and helps with anyone from outside the company who might be looking at the statements (allbusiness.com).

Federal agencies are required by law to follow GAAP when preparing their financial statements (fasab.gov).  By understanding GAAP, we can read and understand nearly any company’s financial statements.

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Double entry accounting is a method of keeping track of business transactions.  For every transaction there are two components: debit and credit.  Debit is the increase in an asset item or a decrease in a claim or expense item.  Credit is an increase in a claim item or a decrease in an asset or revenue item (bizzer.com).  Any time a company buys or sells something, this is the way the revenue and the gain or loss of inventory is tracked.

Historical cost is a measure of value used in accounting in which the price of an asset on the balance sheet is based on its nominal or original cost when acquired by the company.  It is a principle used under GAAP (investopedia.com).  It is important to us because it is the value of an asset that is listed on the balance sheet.

Accrual basis and cash basis accounting are the two main methods of recording accounting transactions (associatedcontent.com).  In accrual basis accounting, revenue is recognized when earned and expenses are recognized when incurred.  This provides a more accurate picture of how a business is performing over the long-term.  Cash basis accounting recognizes revenue when cash is received and expenses when cash is disbursed.

This method is simple and inexpensive to utilize, but makes it difficult to determine if the company is gaining or losing money, i.e. profit.  However, this method may be more advantageous with respect to taxes.

When looking at assets owned by the company, there are two basic categories: current assets and liabilities and non-current items.  Current assets and liabilities are likely to be used up or converted to cash within one business cycle – typically one year.

The four most common categories are cash, short-term investments, accounts receivable (bills), and inventory.  Non-current items are everything else: long term investments, PP&E (property, plant, and equipment – overhead), goodwill and other intangible assets (news.morningstar.com).  These figures are important in determining how liquid the company’s assets are.  That is, if needed, how quickly the company can acquire cash.

II. BP’s financial statements for 2008 were prepared by an audit from Ernst and Young LLP.  It is not obvious that the statements give the information for current and past years unless you specifically download the full Excel spreadsheets.  Then it is apparent that the income statement and the statement of cash flows show the past three years, while the balance sheet only shows the past two.

The income statement is first and shows the sales total revenue, expenses, adjusted net income, and EPS.  The balance sheet is next and seems to be a bit backwards.  It lists the non-current assets first, and then works to the more liquid assets and liabilities at the end.  The balance sheet is top to bottom, versus side to side and makes picking out the numbers someone difficult.  The statement of cash flows is third and shows the cash from operations, investing and financing.  This page was straightforward and easy to follow.

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