“What is the use of a book,” thought Alice, “without pictures
or conversation?
Lewis Carroll, Alice’s Adventures in Wonderland
Perfection has one grave defect; it is apt to be dull.
W. Somerset Maugham, The Summing Up
There is only one place you will nd any pictures or conver-
sation in the kinds of books accountants keep: the annual
report to shareholders of a corporation. Otherwise, and I’ll be
right up front about this, accounting books and records are
pretty dull. Perhaps this is because accountants try awfully
hard for perfection, coming lots closer than most professions,
such as doctors or lawyers.
In this chapter, were going to cover some basic account-
ing principles and examine some of those perfect books and
records that accountants keep. Despite the fact that the mate-
rial may be dull, it’s good to have an idea of how these things
work. Later on, when youre looking at the balance sheet of a
corporation and wondering whether it’s a shell or some kind
of a scam, you may be able to use some of this knowledge.
You don’t seem to have the usual qualifications we’re
looking for in an accountant.
Also, if youre into investing, this chapter covers the basics
of what you need to know to evaluate a company to make
that investment decision. In fact, that’s exactly what those
fancy annual reports are really all about. Why should you,
the stockholder, buy or keep our stock? Here, check out our
slick, full-color, multipage report. Lots of pictures and even
some conversation: the “Message to Our Shareholders.
Actually, the reports prepared by accountants, all of which
follow a very rigid set of clearly dened rules, are used for
a variety of purposes. Banks use them in making loan deci-
sions; businesses use them in making all sorts of decisions—
whether to buy or sell, whether to extend or refuse credit,
whether to acquire or divest. Reports such as the balance
sheet and income statement are used to track progress and
to compare performance against other periods, divisions,
or businesses. The accountantswork is like a Swiss Army
knife for business—it has a thousand uses.
Because the accuracy of their reports is so important,
the accountantsclub, in this case the American Institute of
Certied Public Accountants (AICPA), has set forth a long list
of rules and regulations to be followed by all its members. These
rules, known as the Generally Accepted Accounting Principles
(GAAP), dictate how records are to be kept and results reported.
Since everybodys supposed to follow the same rules, you can
look at the balance sheet of a car parts business in Florida and
one from a timber business in Idaho and be fairly sure that they
will allow you to make a reasonable comparison.
Everything leading up to the bottom line on that balance
sheet is covered by those GAAP rules. All of the numbers on
that sheet are traced backward to the original transactions that
created them and always (at least in theory) in the same con-
sistently reliable way. Again (in theory), an accountant should
be able to walk into a corporation with the annual report and
work backward from there, verifying every number along the
way. They really do this, by the way; it’s called an audit.
An audit is made possible by something called an audit
trail, and the GAAP rules dictate exactly how this path is
to be laid. The trail is created with documents created in a
set pattern and sequence, in which nancial transactions are
recorded, classied, summarized, and reported. Figure 9.1
illustrates this process.
Instead of starting at the bottom of the pyramid, were going
to begin with the top, looking at the nancial reports of a cor-
poration, and work our way down from there. For our in-depth
review of how everything ows to the preparation of these two
reports, were going to use an example from real life: the books
and records of Chicago gangster Al Capone. Al’s business,
Alphonse Capone Second Hand Furniture, Inc., was selected to
make things more interesting. Trying to put Als books together
while retaining as much historical accuracy as possible was an
enjoyable exercise. See Figure 9.2 for some notes about this
process and the presentation of the information.
There are one or two things to keep in mind in review-
ing the annual report of any publicly held corporation: First,
the company is required by law to prepare these reports,
to keep the owners (i.e., shareholders) and the government
(i.e., Securities and Exchange Commission) informed about
Introduction to Books and Records

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