In the United States today there are, quite literally, millions of small businesses. In comparison, there are about 5,000 public companies whose stocks are traded on securities markets. And there are thousands of large private companies whose ownership shares are not traded in a public marketplace.

Regardless of size, all businesses need effective accounting systems for conducting operations, for complying with tax laws, and for providing essential financial information to their managers (especially profit or loss, financial condition, and cash flows). Then there is the fourth function of accounting—preparing the external financial reports of the business to its lenders and outside investors who don’t participate in managing the business.

The financial statements of a business depend on the completeness and accuracy of its accounting records, of course, and on the profit accounting methods the business uses. In Chapter 3 we explain the assets and liabilities used in recording revenue and expenses. Profit accounting drives a large portion of the assets and liabilities reported in the balance sheet. Suppose a company’s profit accounting methods are wrong. Then the values reported by the company for some of its assets and liabilities would be inaccurate. Both its income statement and balance sheet would have errors.

Up to the time of revising this book all businesses, large and small, private and public, were subject to the same accounting ...

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