Accrual accounting attempts to match revenues and expenses to the time periods in which they are accrue, as opposed to the time when they are paid. For example, a machine might be purchased in one year and have a productive life of ten years. Rather than “expense” the cost of the machine during the year of its purchase, the company will accrue the expense of the machine over its expected life. With accrual accounting, the expense of the machine is matched to the ten years of its use by expensing a fraction of the machine’s total cost each year as it slowly “depreciates.”
For the bookkeeper, accrual accounting means that a single large expense transaction, such as the purchase of a machine, is recorded not once when it occurs, but many times as fractions of the total expense are “matched” to a time periods of the machine’s life. The machine with a useful life of ten years, purchased at, let’s say, $100,000.00, could be expensed as a cost of $10,000.00 per year over its ten year life (this assumes straight-line depreciation and no salvage value). At the end of the ten years, the total expense of the machine, the $100,000.00, will have been fully expensed.
If the company only reports its expenses once a year, each year of the machine’s life will cause the bookkeeper to enter one transaction recording the $10,000.00 expense for that year’s depreciation. On the other hand, if the company wants its financial information to be more current, it might report its expenses on a quarterly basis. Since there are four quarters in a year, there would be forty quarters in the ten-year life of the machine. The bookkeeper would then have to produce forty accrual entries for the gradual depreciation of the machine, one expense entry of $2,500.00 for each quarter of the machine’s life. This quarterly reporting schedule has all of the advantages of the annual schedule in that, if someone wants to know the amount of depreciation for the whole year, they can simply ask a computer to sum all of the accrued expenses for the four quarters of the year. The arithmetic operation of addition is quite easy for a modern computer.
If we take this reporting schedule even further to provide daily reports to our information-starved executives, we need to produce accrual transactions each day of the ten-year period. This is possible with modern automation because the bookkeeping labor can be automated, allowing the entries to occur automatically each night of the machine’s life.
A daily accrual schedule offers the company the advantage of having an accurate daily expense report (and therefore, accurate daily earnings and balance sheets). In addition, the computation of the amount of accrual for a quarter or year can be accomplished by simply summing the appropriate daily accrual entries.
Most importantly, with daily accruals, a clever financial analyst could produce reports for particular weeks, months, or even sales periods without regard for any rigid fiscal reporting schedule. By having a busy executive simply enter the beginning and ending points of time, a computer program should be able to produce complete financial information about the intervening period.
Showing posts with label real-time accounting. Show all posts
Showing posts with label real-time accounting. Show all posts
Wednesday, July 30, 2008
Tuesday, July 29, 2008
13. Daily Account Balances
In the preceding post, the production of a trial balance on a daily basis was proposed. By simply using the power of the computer to add a few numbers together, a complete trial balance should be available as soon as the business transactions are recorded. It was also shown how to-date earnings and other information could be produced at little or no cost from this trial balance.
A trial balance, however, has the formality of being part of the official quarterly report preparation process and, since we are just trying to get critical information quickly to the company’s executives, we get dispense with formalities and just talk about producing real information on a real-time basis. Balance sheets, trial balances, and income statements aren’t as important as the information contained in them, and we can produce that information as easily as the dashboards in our car produce current information about speed and mileage. There is no reason why every detail of a company’s financial data could not be made available to corporate leaders on a daily basis.
The general ledger is made up of accounts; each account has entries in it that represent deposits (debits) or withdrawals (credits); and each account has a balance that represents the sum of the deposits and withdrawals. The account balances of the general ledger are really all that is needed to easily produce the information found in the formal GAAP reports.
Because this is the twenty-first century, we can assume that the general ledger is automated and that the entries in each account are recorded by a program. As easy as it is for the program to record the entry, it can also keep the running balance of the account, adding a ten dollar debit entry could automatically update the running balance ten dollars in the debit direction. An automated running balance means that the balance of every account in the General Ledger (representing all of the financial data in the company) is available to us as quickly as the data is posted.
This means that for any company large enough to have its bookkeeping on a machine of laptop power or greater, the account balances should be always available. The account balances are the details of the trail balance that was discussed in the previous post, so we are essentially where we were in the previous post, having the ability to present all of the critical GAAP quarterly report information to executives on a daily basis (see previous post).
More essentially, it can be shown that if we have the account balances available to us, it is simply a matter of grammar school arithmetic to produce totals of assets, liabilities, revenues, expenses, and earnings (revenues less expenses).
Quarterly reports can be converted into real-time dashboard information by simply performing trivial arithmetic on the ledger account balances that should be available and current at any point in time. Greater sophistication can be made real-time by making accrual entries daily (this will be the subject of a later post).
A trial balance, however, has the formality of being part of the official quarterly report preparation process and, since we are just trying to get critical information quickly to the company’s executives, we get dispense with formalities and just talk about producing real information on a real-time basis. Balance sheets, trial balances, and income statements aren’t as important as the information contained in them, and we can produce that information as easily as the dashboards in our car produce current information about speed and mileage. There is no reason why every detail of a company’s financial data could not be made available to corporate leaders on a daily basis.
The general ledger is made up of accounts; each account has entries in it that represent deposits (debits) or withdrawals (credits); and each account has a balance that represents the sum of the deposits and withdrawals. The account balances of the general ledger are really all that is needed to easily produce the information found in the formal GAAP reports.
Because this is the twenty-first century, we can assume that the general ledger is automated and that the entries in each account are recorded by a program. As easy as it is for the program to record the entry, it can also keep the running balance of the account, adding a ten dollar debit entry could automatically update the running balance ten dollars in the debit direction. An automated running balance means that the balance of every account in the General Ledger (representing all of the financial data in the company) is available to us as quickly as the data is posted.
This means that for any company large enough to have its bookkeeping on a machine of laptop power or greater, the account balances should be always available. The account balances are the details of the trail balance that was discussed in the previous post, so we are essentially where we were in the previous post, having the ability to present all of the critical GAAP quarterly report information to executives on a daily basis (see previous post).
More essentially, it can be shown that if we have the account balances available to us, it is simply a matter of grammar school arithmetic to produce totals of assets, liabilities, revenues, expenses, and earnings (revenues less expenses).
Quarterly reports can be converted into real-time dashboard information by simply performing trivial arithmetic on the ledger account balances that should be available and current at any point in time. Greater sophistication can be made real-time by making accrual entries daily (this will be the subject of a later post).
12. Daily Balance Sheet
In the preceding post, I proposed, as a thought experiment, the daily closing of the books, allowing for a computation of the earnings reports on a daily basis. Let us extends that thought experiment a little further and propose that a balance sheet, summarizing the financial position of the company, be produced on a daily basis.
With modern automation, all of the arithmetic of producing a balance sheet should take only moments and be relatively costless. It can be set to go off automatically, immediately after all of the day’s transactions are posted. To make the job easier, let us propose that we do not even have to close the books to prepare the balance sheet. We can, for example, obtain our up-do-date financial position from a daily “trial balance.”
The trial balance will give us an intact summary of critical parts of our financial position. For example, directly from the trial balance, before any accounts are closed, we can obtain the amount of the assets broken down by category. An accurate summary of all liabilities would also be available directly from the trial balance. What would be missing from the trial balance would be earnings information. For the earnings data to be directly in our balance sheet the closing operations would normally be performed, turning our trial balance into a true balance sheet.
However, our daily trial balance would include the balance of every account in the ledger and a complete and accurate earnings summary could be produced in milliseconds by simply adding the balances of the revenue and expense accounts together. Therefore, in effect, our trial balance could produce all of the information in a true balance sheet as well as the earnings data normally found in the income statement, without the closing of the books.
In summary, all of the data found in quarterly reports could be generated on a daily basis by simply summing the balance of each account and putting it into a trial balance. This, of course, could be done without closing the books. The key to producing real-time financial data in the age of automation is to simply allow a trivial computer program to perform addition on ledger accounts each night as soon as the day’s transactions are recorded.
With modern automation, all of the arithmetic of producing a balance sheet should take only moments and be relatively costless. It can be set to go off automatically, immediately after all of the day’s transactions are posted. To make the job easier, let us propose that we do not even have to close the books to prepare the balance sheet. We can, for example, obtain our up-do-date financial position from a daily “trial balance.”
The trial balance will give us an intact summary of critical parts of our financial position. For example, directly from the trial balance, before any accounts are closed, we can obtain the amount of the assets broken down by category. An accurate summary of all liabilities would also be available directly from the trial balance. What would be missing from the trial balance would be earnings information. For the earnings data to be directly in our balance sheet the closing operations would normally be performed, turning our trial balance into a true balance sheet.
However, our daily trial balance would include the balance of every account in the ledger and a complete and accurate earnings summary could be produced in milliseconds by simply adding the balances of the revenue and expense accounts together. Therefore, in effect, our trial balance could produce all of the information in a true balance sheet as well as the earnings data normally found in the income statement, without the closing of the books.
In summary, all of the data found in quarterly reports could be generated on a daily basis by simply summing the balance of each account and putting it into a trial balance. This, of course, could be done without closing the books. The key to producing real-time financial data in the age of automation is to simply allow a trivial computer program to perform addition on ledger accounts each night as soon as the day’s transactions are recorded.
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