Why do we use Accounting?

Accounting became a necessity as merchants needed to track who owed money to them and what they owed to suppliers.

The next need was to determine whether the business was making a profit, or in the case of a charitable venture of at least covering costs. The concept of how this is achieved is the subject of many accounting theories and will be dealt with later.

Of course, in a Western Society we must all contribute to the cost of providing community services and this means the determination of taxes.

After the taxes have been calculated, then what remains may be distributed to the owners of the business.

Unfortunately, the pressure of meeting the requirements of the Australian Tax Office means that few public accountants have the time to assist the business owner evaluate his or her specific measures, and to guide them in setting up an appropriate method of reporting on performance.

When the GST was introduced in Australia the need arose to account for not only year end trading result taxes, but also for the collection of GST. What was originally a very simple value added tax concept has gradually become more complex as the requirement to cater for different groups in our community has become apparent.

The Australian Tax Office has indicated a preference for accounting performed on a commercially produced computer accounting system that meets with specifications that have now been provided to the various software writers.

What are these requirements?

Well broadly speaking the system must provide a record of all transactions undertaken, and of any changes that have been made to those transactions. This means that a proper audit trail or log of those transactions must be maintained. Some accounting packages need this to be turned on in a new set-up in others it is active by default.

In addition, it is desirable that the system be set-up with account cards (some systems use columns) that automatically allocate the correct GST code to an entry when it is made. These accounts accumulate totals of the relative transactions.

Some so called Australian packages, also do not provide the correct GST allocation until a specialist approved by the Australian Tax Office (pursuant to S251L) has visited the installation and entered the correct defaults. These specialists are also authorised to turn on the audit trail.

How do we determine whether we are making a profit?

Obviously, the short answer must be that we sell a product or service for more than it costs to produce.

What are these costs?

They are what we call Direct Costs such as the purchase price of materials and labour used in producing the good or service. Wherever possible, these should be traced and allocated to the Cost of Goods Sold (COGS).

Then we have the Indirect Costs such as the running of an office, marketing etc. that do not relate directly to the cost of manufacture or the provision of a service. These are often referred to as 'oncosts' and must also be recovered in the base of any selling price that we may arrive at. In addition to all these base costs, we need to provide for a profit if the owners are to justify investment in a business venture. Unless they obtain a reasonable return, they may just as well invest in some other venture, or in the short term money market.

Any net profit is then taxed both in the hands of a company, and in the hands of shareholders or proprietors. That is the realm of a Registered Tax Agent and professional advice should be obtained.

This is a very brief summary of why we use accounting systems whether they be manual or computerised. Much of this will need to be considered, and a Business Plan written up before the risk of starting a new business venture is assessed. It is at this point that those contemplating a venture must decide why they want to go into business. They should also decide even at the outset what they want to do in retirement. That is, they have only one life on this earth and therefore they should plan an exit policy. Who should take over the business, what will be expected - should it be sold, or handed to the remaining family or families. Would family members have sufficient interest or capability to carry on the business?

Future articles will deal with the concepts of cost accounting, then budget setting in more detail.