Chapter McGraw-Hill/Irwin Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved. The Nature and Purpose of Accounting 1

1-2 What Accounting Does Accounting is a system that provides information on: –Amounts of resources. –How resources were financed. –Results achieved by using resources. For either: –Parties inside or outside of organization. –Profit and nonprofit organizations.

1-3 Categories of Accounting Information Operating Financial accounting. Management accounting. Tax accounting.

1-4 Operating Information Needed to conduct day-to-day activities. Largest quantity of accounting data. Examples: –Hours worked by employees for payroll purposes. –Automobiles available for sale to customers. –Amounts owed by customers. –Parts and accessories on hand.

1-5 Financial Accounting Information For external users (investors) and managers. Used by investors to make decisions to buy, sell or hold shares of company. Primary financial statements: –Balance sheet. –Income statement. –Statement of cash flows. Common rules used so investors can compare with other companies’ financial statements.

1-6 Management Accounting Information For internal users such as president, marketing manager and production manager. Used for three functions of managers: –Planning. –Implementation. –Control.

1-7 Planning Deciding what actions should be taken. Decision making involves: –Identify problem or opportunity. –Specify and rank criteria. –Identify alternatives. –Use accounting and other information to analyze. –Compare alternatives and select best. Budgeting = process of planning for a specified time, often for one year.

1-8 Implementation Actions to provide human and other resources to achieve planned results. Requires supervision of managers. Managers must change plans as conditions require.

1-9 Control Process to ensure employees perform properly. Accounting information is used to: –Communicate. Inform employees of plans. –Motivate. Encourage employees to act consistently with organization’s goals. –Direct attention. Provide feedback, that is, signal when a problem may exist. –Appraise. Provide information to appraise performance of managers and other employees.

1-10 Tax Accounting Information Preparation of federal, state, and other taxes. Tax accounting rules can differ from financial accounting rules.

1-11 Definition of Accounting Process of: –Identifying –Measuring –Communicating Economic information. To make decisions.

1-12 Accountants in Organizations Bookkeepers and other data entry personnel. –Maintain detailed operating records. Staff accountants. –Prepare and interpret reports. –Design and operate information systems. –Ensure accuracy of information.

1-13 Certified Public Accountants (CPAs) Independent public accountants. Audit publicly owned companies and provide other services. Licensed by state. Large and small firms. American Institute of CPAs (AICPA).

1-14 Other Professional Organizations and Designations Institute of Management Accountants (IMA). –Certified Management Accountants (CMAs). Institute of Internal Auditors (IIA). –Certified Internal Auditors (CIAs). American Accounting Association (AAA). –Academic accountants.

1-15 Responsibilities of Controller Manage professionals; prepare reports. –Management accounting. –Financial accounting. –Tax accounting. Design, installation and operation of information systems.

1-16 Approaches to Study Accounting Viewpoint of accountant (preparer). –Collecting, summarizing and reporting accounting information. Viewpoint of user. –Understanding, analyzing, and interpreting accounting reports to make decisions. Authors emphasize perspective of current and potential future users, recognizing need for some knowledge of how accounting reports are prepared.

1-17 Misconceptions about Accounting Not all resources of organizations can be measured and reported. –Knowledge and skills of employees. Actual value or “worth” of a business may not be included in usual financial reports.

1-18 Plan of Book/Course Part One Financial Accounting –Chapters 2,3 and 4: Includes basic structure underlying all accounting. –Chapters 5-14: Reviews same material in more detail. Part Two Management Accounting –Chapters –Often uses same or similar information as financial accounting. –Management can establish whatever rules, and analysis it believes to be useful.

1-19 Financial Accounting Rules Terminology, rules and conventions evolved over centuries. Rules that worked and were useful were kept.

1-20 Accounting: The Language of Business Many words have similar, but not same, meaning as in common English. Similar to English, some rules are definite others are not. Rules continue to evolve. XBRL (extensible business reporting language): a digital business language.

1-21 Accounting Principles General rule or law. Convention. Evolutionary. Criteria: –Relevance. Useful and meaningful. –Objectivity. Reliable and verifiable. –Feasibility. Implemented without undue cost. Trade-off among criteria.

1-22 Generally Accepted Accounting Principles (GAAP) Currently established by Financial Accounting Standards Board (FASB). –7 members, diverse accounting backgrounds. –Supported by professional staff. –Private organization. –Due process. Not legally required. Emerging Issues Tax Force.

1-23 Securities Exchange Commission (SEC) U.S. agency empowered by congress to protect investors. Jurisdiction over publicly traded company. Influences accounting rules through Regulation S-X, Financial Reporting Series Releases, and Staff Bulletins. Delegated authority for GAAP to FASB.

1-24 American Institute of CPAs (AICPA) Members include auditors. Statements of Position (SOP). Accounting Trends & Techniques summarizes practices of 600 companies.

1-25 International Accounting Standards Board (IASB) International Financial Reporting Standards (IFRS) –Include International Accounting Standards (IAS) developed by predecessor, International Accounting Standards committee (IASC). Based in London, England. No authority to require compliance. Required by European Union (EU) for listed companies. Convergence project with FASB.

1-26 Financial Statements Required by GAAP Statement of Financial Position (Balance Sheet). Income Statement. Statement of Cash Flows.

1-27 Stock vs. Flow Stock/resources and obligations at a point in time: –Balance sheet. Flow/activity over a period of time: –Income statement. –Statement of cash flows.

1-28 Sources of Financial Statements Company websites: – – – SEC’s EDGAR: –

1-29 Dual Aspect: Balance Sheet (Fundamental Accounting Equation) Assets = Liabilities + Owners’ equity. LHS = RHS. Resources = Obligations to creditors or claims on resources + Residual claim. Amounts invested in resources = how these amounts were financed. Resources = financed by creditors + financed by owners.

1-30 Owners’ Equity Equivalently net assets (i.e. = A -L). 2 sources of OE: –Amounts provided directly by equity investors (Paid-in-capital). –Amounts retained from earnings, i.e. profits (Retained Earnings).

1-31 Fundamental Accounting Equation Assets – Liabilities = Owners’ Equity Net Assets = Owners’ Equity Every accounting transaction has an equal affect on both sides of equation. Purchase a $20,000 car for cash. –Increase asset car and decrease asset cash by $20,000. No net change to assets. Purchase a $20,000 car on credit. –Increase asset car and increase liabilities by $20,000.

1-32 Income Statement Shows changes in Owners’ Equity or Retained Earnings from operations of business. Reconciles Retained Earnings from beginning to end of period resulting from operations of business. Revenues – Expenses = Net Income –Sales Revenue = amount for product sold to customers during accounting period. –Gross margin = Sales revenue – Cost of sales

1-33 Financial Statement Objectives Useful for investment decisions. (All financial statements) Comprehensible. (All financial statements) About economic resources and claims on resources (Balance Sheet). About financial performance during a period (Income Statement). About cash flows (Statement of Cash Flows).

1-34 Sarbanes-Oxley Act (2002) Chief executives and chief financial officers certify financial statements filed with SEC are materially accurate and complete. Potential civil and criminal liability.

1-35 Financial vs. Income Tax vs. Management Reporting Operating information summarized under three different sets of rules. Differences among: –Financial Reporting (GAAP) –Income Tax Reporting (Congress and IRS). –Management Reporting (Top management). Similarities tend to be greater than differences.

Chapter McGraw-Hill/Irwin Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved. End of Chapter 1 1