Chapter
1


The
Nature
and
 Purpose
of
 Accoun3ng


McGraw-Hill/Irwin

Copyright © 2011. The McGraw-Hill Companies. All Rights Reserved.

What
Accoun0ng
Does

• Accoun3ng
is
a
system
that
provides
 informa3on
on:

– Amounts
of
resources.
 – How
resources
were
financed.
 – Results
achieved
by
using
resources.


• For
either:

– Par3es
inside
or
outside
of
organiza3on.
 – Profit
and
nonprofit
organiza3ons.

1-2

Categories
of
Accoun0ng
 Informa0on

• Opera3ng
 • Financial
accoun3ng.
 • Management
accoun3ng.
 • Tax
accoun3ng.


1-3

Opera0ng
Informa0on

• Needed
to
conduct
day‐to‐day
 ac3vi3es.
 • Largest
quan3ty
of
accoun3ng
data.
 • Examples:

– Hours
worked
by
employees.
 – Inventory
on
hand.
 – Amounts
owed
by
customers.
 – Amount
of
money
in
bank.

1-4

Financial
Accoun0ng
Informa0on

• 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”
informa3on


1-5

Management
Accoun0ng
 Informa0on

• For
internal
users
such
as
president,
 marke3ng
manager,
produc3on
 manager,
etc.
 • Used
for
three
management
func3ons:

– Planning.
 – Implementa3on.
 – Control.

1-6

Planning

• Deciding
what
ac3ons
should
be
taken.
 • Decision
making
involves:

1. 2. 3. 4. 5. Iden3fy
problem
or
opportunity.
 Specify
and
rank
criteria.
 Iden3fy
alterna3ves.
 Analyze
alterna3ves.
 Compare
alterna3ves
and
select
best.

1-7

Planning

• Budge3ng

– Process
of
planning
for
a
specified
3me,
 o^en
for
one
year.
 – Objec3ve
is
to
coordinate
plans
to
provide
 consistency


1-8

Implementa0on

• Ac3ons
to
provide
human
and
other
 resources
to
achieve
planned
results.
 • Requires
supervision
by
managers.
 • Must
change
plans
as
condi3ons
 require.


1-9

Control

• Process
to
ensure
employees
perform
 properly.
 • Accoun3ng
informa3on
is
used
to:

– Communicate
plans
and
expected
ac3ons.
 – Mo0vate
employees
to
act
consistently
with
 organiza3on’s
goals.
 – Focus
a>en0on
on
problem
areas
(via
 feedback).
 – Appraise
performance
of
managers
and
other
 employees.

1-10

Tax
Accoun0ng
Informa0on

• Prepare
returns
for
taxing
authori3es:

– Federal
 – State
 – Local
 – Interna3onal


• Tax
accoun3ng
rules
can
differ
from
 financial
accoun3ng
rules.

1-11

Defini0on
of
Accoun0ng

• Process
of:

– Iden3fying
 – Measuring
 – Communica3ng


• Economic
informa3on.
 • To
make
decisions.

1-12

Accountants
in
Organiza0ons

• Bookkeepers
and
other
data
entry
 personnel.
 • Staff
accountants.


– Maintain
detailed
opera3ng
records.

 – Prepare
and
interpret
reports.
 – Design
and
operate
informa3on
systems.
 – Ensure
accuracy
of
informa3on.


1-13

Cer0fied
Public
Accountants
 (CPAs)

• Independent
public
accountants.
 • Audit
publicly
owned
companies
and
 provide
other
services.
 • Licensed
by
state.
 • Work
in
large
firms,
small
firms,
 independent
prac3ces.
 • American
Ins3tute
of
CPAs
(AICPA).

1-14

Public
Company
Accoun0ng
 Oversight
Board
(PCAOB)

• Monitors
auditors
of
public
companies.
 • Has
power
to:

– Set
audi3ng
standards.
 – Discipline
auditors
who
do
not
follow
 standards.


1-15

Other
Professional
Organiza0ons
 and
Designa0ons

• Ins3tute
of
Management
Accountants
(IMA).
 – Cer3fied
Management
Accountants
(CMAs).
 • Ins3tute
of
Internal
Auditors
(IIA).
 – Cer3fied
Internal
Auditors
(CIAs).
 • American
Accoun3ng
Associa3on
(AAA).
 – Academic
accountants.


1-16

Role
of
Controller

• Top
accoun3ng
manager.
 • Oversees:

– Accoun3ng
professionals
in
areas
of
 management
accoun3ng,
financial
accoun3ng,
 and
tax
accoun3ng.
 – Requests
for
informa3on
and
reports.
 – Compliance
with
applicable
rules
and
 regula3ons.
 – Design,
installa3on,
and
opera3on
of
 informa3on
systems.


1-17

Approaches
to
Study
 Accoun0ng

• Viewpoint
of
accountant
(preparer).

 • Viewpoint
of
user.
 • Our
authors:

– Collec3ng,
summarizing
and
repor3ng
accoun3ng
 informa3on.
 – Understanding,
analyzing,
and
interpre3ng
 accoun3ng
reports
to
make
decisions.
 – Emphasize
perspec3ve
of
current
and
poten3al
 future
users.
 – However,
recognize
need
for
some
knowledge
of
 how
accoun3ng
reports
are
prepared.

1-18

Misconcep0ons
about
 Accoun0ng

• Actual
value
or
“worth”
of
a
business
 may
not
be
included
in
usual
financial
 reports.
 • Not
all
resources
(assets)
of
 organiza3ons
are
(or
can
be)
measured
 and
reported.

– e.g.,
knowledge
and
skills
of
employees.

1-19

Plan
of
Book/Course

• Part
One:

Financial
Accoun3ng

– Chapters
1‐4:
Overview
of
basic
structure
 underlying
all
accoun3ng.
 – Chapters
5‐14:
Reviews
same
material
in
more
 detail.


• Part
Two:

Management
Accoun3ng

– Chapters
15‐28.
 – O^en
uses
same
or
similar
informa3on
as
financial
 accoun3ng.
 – But
tailor‐made
to
meet
the
needs
of
a
specific
 organiza3on.

1-20

Financial
Accoun0ng
Rules

• Terminology,
rules
and
conven3ons
 evolved
over
centuries.
 • Rules
that
worked
and
were
useful
 were
kept.


1-21

Accoun0ng:

 The
Language
of
Business

• But
like
any
language:

– Many
words
have
similar,
but
not
same,
 meaning.
 – Some
rules
are
definite
others
are
not.
 – Rules
con3nue
to
evolve.
 – Differing
presenta3ons.


• XBRL
(extensible
business
repor3ng
 language).

– Helps
adjust
for
presenta3onal
differences.

1-22

Accoun0ng
Principles

• General
rule
or
law.
 • Flexibility.
 • Evolu3onary.
 • Criteria:

– Relevance.
Useful
and
meaningful.
 – Objec0vity.
Reliable
and
verifiable.
 – Feasibility.
Implemented
without
undue
cost.


• Trade‐off
among
criteria.


1-23

Generally
Accepted
Accoun0ng
 Principles
(GAAP)

• Currently
established
by
Financial
 Accoun3ng
Standards
Board
(FASB).

– 7
member
board
with
diverse
 backgrounds.
 – Supported
by
professional
staff.
 – Nongovernmental
organiza3on.
 – Due
process
procedure
to
establish
 standards.

1-24

Generally
Accepted
Accoun0ng
 Principles
(GAAP)

• Not
legally
required.
 • Emerging
Issues
Task
Force
for
“quick
 decisions”
 • FASB
Accoun3ng
Standards
Codifica3on


1-25

Securi0es
Exchange
Commission
 (SEC)

• U.S.
agency
empowered
by
Congress
to
 protect
investors.
 • Jurisdic3on
over
publicly
traded
 companies.
 • Enhances
accoun3ng
rules
through
 Regula'on
S‐X,
Financial
Repor'ng
Series
 Releases,
and
Staff
Accoun'ng
Bulle'ns.
 • Delegated
authority
for
GAAP
to
FASB.

1-26

Interna0onal
Accoun0ng
 Standards
Board
(IASB)

• Interna3onal
Financial
Repor3ng
 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.

1-27

Financial
Statements
Required
 by
GAAP

• Statement
of
Financial
Posi3on
(Balance
 Sheet).
 • Income
Statement.
 • Statement
of
Cash
Flows.


1-28

Status
vs.
Flow

• Status
Report:

Resources
and
 obliga3ons
at
a
point
in
3me:

– Balance
sheet.


• Flow
Report:

Ac3vity
over
a
period
of
 3me:

– Income
statement.
 – Statement
of
cash
flows.

1-29

Sources
of
Financial
Statements

• Company
websites:

– www.cocacola.com
 – www.ge.com
 – www.microso^.com


• SEC’s
EDGAR:

– www.sec.gov



1-30

Balance
Sheet

Assets
=
Liabili3es
+
Owners’
equity
 Resources














Sources
of
financing


1-31

Balance
Sheet

• Assets:

Resources
of
en3ty.

– Cash.
 – Accounts
Receivable.
 – Inventory.
 – Equipment.
 – Investments.
 – etc.

1-32

Balance
Sheet

• Liabili3es:

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).

1-33

Fundamental
Accoun0ng
 Equa0on

• Assets
=
Liabili3es
+
Owners’
Equity.
 • Every
accoun3ng
transac3on
maintains
 equality
of
equa3on.
 • 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.


1-34

Income
Statement

• Summaries
results
of
opera3ng
ac3vity
 over
a
period
of
3me.
 • Revenues
–
Expenses
=
Net
Income.
 • Net
income
(or
net
loss)
is
the
amount
 added
to
(subtracted
from)
Retained
 earnings.


1-35

Financial
Statement
 Objec0ves

• 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).

1-36

Sarbanes‐Oxley
Act
(2002)

• Chief
execu3ves
and
chief
financial
 officers
of
public
companies
cer3fy
 financial
statements
filed
with
SEC
are
 materially
accurate
and
complete.
 • Poten3al
civil
and
criminal
liability.


1-37

Financial
vs.
Income
Tax
vs.
 Management
Repor0ng

• Opera3ng
informa3on
summarized
under
 three
different
sets
of
rules.
 • Differences
among:

– Financial
Repor3ng
(GAAP).
 – Income
Tax
Repor3ng
(Congress
and
IRS).
 – Management
Repor3ng
(Top
management).


• Similari3es
tend
to
be
greater
than
 differences.

1-38