the nature and purpose of accounting
TRANSCRIPT
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McGraw-Hill/Irwin
Chapter 1
The Nature and Purpose of Accounting
Copyright © 2011. The McGraw-Hill Companies. All Rights Reserved.
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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.
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Categories of Accounting Information
• Operating• Financial accounting.• Management accounting.• Tax accounting.
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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.
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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
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Management Accounting Information
• For internal users such as president, marketing manager, production manager, etc.
• Used for three management functions:– Planning.– Implementation.– Control.
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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.
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Planning
• Budgeting– Process of planning for a specified time,
often for one year.– Objective is to coordinate plans to provide
consistency
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Implementation
• Actions to provide human and other resources to achieve planned results.
• Requires supervision by managers.• Must change plans as conditions
require.
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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
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Tax Accounting Information
• Prepare returns for taxing authorities:– Federal– State– Local– International
• Tax accounting rules can differ from financial accounting rules.
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Definition of Accounting
• Process of:– Identifying– Measuring– Communicating
• Economic information.• To make decisions.
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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.
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Certified Public Accountants (CPAs)
• Independent public accountants.• Audit publicly owned companies and
provide other services.• Licensed by state.• Work in large firms, small firms,
independent practices.• American Institute of CPAs (AICPA).
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Public Company Accounting Oversight Board (PCAOB)
• Monitors auditors of public companies.• Has power to:
– Set auditing standards.– Discipline auditors who do not follow
standards.
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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.
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Role of Controller
• Top accounting manager.• Oversees:
– Accounting professionals in areas of management accounting, financial accounting, and tax accounting.
– Requests for information and reports.– Compliance with applicable rules and
regulations.– Design, installation, and operation of
information systems. 1-17
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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.
• Our authors:– Emphasize perspective of current and potential
future users.– However, recognize need for some knowledge of
how accounting reports are prepared.1-18
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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.
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Plan of Book/Course
• Part One: Financial Accounting– Chapters 1-4: Overview of basic structure
underlying all accounting.– Chapters 5-14: Reviews same material in more
detail.• Part Two: Management Accounting
– Chapters 15-28.– Often uses same or similar information as
financial accounting.– But tailor-made to meet the needs of a specific
organization.1-20
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Financial Accounting Rules
• Terminology, rules and conventions evolved over centuries.
• Rules that worked and were useful were kept.
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Accounting: The Language of Business
• But like any language:– Many words have similar, but not same,
meaning.– Some rules are definite others are not.– Rules continue to evolve.– Differing presentations.
• XBRL (extensible business reporting language).– Helps adjust for presentational differences.
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Accounting Principles
• General rule or law.• Flexibility.• Evolutionary.• Criteria:
– Relevance. Useful and meaningful.– Objectivity. Reliable and verifiable.– Feasibility. Implemented without undue cost.
• Trade-off among criteria.1-23
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Generally Accepted Accounting Principles (GAAP)
• Currently established by Financial Accounting Standards Board (FASB).– 7 member board with diverse
backgrounds.– Supported by professional staff.– Nongovernmental organization.– Due process procedure to establish
standards.1-24
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Generally Accepted Accounting Principles (GAAP)
• Not legally required.• Emerging Issues Task Force for “quick
decisions”• FASB Accounting Standards Codification
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Securities Exchange Commission (SEC)
• U.S. agency empowered by Congress to protect investors.
• Jurisdiction over publicly traded companies.
• Enhances accounting rules through Regulation S-X, Financial Reporting Series Releases, and Staff Accounting Bulletins.
• Delegated authority for GAAP to FASB.1-26
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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.
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Financial Statements Required by GAAP
• Statement of Financial Position (Balance Sheet).
• Income Statement.• Statement of Cash Flows.
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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.
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Sources of Financial Statements
• Company websites:– www.cocacola.com– www.ge.com– www.microsoft.com
• SEC’s EDGAR:– www.sec.gov
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Balance Sheet
Assets = Liabilities + Owners’ equity
Resources Sources of financing
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Balance Sheet
• Assets: Resources of entity.– Cash.– Accounts Receivable.– Inventory.– Equipment.– Investments.– etc.
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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).1-33
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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. 1-34
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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.
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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).
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Sarbanes-Oxley Act (2002)
• Chief executives and chief financial officers of public companies certify financial statements filed with SEC are materially accurate and complete.
• Potential civil and criminal liability.
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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.
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