Introduction to Accounting

Part 1

Łazarski University
A. Mark Galanter

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 Introduction to Accounting

 Types of business organizations

 Business organization stakeholders

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 Definition
An organization is a social arrangement which:
 pursues collective goals,
 controls its own performance and
 has a boundary separating it from its environment.

These boundaries can be physical or social

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 KEY CATEGORIES OF BUSINESSES
1. Commercial
2. Public sector
3. Not-for-profit
4. Charities
5. Trade unions
6. Local authorities
7. Co-operatives
8. Non-governmental organizations (NGO)

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 Reasons for setting up an organization:

 Overcome people’s individual limitations

 Enable people to specialize

 Save time

 Accumulate and share knowledge and pool their expertise

 Enable synergy

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 SECTORS

Organizations owned or run by the government (local or

national) or government agencies are described as being in the
public sector.
All other organizations are classified as the private sector.

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 Key differences between profit and not-
for-profit organizations:

 Owner and other stakeholders

 Sources of funding (eg impact of sources of donations)

 Goals (primary goal of profit orientated business is maximizing

shareholder wealth while not-for-profit is the provision of goods /
services)

 How they measure performance; profit focus vs value for money /

efficiency.

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 Limited liability company

 What is seen as a key advantage of a limited liability

company can be found in the name itself. That is to say that
the shareholder’s liability is limited to the amount they have
invested into that company. This is because limited liability
companies (denoted by Ltd or plc) are set up so as to have a
separate legal entity from their owners (shareholders).

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 Limited liability company cont.
Advantages of a Ltd / plc company are:

 More money available for investment from Shareholders

 Easier to raise capital from banks and other lenders

 Ownership and control are legally separated, investors need not run the
company

Disadvantages would include:

 Great administrative burden and cost, especially for listed entities

 Lack of privacy to your results as anyone can download the financial statements
to view

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 Limited liability company cont.
 Private companies are usually owned by a small number of
people (family members), and these shares are not easily
transferable usually denoted by “Ltd” after their name.

 Shares of public companies, “plc”s will usually be traded on

a Stock Exchange. The directors of a public company are less
likely to hold a significant shareholding in the company.

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 STAKEHOLDER GOALS AND OBJECTIVES

Definition

Stakeholder is a person or group of persons who have a

vested interest (stake) in the organization.

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 PRIMARY STAKEHOLDERS
STAKEHOLDER What’s at stake ? What do they expect?

Shareholders (or partners or Money invested Return on invested money in

proprietor) order to increase their
wealth:
•Steady, growing profits paid
by their business (dividends)
•Growth in capital value of
their share of the business

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 SECONDARY STAKEHOLDERS
Stakeholder What’s at stake ? What do they expect?

Directors/managers, Livelihoods, careers and •Fair and growing

employees and reputations remuneration
trade unions •Career progression
•Safe working environment
•Training, Pension

Their custom (habits)

Customers
•Products/services that are of
good quality and value
•Fair terms of trade, continuity
of supply
The items they supply •Fair terms of trade, prompt
Suppliers and other
business partners payment
•Continuity of custom
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 SECONDARY
Stakeholder STAKEHOLDERS
What’s at stake ? Whatcont.
do they expect?

Lenders (banks, financial Money lent A return on their investment:

institutions) •Interest
•repayment of capital

Government and its agencies •National infrastructure used •Reasonable employment and
by business other business practices
•The welfare of employees •Steady or rising stream of
•Tax revenue tax revenue

The local community and the •National infrastructure used •Reasonable employment and
public at large by business other business practices
•The welfare of employees

The environment shared by Reasonable enviromental and

The natural environment
all other business practices

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 Johnson and Scholes stakeholders
categorization (ICE)

 Internal: corporate management, employees

 Connected: shareholders, debt holders (eg bank),
intermediate (business) and final (consumer) customers,
suppliers
 External: immediate community / society at large, special
interest groups, government, competitors

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 Mendelow’s Matrix –
stakeholders interest categorization

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 The purpose of accounting

 Accounting is a way of recording, analyzing and

summarizing the transactions of a business and the
accounting system must be adequate to fulfil this task.
 Accounting is often called „the language of business”

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 The purpose of accounting cont.
 Quite simply, accounting is a language: a language that
provides information about the financial position of an
organization. When you study accounting you are essentially
learning this specialized language. By learning this language
you can communicate and understand the financial
operations of any and all types of organizations.

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 The purpose of accounting cont.
This is because the information required by most
organizations is very similar and can be broken down into
three main categories:
1. Operating information
2. Financial Accounting information
3. Managerial Accounting information

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 The purpose of accounting cont.
 Operating Information
This is the information that is needed on a day-to-day basis in
order for the organization to conduct its business. Employees need
to get paid, sales need to be tracked, the amounts owed to other
organizations or individuals need to be tracked, the amount of
money the organization has needs to be monitored, the amounts
that customers owe the organization need to be checked, any
inventory needs to be accounted for: the list goes on and on.
Operating information is what constitutes the greatest amount of
accounting information and it provides the basis for the other two
types of accounting information.

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 The purpose of accounting cont.
 Financial Accounting Information
This is the information that is used by managers, shareholders, banks,
creditors, the government, the public, etc… to make decisions involving
the organization and its operations. Shareholders want information
about what their investment is worth and whether they should buy or
sell shares, bankers and other creditors want to know whether the
organization has an ability to pay back money lent, managers want to
know how the company is doing compared to other companies. This
type of information would be very difficult to extract if every company
used a different system for recording their financial position. Financial
accounting information is subject to a set of ground rules that dictate
how the information is reported and this ensures uniformity.

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 The purpose of accounting cont.
 Managerial Accounting Information
In order for the managers of a company to make the best
decisions for a company they need to have specific
information prepared. They use this information for three
main management functions: planning, implementation and
control. Financial information is used to set budgets, analyze
different options on a cost basis, modify plans as the need
arises, and control and monitor the work that is being done.

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 Financial information provided by
accounting
There are some variations in accounting systems. They
will depend upon:

 Size of the organization

 Type of organization

 Structure of organization

 Legal jurisdiction of the organization

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 Financial information provided by
accounting cont.
The accounting system will provide the basis for financial
information used externally and internally
External reports produced for external purposes are as
follows:
 Statement of profit or loss (income statement)
 Statement of financial position (balance sheet)
 Statement of cash flows
 Statement of retained earnings
 Other as required by country fiscal law or by financial
institutions

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 Financial information provided by
accounting cont.

There is a large variety of internal reports generated by accounting

department. Their purpose is to help employees of a company to
efficiently manage the business.

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 Financial information provided by
accounting cont.
Financial statements have to be produced as a result of
requirements of:

 Law (Companies legislation)

 Tax authority requirements
 Banks (if providing finance to the company)
 Employee reports

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 Financial information provided by
accounting cont.
Key users of accounting information
include:

 Managers

 Shareholders

 Trade contacts

 Providers of finance

 Analysts

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 Financial information provided by
accounting cont.
 Good accounting information must have the following qualities:

 Be relevant

 Be comprehensive

 Be reliable

 Be complete

 Be objective

 Be timely

 Be comparable

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 Typical financial function structure in
large business organization
CEO (Chief Executive
Officer)/President/General
Manager/Managing Director/Board
of Directors

CFO(Chief Finance Officer)

or
Finance Director

Financial Management
Treasurer Controler Accountant
(responsible for cash (responsible for (responsible for
flow control) routine budgets/ cost
accounting) accounting)

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 Nature, principles and scope of
accounting

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 Nature, principles and scope of
accounting cont.
Financial accounting

 Records historic results

 Provides information for external users

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 Nature, principles and scope of
accounting cont.
Management accounting

 Produces information for decision-making

 Provides information for internal users

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 Nature, principles and scope of
accounting cont.
 The accounts department interacts with other departments
in the organisation and so there is a need for close co-
ordination.

 As part of that co-ordination, information must be passed

within and between departments and this information must
be of a certain quality for it to be of any use.

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 Nature, principles and scope of
accounting cont.

Information may be from external sources as well as internal

but consideration must be given to several aspects of
information to ensure its quality:

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 Nature, principles and scope of
accounting cont.
 A – accurate
 C – complete
 C – cost – beneficial
 U – user – targeted
 R – relevant
 A – authoritative (ie credible)
 T – timely
 E – easy to use

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 Ethics in Accounting

Ethics deals with the ability to

distinguish right from wrong.

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 Ethics in Accounting cont.
 Accountants, like others operating in the business world, are
faced with many ethical dilemmas, some of which are
complex and difficult to resolve. For instance, the capital
markets’ focus on periodic profits may tempt a company’s
management to bend or even break accounting rules to
inflate reported net income. In these situations, technical
competence is not enough to resolve the dilemma.

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 Ethics in Accounting cont.
 Ethics and standards in accounting exist to protect the public
from unscrupulous corporations and the accountants who
hide or misrepresent information. Certainly, not all
accountants are unethical, but when proper ethics are
breached, the consequences can be disastrous. In 2001, the
collapse of Enron resulted in losses of more than $60 billion,
which impacted investors, individuals whose retirement
accounts were decimated, and the 5,600 people who lost
their jobs. Despite continued legislation, ethics continues to
play an important role in the field of accounting.

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 Ethics in Accounting cont.
Disclosure and Conflict of Interest
 According to “Accounting Ethics,” “the accountant’s role is to
furnish various entities that have a legitimate right to know about
an organization’s affairs with useful information about those
economic affairs”. This role is difficult to properly undertake when
there are conflicting interests. For example, if a corporation hires
an accounting firm to conduct an audit of profit and losses, the
accounting firm has the responsibility to provide accurate
information to shareholders and the general public -- even if that
information is potentially damaging to its client.

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 Ethics in Accounting cont.
 Sarbanes-Oxley Act
 Following several large corporate scandals, in 2002, the Sarbanes-
Oxley Act was signed into law. This act, authored by senators Paul
Sarbanes of Maryland, and Michael G. Oxley of Ohio, further
protects the public from unethical accounting practices. New
disclosure standards require companies to institute internal
control systems and assess those systems annually. Companies also
are required to provide full disclosure of off-balance sheet items in
periodic reports. In section 802, the act clearly states the penalties
for unethical accountants, which includes fines and imprisonment.
This act was introduced due to unethical accounting professionals
and the companies for whom they worked.

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 Ethics in Accounting – Case Study
Kenneth Lay - ENRON

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 Ethics in Accounting – Case Study
cont.
 Kenneth Lay – Enron
 Enron’s downfall, and the imprisonment of several of its leadership group, was one of the most
shocking and widely reported ethics violations of all time. It not only bankrupted the company but
also destroyed Arthur Andersen, one of the largest audit firms in the world.
 The Securities and Exchange Commission (SEC) announced in 2001 that it was investigating the
accounting practices of Enron after several years of questions raised by analysts and shareholders.
The resulting disclosures and write-downs by the company reduced investor confidence and the
company’s credit rating, leading to thebankruptcy in December 2001. The SEC announced that it
would pursue charges against Lay, former CEO Jeffrey Skilling, CFO Andrew Fastow and other
high-ranking employees.
 The charges related to knowingly manipulating accounting rules and masking the enormous losses
and liabilities of the company. Lay and Skilling were tried together on 46 counts, including money
laundering, bank fraud, insider trading and conspiracy. Skilling was convicted on 19 counts and
sentenced to over 24 years in prison.
 Lay was convicted on six counts of fraud and faced up to 45 years in jail. Lay died in 2006, three
months prior to his sentencing hearing. The resulting investigation of the Enron scandal resulted in
Congress passing the Sarbanes-Oxley Act to improve corporate accountability.

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 Ethics in Accounting – Case Study
cont.
 Bernard Ebbers – Worldcom
 As the SEC was conducting its investigation of Enron, an even larger CEO ethics violation was
brewing. Worldcom, which at the time was the United States‘ second-largest long-distance
telecommunications company, entered into merger discussions with Sprint. The merger was
ultimately dashed by the Department of Justice over concerns about it creating a virtual monopoly.
The situation took its toll on the company’s stock price.
 CEO Bernard Ebbers owned hundreds of millions of dollars in Worldcom stock, which he margined
to invest in other business ventures. As the stock price dropped, banks began demanding that
Ebbers cover more than $400 million in margin calls. Ebbers convinced the board to lend him the
money so that he would not have to sell substantial blocks of stock. He also began an aggressive
campaign to prop up the stock price by creating outright fraudulent accounting entries. The fraud
was ultimately discovered by Worldcom’s internal audit department, and the audit committee was
informed. The resulting SEC investigation resulted in the company’s bankruptcy filing in 2002 and
the conviction of Ebbers on fraud, conspiracy and filing false documents charges. Ebbers began a
25-year sentence in federal prison in 2006.

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 Ethics in Accounting – Case Study
cont.
 Conrad Black – Hollinger International
 Canadian Conrad Black created Hollinger Inc., the parent company of Hollinger
International, in the mid-1980s with the purchase of the controlling interest in
the Daily Telegraph. With a number of other purchases throughout the
following 15 years, Hollinger became one of the largest media groups in the
world. As CEO of Hollinger International, Black had substantial control over
the company’s finances.
 The board of directors confronted Black in 2003 over payments the company
made to him and four other directors in the $200 million range. The board
called in the SEC to investigate the validity of the payments and the accounting
transactions created to account for them. Charges were laid against Black for
fraud, tax evasion and racketeering, among others. In 2007, Black was
convicted of four of the 13 charges against him and was sentenced to 78 months
in prison, of which he served 42. He was released from prison in 2012.

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  End of Part 1

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