USERS OF

ACCOUNTING INFORMATION

PREPARED BY : PROF. JONAH C. PARDILLO

 LEARNING OBJECTIVES

After reading this chapter, you should be able to:

 Define external users and gives examples

 Define internal users and give examples

 Users of Accounting Information

The basic objective of accounting is to provide information which is useful for persons inside the
organization and for persons or groups outside the organization. Accounting is the discipline that
provides information on which external and internal users of the information may base decisions
that result in the allocation of economic resources in society
 External Users of Accounting Information

 External users are those groups or persons who are outside the organization for whom accounting
function is performed. Following can be the various external users of accounting information:

1. Investors: Those who are interested in investing money in an organization are interested in
knowing the financial health of the organization of know how safe the investment already made is
and how safe their proposed investment will be.
 Cont…

To know the financial health, they need accounting information which will help them in evaluating the past
performance and future prospects of the organization. Thus, investors for their investment decisions are
dependent upon accounting information included in the financial statements. They can know the
profitability and the financial position of the organization in which they are 12 interested to make that
investment by making a study of the accounting information given in the financial statements of the
organization
 External users of information

2. Creditors
 Creditors (i.e. supplier of goods and services on credit, bankers and other lenders of money) want to
know the financial position of a concern before giving loans or granting credit. They want to be
sure that the concern will not experience difficulty in making their payment in time i.e. liquid
position of the concern is satisfactory. To know the liquid position, they need accounting
information relating to current assets, quick assets and current liabilities which is available in the
financial statements.
 External users of information

2. Members of Non-Profit Organizations

 Members of non-profit organizations such as schools, colleges, hospitals, clubs, charitable
institutions etc. need accounting information to know how their contributed funds are being utilized
and to ascertain if the organization deserves continued support or support should be withdrawn
keeping in view the bad performance depicted by the accounting information and diverted to
another organization. In knowing the performance of such organizations, criterion will not be the
profit made but the main criterion will be the service provided to the society
 External users of information

3. Government
 Central and State Governments are interested in the accounting information because they want to
know earnings or sales for a particular period for purposes of taxation. Income tax returns are
examples of financial reports which are prepared with information taken directly from accounting
records. Governments also needs accounting information for compiling statistics concerning
business which, in turn helps in compiling national accounts.
 External users of information

4. Customers
 Consumers need accounting information for establishing good accounting control so that cost of
production may be reduced with the resultant 13 reduction of the prices of goods they buy.
Sometimes, prices for some goods are fixed by the Government, so it needs accounting information
to fix reasonable prices so that consumers and manufacturers are not exploited. Prices are fixed
keeping in view fair return to manufacturers on their investments shown in the accounting records.
 External users of information

5. Research Scholars
 Accounting information, being a mirror of the financial performance of a business organization, is
of immense value to the research scholars who wants to make a study to the financial operations of
a particular firm. To make a study into the financial operations of a particular firm, the research
scholar needs detailed accounting information relating to purchases, sales, expenses, cost of
materials used, current assets, current liabilities, fixed assets, long term liabilities and shareholders'
funds which is available in the accounting records maintained by the firm.
 Internal Users of Accounting Information

 Internal users of accounting information are those persons or groups which are within the
organization. Following are such internal users :

1. Owners: The owners provide funds for the operations of a business and they want to know
whether their funds are being properly used or not. They need accounting information to know the
profitability and the financial position of the concern in which they have invested their funds. The
financial statements prepared from time to time from accounting records depicts them the
profitability and the financial position.
 Internal Users of Accounting Information

2. Management: Management is the art of getting work done through others, the management should
ensure that the subordinates are doing work properly. Accounting information is an aid in this respect
because it helps a manager in appraising the performance of the subordinates. Actual performance of
the 14 employees can be compared with the budgeted performance they were expected to achieve and
remedial action can be taken if the actual performance is not upto the mark. Thus, accounting
information provides "the eyes and ears to management".
 Cont…

The most important functions of management are planning and controlling. Preparation of various budgets,
such as sales budget, production budget, cash budget, capital expenditure budget etc., is an important part of
planning function and the starting point for the preparation of the budgets is the accounting information for the
previous year. Controlling is the function of seeing that programmed laid down in various budgets are being
actually achieved i.e. actual performance ascertained from accounting is compared with the budgeted
performance, enabling the manager to exercise controlling case of weak performance.
 Cont…

Accounting information is also helpful to the management in fixing reasonable selling prices. In a competitive
economy, a price should be based on cost plus a reasonable rate of return. If a firm quotes a price which
exceeds cost plus a reasonable rate of return, it probably will not get the order. On the other hand, if the firm
quotes a price which is less than its cost, it will be given the order but will incur a loss on account of price
being lower than the cost. So, selling prices should always be fixed on the basis of accounting data to get the
reasonable margin of profit on sales.
 Internal Users of Accounting Information

3. Employees: . Employees are interested in the financial position of a concern they serve particularly
when payment of bonus depends upon the size of the profits earned. They seek accounting
information to know that the bonus being paid to them is correct. The employee wants higher wages,
benefits, good working conditions and security of tenure. A review of the company’s financial reports
will enable one to assess the ability of the business to grant these demands. The company cannot
afford to grant higher salaries and more benefits of the business is losing as reflected in its financial
reports.
 Channels of Accounting Information Flow

Management

(A)
Management
Reports

Certain
Taxing Agencies (B) Tax Special Regulatory
Returns Accounting Process Reports (c) Agencies

Financial
Reports
(D)

Suppliers Lenders Investors Employees Regulatory Board Customs

 Four types of Reports

(A) Management reports are internal reports prepared for management use. Management required additional
information such as product cost, estimate of profit to be earned for a planned project, comparison of two
alternative courses of solving a problem, and budgets.

(B) All firms are required to prepare and file Tax Returns to the Bureau of Internal Revenue (BIR). Different
taxes require different tax forms which are to be filled up and submit to the BIR. Example: Income Tax,
VAT, Sales Tax, among others.
(A) Some firms, by the nature of their organization/operation, are required to prepare Special Reports by certain
regulatory bodies. For example: banks prepare monthly, quarterly, and annual reports to be submitted to Bangko
Sentral ng Pilipinas.

(B) Financial Reports are the main source of information of stakeholders. These are general purpose financial
statements usually audited by a Certified Public Accountant who attest to its fair presentation and validity thus
making it reliable and acceptable by the stakeholders.
 Accounting Information System

 Accounting Information System (AIS) involves an orderly way of accumulating and reporting
business transactions through a process of analyzing, measuring, recording, classifying and
summarizing, and from which reports are generated for proper communication to decision-makers.
 Accounting Information System (Simple)

Analyzed Summarized
Classified Stored Decision
Data gathered Measured Reported
Recorded Making
Interpreted

Computerized Accounting System

INPUT OUTPUT OUTPUT

From the source documents data are The data are measured, recorded, classified, Reports come out from processed
analyzed and encoded by the summarized and stored by the computer data.
employees
 Financial Reports

 The accounting information resulting from transactions or economic events documents recorded and classified
are summarized into financial statements. These are prepared at least annually and are directly toward the
common needs of practically all the stakeholders.

 Components of financial statements:

 Balance Sheet

 Income Statement

 Statement of Changes in Owners Equity

 The Cash Flow Statement

 Balance Sheet

 Balance Sheet
 It gives information about the financial position of the business by showing a list of its assets (cash and
properties) and liabilities (debts or obligations to pay) and from which the net worth of the business
representing equity or share of the owner could be determined.

 Net Worth represents the net assets of the business (assets left after deducting the liabilities) belonging to the
owner.
 Balance Sheet

 Example: assume that as at May 31 of the current year your business has listed a total of
P1,000,000 assets, against P400,000 liabilities. The net asset of your business is P600,000.
Compare this against business of your friend with asset listed as P1,5000,000 against which it
owes creditors P1,200,000. Your friend has net worth of P300,000 only.
 It is apparently your business is financially stronger and solvent.

 Solvency is the ability of the business to pay for its liabilities.

 Income Statement

 Income statement
 is a report which describes how the business operated over a given period of time.

 It describes the revenues or income earned as well as the expenses incurred by the business.

 A favorable operation called profit or income.

 Example: Revenues earned for the year P750,000, while expenses incurred amounted to
P500,000 only, the profit is P250,000. The revenues is greater than expenses incurred by the
business, therefore the results of operation is favorable.
 Statement of Changes in Owner’s equity

 It explains the activities foe the period of time that changed the owner’s share over the net
assets of the business. Net worth or owner’s equity is affected by the following activities:
 Investment

 withdrawal

 Profit or loss
 Statement of Changes in Owner’s equity

 Example:
 If the Balance Sheet this year showed net worth of P600,000, last year showed net worth of P500,000, the
owner’s equity increase P100,000 may be due to profit of P50,000 plus additional investment of the owner
amounting P50,000. Or may be due to profit of P150,000 less owner’s withdrawal of P50,000.

 A cash withdrawal decreases the assets which in turn decrease owner’s equity.
 The Cash Flow Statement

 The Cash Flow Statement

 It is another financial statement prepared by the accountant. This report explains why the amount of cash
changes over a period of time by listing the cash inflow activities (cash receipts) and the cash outflow
activities (cash payments) of the business.

 Example: assume that the cash (assets) at the end of the current year was listed in the balance sheet
as P50,000, while the balance last year showed it to be P25,000. you might ask why the cash
increased by P25,000 only when business earned P250,000, and the owner invested another P50,000.

 The cash flow statement will explain what happened to the cash.
 Reporting Periods

 Reporting periods

Divided into equal time-periods as:

o Accounting periods

o Bookkeeping periods or reporting periods

..this basic accounting assumption, called the periodicity concept, is useful so that timely
financial reports can be made available to the data-users.
 Cont….
 A reporting period that begins on January 1 and ends on December 31 ----- is so called
calendar year or a calendar year reporting period.

 A one year reporting periods that ends on a date other than December 31 ----- is called fiscal
year or a fiscal year reporting period.

 Some of the business enterprise also prepare interim financial statements (semester, quarter, or
month)

1 year = 52 weeks = 12 months = 4 quarters = 2 semesters

1 semester = 26 weeks = 6 months = 2 quarters

1 quarter = 13 weeks = 3 months

 Relationship of the balance sheet with other
statements
Income Income
Statement Statement
+ +
Balance Statement of Balance Statement of Balance
sheet changes in sheet changes in sheet
Owner’s equity Owner’s equity
+ +
Statement of Statement of
Cash flows Cash flows

reporting period reporting period

As of As of As of
reporting date reporting date reporting date
 Relationship among the Financial Statements

 The statement of cash flows complements both the income statement and the balance
sheet. The statement of changes in equity explains why the ending capital of the
owner increased or decreased as compared with the beginning balance. This ending
balance of capital is then forwarded to the balance sheet. The income statement
explains, partly, why the cash position of the company increased or decreased.
Usually, a balance sheet cannot be prepared without first preparing an income
statement. The net profit of a period can be computed by analyzing the balance
sheets of two dates.
 Role of Management in the Preparation of
Financial Statement

 The proprietor or manager reviews these statements and gives the final approval before they are
released to any government agency, creditor, or other data-user. He decides what other financial
information should be gathered or other data user.

 He decides what other financial information should be gathered and presented in order to meet the
financial information needs of the decision-makers.

 He has the advantage of having immediate access to additional management and financial information
that is helpful in carrying out his various planning, decision-making, and controlling responsibilities.
 Limitations of Financial Statements

 External users should understand that there are some constraints in the manner of preparing and
presenting the traditional general-purpose financial statements.
 Data-users should be aware of both the usefulness and limitations of the prepared financial statements.

 They should remember that the prepared general-purpose financial statements are not instant tools for
decision-making.

 They must also have a clear understanding of the accounting elements reported in the balance sheet
and income statement. Knowledge of accounting would give them a far deeper appreciation for the
information contained in the financial reports.
 THE END

References:

Kimwell, M.B., “Fundamentals of Accounting”

Manuel, Z.C “Accounting Process, Basic Concepts and Procedures, Int’l Ed.”