2. ©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones2 - 1 Chapter 2 Economic Decision Making

3. ©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones2 - 2 Learning Objective 1 Explain the concepts of extrinsic and intrinsic rewards, sacrifices, and opportunity costs as they pertain to routine and non-routine decision situations.

4. ©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones2 - 3 Decision Making Identifying alternative courses of action. Selecting an appropriate alternative.

5. ©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones2 - 4 Rewards and Sacrifices In general, the aim of all decisions is to obtain some type of reward, either economic or personal. Reward requires sacrifice.

6. ©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones2 - 5 Opportunity Cost It is the reward we give up because we choose a particular alternative instead of another. Examining the relationship between rewards and sacrifices is known as cost/benefit analysis.

7. ©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones2 - 6 Types of Rewards ExtrinsicIntrinsic

8. ©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones2 - 7 Coping with Uncertainty and Risk Uncertainty in any given decision situation increases the chances of making the wrong choice. The higher the degree of uncertainty, the greater the risk.

9. ©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones2 - 8 Routine and Non-routine Decisions RoutinedecisionsSituationrecurs Non-routinedecisionsUnfamiliarcircumstances

10. ©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones2 - 9 Learning Objectives 2 and 3 Use a cognitive problem-solving model to make decisions. Explain how information processing styles affect decision making and be able to identify examples of systematic and intuitive styles.

11. ©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones2 - 10 Information Processing Styles Intuitive Thinkers See the “forest” Rely on “hunches” See the big picture Prefer non-routine environments Systematic Thinkers See the “tree” Are “detail” people Prefer careful analysis Are methodical

12. ©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones2 - 11 Reasoned Decision making It is also called cognitive or rational decision making. This approach can be used with both intuitive and systematic information.

13. ©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones2 - 12 The Seven-Step Decision Model 1 Determine the real decision to be made. 2 Identify alternative courses of action. 3 Analyze each alternative critically. 4 Select the best alternative in the circumstances. Non-routine Decisions Routine Decisions

14. ©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones2 - 13 The Seven-Step Decision Model 5 Implement the chosen alternative. 6 Reevaluate the decision as new information becomes available. 7 Evaluate the final outcome.

15. ©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones2 - 14 Learning Objective 4 Explain the importance of creativity and the role of values and ethics in the decision-making process.

16. ©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones2 - 15 Creative Decision Making The second step of the decision-making model stresses the importance of being creative in identifying possible courses of action. The most important influence on the decisions we make is the set of personal values we hold.

17. ©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones2 - 16 Ethics and Personal Values Virtues Ethics = Character or Classical Ethics Rules Ethics = Quandary or Modern Ethics

18. ©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones2 - 17 Learning Objective 5 Describe the advantages and disadvantages of individual and group decision making.

19. ©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones2 - 18 Individual versus Group Decision Making What are some advantages of individual decision making? Not a lot of time organizing meetings Do not need to consider others’ comments Compromise is unnecessary What is a limitation? Decision depends on individual judgment

20. ©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones2 - 19 Individual versus Group Decision Making What are some advantages of group decision making? Greater knowledge base for the decision More alternative solutions Takes the pressure of responsibility off individuals What is a limitation? Actual functioning of groups

21. ©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones2 - 20 Problems with Group Decisions Information processing styles Domineering members Social pressure Goal replacement Different personal values Unequal efforts Groupthink

22. ©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones2 - 21 Economic Decision Making The term economic decision making refers to the process of making business decisions involving money. InternalExternal

23. ©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones2 - 22 Economic Decision Making External Decision Makers – make decisions about the company – use Financial Accounting Available information is limited to what the company supplies to external users Stockholders Stockholders (present and potential) (present and potential) Bankers and other lenders Bankers and other lenders Bondholders Bondholders (present and potential) (present and potential) Suppliers Suppliers Customers Customers Internal Decision Makers – make decisions for the company – use Managerial Accounting Available information is limited only by time and the user’s position within the company Marketing managers Marketing managers Salespersons Salespersons Production managers Production managers Strategic planners Strategic planners Company president Company president Engineers Engineers Financial officers Financial officers

24. ©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones2 - 23 Learning Objective 6 Explain the basic differences between management accounting and financial accounting.

25. ©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones2 - 24 Management and Financial Accounting Management accounting generates information for use by internal decision makers. Financial accounting generates information for use by external parties.

26. ©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones2 - 25 Contrast of Financial and Management Accounting Principalusers Rules and regulations Level of detail TimelinessFuture/pastorientationFeature External parties for decisions about firm. Governed by GAAP. Little detail. Quarterly and annually. Depicts present condition and past results. Does not generally include future projections.FinancialAccounting Internal parties for decisions for firm. Company policy. Need not conform to GAAP. Quite detailed. As needed by users. Includes future projections, present condition, and past results. ManagementAccounting

27. ©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones2 - 26 Learning Objective 7 List the three questions all economic decision makers attempt to answer and explain why these questions are so important.

28. ©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones2 - 27 What all Economic Decision Makers Want to Know Economic decision makers attempt to predict future cash flow. Will I be paid? When will I be paid? How much will I be paid?

29. ©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones2 - 28 What all Economic Decision Makers Want to Know The answer to each question contains two parts: Return on investment Return of investment

30. ©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones2 - 29 What all Economic Decision Makers Want to Know Net cash flow is the mathematical difference between cash inflows and cash outflows. PositiveNegative PositiveNegative Cash inflow1,000,000500,000 Cash outflow 950,000575,000 Net cash flow 50,000 ( 75,000 )

31. ©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones2 - 30 What all Economic Decision Makers Want to Know Three Big Questions for Economic Decision Makers 1. Will I be paid? 2. When will I be paid? 3. How much will I be paid? I be paid? UncertaintyTimingAmountConceptsInterestEachquarter$25/quarter; $200 total Return on Investment CD maturity At the end of two years $1,000 Return of Investment

32. ©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones2 - 31 What all Economic Decision Makers Want to Know What are the returns? Interest:Return on investment$ 200 Principle:Return of investment 1,000 Total return$1,200 Less:Initial investment 1,000 Profit on investment$ 200

33. ©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones2 - 32 Learning Objective 8 Describe the importance of cash as a measure of business success or failure.

34. ©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones2 - 33 Cash is the “Ball” of Business The secret to becoming a street-smart user of accounting information is learning to balance the complexity of business with the simple rule of keeping your eye on cash flow.

35. ©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones2 - 34 Learning Objective 9 Describe the basic assumptions and constraints underlying accounting information and distinguish accounting information from accounting data.

36. ©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones2 - 35 Accounting Information Accounting is a service activity. Its function is to provide quantitative information, primarily financial in nature, about economic entities that is intended to be useful in making economic decisions.

37. ©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones2 - 36 Data versus Information Data are the raw result of transactions. Data become information only when they are put into some useful form.

38. ©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones2 - 37 Assumptions Underlying Accounting Information Assumptions Assumptions 1. Economic entity 2. Going concern 3. Monetary unit 4. Periodicity

39. ©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones2 - 38 Constraints to Consider in Generating Accounting Information Constraints Constraints 1. Cost/benefit 2. Materiality 3. Industry practice 4. Conservatism

40. ©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones2 - 39 Learning Objective 10 Describe the qualitative characteristics of useful accounting information and apply them in decision-making situations.

41. ©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones2 - 40 Qualitative Characteristics of Useful Accounting Information 1. Primary qualities A. Relevance (1) Predictive value (2) Feedback value (3) Timeliness B. Reliability (1) Representational faithfulness (2) Verifiability (3) Neutrality 2. Secondary qualities A. Comparability B. Consistency

42. ©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones2 - 41 Learning Objective 11 Identify, discuss, and contrast information found in typical annual reports.

43. ©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones2 - 42 Decision Makers and Understandability Decision-makers and users of accounting information must evaluate financial information to assess its usefulness. Information presented in the financial statements constitutes only a part of the information needed to make sound economic decisions.

44. ©2004 Prentice Hall Business Publishing Introduction to Financial Accounting, 3e by Werner/Jones2 - 43 End of Chapter 2