Financial accounting problems can arise from incomplete financial documents, inconsistent recording of transactions, and depreciation methods. However, double-entry bookkeeping helps prevent math errors from causing major problems.
There are several issues that can lead to financial accounting problems. These include the elements of financial performance that a company tracks, the basis on which it records transactions, and the way it handles depreciation. Conversely, math errors are unlikely to cause major problems thanks to double-entry bookkeeping’s built-in checkpoints.
One of the simplest sources of financial accounting problems is the lack of coverage of the three main types of financial documents. The first is a simple record of transactions, which is added to a profit and loss account. The second is a record of cash flow, which doesn’t always match transactions due to credit agreements and late payments; Cash flow forecasts are also important. The third is a balance sheet, which lists a company’s overall assets and liabilities, effectively measuring its financial health. Not having these three documents can reduce opportunities to identify problems with finances and possible solutions for a company.
Some financial accounting problems can be caused by inconsistencies in the basis on which the accounts are prepared. One such area is the decision to record transactions at the time of payment or at the time the goods or services are physically delivered. Not using the same basis for all transactions can cause confusion. This is particularly true when payment is made in one accounting period and delivery in another.
Depreciation is another source of financial accounting problems. It is the accounting process used to account for the fact that an asset loses value over time, such as the time it takes to physically wear out. Because depreciation must be fixed in advance, it is effectively an estimate. Different methods can vary in how long the depreciation period is set, the rate and pace of depreciation, and what value, if any, is placed on the asset. A company deciding on a depreciation method will often have to work out both legal accounting requirements and rules set by tax officials.
Perhaps surprisingly, math errors are not a major source of financial accounting problems. This is due to the use of double-entry bookkeeping in which each transaction is recorded twice, once as a debit and once as a credit. This involves looking at both sides of a transaction; For example, a store that makes a sale increases its cash balance, but sees a corresponding decrease in the value of its unsold stock. The double entry system means that during any period of time, the total value of the entries in the credit column and the debit column must be identical. Checking this regularly for mismatches can uncover errors quickly, before they cause major problems.
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