Chapter One

Asmamaw for Managers

Accounting
General Overview
Reading:
1. Warren et al. (2018) Accounting, 27 ed. (Chapter 1)
2. Jerry J. Weygandt, et al. (2012), Managerial accounting: Tools for business decision
making (Chapter 1)
3. Brigham & Houston (2019) Fundamentals of Financial management (Chapter 1)

1
 Introduction to Accounting
 Accounting can be defined as an information system that provides reports
to users about the economic activities and condition of a business.
 Its purpose is to communicate or report the results of business operations
and its various aspects.
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 It is the process of identifying, measuring and communicating economic
information to permit informed judgments and decisions by users of the
information. 
 Hence, accounting is an information system that provides useful
information to users (decision makers).
 Accounting Activities and Users
Internal Users

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 Cont’d…
External Users
 Taxing authorities: Does the
company comply with the tax
laws?
Asmamaw  Regulatory agencies: Is the
company operating within
prescribed rules?
 Labor unions: Does the
company have the ability to pay
increased wages and benefits to
union members?
 Cont’d…
• Accounting Information(AI): A Means to an End

• Accounting information is not an end , but is a means to an end i.e. its

final product is decision which is ultimately enhanced by the use of
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accounting information, whether that decision made by owners,
management, creditors, government bodies, labor unions ,etc.
 Financial, Cost and Management Accounting
Financial Accounting
 Financial accounting information provides information about
the financial resources, obligations, & activities of an
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enterprise that is intended for use primarily by external
decision makers.
 Cont’d…
Cost Accounting
 Cost accounting is a process of collecting, analyzing, summarizing and
evaluating various alternative courses of action.
 Cost accounting provides the detailed cost information that management
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needs to control current operations and plan for the future.
 A type of accounting process that aims to capture a company's costs of
production by assessing the input costs of each step of production as well
as fixed costs such as depreciation of capital equipment.
 Cost accounting information is commonly used in financial accounting
 information, and by managers to make decisions.
 Cont’d…
Management Accounting
 Managerial accounting, also called management accounting, is a field of
accounting that provides economic and financial information for managers
and other internal users.
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 It is for internal use & provides special information for managers.
 Managers use this information in
Setting companies goals,
Evaluating the performance of departments and individuals,
Deciding whether to introduce a new line of products, and
Making virtually all types of managerial decisions.
 Cont’d…
 Generally, management accounting generates information that
managers can use to make sound decisions such as
• Financial,
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• Resource allocation,
• Production &
• Marketing decisions.
 Financial Accounting Vs Management Accounting
 There are both similarities and differences between managerial and
financial accounting.
 First, each field of accounting deals with the economic events of a
business.
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 Thus, their interests overlap. For example, determining the unit
cost of manufacturing a product is part of managerial accounting.
 Reporting the total cost of goods manufactured and sold is part of
financial accounting. In addition, both managerial and financial
accounting require that a company’s economic events be quantified
and communicated to interested parties.
Asmamaw
 Finance
 The study of how to raise money and invest it productively.
 Virtually all individuals and organizations earn or raise money and
spend or invest money.
 Finance is concerned with the process, institutions, markets, and
instruments involved in the transfer of money among individuals,
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businesses and governments.
 The general areas of finance are business, personal and public finance.
 Finance is important to individuals, business and government to achieve
their economic objectives.
 FINANCE uses accounting information as inputs to decision-making.
 Finance…
Financial management defined:

 It is an integral part of overall management. concerned with the

efficient use of an important economic resource namely, capital
funds”
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 “Financial Management deals with procurement of funds and

their effective utilization in the business”
 In simple words, Financial Management as practiced by
business firms can be called as corporation Finance or
business Finance.
 Finance…
Financial decisions in a firm
There are four broad areas of financial decision making in a firm.
These are:
Asmamaw 1. Investment decisions (Capital budgeting)
2. Financing decisions (capital structure)
3. Liquidity decisions (working capital management/short
term asset mix decision)
4. Dividend decisions
 Finance…
1. Investment decisions:
 A firm’s investment decisions involve capital expenditures.
 They are, therefore, referred as capital budgeting decision.
 Capital investment is the allocation of capital to investment proposals
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 Involves commitment of funds to long term assets that would yield long
term benefits
 Two important aspects of investment decision are:
1. The evaluation of the prospective profitability of new investment, and
2. The measurement of a cut-off rate against that the prospective return of
new investments could be compared.
Investment proposal should be evaluated in terms of both expected return and risk.
 Finance…
2. Financing decisions:
 Once a firm has decided the investment projects it wants to undertake, it
has to figure out ways and means of financing them.
 This is the function of raising funds.
Asmamaw  The central issue here is to determine the appropriate proportion of
equity and debt; the mix of debt and equity is called capital structure.
 The financial manager must strive to obtain the best financing mix or the
optimum capital structure.
 The use of debt affects the return and risk of shareholders; it may
increase the return on equity funds, but it always increases risk as well.
 Finance…
3. Working capital management (Liquidity) decision:
Also referred as short term financial management that deals with current
assets and current liabilities.
Investment in current assets affect the firm’s profitability and liquidity.
Asmamaw Current assets should be managed efficiently for safeguarding the firm
against the risk of illiquidity.
If the firm does not invest sufficient funds in current assets, it may become
illiquid and therefore, risky; but it would lose profitability, as idle current
assets would not earn anything.
Conflict exists between profitability and liquidity while managing current
assets and hence it deals with proper trade-off between liquidity and
profitability.
 Finance…
4. Dividend Decision:
 The financial manager must decide whether the firm should distribute all
profits, or retain them or distribute a portion and retain the balance.
 The proportion of profits distributed as dividends is called the dividend
Asmamaw payout ratio and the retained portion of profit is known as the retention
ratio.
 The optimum dividend policy is that one maximizes the market value of
the firm’s shares
 Conclusion
 Accounting provides useful information about the economic activities of
business organizations to decision makers
 Finance uses accounting information
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 Almost all business activities directly or indirectly involve the
acquisition and use of funds.
 Accounting & Finance is closely related with the main functional areas of
a firm (production, marketing and HRM) and hence finance is considered
as a life blood of any organization.
 Financial management will be discussed in a separate course.
 ?
1. Why accounting is being called as “the language of
business”? Discuss with practical examples.
2. Accounting information is a means to an end, not the end in
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itself. Discuss
3. Discuss the difference and similarities between financial
accounting, managerial accounting and Financial
management.
4. How can you explain the contribution of accounting &
finance in administering business?
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END OF CHAPTER 21