Forming a New Business

Forming a New Business

In this e-mail, I will discuss the meaning of GAAP and the difference between accrual and cash accounting. I will also discuss different forms of businesses such as partnerships, LLCs, and corporations.

What is GAAP?

GAAP, or generally accepted accounting principles, is a set of guidelines used in recording, preparing, and presenting financial accounting information to external users of companies (Kieso, Weygandt, & Warfield, 2007). With just one standard, external users, including investors, creditors, auditors, and regulatory agencies, can expect the same sets of rules in financial accounting to be used by public companies in various industries year after year. Even if the external user has limited knowledge of the company, the user can still make informed decisions just by looking at the company’s GAAP-compliant financial reports.

Accrual vs. Cash Accounting

The accrual method of accounting is required under GAAP. Under the accrual method, revenues are recognized when they are earned (products delivered or services rendered) and when revenue is realized (cash is received) or realizable (cash is to be received in the future) (Kimmel, Weygand, & Kieso, 2007). A landscaper should recognize revenue the same day service is performed even though client has not yet received or paid the bill. If a landscaper recognizes revenue only when a bill is paid, the landscaper is using cash basis accounting.

Under the accrual method, expenses are also recognized when incurred and not when paid (Kimmel et al., 2007). The landscaper pays a bill for advertising 30 days after the bill is received. The landscaper must recognize advertising expense the day the bill is received. If the landscaper recognizes advertising expense only when the bill is paid, the landscaper uses cash basis accounting.

Cash basis accounting may distort a company’s true financial picture. Say, in the previous period, the landscaper collected many payments from clients...