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Principles of Accounting, Volume 1: Financial Accounting

Chapter 1 ROLE OF ACCOUNTING IN SOCIETY
PowerPoint Image Slideshow

Chapter Outline
• 1.1 Explain the Importance of Accounting and Distinguish between
Financial and Managerial Accounting
• 1.2 Identify Users of Accounting Information and How They Apply
Information
• 1.3 Describe Typical Accounting Activities and the Role Accountants
Play in Identifying, Recording, and Reporting Financial Activities
• 1.4 Explain Why Accounting Is Important to Business Stakeholders
• 1.5 Describe the Varied Career Paths Open to Individuals with an
Accounting Education

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Module 1.1 Explain the Importance of Accounting and Distinguish

between Financial and Managerial Accounting

Accounting is the process of organizing, analyzing, and communicating

financial information that is used for decision-making.

“Accounting is the language of business.”

“Accounting is the language of life.”

Understanding financial and managerial accounting is valuable and

necessary for practically any career you will pursue.

Distinguish between Financial and Managerial Accounting

Financial accounting measures the financial performance of an organization
using standard conventions (rules) to prepare and distribute financial
reports.
• The purpose is to communicate information for decision-making by both
internal and external users.
• External users: owners (stockholders), lenders, and governmental entities such as
the Securities and Exchange Commission (SEC) and the Internal Revenue Service
(IRS)

Managerial accounting uses both financial and nonfinancial information as a

basis for making decisions within an organization.
• The purpose is to equip decision makers with information to assist in
setting and evaluating business goals by determining what information is
needed and how to analyze and communicate this information.
• Information tends to be used internally, for purposes such as budgeting,
pricing, and determining production costs.

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Module 1.2 Identify Users of Accounting Information and How They

Apply Information
Users of accounting information are generally divided into two
categories: internal and external.
• Internal users are those within an organization who use financial
information to make day-to-day decisions. They include managers and
other employees who use financial information to confirm past results
and help make adjustments for future activities.
• External users are those outside of the organization who use the
financial information to make decisions or to evaluate an entity’s
performance. They include investors, financial analysts, loan officers,
governmental auditors, such as IRS agents, and an assortment of other
stakeholders.

Characteristics of Financial Accounting Information

• Financial information is primarily communicated through financial statements.

• Income Statement, Statement of Owner’s Equity, Balance Sheet, and Statement of Cash Flows and
Disclosures
• Financial accounting information is mostly historical in nature, although companies and
other entities also incorporate estimates into their accounting processes.
• Financial information is prepared using a comprehensive, prescribed set of conventions,
called generally accepted accounting principles (GAAP). They are set by the Financial
Accounting Standards Board (FASB).
• Part of an accountant’s responsibility is to quantify activities and events, which are then
summarized and reported. Virtually every activity and event that occurs in a business has an
associated cost or value and is known as a transaction.
• Common computerized accounting systems include QuickBooks, which is designed for small
organizations, and SAP, which is designed for large and/or multinational organizations.

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Characteristics of Managerial Accounting Information

• Managerial accounting is not prepared using a comprehensive, prescribed set of conventions

like those required by financial accounting—there is no rule or standard-setting body.
• Managerial accountants provide managerial accounting information that is intended to serve
the needs of internal users.
• Managerial accounting information is rarely shared with those outside of the organization.
The information often includes strategic or competitive decisions; managerial accounting
information is often closely protected.
• Management accounting information as a term encompasses many activities within an
organization. Accountants must be adaptable and flexible in their ability to generate the
necessary information for management decision-making and have both broad and detailed
knowledge.
• Management accounting information uses both financial and nonfinancial information. This
is important because there are situations in which a purely financial analysis might lead to
one decision, while considering nonfinancial information might lead to a different decision.

Figure 1.3

Comparing Reports between Financial and Managerial Accounting. (attribution: Copyright Rice University, OpenStax, under
CC BY-NC-SA 4.0 license)

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Module 1.3 Describe Typical Accounting Activities and the Role

Accountants Play in Identifying, Recording, and Reporting Financial Activities
Three categories of organizations:
• For-profit businesses: the primary purpose is to earn a profit by selling
goods and services.
• Manufacturing: use raw materials, or component parts, to produce a final product
that is sold to another manufacturer or consumers
• Retail: buy goods that are already produced and sell them to other businesses or
consumers
• Service: do not sell tangible products to customers, but rather provide intangible
benefits (services) to customers
• Governmental entities: provide services to the general public (taxpayers).
Governmental agencies exist at the federal, state, and local levels. These
entities are funded through the issuance of taxes and other fees.
• Not-for-profit entities: the primary purpose or mission is to serve a
particular interest or need in the community. A not-for-profit entity tends
to depend on donations and grants.

Figure 1.5

Automobiles can be a component of manufacturing, retail, or service

organizations.

Manufacturing, Retail, and Service. An auto manufacturing plant, a car sales lot, and a taxi represent three types of
businesses: manufacturing, retail, and service. (credit left: modification of “Maquiladora” by “Guldhammer”/Wikimedia
Commons, CC0; credit center: modification of “Mercedes Benz Parked” by unknown/Pixabay, CC0; credit right: modification
of “Taxi Overtaking Bus” by “Kai Pilger”/Pixabay, CC0)

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Your Turn: Categorizing Restaurants

So far, you’ve learned about three types of for-profit businesses:
manufacturing, retail, and service. Previously, you saw how some firms
such as Dell serve as both manufacturer and retailer.
Now, think of the last restaurant where you ate. Of the three business
types (manufacturer, retailer, or service provider), how would you
categorize the restaurant? Is it a manufacturer? A retailer? A service
provider? Can you think of examples of how a restaurant has
characteristics of all three types of businesses?

Module 1.4 Explain Why Accounting Is Important to Business

Stakeholders
Stakeholder refers to a person or group who relies on financial information
to make decisions. Examples of stakeholders are:
• Stockholders: owner of stock in a business. Owners are called stockholders
because in exchange for cash, they are given an ownership interest (stock)
in the business. Owners are concerned with the success, and other factors,
of the company they own. If the company’s value increases, then the
stockholder’s stock (ownership) value increases.
• Creditors and lenders: must assess the risk of not being repaid
• Rarely do businesses pay for goods and services they purchase at the time the goods
or services are delivered; rather the good or service provider extends credit to the
purchasing business who will pay at a later date.
• Companies also borrow money from banks when needed to finance certain aspects
of their operations and typically pay this money back over time along with interest
on those borrowed funds.

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More Examples of Stakeholders

• Governmental and regulatory agencies
• Publicly traded companies are required to file financial and other informational reports with
the Securities and Exchange Commission (SEC), a federal regulatory agency that regulates
corporations with shares listed and traded on security exchanges through required periodic filings.
• The SEC is responsible for establishing guidelines for the accounting profession called accounting
standards or generally accepted accounting principles (GAAP).
• Although the SEC also had the responsibility of issuing standards for the auditing profession, they
relinquished this responsibility to the Financial Accounting Standards Board (FASB).
• Customers: those who purchase products and services from a business
• Can be another business, often referred to as a B2B (business to business) transaction, such as
Nabisco selling products to grocery stores
• End-user customer, such as a shopper in a grocery store
• Managers and other employees
• Employees have a strong interest in the financial performance of the organizations; employees
want to know their jobs will be secure; an organization that is financially successful is able to
reward employees for commitment to the organization through bonuses and increased pay.
• Managers and others in the organization have the responsibility to make day-to-day and long-term
(strategic) decisions for the organization. Understanding financial information is vital to making
good organizational decisions. Not all decisions, however, are based on strictly financial
information.

Ways in Which an Organization Can Raise Funding (Capital)

1. Profitable operations
• Generating income from the day-to-day activities of the business
2. Borrowing
• Also known as debt funding
3. Issuing (selling) stock
• Also known as equity funding

Most organizations raise or generate funding in some combination of

these methods. A company that is unable to eventually earn profits
from their business activities will not likely survive. Why?

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Your Turn: Daily Decisions

Many academic studies have been conducted on the topic of consumer
behavior and decision-making. It is a fascinating topic of study that attempts
to learn what type of advertising works best, the best place to locate a
business, and many other business-related activities.
One such study, conducted by researchers at Cornell University, concluded
that people make more than 200 food-related decisions per day (Wansink,
B., & Sobal, J. [2007]. Mindless Eating: The 200 Daily Food Decisions We
Overlook. Environment & Behavior, 39[1], 106–123.).
This is astonishing considering the number of decisions found in this
particular study related only to decisions involving food. Imagine how many
day-to-day decisions involve other issues that are important to us, such as
what to wear and how to get from point A to point B. For this exercise,
provide and discuss some of the food-related decisions that you recently
made.

Module 1.5 Describe the Varied Career Paths Open to Individuals with
an Accounting Education
Characteristics of accounting professionals:
• Personal attributes
• Goal oriented
• Problem solver
• Organized and analytical
• Good interpersonal skills
• Pays attention to detail
• Good time-management skills
• Outgoing
• Education
• Entry-level positions: usually require a minimum of a bachelor’s degree
• Advanced positions: may consider factors such as years of experience, professional
development, certifications, and advanced degrees, such as a master’s or doctorate
• Related careers
• An accounting degree is a valuable tool for other professions such as financial analysts,
personal financial planners, and business executives.

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Figure 1.8

Career Paths. There are many career paths open to students of accounting. (attribution: Copyright Rice University, OpenStax,
under CC BY-NC-SA 4.0 license)

Major Categories of Accounting Functions

• Auditing
• Taxation
• Financial accounting
• Consulting
• Accounting information services
• Cost and managerial accounting
• Financial planning
• Entrepreneurship

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Figure 1.10

Accountant Employer Types. Accountants may find employment within a variety of types of entities. (attribution: Copyright
Rice University, OpenStax, under CC BY-NC-SA 4.0 license)

Potential Certifications for Accountants

• Certified Public Accountant (CPA)
• Certified Management Accountant (CMA)
• Certified Internal Auditor (CIA)
• Certified Fraud Examiner (CFE)
• Chartered Financial Analyst (CFA)
• Certified Financial Planner (CFP)

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Summary
• Accounting is the process of organizing, analyzing, and communicating financial information that
is used for decision-making.
• Accounting is often called the “language of business.”
• Financial accounting measures performance using financial reports and communicates results to
those outside of the organization who may have an interest in the company’s performance, such
as investors and creditors.
• Managerial accounting uses both financial and nonfinancial information to aid in decision-making.
• The primary goal of accounting is to provide accurate, timely information to decision makers.
• Accountants use common conventions to prepare and convey financial information.
• Financial accounting is historical in nature, but a series of historical events can be useful in
establishing predictions.
• Financial accounting is intended for use by both internal and external users.
• Managerial accounting is primarily intended for internal users.
• Accountants play a vital role in many types of organizations.
• Organizations can be placed into three categories: for profit, governmental, and not for profit
• For-profit businesses can be further categorized into manufacturing, retail (or merchandising),
and service.

Summary (continued)
• Stakeholders are persons or groups that rely on financial information to make decisions.
• Stakeholders include stockholders, creditors, governmental and regulatory agencies, customers,
and managers and other employees.
• The Securities and Exchange Commission (SEC) is responsible for establishing accounting
standards for companies whose stocks are traded publicly on a national or regional stock
exchange, such as the New York Stock Exchange (NYSE).
• It is important for accountants to be well versed in written and verbal communication and
possess other nonaccounting skill sets.
• A bachelor’s degree is typically required for entry-level work in the accounting profession.
• Advanced degrees and/or professional certifications are beneficial for advancement within the
accounting profession.
• Career paths within the accounting profession include auditing, taxation, financial accounting,
consulting, accounting information systems, cost and managerial accounting, financial planning,
and entrepreneurship.
• Accountants have opportunities to work for many types of organizations, including public
accounting firms, corporations, governmental entities, and not-for-profit entities.
• Common professional certifications include Certified Public Accountant (CPA), Certified
Management Accountant (CMA), Certified Internal Auditor (CIA), Certified Fraud Examiner (CFE),
Chartered Financial Analyst (CFA), and Certified Financial Planner (CFP).

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SA 4.0 International license; it may be reproduced or modified for
noncommercial purposes only but must be attributed to OpenStax,
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