[MUSIC] Learning Outcomes.

After watching this video, you will

be able to define what accounting is, briefly describe the three
types of accounting, discuss what accrual accounting is and
it's pros and cons. Before we define the different
financial statements, companies typically report publicly, let's
broadly look at what accounting is and the different types of accounting.
Accounting is the formal collection,
aggregation, analysis and reporting of financial and non-financial
data about a company to various end users. Some of the financial and
non-financial reporting is mandated and the companies are required to release
these periodically, typically quarterly. Accounting itself
comprises of three types. One is financial accounting,
two is managerial accounting, and three is tax accounting. Financial accounting
provides information
about the company to people outside it. Managerial accounting provides information
about the company to those within it. Finally, tax accounting is
the estimation of taxes to be paid and the compliance with tax disclosures. The
primary purpose of financial
accounting is to inform outsiders about the financial
performance and health of the company, which will
assist them in their decision-making. This could be for
valuation purposes by equity investors and investment banks and for assessment of
credit risk by banks and suppliers. A secondary purpose of financial
accounting is to monitor and evaluate the performance of managers and to ensure
that its managers use
the company's resources responsibly. Financial accounting communicates to
outsiders through financial statements and additional disclosures all of which
are a part of the company's quarterly and annual reports. These reports are audited
for accuracy and
conformity with accounting rules. The primary purpose of managerial
accounting is to provide information for decision making within the company. The
information provided
through managerial accounting helps determine product costs,
profitability and pricing, determining product mix, introducing and
discontinuing products and capacity planning and
determining production volumes. A secondary purpose is for
performance evaluation and cost control. Unlike financial accounting reports,
there is no fixed format for managerial accounting reports and
they are not audited. Tax accounting provides
information to tax authorities. It is legal to prepare separate
statements for tax and financial purposes, as some of the rules
used to prepare statements for tax purposes may differ from those
used to form financial statements. In this course, we will focus
only on financial accounting. A key element of financial
accounting is the idea of accrual. Financial statements are based on
accruals rather than on cash basis. That is, transactions are recognized
on financial statements as and when the primary economic event occurs, rather
than when the actual cash flow occurs. This accrual-based accounting allows
the verification of earnings and the net financial position of
a company during a period. This accrual-based accounting gives
rise to two major financial statements. Namely, the income statement, also
called a profit and loss statement, and the balance sheet. Accrual accounting
occurs through
the process of revenue recognition and matching costs to revenues. Revenue
recognition means that a company
can report revenue that it has earned through delivery of service or
product, can measure this revenue and is reasonably sure of
receiving this revenue. Matching costs to revenues means
that expenses directly related to revenues are recognized in the same
period as the revenues are recognized. It also includes expenses that are not
directly related to revenues, but are recognized as expenses over the time
period the benefits are realized. In a nutshell,
accrual accounting says that we do not have to see the cash to
record a transaction. The advantage of accrual accounting is
that since transactions are recorded when the economic event happens the financial
statements provide timelier and more decision-relevant information. On the other
hand, accrual accounting is
based on judgements and estimates and so less reliable than cash flows. As the
common adage goes, cash flow is
a fact, earnings is a matter of opinion. For this reason, financial accounting
is guided by well-specified rules. But these rules do give some room for
managerial discretion, which is why external auditors
audit financial statements. Next time, we will start looking at some of the common
financial statements. [MUSIC]