1. McGraw-Hill/Irwin Chapter 1 The Nature and Purpose of Accounting Copyright © 2011. The McGraw-Hill Companies. All Rights Reserved.

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. 1-2

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

4. Operating Information Needed to conduct day-to-day activities. Largest quantity of accounting data. Examples: –Hours worked by employees. –Inventory on hand. –Amounts owed by customers. –Amount of money in bank. 1-4

5. Financial Accounting Information For external users (investors) and managers. Used by investors to make decisions to buy, sell, or hold shares of a company. Annual report and its financial statements. –Common rules used so investors can compare with other companies’ financial statements. –No “tailor-made” information 1-5

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

7. Planning Deciding what actions should be taken. Decision making involves: 1.Identify problem or opportunity. 2.Specify and rank criteria. 3.Identify alternatives. 4.Analyze alternatives. 5.Compare alternatives and select best. 1-7

8. Planning Budgeting –Process of planning for a specified time, often for one year. –Objective is to coordinate plans to provide consistency 1-8

9. Implementation Actions to provide human and other resources to achieve planned results. Requires supervision by managers. Must change plans as conditions require. 1-9

10. Control Process to ensure employees perform properly. Accounting information is used to: –Communicate plans and expected actions. –Motivate employees to act consistently with organization’s goals. –Focus attention on problem areas (via feedback). –Appraise performance of managers and other employees. 1-10

11. Tax Accounting Information Prepare returns for taxing authorities: Tax accounting rules can differ from financial accounting rules. 1-11

12. Definition of Accounting Process of: –Identifying –Measuring –Communicating economic information to make decisions. 1-12

13. Misconceptions about Accounting Actual value or “worth” of a business may not be included in usual financial reports. Not all resources (assets) of organizations are (or can be) measured and reported. –e.g., knowledge and skills of employees. 1-13

14. Plan of Course Part One: Financial Accounting –Overview of basic structure underlying all accounting. –Reviews same material in more detail. Part Two: Management Accounting –Often uses same or similar information as financial accounting. –But tailor-made to meet the needs of a specific organization. 1-14

15. Financial Accounting Rules Terminology, rules and conventions evolved over centuries. Rules that worked and were useful were kept. 1-15

16. Accounting Principles General rule used as a guide to action. Flexibility: several alternatives. Acceptance of a principle depends on how well it meets three Criteria: –Relevance. Useful and meaningful. –Objectivity. Reliable and verifiable. –Feasibility. Implemented without undue cost. Trade-off among criteria. 1-16

17. Generally Accepted Accounting Principles (GAAP) Not legally required Currently established by Financial Accounting Standards Board (FASB). 1-17

18. Securities Exchange Commission (SEC) U.S. agency empowered by Congress to protect investors. Jurisdiction over publicly traded companies. Delegated authority for GAAP to FASB. 1-18

19. International Accounting Standards Board (IASB) International Financial Reporting Standards (IFRS) No authority to require compliance. But, required by European Union (EU) for listed companies. Similar to US GAAP in many ways. Convergence project with FASB. 1-19

20. Financial Statements Required by GAAP Statement of Financial Position (Balance Sheet). Income Statement. Statement of Cash Flows. 1-20

21. Status vs. Flow Status Report: Resources and obligations at a point in time: –Balance sheet. Flow Report: Activity over a period of time: –Income statement. –Statement of cash flows. 1-21

22. Balance Sheet Assets = Liabilities + Owners’ equity Resources Sources of financing 1-22

23. Balance Sheet Assets: Resources of entity. –Cash. –Accounts Receivable. –Inventory. –Equipment. –Investments. –etc. 1-23

24. Balance Sheet Liabilities: Claims by creditors. –Accounts payable. –Notes payable. Owners’ Equity: Claims by investors. –Amounts provided directly by equity investors (Paid-in-capital). –Amounts retained from earnings, i.e. profits (Retained earnings). 1-24

25. Fundamental Accounting Equation Assets = Liabilities + Owners’ Equity. Every accounting transaction maintains equality of equation. Purchase $20,000 of equipment for cash. –Increase Equipment (asset) by $20,000 and decrease Cash (asset) by $20,000. No net change to assets. Purchase $20,000 of equipment on credit. –Increase Equipment (asset) by $20,000 and increase Notes Payable (liability) by $20,000. 1-25

26. Income Statement Summaries results of operating activity over a period of time. Revenues – Expenses = Net Income. Net income (or net loss) is the amount added to (subtracted from) Retained earnings. 1-26

27. Financial Statement Objectives Is useful for investment decisions. (All financial statements). Is comprehensible. (All financial statements). Shows economic resources and claims on resources (Balance Sheet). Shows financial performance during a period (Income Statement). Shows cash flows (Statement of Cash Flows). 1-27

28. Financial vs. Income Tax vs. Management Reporting Operating information summarized under three different sets of rules. Differences among: –Financial Reporting (GAAP). –Income Tax Reporting (IRS). –Management Reporting (Top management). Similarities tend to be greater than differences. 1-28