Accounting: Information for Decision Making

Lecture 1

Accounting is “the language of business.”

More precisely, accounting is a system of maintaining records of a company’s operations and communicating that information to decision makers

Accounting Information

Accounting from a User’s Perspective

Financial Accounting – refers to information describing the financial resources, obligations and activities of an economic entity used by external parties for decision making

Management Accounting - deals with the methods accountants use to provide information to an organization’s internal users—that is, its own managers

Tax Accounting

Types of Accounting Information

Decisions People Make about Companies

Used by an Organization to:◦ Develop accounting information◦ Communicate this information to decision makers

Important factors that affect the structure are:◦ The company’s needs for accounting information◦ The resources available for operation of the

system

Accounting as an Information System

Interpret and record the effects of business transactions

Classify the similar transactions in a manner that permits determination of the various totals and subtotals useful to management and used in accounting reports

Summarize and communicate the information contained in the system to decision makers

Basic Functions of Accounting System

Investors make decisions related to buying and selling the company’s stock (shares of ownership): Is the company profitable?

Creditors make decisions related to lending money to the company: Will the company be able to repay its debt when it comes due? Will it be able to pay interest in the meantime?

External Users of Accounting Information

Owners Labor Unions Governmental Agencies Suppliers Customers Trade Associations General Public

Other External Users

Management is the design and use of accounting information to achieve the organization’s objectives by supporting decision makers inside the enterprise

Management accounting systems assign decision-making authority over the enterprise’s resources to its employees

Management accounting systems provide a wealth of information for supporting decision-making activity

The system is also used to evaluate and reward decision making performance

Objectives of Management Accounting

Board of Directors Chief Executive Officer (CEO) Chief Financial Officer (CFO) Vice-presidents Business Unit Managers Plant Managers Store Managers Line Supervisors

Internal Users of Accounting Information

Financing activities are transactions involving external sources of funding - There are two basic sources of this external funding—the owners of the company who invest their own funds in the business, and creditors who lend money to the company. With this financing, the company engages in investing activities.

Investing activities include the purchase and sale of◦ long-term resources such as land, buildings, equipment, and

machinery and ◦ any resources not directly related to a company’s normal operations.

Once these investments are in place, the company has the resources needed to run the business and can perform operating activities.

Operating activities include transactions that relate to the primary operations of the company, such as providing products and services to customers and the associated costs of doing so, like utilities, taxes, advertising, wages, rent, and maintenance.

Business Activities to Measure

HOW TO MEASURE BUSINESS ACTIVITIES

We measure resources owned by a company as assets

Amounts owed to creditors are liabilities

The ownership on the business is the owner’s equity – it reflects total worth of business◦ Owner’s Equity is simply Assets-Liabilities◦ Stockholder’s Equity is Common stock + Retained

Earnings where Retained Earnings is calculated :Retained Earnings = Net income - Dividends

Assets, Liabilities and Owner’s Equity

The accounting equation illustrates a fundamental model of business valuation

Assets = Liabilities + Owner’s Equity

Accounting Equation

Increase in an asset = Decrease in another assetIncrease in an asset = Increase in a liabilityDecease in an asset = Decrease in a liabilityDecrease in an asset = Decrease in equity

Decrease in an asset = Increase in another asset

Revenues are the amounts earned from selling products or services to customers

Expenses are the costs of providing products and services

A dividend is a payment made by a corporation to its shareholders, usually as a distribution of profit/ Net Income

We measure the difference between revenues and expenses as net income

Net Income = Revenue - Expenses

Revenues, Expenses and Dividends

Problem

Match the term with the appropriate definition.1. Assets A. Costs of selling products or services.2. Liabilities

B. Amounts earned from sales of3. Stockholders’ equity products or services.4. Dividends C . Amounts owed.5. Revenues D. Distributions to stockholders.6. Expenses E . Owners’ claims to resources.

F. Resources owned.

Sole Proprietorship

Partnership

Corporation

FORMS OF BUSINESS ORGANIZATION

An unincorporated business owned by one person

Not a separate legal entity

Personal liability for business debts – Unlimited liability

Income taxable to owner

The owner has the managerial authority

Entity ceases with retirement or death of owner

Sole Proprietorship

An unincorporated business owned by two or more partners

Not a separate legal entity

Personal liability for partnership debts

Income taxable to partners

Every partner has the managerial authority

New partnership is formed with a change in partners

Partnership

Legal entity having an existence separate and distinct from that of its owners

The owners of a corporation are called stockholders (or shareholders)

Ownership is evidenced by transferable shares of capital stock

No personal liability for corporate debts

Files a corporate tax return and pays income taxes on its earnings

Managed by hired professional managers

Indefinite existence

Corporation

Financial statements are periodic reports published by the company for the purpose of providing information to external users

Four primary financial statements:1. Income statement2. Statement of stockholders’ equity3. Balance sheet4. Statement of cash flows

Communicating through Financial Statements

A financial statement that reports the company’s revenues and expenses over an interval of time

Revenues − Expenses = Net income

If expenses exceed revenues, then the company reports a net loss.

THE INCOME STATEMENT

Presents the financial position of the company on a particular date

Assets = Liabilities +Owner’s Equity/Stockholders’ Equity

THE BALANCE SHEET

Sole Proprietorship

Corporation

Measures activities involving cash receipts and cash payments over an interval of time

There are three fundamental business activities◦ Operating cash flows include cash receipts and cash payments for

transactions involving revenues and expenses

◦ Investing cash flows generally include cash transactions for the purchase and sale of investments and productive long-term assets. Long-term assets are resources owned by a company that are thought to provide benefits for more than one year

◦ Financing cash flows include cash transactions with lenders, such as borrowing money and repaying debt, and with stockholders, such as issuing stock and paying dividends

THE STATEMENT OF CASH FLOWS