Introduction to Advantages and Disadvantages of Accounting

Did you know that in 2022, Tesla’s revenue was around $81,462 million, while Apple reached a staggering $90,146 million in revenue, mainly due to the success of the iPhone? At the same time, a significant accounting scandal in 2023 involving PwC Australia shook up the financial landscape and questioned the ethical considerations involved in business practices. These examples demonstrate how accounting is an indispensable tool in understanding and analyzing the financial health of companies and how it impacts the broader economy. In this article, you will learn a few advantages and disadvantages of accounting.

Advantages of Accounting

1. Maintenance of Financial Records

Accounting involves periodic and organized recording of all financial transactions during a certain time, like a month or a fiscal year. It helps accountants because remembering every transaction is not practical or reliable. Therefore, by keeping all timely records, they can keep track of every transaction in the books of accounts.

Example: A company maintains records (total amount), such as $30,000 for sales revenue, $20,000 for purchases, $15,000 expenses, and $8,500 for payments in its cash book, which provides detailed information on all financial activities.

2. Preparation of Financial Statements

Proper recording of all transactions helps create financial statements, like balance sheets, income statements, and cash flow statements. This information is important for understanding the financial position of a business. Accounting also ensures that all financial statements adhere to accounting standards so investors and stakeholders uniformly accept them.

Example: A company prepares a balance statement at the end of the year. The balance statement provides information that a company has $100,000 in assets, $50,000 in liabilities, and $50,000 in equity.

3. Evaluation of Business Performance and Growth

Accounting information allows businesses to assess their performance by analyzing financial statements using key financial indicators and measures. It provides a clear idea of a company’s finances and helps compare how its financial position has changed over time. In addition, when financial statements follow the same standard rules, it’s easier to compare one company to another in the same industry. This way, businesses can see how they’re doing compared to others.

Example: XYZ Mobile Inc. uses key performance indicators (KPIs) to monitor the monthly number of smartphones it sells. They also use the Return on Investment (ROI) metric to determine their profit for every dollar they spend making smartphones. The ROI data shows that for every $1 spent, they make a profit of $3, which is good. They use another metric, like EBITDA, to determine how much revenue they earn before deducting expenses such as taxes and depreciation. All these metrics help XYZ Mobile Inc. keep track of its financial health.

4. Benefits in Data-Driven Decision-making

Accounting also helps make informed decisions about financial issues, investments, business expansions, etc. It also includes decisions about a product or service’s price to evaluate profitability and efficiency. Evaluation of business performance also helps in making decisions to improve areas of improvement, budgeting, and future financial planning.

Example: Let’s say that in Year 1, XYZ Manufacturing Corp. purchased a new machine for $50,000. According to their cash flow statement, their cash balance at the end of Year 1 was $2 million. In Year 2, their ending cash balance was $1.5 million. However, they encountered some market challenges. This careful analysis of their cash flow statement helped them decide not to invest further.

5. Facilitates Auditing

Audit is necessary and involves careful examination and review of financial information for accuracy. It ensures that all records are valid, and here, financial statements serve as evidence for the auditing process. In addition, it also makes sure that the company makes financial statements according to standard rules and regulations and may even sometimes identify fraudulent transactions.

Example: Companies usually hire an external auditor to evaluate their financial statements and to ensure compliance with accounting standards. Auditors provide a detailed analysis of the company’s performance.

6. Helps in Calculating Tax Liabilities

Tax departments or authorities rely on accounting data for calculating income tax, value-added tax, and direct and indirect tax. This data provides insight into planning and making decisions like tax-deduction strategies or tax-saving options.

Example: Suppose ABC Tech Inc. used financial records to calculate its taxable income. They found out that they owe the government $100,000 as tax liability.

7. Ensures Compliance with Legal terms

It also ensures that all recording and preparation of financial records and statements adhere to legal and regulatory (national and international) requirements. It builds trust among stakeholders and investors in the company’s provided data. In addition, these records may act as financial evidence in court in any legal transaction disputes.

Example: A company must maintain and record all financial data as per government regulations and reporting standards to avoid legal penalties.

Disadvantages of Accounting

1. Time-Consuming

Accounting can be slow because it involves carefully recording, organizing, and analyzing financial transactions. It leads to disadvantages for businesses that need quick decision-making.

Example: Suppose every month, the accountants at Company ABC spend 50+ hours carefully checking thousands of transactions, deposits, and withdrawals to ensure that the company’s records match its bank statements. If they find a discrepancy between the company’s records and the bank statements, they must look at all previous transactions and contact the bank.

2. Might be Costly for Small Businesses

Besides being time-consuming, implementing proper and standard accounting practices can burden small businesses financially. It can be costly for companies with limited or low-profit income.

Example: Imagine a small software development startup called “Sprint2 Ltd” with only 10 employees. The company operates from a shared office space to reduce costs and has a limited budget. As a result, hiring experienced accountants or investing in accounting software would be expensive for them.

3. Increase Complexity

It can become difficult to understand financial standard terms, accounting principles, and conventions if one is unfamiliar with them. In addition, it is challenging for businesses to keep and maintain records with huge transactions with global operations.

Example: A fresher or non-accountant without a financial background will find understanding accounting standards and practices such as depreciation methods (like straight-line or declining balance) complex.

4. Based on Personal Estimates

Even though recording all transactions is based on evidence, sometimes, few financial records involve subjective judgments or estimates. Therefore, it is not accurate to consider data based on estimates and can lead to false interpretations. Accountants may use different valuation methods, and the account data may be biased.

Example: The estimation of the useful life of an asset for depreciation purposes can vary among accountants depending upon their experience. Also, different accountants may use methods like First-In, First-Out (FIFO) or Last-In, First-Out (LIFO) and practices to calculate depreciation, stock price, etc.

5. Chances of Manipulating Records

Accountants may sometimes manipulate or misrepresent data to show higher profits for investors or may change financial records to reduce tax. It will indirectly reflect the wrong financial position of the company and can lead to an accounting scandal.

Example: Some real companies, like Worldcom, Bernie Madoff, Healthsouth, and Enron Corporation, have misrepresented financial data to represent false sales and expense data.

6. Risks of Errors

Accounting requires careful methods of keeping records, and any errors by humans in data entry or calculations can lead to inaccuracies in financial records.

Example: Imagine an accountant of XYZ Company enters the wrong amount in the financial statements. For instance, by mistake, he records $50,000 instead of $5,000 as the expense for utilities. This error can greatly affect the profit amount in the Income Statement.

Final Thoughts on Advantages and Disadvantages of Accounting

Accounting is an essential part of financial budgeting and forecasting. Its advantages lie in providing valuable information for making informed decisions, while its disadvantages lie in not providing 100% accurate data.

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