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