1. © PHI Learning, 2008. All rights reserved.1 Financial Accounting: A Managerial Perspective Third Edition Prepared by R. Narayanaswamy Indian Institute of Management Bangalore

2. © PHI Learning, 2008. All rights reserved.2 Accounting and Economic Decisions Chapter 1

3. © PHI Learning, 2008. All rights reserved.3 The Aim of the Course 1.Appreciate the information needs of different categories of users of company financial reports. 2.Understand the significance of accounting principles and the systems and processes involved in preparing and presenting financial reports. 3.Analyse and interpret financial reports. Chapter 1

4. © PHI Learning, 2008. All rights reserved.4 The Approach in this Book 1.Understanding the economic basis of accounting 2.Connecting accounting to capital market and corporate governance 3.Emphasis on principles 4.Student-friendly presentation, easy-to-read style 5.Real-world applications 6.Integrating preparation and use of financial statements 7.Linking accounting theory, empirical research and practice Chapter 1

5. © PHI Learning, 2008. All rights reserved.5 Understanding Business Organizations  What do business organizations do?  e.g., Apollo Hospitals, Amazon.com, Bharti Airtel, Tata Motors  Types of business organizations  Merchandising or trading  Manufacturing  Service  Business organizations are “cash machines” Chapter 1

6. © PHI Learning, 2008. All rights reserved.6 What is Accounting  Accounting is the language of business  Accounting provides information for making decisions  Accounting is an information system  Accounting and economic decisions  Why should managers and other decision- makers know accounting? Chapter 1

7. © PHI Learning, 2008. All rights reserved.7 The Accounting Information System Inputs Processing Outputs Users Business Accounting Financial Investors, transactions principles statements lenders, and events and procedures and reports managers Chapter 1

8. © PHI Learning, 2008. All rights reserved.8 Users of Accounting Information  Investors  Lenders  Security analysts and advisers  Managers  Employees and trade unions  Suppliers and other trade creditors  Customers  Government authorities and regulators  The public Chapter 1

9. © PHI Learning, 2008. All rights reserved.9 Major Branches of Accounting Chapter 1 Financial Accounting  For external users  Historical information  Standardized format  Laws and conventions  Summarized  Income statement; Balance sheet; Cash flow statement; Accounting policies Management Accounting  For internal users  Future-oriented  Flexible format  Context-specific  More detailed  Product cost statement; Standard costs; Budgets; Variances; Performance reports

10. © PHI Learning, 2008. All rights reserved.10 Accounting Measurement  Accounting records the effect of economic activities  Internal events  External events: transactions  exchange (e.g., purchase of goods)  one-way transfer (e.g., donations, thefts)  Other external events  no exchange or transfer (e.g., floods, earthquakes) Chapter 1

11. © PHI Learning, 2008. All rights reserved.11 Assumptions Underlying Accounting Measurement  Accounting entity  Business is distinct from owner  Going concern  Business is a continuing enterprise  Periodicity  Business activities divided into periods  Money measurement  Money is a stable measurement unit Chapter 1

12. © PHI Learning, 2008. All rights reserved.12 Generally Accepted Accounting Principles  What is GAAP?  Importance of GAAP  Institutions that influence GAAP  Government  Accounting profession  Securities regulators  Other regulators  International organizations Chapter 1

13. © PHI Learning, 2008. All rights reserved.13 Institutional Environment in India  Ministry of Corporate Affairs  National Advisory Committee on Accounting Standards  Securities and Exchange Board of India  Institute of Chartered Accountants of India  Central Board of Direct Taxes  Reserve Bank of India  Insurance Regulatory and Development Authority  Comptroller and Auditor-General of India  International Organizations  International Accounting Standards Board  International Federation of Accountants  International Organization of Securities Commissions Chapter 1

14. © PHI Learning, 2008. All rights reserved.14 Accounting Standards and Policies  Accounting standards  Accounting policies  Why does accounting practice differ?  Need for accounting standards  Principle-based and rule-based standards  Standard-setting mechanism in India Chapter 1

15. © PHI Learning, 2008. All rights reserved.15 Forms of Business Organization  Sole proprietorship  Single individual  Partnership  A few individuals  Limited company  Numerous individuals, often strangers  Large business  Limited liability  Limited liability partnership  Legal formalities for a limited company  The corporate organization structure Chapter 1

16. © PHI Learning, 2008. All rights reserved.16 Accounting, Capital Market, and Corporate Governance  The capital market: savers and entrepreneurs  The “lemons principle” and market breakdown  Signalling and capital market  Corporate governance  Accounting disciplines managerial actions Chapter 1

17. © PHI Learning, 2008. All rights reserved.17 The Accounting Equation Economic Resources = Claims Assets = Liabilities + Equity Capital + Revenues – Expenses – Drawings – Dividends Chapter 1

18. © PHI Learning, 2008. All rights reserved.18 Assets  Probable future economic benefits  What a business owns  Examples  Cash  Financial investments  Land  Buildings  Plant and machinery  Patents and copyrights Chapter 1

19. © PHI Learning, 2008. All rights reserved.19 Liabilities  Probable future sacrifices of economic benefits  What a business owes  Contractual, statutory, or constructive  Examples  Loans payable  Salaries payable  Warranty obligations  Pensions payable  Income tax payable Chapter 1

20. © PHI Learning, 2008. All rights reserved.20 Equity  Residual interest of owners  Examples  Share capital  Share premium  Revenues  Expenses  Dividends  Retained profit Chapter 1

21. © PHI Learning, 2008. All rights reserved.21 Financial Statements  Profit and loss account  Statement of financial performance  Revenues; Expenses  Balance sheet  Statement of financial position  Assets; Liabilities; Equity  Cash flow statement  Statement of cash receipts and cash payments  Activities: Operating; Investing; Financing Chapter 1

22. © PHI Learning, 2008. All rights reserved.22 Fields of Accounting Activity  Public accounting  Auditing  Tax  Management advisory services  Small business services  Private accounting  Management accounting  Internal auditing  Information systems  Government accounting  Central  State  Local  Not-for-profit accounting  Accounting as an academic discipline Chapter 1

23. © PHI Learning, 2008. All rights reserved.23 Ethical Issues in Accounting  Business and ethics  Why do people bend the accounting rules  GAAP is of little help  Whistle-blowing  Ethical conduct brings success in the long term Chapter 1