Government and for-profit organizations - Coursework Example

Government and for-profit organizations Introduction Government business organizations are generally referred as non-profit organizations while other private organizations are denoted as for-profit organization, as the primary agenda of these companies is to make profit. Government and for-profit organizations are differentiated primarily in terms of their goal or motive. Since the business goals of both kinds of organizations are different, it can be naturally ascertained that the accounting techniques thereof will be different as well (GASB, 2013). Government entities required responding to various organizations and functional groups such as elected bodies, departmental officials, citizens and investors, who are interested in its activities. These activities and their outcome are measured in terms of financial data that are published in government reports. Financial reports of government are prepared as per various conventions and principles that have been developed by standard setting authorities. Government reports follow exclusive set of principles because they serve needs of relatively more diverse users than that by private for-profit companies. GASB pioneered in 1999 a new financial reporting model for government accounting that comprise elements such as parts of GAAP hierarchy, accounting focused and based on internal control structure, measurement and fund structure (NCES, 2014). Any business transaction can be accurately reflected only if the cash and credit transactions are reported in a manner that prevent duplicity but also represent necessary data thereof. For this purpose double entry system of book keeping is adopted by non-governmental organizations and this accounting method is referred as commercial accounting. Using double entry method, commercial accounting reports every aspect of a transaction (payment or receipt and their respective sources). Commercial accounting is essential for profit making organizations because it helps them in convenient determination of turnover, profit/loss and relevant costs (Warfield, K. Wild & J. Wild, 1995). In this paper, the similarities and dissimilarities between commercial and government accounting have been critically discussed. Similarities between government and non-government organization’s accounting Despite vast difference in their goals and activities, certain similarities can be recognized between government organizations and for-profit organizations in terms of their accounting practices as both kinds of organizations draw their principles from the vast body of Generally Accepted Accounting Principles (GAAP). As GAAP conventions and concepts are adopted by these firms, the points of similarities include consistency, conservatism, historical cost, matching, reporting entity, materiality and full disclosure. Consistency indicates that matching transactions should be recorded in similar manner during a particular period and between two different periods. Conservatism addresses various underlying uncertainties associated with usage of different techniques of financial statements. Conservatism principle is adopted by all firms in order to ensure that their reporting practices have no negative impact on overall value of assets and firm’s net income. Both government and private firms adopt historical cost technique for reporting book value of their assets, as assets are not evaluated on the basis of their present market value in financial statements (Carmichael & Graham, 2012; Delaney & Whittington, 2007). The matching concept is another similarity between government and non-government organizations as it is mandatory for every organization to match their revenue with their expenditure for a specific time period. In other words, the system of double entry is implemented in all firms so as to maintain a track of all the earning and expenditure incurred during a specific time period. Reporting entity is referred to any business venture that is entrusted with reporting responsibilities. In context of this paper, both kinds of organizations are reporting entities, who have the obligation of preparing financial reports for benefit and interest of various stakeholders. Materiality is one of the GAAP conventions that are followed by all organizations irrespective of their nature of business. Materiality explains that an organization should discuss only significant information in its financial reports that of accounting nature. Lastly, full disclosure explains that every organization should disclose all necessary information so that financial position of the firm is correctly presented and understood. Additionally, these two kinds of organizations share certain similarities in terms of components of financial statements as well such as journal, trial balance and ledger (Carmichael & Graham, 2012; Delaney & Whittington, 2007). Another point of similarity that can be recognized between government and commercial organizations is debt refunding. Both these organizations are significantly engaged in debt refunding. In other words, they create new debts whose proceeds are employed for paying off previous debt. The sole reason behind both organizations engaged in this activity is to ensure security of their financial gain (GASB, 2013). Dissimilarities between government and non-government organization’s accounting Government organizations are significantly different from various for-profit firms in a number of ways such as business purpose, method of revenue generation, stakeholders, propensity for longevity and budgetary obligations. All these differences involve separate accounting measures so that financial information is presented in such a manner that it is useful to various stakeholders of these organizations. The major differences between these kinds of organizations are discussed in an elaborate manner in the following section (Barton, 1999). Organizational purposes The main purpose of governmental organizations is to enhance and maintain public wellbeing by means of investment in various public policies. These public policies include education, consumer safety, transportation and social services. For governmental organizations, financial components such as return on investment, earning per share and net earnings are of least importance. Contrastingly, for-profit or public organizations are driven by their primary purpose of wealth maximization. The company is focused on achieving maximum return on their shareholders’ investment and hence primary factors in their financial report are revenue and profit (GASB, 2013; Chan, 2003). Sources of revenue The main source of revenue for government bodies is taxation. The government changes tax from general public in exchange of certain specific transaction between them and any business. The key source of revenue for business organization is earning from various financial transactions between buyers and sellers. Business organizations provide special accounting treatment for tax related transactions as the same is not a business transaction and are not related to any kind of earning process. In this context, it is noteworthy that various taxes such as property tax are reported as revenue for government organizations irrespective of the time period when they were levied (GASB, 2013; Chan, 2003). Implication of profit/loss Business activities and financial management can be considered as an important differentiating point between business organizations and government bodies. Profit and loss are essential factors for business organizations and their stakeholders but in government, these factors fail to denote effectiveness and quality of a particular program. Likewise, stakeholders of government organizations do not appreciate if the financial reports reflect massive surplus or wealth accumulation as government is essentially a non-profit organization (GASB, 2013). Stakeholder needs The conceptual framework of financial reporting of government and business institutions reflects needs of respective users. Considering the nature of business, it can be easily determined that the stakeholders of both kinds of organizations will be different. Business organizations are primarily focused on meeting information needs of their employees, management, investors and creditors, however, the GASB places priority on addressing information need of stakeholders such as national citizen, communities and elected representatives. In context of stakeholder needs, the GASB highlighted certain differences between government accounting and commercial accounting. These differences are: (a) capital assets in government are deployed for delivering community services to citizens instead of generating future cash inflows as done by business firms; (b) revenue recognition and the measurement of the same by both kinds of organizations with respect to charitable acts and taxes; (c) budgetary reporting and fund accounting is considered essential at government organizations so accountability needs of general public are met, no such obligation is mandatory for commercial firms; (d) government organizations are driven by accountability where as business organizations are driven by equity management and control; (e) stakeholder’s financial safety is of utmost importance for government bodies whereas personal gain is the primary motive of commercial firms (GASB, 2013). Potential for longevity It was gathered that scope of liquidation for government organizations is very limited as they hold the ultimate power related to taxation and delivery of public services. However, it was further observed that the scope of longevity is relatively volatile for profit making organizations. These organizations face possibility of being out of business if their products are not sold or if the cost of production is higher than the revenue. It should be noted in this regard that financial statements of profit making firms significantly emphasize on accounting assumption of ‘going concern’, however, this must not be taken in consideration as equivalent to extended longevity. Another noteworthy point in this regard is that considering uncertainty associated with longevity of for-profit organizations, the financial statements stresses more upon asset recoverability by means of future sales and fair valuation of specific assets and liabilities such as shares and debentures. Contrastingly, government organizations’ public interest does not let their longevity to be questioned hence their financial reports are relatively more focused on resource allocation on various government programs, cost management of various services and long term operations. Government organizations do not take in consideration short term fluctuation in asset value and the same is not reflected in financial performance and financial position of these firms either. On the contrary, financial performance of for-profit businesses is significantly affected by short term market fluctuations because these organizations and their shareholders depend strongly on present market price of their equity stakes (GASB, 2013). Fund accounting The notion of fund accounting plays a crucial role in differentiating profit organization and government organization, as private organizations are mostly profitability oriented while government organization are accountability oriented. Additionally, profit making entities usually have one general ledger which is treated as a single self-balancing account whereas non-profit or government organizations comprise more than one general ledger that reflect a variety of funds allocated to different purposes (Barton, 1999; Chan, 2003). The accounting system of commercial firms primarily focused on measurement of performance of the firm, its divisions and products by means of profit and loss. However, accounting is government organizations require measurement of inflow and outflow of funds along with that of social and legal obligations which is not possible through commercial accounting. Government entities require reporting of various funding activities such as grants and other programs in an individual manner along with success or failure thereof. Therefore, it can be suggested that scope of fund accounting is larger than commercial accounting and appropriate for government organizations (GASB, 2013). Final accounts The accounting process in government organization does not lead to creation of final accounts as their primary motive is not associated with profit and loss. The revenue of government organizations are allocated and balanced as per various departments. Additionally, the asset account of government organizations is recorded in statistic books. Moreover, unlike commercial or for-profit organizations, financial statements of government organizations do not consist of personal accounts (Barton, 1999; Chan, 2003). In context of final statements, it should be noted that each of the financial statements under commercial accounting are prepared for a specific purpose. For instance, the balance sheet denotes financial position of the firm, income statement reflects profitability position and ash flow statement reflect cash management of the firm. In for-profit organizations, high profit is associated with business success and otherwise with failure. Deficit and surplus in income statement directly portray firm’s prosperity. However, no meaningful indication can be ascertained from surplus or deficit in the income and expenditure statement of government. If government organizations report little expenditure, it will suggest their inability to allocate funds for necessary purposes. On the other hand, high expenditure reveals effectiveness of government bodies in management of public services (GASB, 2013). Government’s source of revenue is generally taxation, therefore, increase in revenue suggest growth of various tax paying organizations or commercial organizations. In other words, financial statements of business firms reflect only personal growth whereas that of the government not only denote effectiveness of the government but also reflect growth of business institutions. Government’s earnings are primarily dedicated to social and economic development and consequently none of its income is available for personal consumption unlike in for-profit organizations (GASB, 2013). Budgeting The budgeting process of government organizations is significantly different from that of commercial organizations primarily because expenses and revenue allocation in government budget require legal approval unlike commercial accounting. Government budget is considered as an expression of monetary resource allocation to various public policies. Contrastingly, in commercial accounting budgeting is treated as an internal tool for financial management which is essentially controlled by organization’s management and is proprietary by nature (GASB, 2013). Advent of budgeting is often associated with need of development planning by government organizations. Conventionally, government budget consist of budget for expenditure and revenue budget. However, master budgeting (capital budget) is also adopted by a number of government organizations for developing comprehensive budget plans. In public sector, budgeting has been adopted chiefly to ensure legislative accountability in terms of appropriate resource allocation to various departments and providing provision for control. Contrastingly, process of budgeting has been adopted in profit making organizations in anticipation of cost efficiency, investment needs and working capital assessment (Premchand, 1983). Financial reporting model A number of unique features of government reporting with respect to commercial reporting have been noted in GASB (2013). It was observed that general financial statements of government entities present information related operational and fiscal accountability. Operational accountability is presented through information in financial statements that reflect financial position, cash flow and changes thereof; whereas, the fiscal accountability is established through fund statements. Government bodies publish statement of net position in which they highlight various assets, liabilities, and deferred inflow and outflow of resources. Contrastingly, balance sheet of business firms specifically highlights share capital, long term and short term debt and various returns thereof. Additionally, similar to income statement of profit making firms, government bodies publish statement of activities. This statement however differs significantly from the income statement of business organizations. The statement of activities primarily reflects cost associated with various government services and programs, and their contribution to government revenue. Overall, this statement serves information needs associated with performance analysis of government (GASB, 2013). Issues related to reporting entity An essential decision pertaining to financial reporting is determination of entities of the report that are to be presented in a composite manner. Business organizations prepare consolidated financial statements based on control related to equity interest. On the contrary, determination of reporting entity in government accounting is based on various complex accountability relations as government entities lack control associated with equity ownership (GASB, 2013). Conclusion Government accounting and commercial accounting have always been classified on the basis of organizational activities and their goals. Despite adoption of financial concepts, assumptions and accounting standards from the GAAP, the two kinds of accounting exhibit variation due to difference in their business motives and stakeholders. The paper evaluated and elaborately discussed the similarities and dissimilarities between accounting by both kinds of organizations. It was considered that the evaluation will lead to better understanding of the accounting process and fundamentals associated thereof. References Barton, A. (1999). Public and Private Sector Accounting- the Non-identical wins. Australian Accounting Review, 9(18), 22-31. Carmichael, D. R. & L. Graham. (2012). Accountants' handbook, financial accounting and general topics. New York: John Wiley & Sons. Chan, J. L. (2003). Government accounting: an assessment of theory, purposes and standards. Public Money & Management, 23(1), 13-20. Delaney, P. R. & Whittington, O. R. (2007). Wiley CPA Examination Review 2007-2008, Problems and Solutions (Vol. 2). New York: John Wiley & Sons. GASB. (2013). Why governmental accounting and financial reporting is and should be different. Retrieved from http://www.gasb.org/cs/BlobServer?blobkey=id&blobwhere=1175826684726&blobheader=application%2Fpdf&blobcol=urldata&blobtable=MungoBlobs. NCES. (2014). Government accounting. Retrieved from http://nces.ed.gov/pubs2004/h2r2/ch_4.asp. Premchand, A. (1983). Government budgeting and expenditure controls: theory and practice. Washington, DC: International monetary fund. Warfield, T. D., Wild, J. J. & Wild, K. L. (1995). Managerial ownership, accounting choices, and informativeness of earnings. Journal of accounting and economics, 20(1), 61-91. Bibliography Jones, R. (1992). The development of conceptual frameworks of accounting for the public sector. Financial Accountability & Management, 8(4), 249-264. Watts, R. L. (2003). Conservatism in accounting part I: Explanations and implications. Accounting horizons, 17(3), 207-221. Read More