There are many variables that come into play when reviewing and interpreting balance sheets and income statements, but none is more important than the accounting method used by a company. Financial measures such as net income, total assets, and total owners’ equity can vary dramatically for a given accounting period, depending on the accounting method selected by the company.
All public companies, such as the Coca-Cola Company and IBM, use the same basic accounting method, called accrual accounting. This is because these companies are required to comply with generally accepted accounting principles. Private and small companies have more flexibility in their accounting policies than public companies. A common mistake managers and other users of financial statements make is to assume that all companies use the same accounting method.
An accounting method is crucial because it determines how the company accounts for its revenues and expenses when there is a difference between when the company buys and sells goods and services and when it receives or pays the related cash. During the life of the company, all accounting methods report the same profits, but how these profits are allocated to various accounting periods differs significantly depending on which accounting method is used.
To evaluate the company’s financial statements, you need to have an understanding of:
- The three primary accounting methods.
- The advantages and disadvantages of each method.
- The most likely scenarios where each method can be used.
By understanding these basics, you can increase your confidence in reviewing financial statements and asking the right questions. Is your background in accounting limited? The Accenture Academy course Introduction to Accrual, Cash, and Hybrid Accounting Methods will provide you with a basic understanding of these accounting methods and give you the tools to help you to become a more valuable member of your team.