Chapter 1

The Nature
and Purpose of
Accounting

McGraw-Hill/Irwin

Copyright 2011. The McGraw-Hill Companies. All Rights Reserved.

What Accounting
Does
Accounting is a system that provides
information on:
Amounts of resources.
How resources were financed.
Results achieved by using resources.

For either:
Parties inside or outside of organization.
Profit and nonprofit organizations.
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Categories of
Accounting
Information
Operating
Financial accounting.
Management accounting.
Tax accounting.

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Operating
Information
Needed to conduct day-to-day
activities.
Largest quantity of accounting data.
Examples:
Hours worked by employees.
Inventory on hand.
Amounts owed by customers.
Amount of money in bank.
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Financial Accounting
Information
For external users (investors) and
managers.
Used by investors to make decisions to
buy, sell, or hold shares of a company.
Annual report and its financial
statements.
Common rules used so investors can
compare with other companies financial
statements.
No tailor-made information
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Management
Accounting Information
For internal users such as president,
marketing manager, production
manager, etc.
Used for three management
functions:
Planning.
Implementation.
Control.
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Planning
Deciding what actions should be
taken.
Decision making involves:
1.
2.
3.
4.
5.

Identify problem or opportunity.

Specify and rank criteria.
Identify alternatives.
Analyze alternatives.
Compare alternatives and select best.
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Planning
Budgeting
Process of planning for a specified
time, often for one year.
Objective is to coordinate plans to
provide consistency

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Implementation
Actions to provide human and
other resources to achieve
planned results.
Requires supervision by
managers.
Must change plans as conditions
require.
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Control
Process to ensure employees perform
properly.
Accounting information is used to:
Communicate plans and expected actions.
Motivate employees to act consistently
with organizations goals.
Focus attention on problem areas (via
feedback).
Appraise performance of managers and
other employees.
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Tax Accounting
Information
Prepare returns for taxing
authorities:
Federal
State
Local
International

Tax accounting rules can differ from

financial accounting rules.
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Definition of
Accounting
Process of:
Identifying
Measuring
Communicating

Economic information.
To make decisions.
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Accountants in
Organizations
Bookkeepers and other data entry
personnel.
Maintain detailed operating records.

Staff accountants.

Prepare and interpret reports.

Design and operate information
systems.
Ensure accuracy of information.
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Certified Public
Accountants (CPAs)
Independent public accountants.
Audit publicly owned companies
and provide other services.
Licensed by state.
Work in large firms, small firms,
independent practices.
American Institute of CPAs (AICPA).
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Public Company
Accounting Oversight
Board (PCAOB)
Monitors auditors of public
companies.
Has power to:
Set auditing standards.
Discipline auditors who do not
follow standards.

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Other Professional
Organizations and
Designations
Institute of Management Accountants
(IMA).
Certified Management Accountants
(CMAs).
Institute of Internal Auditors (IIA).
Certified Internal Auditors (CIAs).
American Accounting Association (AAA).
Academic accountants.
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Role of Controller
Top accounting manager.
Oversees:
Accounting professionals in areas of
management accounting, financial accounting,
and tax accounting.
Requests for information and reports.
Compliance with applicable rules and
regulations.
Design, installation, and operation of
information systems.
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Approaches to Study
Accounting
Viewpoint of accountant (preparer).
Collecting, summarizing and reporting
accounting information.

Viewpoint of user.

Understanding, analyzing, and interpreting

accounting reports to make decisions.

Our authors:

Emphasize perspective of current and

potential future users.
However, recognize need for some knowledge
of how accounting reports are prepared.
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Misconceptions about
Accounting
Actual value or worth of a
business may not be included in
usual financial reports.
Not all resources (assets) of
organizations are (or can be)
measured and reported.
e.g., knowledge and skills of
employees.
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Plan of Book/Course
Part One: Financial Accounting
Chapters 1-4: Overview of basic structure
underlying all accounting.
Chapters 5-14: Reviews same material in
more detail.

Part Two: Management Accounting

Chapters 15-28.
Often uses same or similar information as
financial accounting.
But tailor-made to meet the needs of a
specific organization.
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Financial Accounting
Rules
Terminology, rules and
conventions evolved over
centuries.
Rules that worked and were
useful were kept.

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Accounting:
The Language of
Business
But like any language:
Many words have similar, but not same,
meaning.
Some rules are definite others are not.
Rules continue to evolve.
Differing presentations.

XBRL (extensible business reporting

language).
Helps adjust for presentational differences.
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Accounting Principles
General rule or law.
Flexibility.
Evolutionary.
Criteria:
Relevance. Useful and meaningful.
Objectivity. Reliable and verifiable.
Feasibility. Implemented without undue cost.

Trade-off among criteria.

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Generally Accepted
Accounting Principles
(GAAP)

Currently established by Financial

Accounting Standards Board (FASB).
7 member board with diverse
backgrounds.
Supported by professional staff.
Nongovernmental organization.
Due process procedure to establish
standards.

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Generally Accepted
Accounting Principles
(GAAP)

Not legally required.

Emerging Issues Task Force for
quick decisions
FASB Accounting Standards
Codification

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Securities Exchange
Commission (SEC)
U.S. agency empowered by Congress to
protect investors.
Jurisdiction over publicly traded
companies.
Enhances accounting rules through
Regulation S-X, Financial Reporting Series
Releases, and Staff Accounting Bulletins.
Delegated authority for GAAP to FASB.

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International
Accounting Standards
Board (IASB)
International Financial Reporting
Standards (IFRS)
No authority to require
compliance.
But, required by European Union
(EU) for listed companies.
Similar to US GAAP in many ways.
Convergence project with FASB.
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Financial Statements
Required by GAAP
Statement of Financial Position
(Balance Sheet).
Income Statement.
Statement of Cash Flows.

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Status vs. Flow

Status Report: Resources and
obligations at a point in time:
Balance sheet.

Flow Report: Activity over a

period of time:
Income statement.
Statement of cash flows.
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Sources of Financial
Statements
Company websites:
www.cocacola.com
www.ge.com
www.microsoft.com

SECs EDGAR:
www.sec.gov

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Balance Sheet
Assets = Liabilities + Owners
equity
Resources

Sources of financing

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Balance Sheet
Assets: Resources of entity.
Cash.
Accounts Receivable.
Inventory.
Equipment.
Investments.
etc.
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Balance Sheet
Liabilities: Claims by creditors.
Accounts payable.
Notes payable.

Owners Equity: Claims by investors.

Amounts provided directly by equity
investors (Paid-in-capital).
Amounts retained from earnings, i.e.
profits (Retained earnings).
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Fundamental
Accounting Equation
Assets = Liabilities + Owners Equity.
Every accounting transaction maintains
equality of equation.
Purchase $20,000 of equipment for cash.
Increase Equipment (asset) by $20,000 and
decrease Cash (asset) by $20,000. No net
change to assets.

Purchase $20,000 of equipment on credit.

Increase Equipment (asset) by $20,000 and
increase Notes Payable (liability) by $20,000.
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Income Statement
Summaries results of operating
activity over a period of time.
Revenues Expenses = Net
Income.
Net income (or net loss) is the
amount added to (subtracted
from) Retained earnings.
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Financial Statement
Objectives
Is useful for investment decisions. (All
financial statements).
Is comprehensible. (All financial statements).
Shows economic resources and claims on
resources (Balance Sheet).
Shows financial performance during a period
(Income Statement).
Shows cash flows (Statement of Cash Flows).

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Sarbanes-Oxley Act
(2002)
Chief executives and chief financial
officers of public companies certify
financial statements filed with SEC
are materially accurate and
complete.
Potential civil and criminal liability.

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Financial vs. Income Tax

vs. Management
Reporting
Operating information summarized
under three different sets of rules.
Differences among:
Financial Reporting (GAAP).
Income Tax Reporting (Congress and IRS).
Management Reporting (Top management).

Similarities tend to be greater than

differences.
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