ACCOUNTING FOR MANAGERS

CHAPTER ONE

A GENERAL OVERVIEW

 Introduction
 Accounting vs Finance: A distinction
 Financial vs Management Accounting: User perspective
 Finance
 INTRODUCTION

“Accounting is the art of recording, classifying and summarizing in a significant

manner and in terms of money transactions and events which are, in part at least,
of a financial character and interpreting the results thereof.” AICPA

“It is the process of identifying, measuring and communicating economic

information to permit informed judgments and decisions by users of the
information.” AAA

Its purpose is to communicate or report the results of business operations and its
various aspects.
CONT’D

On analyzing the above definitions, the following characteristics of accounting

emerges:

Accounting is the art of recording and classifying different business transactions.

Generally the business transactions are described in monetary terms.

In accounting process, the business transactions are summarized and analyzed so
as to arrive at a meaningful interpretation.

The analysis and interpretations thus obtained are communicated to those who are
responsible to take certain decisions to determine the future course of business.
 OBJECTIVES OF ACCOUNTING

To record the business transactions in a systematic manner.

To determine the gross profit and net profit earned by a firm during a specific period.

To assess the taxable income and the sales tax liability.

To know the financial position of a firm at the close of the financial year by way of
preparing the balance sheet.

To facilitate management control.

To provide requisite information to different parties, i.e., owners, creditors,

employees, management, government, investors, financial institutions, banks etc.
 USERS OF ACCOUNTING INFORMATION

Internal Users
External Users

•Lenders •Consumer Groups •Managers •Sales Staff

•Shareholders •Employee Unions •Officers •Budget Officers
•Governments •Potential Investors •Internal Auditors •Controllers

1-7
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
accounting information, whether that decision made
by owners, management, creditors, government
bodies, labor unions ,etc.
• Why accounting is being called as “the
language of business”?

• Why Accounting information is a means

to an end, not the end in itself?
 FINANCIAL ACCOUNTING & MANAGEMENT ACCOUNTING

Financial Accounting:

• Financial accounting information provides information about the financial resources,

obligations, & activities of an enterprise that is intended for use primarily by external
decision makers.

• Financial accounting information appears in financial statements that are intended for
external use.

• The primary questions about an organization’s success that decision makers want to know
are:

• What is the financial picture of the organization on a given day?

• How well did the organization do during a given period?
CONT’D

• Accountants answer these primary questions with three

major financial statements.

• Balance sheet- Shows financial picture on a given day.

• Income statement- shows performance over a given
period.
• Statement of cash flows- shows performance over a given
period.
C ONT ’D

Management Accounting:
Management accounting involves the development and interpretation of
accounting information intended specifically to assist managing in
operating the business.
Management accounting information 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.
C ONT ’D

• Management accounting generates information

that managers can use to make sound decisions
such as:
• Financial,
• Resource allocation,
• Production &
• Marketing decisions
 FI NANCI AL A CCOUNTI N G VS MANAG EME NT
ACC OU NTI NG

• Financial accounting is aimed to provide accounting

information to external users.

• Managerial Accounting is aimed to provide accounting

information to internal users.

• Although there is a difference in the type of information

presented in financial and managerial accounting, the
underlying objective is the same; to satisfy the information
needs of the user.
 M A N A GE M E N T A C C O U N T I N G V S FI NA NC I A L A C C O U N T I N G
Criteria Management Accounting Financial Accounting

Purpose of information
Primary users
Help managers make decisions to fulfill an Communicate organization’s financial Position
organization’s goals and operating results to investors, banks,
regulators, and other outside parties
Managers of the organization External users such as investors, banks,
regulators, and suppliers

Focus and emphasis` Future-oriented (budget for 2014 prepared in Past-oriented (reports on 2013 performance
2013) prepared in 2014)

Rules of measurement
and reporting
Time span and type of reports
Internal measures and reports do not have to
follow GAAP (IFRS) but are based on cost-benefit
analysis and usefulness to managers
Varies from hourly information to 15 to 20 years,
with financial and nonfinancial reports on
products, departments, territories, and strategies
Financial statements must be prepared in
accordance with GAAP (IFRS) and be certified by
external, independent auditors
Annual and quarterly financial reports, primarily
on the company as a whole

Behavioral implications Designed to influence the behavior of managers Primarily reports economic events but also
and other employees influences behavior because manager’s
compensation is often based on reported financial
results
1. What is the purpose of the 3 major financial statements?

2. How are the three major financial statements related?

3. Discuss the differences between managerial and

financial accounting.
 FINANCE

 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, 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.
CONT’D

 Finance plays a pivotal role to every general person to earn and invest money;
for business to raise and invest funds; and to the government to plan expenses
and incomes, to execute goals of government and to achieve development of a
country.

 FINANCE uses accounting information as inputs to decision-making.

 The study of how to raise money and invest it productively.

CONT’D

Financial management defined:

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

of an important economic resource namely, capital funds”

 “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.
CONT’D

Financial decisions in a firm

There are four broad areas of financial decision making in a firm. These are:

1. Investment decisions (Capital budgeting)

2. Financing decisions (capital structure)

3. Liquidity decisions (working capital management/short term asset

mix decision)

4. Dividend decisions
CONT’D

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
 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.
CONT’D

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.
 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.
CONT’D

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.
 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.
CONT’D

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
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
1. Distinguish Accounting and Finance.

2. Explain the Four key decision areas of financial Management.

3. How can you explain the contribution accounting & finance in

administering business/managing projects?
End of Chapter One!