Chapter 1

Accounting
Information for
Decision Making

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reproduction or further distribution permitted without the prior written consent of McGraw Hill.
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 Introduction
The primary objective of accounting is to
provide information that is useful in making
good decisions, and as a result of good
decisions, societal prosperity and welfare is
maximized.
Accounting is sometimes called the
“language of business.”

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 Primary Goals
In order to develop your ability to understand
and use accounting information, you need to
understand the following:
• The nature of economic activities that
accounting information describes.
• The assumptions and measurement
techniques involved in developing
accounting information.
• The information that is most relevant for
making various types of decisions.
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 Types of Accounting Information:
Financial
1. Financial Accounting.
• Information describes the financial
resources, obligations, and activities of an
economic entity.
• Assists external users such as investors
and creditors in the decision-making
process.
• Is often called “general-purpose” accounting
information.

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 Types of Accounting Information:
Management
2. Management Accounting.
• Involves the development and interpretation
of accounting information for management.
• Information can be specifically tailored to
management’s needs in order to assist in
the decision-making process.
• Reports are only provided to internal users.

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 Types of Accounting Information:
Tax
3. Tax Accounting.
• Information must conform with income tax
reporting requirements.
• Laws and regulations are often different
from those underlying the preparation of
financial accounting information.
KEY POINT
Because the focus of this text is introductory accounting, and
because tax accounting is quite complex, coverage of tax
accounting subjects is deferred to subsequent accounting
courses.

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 Information Systems
An information system consists of the
personnel, procedures, technology, and
records used by an organization (1) to
develop information and (2) to
communicate this information to
decision makers.

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 Accounting as an Information
System

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 Basic Functions of an Information
System
Every accounting system performs the
following basic functions:
1. Interpret and record the effects of business
transactions.
2. Classify the effects of similar transactions
to compute totals to be used in reports.
3. Summarize and communicate the
information contained in the system to
decision makers.

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 Components of Internal Control
• Control Environment.
• Risk Assessment.
• Control Activities.
• Information and Communication.
• Monitoring.

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 Control Environment
• Sets the tone for the organization.
• Organizational commitment to ethical
values.
• Independence of the board of directors.
• Appropriate assignment of responsibility.
• Development and retention of competent
employees.
• Accountability at all levels.

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 Risk Assessment
• Identifying, analyzing, and managing risks
that pose a threat to the achievement of
organizational goals.
• Involves the identification of risks and the
implementation of risk mitigation techniques.

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 Control Activities
Policies and procedures established by
management to address risks.
Examples include:
• Approvals.
• Reconciliations.
• Reviews.
• Segregation of duties.
• Safeguarding assets.

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 Information and Communication 1

• Developing information systems to capture

and communicate operational, financial, and
compliance-related information.
• Capturing both internal and external
information.

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 Information and Communication 2

Facilitates the flow of information:

• Downstream (from management to
employees).
• Upstream (from employees to
management).
• Across the organization.

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 Monitoring
• Evaluate the effectiveness of internal
controls.
• Accomplish through ongoing management
and supervisory activities.

KEY POINT
The New York Stock Exchange (NYSE) requires all
listed companies to maintain an internal audit
function.

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 External Users of Accounting
Information
Examples include:
• Owners. • Suppliers.
• Creditors. • Customers.
• Potential investors. • Trade associations.
• Labor unions. • General public.
• Governmental
agencies.

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 Objectives of External Financial
Reporting

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 Primary Financial Statements 1

• Balance sheet: shows where the company

stands in financial terms on a specific date;
also called the statement of financial
position.
• Income statement: shows the details of a
company’s profit-related activities over a
period of time.

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 Primary Financial Statements 2

• Statement of cash flows: shows the details

of a company’s activities involving cash
during a period of time.

NOTE
You will learn more about each of these financial
statements in future chapters.

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 Characteristics of Externally
Reported Information
1. Financial Reporting—A Means.
a. A means to an end; not an end in and of
itself.
b. Improves the quality of decision making for
outside users.
c. Helps to create prosperous society.
2. Financial Reporting versus Financial
Statements.
a. Financial statements are a subset of the
broader concept of financial reporting.
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 Characteristics (cont.): Historical
c. Financial reporting also includes other
communications to external parties
including press releases, disclosures, and
other open communications.
3. Historical in Nature.
a. Financial statements report events for an
accounting period that has already
occurred.
b. Focuses on the past more than the future.

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 Characteristics (cont.): Inexact
4. Inexact and Approximate Measures.
a. Accounting information is often based on
estimates, judgments, and assumptions
about the past and the future.
b. This characteristic is often misunderstood.
5. General-Purpose Assumption.
a. Information is not tailored for a specific
user.
b. The same financial reporting package is
available for multiple user groups.

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 Characteristics (cont.): Explanation
6. Explanation.
a. Value is enhanced by management
explanations.
b. Qualitative information assists in
interpreting the financial reports.

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 Users of Internal Accounting
Information
Examples include:
• Board of directors.
• Chief executive officer (CEO).
• Chief financial officer (CFO).
• Vice presidents.
• Business unit managers.
• Plant managers.
• Store managers.
• Line supervisors.

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 Simple Organizational Chart

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 Objectives of Management
Accounting Information
• Help management achieve the
organization’s mission and goals.
• Evaluate and reward decision-making
performance.

KEY POINT
Many companies have a reward system linked to
performance as measured by the accounting system.

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 Characteristics of Management
Accounting Information
1. Timeliness.
a. Timely information is needed for planning
and controlling business activities.
b. Management can save money and make
better decisions by being able to act
quickly.
2. Identity of Decision Maker.
a. The right people need the right
information to make decisions and correct
problems.
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 Characteristics (cont.): Future
Oriented
3. Future Oriented.
a. Purpose of generating management
information is to affect the future.
b. Motivate management to make future
decisions to achieve the organization’s
goals.

4. Efficiency and Effectiveness.

a. Measures the efficiency and
effectiveness of resource usage.

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 Characteristics (cont.): A Means
5. A Means.
a. A means to an end; not an end in and of
itself.
b. Ultimate objective is to design and use
an accounting system that helps
management achieve the goals and
objectives of the enterprise.

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 Integrity of Accounting Information
Integrity refers to the following qualities:
• Complete.
• Unbroken.
• Unimpaired.
• Sound.
• Honest.
• Sincere.

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 Enhancing Integrity
The integrity of accounting information is
enhanced in three primary ways:
1. Institutional features.
2. Professional accounting organizations.
3. Personal competence, judgment, and
ethical behavior.

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 Integrity: GAAP
1. Institutional Features.
a. Generally Accepted Accounting Principles
(GAAP).
1) Provides the general framework for
determining what information is included
in the financial statements and how this
information is prepared and presented.
2) Originates from a combination of
tradition, experience, and official decree.
3) May change over time.

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 Integrity: SEC
1. Institutional Features.
b. Securities and Exchange Commission (SEC).
1) Governmental agency with the legal power to
establish accounting principles and financial
reporting requirements for publicly owned
corporations.
2) Delegates standard setting responsibility to
the FASB (discussed on next slide).
3) Reviews the financial statements of publicly
owned corporations.
4) May initiate legal action against companies.

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 Integrity: FASB
1. Institutional Features.
c. Financial Accounting Standards Board (FASB).
1) Independent rule-making body.
2) Recognized as the most authoritative source
of GAAP.
3) Maintains the Accounting Standards
Codification which includes all standards and
represents an official expression of GAAP.

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 Integrity: IASB 1

1. Institutional Features.
d. International Accounting Standards Board
(IASB).
1) London-based panel of elite professionals
with expert knowledge of accounting methods
used in the most vibrant capital markets.
2) Issues International Financial Reporting
Standards (IFRS).
3) More than 100 countries, including those in
the European Union, require companies to
follow IASB standards.

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 Integrity: IASB 2

1. Institutional Features.
d. International Accounting Standards Board
(IASB).
4) The SEC accepts financial statements
prepared using IASB standards from
foreign companies that are cross-listed
on a U.S. stock exchange.
5) The AICPA, which maintains jurisdiction
over private company reporting,
accepts either FASB standards or IASB
standards as authoritative sources of
accounting principles.
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 Case in Point: IFRS
• If the United States moves to IFRS, it likely
would require significant changes to
accounting systems, controls, and procedures.
For example, IFRS requires that an entity
account for similar transactions in an identical
manner regardless of where the transaction
occurs in the entity, a requirement that does
not exist under U.S. GAAP. Therefore, if IFRS
becomes mandatory for U.S. public
companies, companies would have to develop
a listing of all of their transactions and how
they are accounted for throughout the entity.
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 Integrity: PCAOB
1. Institutional Features.
e. Public Company Accounting Oversight Board
(PCAOB).
1) Board created by the Sarbanes-Oxley Act of
2002.
2) Charged with oversight of the public
accounting profession.
3) Sets auditing standards for audits of
publicly traded companies.
4) Inspects the quality of audits.
5) Conducts investigations and administers
penalties.
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 Integrity: Audits
1. Institutional Features.
f. Financial Statement Audits.
1) An examination of a company’s financial
statements, designed to determine the
fairness of the statements.
2) Must be conducted by an independent
certified public accountant (CPA).
3) Financial statements are judged based on
the standards of GAAP.

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 Key Point
For the auditor to reach the conclusion that
the financial statements are fair
representations of a company’s financial
position, results of operations, and cash flows,
the statements must comply in all important
ways with generally accepted accounting
principles.

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 Integrity: Legislation
1. Institutional Features.
g. Legislation.
1) Congress passed the Sarbanes-Oxley Act in
2002.
2) Auditors are prohibited from providing certain
nonaudit services to their audit clients to preserve
objectivity.
3) Board of directors and audit committees are
tasked with additional oversight responsibilities.
4) Chief executive officers (CEOs) and chief
financial officers (CFOs) must certify the fairness
of the company’s financial statements.
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 Integrity: AICPA
2. Professional Organizations.
Several professional accounting organizations
play an active role in improving the quality of
accounting information that is used by investors,
creditors, management, and others.
a. American Institute of CPAs (AICPA).
1) Mission is to provide members with the
most relevant knowledge.
2) Conducts research and works closely
with the FASB in the establishment and
interpretation of GAAP.
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 Integrity: IMA
b. Institute of Management Accountants (IMA).
1) Provides a forum for research, practice
development, education, knowledge
sharing, and the advocacy of the highest
ethical and best business practices in
management accounting and finance.
2) Influences concepts and ethical practices
for management accounting and financial
management.
3) Offers the Certified Management
Accountant (CMA) designation.

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 Integrity: IIA
c. Institute of Internal Auditors (IIA)
1) Primary international professional
association dedicated to the promotion
and development of the practice of
internal auditing.
2) Offers professional development through
conferences and seminars.
3) Provides audit specialty services and
industry-specific auditing programs as
well as quality assurance review and
benchmarking services.

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 Integrity: AAA
d. American Accounting Association (AAA)
1) Mission is to further the discipline and
profession of accounting through
education, research, and service.
2) Made up primarily of accounting
educators who focus on improving the
quality of accounting education.

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 Integrity: COSO
e. Committee of Sponsoring Organizations of
the Treadway Commission (COSO)
1) Private-sector organization dedicated to
providing thought leadership through the
development of comprehensive frameworks
and guidance on enterprise risk
management, internal control, and fraud
deterrence designed to improve
organizational performance and governance
and to reduce the extent of fraud in
organizations.
2) Best known for its work in developing the
standards for evaluating internal control.
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 Integrity: Competence 1

3. Competence, Judgment, and Ethical

Behavior
To illustrate the importance of competence,
professional judgment, and ethical behavior in
the preparation of financial statements, consider
the following complex issues that must be
addressed by the accountant:
• At what point should an enterprise account for
transactions that continue over a long period of
time, such as a long-term contract to construct
an interstate highway?
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 Integrity: Competence 2

• What constitutes adequate disclosure of information that

would be expected by a reasonably informed user of
financial statements?
• At what point are a company’s financial problems
sufficient to question whether it will be able to remain in
business for the foreseeable future, and when should
that information be communicated to users of its
financial statements?
• When have efforts by management to improve (that is,
“window dress”) its financial statements crossed a line
that is inappropriate, making the financial statements
actually misleading to investors and creditors?

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 Integrity: CPA
Certification in a given area signals a level of
competence to financial users and decision
makers.
1. Certified Public Accountant (CPA).
a. Licensed by the state.
b. Must have completed 150 semester hours of
college work with a major in accounting.
c. Must pass the CPA exam.
d. Must have adequate professional experience.
e. Must spend at least 40 hours of continuing
professional education each year.

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 Integrity: CMA and CIA
2. Certified Management Accountant (CMA).
a. Issued by the IMA.
b. Signifies professional competence in the area of
managerial accounting.
c. Requirements are similar to those of the CPA.

3. Certified Internal Auditor (CIA).

a. Issued by the IIA.
b. Signifies professional competence in the area
of internal auditing.
c. Requirements are similar to those of the CPA.
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 Your Turn
You are a professional accountant working for a public
accounting firm and find yourself in a difficult situation.
You have discovered some irregularities in the financial
records of your firm’s client. You are uncertain whether
these irregularities are the result of carelessness on the
part of the company’s employees or represent intentional
steps taken to cover up questionable activities. You
approach your superior about this and she indicates that
you should ignore it. Her response is, “These things
happen all of the time and usually are pretty minor. We
are on a very tight time schedule to complete this
engagement, so let’s just keep our eyes on our goal of
finishing our work by the end of the month.” What would
you do?

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 Integrity: AICPA Code of Conduct
Excerpts from key parts of the AICPA Code of
Professional Conduct:
I. Responsibilities
In carrying out their responsibilities as professionals,
members should exercise sensitive professional and
moral judgments in all their activities.
II. The Public Interest
Members should accept the obligation to act in a way
that will serve the public interest, honor the public
trust, and demonstrate commitment to
professionalism.

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 Integrity: AICPA Code (cont.)
III. Integrity
To maintain and broaden public confidence,
members should perform all professional
responsibilities with the highest sense of integrity.
IV. Objectivity and Independence
A member should maintain objectivity and be
free of conflicts of interest in discharging
professional responsibilities. A member in public
practice should be independent in fact and
appearance when providing auditing and other
attestation services.

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 Integrity: AICPA Code (concluded)
V. Due Care
A member should observe the profession’s
technical and ethical standards, strive continually
to improve competence and the quality of
services, and discharge professional
responsibility to the best of the member’s ability.
VI. Scope and Nature of Services
A member in public practice should observe the
Principles of the Code of Professional Conduct in
determining the scope and nature of services to
be provided.

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 Careers in Accounting
Accountants tend to specialize in specific
fields, as do the members of other
professions. Career opportunities in
accounting may be divided into four broad
areas:
1. Public accounting.
2. Management accounting.
3. Governmental accounting.
4. Accounting education.

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 What about Bookkeeping?
• Bookkeeping is the clerical side of
accounting—the recording of routine
transactions and day-to-day record
keeping.
• Professional accountants are involved
more with the interpretation and use of
accounting information than with its
actual preparation.

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 Accounting as a Stepping-Stone
• An accounting background is
invaluable for key positions in
management or administration,
because top management works
continuously with issues defined and
described in accounting terms and
concepts.

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 I’m Not an Accounting Major
• Accounting is the language of business, and
trying to run a business without
understanding accounting information is
analogous to trying to play sports without
understanding the rules.
• Accounting knowledge is helpful in many
aspects of your personal life as well,
including personal budgeting, retirement
and college planning, lease versus buy
decisions, and evaluation of loan terms and
investment opportunities.
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 Ethics, Fraud, & Corporate
Governance
• Corporate governance entails corporate
structures and processes for overseeing the
company’s affairs to ensure that the
company is being managed with the best
interests of shareholders in mind.
Dennis Kozlowski, the former CEO of Tyco, was sentenced
to 8 1 3 to 25 years in prison for his conviction for
conspiracy, securities fraud, and falsifying records.

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 Learning Objective Summary LO1-1
LO1-1: Discuss accounting as the language of
business and the role of accounting information
in making economic decisions. Accounting is the
means by which information about an enterprise is
communicated and is sometimes referred to as the language of
business. Many different users have need for accounting
information in order to make important decisions. These users
include investors, creditors, management, governmental
agencies, labor unions, and others. Because the primary role of
accounting information is to provide useful information for
decision-making purposes, it is sometimes referred to as a
means to an end, with the end being the decision that is helped
by the availability of accounting information.

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 Learning Objective Summary LO1-2
LO1-2: Discuss the significance of information
systems in generating reliable accounting
information and understand the five components
of internal control. Information systems are critical to the
production of quality accounting information on a timely basis
and the communication of that information to decision makers.
While there are different types of information systems, they all
have one characteristic in common—to meet the organization’s
needs for accounting information as efficiently as possible. Per
the COSO framework, the five elements of internal control are:
(1) control environment, (2) risk assessment, (3) control
activities, (4) information and communication, and (5) monitoring
activities.

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 Learning Objective Summary LO1-3
LO1-3: Explain the importance of financial
accounting information for external parties—
primarily investors and creditors—in terms of the
objectives and the characteristics of that
information. The primary objectives of financial accounting
are to provide information that is useful in making investment
and credit decisions; in assessing the amount, timing, and
uncertainty of future cash flows; and in learning about the
enterprise’s economic resources, claims to resources, and
changes in claims to resources. Some of the most important
characteristics of financial accounting information are it is a
means to an end, it is historical in nature, it results from inexact
and approximate measures of business activity, and it is based
on a general-purpose assumption.

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 Learning Objective Summary LO1-4
LO1-4: Explain the importance of accounting
information for internal parties—primarily
management—in terms of the objectives and the
characteristics of that information. Accounting
information is useful to the enterprise in achieving its goals,
objectives, and mission; assessing past performance and future
directions; and evaluating and rewarding decision-making
performance. Some of the important characteristics of internal
accounting information are its timeliness, its relationship to
decision-making authority, its future orientation, its relationship to
measuring efficiency and effectiveness, and the fact that it is a
means to an end.

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 Learning Objective Summary LO1-5
LO1-5: Discuss elements of the system of
external and internal financial reporting that
create integrity in the reported information.
Integrity of financial reporting is important because of the
reliance that is placed on financial information by users both
outside and inside the reporting organization. Important
dimensions of financial reporting that work together to ensure
integrity in information are institutional features (accounting
principles, internal structure, audits, and legislation);
professional organizations (the AICPA, IMA, IIA, AAA); and the
competence, judgment, and ethical behavior of individual
accountants.

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 Learning Objective Summary LO1-6
LO1-6: Identify and discuss several professional
organizations that play important roles in
preparing and communicating accounting
information. The FASB, IASB, PCAOB, and SEC are
important organizations in terms of standard setting in the United
States. The FASB and IASB are private-sector organizations
that establish accounting standards for public and private
companies. The PCAOB oversees public accounting firms,
including setting standards for audits of public companies. The S
EC is a governmental entity that oversees U.S. public
companies and the capital markets.

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 Learning Objective Summary LO1-7
LO1-7: Discuss the importance of personal
competence, professional judgment, and ethical
behavior on the part of accounting professionals.
Personal competence and professional judgment are, perhaps,
the most important factors in ensuring the integrity of financial
information. Competence is demonstrated by one’s education
and professional certification (CPA, CMA, CIA). Professional
judgment is important because accounting information is often
based on inexact measurements and assumptions are required.
Ethical behavior refers to the quality of accountants being
motivated to “do the right thing.”

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 Learning Objective Summary LO1-8
LO1-8: Describe various career opportunities in
accounting. Accounting opens the door to many career
opportunities. Public accounting is the segment of the profession
where professionals offer audit, tax, and consulting services.
Management, or managerial, accounting refers to that segment
of the accounting profession where professional accountants
work for individual companies in a wide variety of capacities.
Many accountants work for governmental agencies. Some
accountants choose education as a career and work to prepare
students for future careers in one of the other segments of the
accounting profession. While keeping detailed records (that is,
bookkeeping) is a part of accounting, it is not a distinguishing
characteristic of a career in accounting; in fact, many accounting
careers involve little or no bookkeeping. Accounting skills are
important to non-accounting majors and to all students in their
personal lives.
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 End of Chapter 1

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