Financial and Managerial

Masters of Business Administration

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 Nature of the Course
• It has THREE Independent Parts:
Part I: Financial Accounting and Reporting
Part II: Management and Cost Accounting
Part III: Financial Management

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 Course Contents:
Part I: Introduction
Part II: Summary of accounting process
Part III: Management Accounting
Part IV: Financial Management

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 Accounting: Information for
Part Decision Making
I Chapter Contents:
Introduction
Accounting Defined . . .
Accounting As An Information System
Decision Makers: The Users of Accounting
Information
Financial Vs Management Accounting
The Foundation of accounting Principles
Types of Business Organization
Business Goals, Activities, & Performance Measures
Basic Functions of an Accounting System
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 Nature of Accounting
An information system whose purpose is to . . .

Identify Measure

Collect Communicate

• Information about an economic entity to

those with an interest in the financial
affairs of the entity.
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 n g D efi n ed:
Ac c o un ti
Accounting is the process of measuring, interpreting,
and communicating financial information to support
internal and external business decision making.
-Measuring??
-Interpreting?? and
-Communicating??

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 Nature of Accounting . . .
• All organizations . . .
– Large or small;
– Manufacturing, merchandising or service;
– Profit or nonprofit . . .
have a need for accounting information

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 Nature of Financial
• Thus, Accounting
the primary role of . accounting
.. is to
provide useful information for the decision
making needs of:
• investors, lenders, owners, managers, and
others both inside and outside the
company.
• However, the need of internal and external
users often differ.
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 Accounting as an Aid to Decision Making
• Accounting information is useful to anyone who makes
decisions that have economic results.
• Managers want to know if a new product will be
profitable.
• Owners want to know which employees are productive.
• Investors want to know if a company is a good
investment.
• Creditors want to know if they should extend credit,
how much to extend, and for how long.
• Government regulators want to know if financial
statements conform to requirements.
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 Who are the

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 Accounting Environment
External Accounting Information . . .

For those who lack

direct access to the
information generated
by the internal Concepts, principles, and
operations of a procedures known as
company. Generally Accepted Accounting
Principles (GAAP) were
developed to meet the
IFR
S needs of external users.

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. .
 Accounting Environment . . .cntd
Internal Accounting Information

Developed to Information that

meet the needs aids planning and
of management. control.

Much of the
information is
confidential.
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Management Accounting Vs Financial Accounting
Internal Users
External Users

Managerial accounting
provides information needs Financial accounting provides
for internal decision external users with financial
makers. statements.
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 Managerial vs Financial Accounting
Issue Managerial Financial

Primary Users Internal External

Purpose of Plan, Direct, Users make

Information Control, Decide investing and
lending, etc
decisions

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 Managerial vs Financial Accounting
Issue Managerial Financial

Primary Accounting Internal Reports General Purpose

Product useful to Financial
Management Statements

What is included? Defined by Determined by

Management GAAP

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 Managerial vs Financial Accounting
Issue Managerial Financial

Underlying Basis of Internal and Based on historical

Information External transactions with
Transactions, focus external parties
on future

Emphasis Data must be Data must be

relevant reliable and
objective

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 Managerial vs Financial Accounting
Issue Managerial Financial
Business Unit Segments of the Company as a whole
business
Preparation Depends on Annually and
management needs Quarterly

Verification Internal audit External audit

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 Ac c o unt ing IFR
un datio n o f S
The Fo
Systems
• Generally accepted accounting principles (GAAP) encompass the
conventions, rules, and procedures for determining acceptable
accounting practices at a particular time.
• They are pronouncements by designated authoritative bodies that
must be followed in all applicable cases.
• Accounting practices developed by respected bodies and
industries or that have evolved over time.
• International Accounting Standard Board (IASB) is primarily
responsible for evaluating, setting, or modifying IFRS.
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 Conceptual Framework for Financial Reporting

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 Conceptual Framework
Conceptual Framework establishes the concepts that underlie financial
reporting.

Need for a Conceptual Framework

Rule-making should build on and relate to an
established body of concepts.

Enables IASB to issue more useful and consistent

pronouncements over time.
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 Conceptual Framework

Development of a Conceptual Framework

IASB and FASB are working on a joint project to develop a
common conceptual framework

Framework will build on existing IASB and FASB frameworks.

Project has identified the objective of financial reporting

(Chapter 1) and the qualitative characteristics of decision-
useful financial reporting information.
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 Conceptual Framework

Overview of the Conceptual Framework

Three levels:
First Level = Basic objective

Second Level = Qualitative characteristics and elements of financial

statements

Third Level = Recognition, measurement, and disclosure concepts

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 ASSUMPTIONS PRINCIPLES CONSTRAINTS
1. Economic entity 1. Measurement 1. Cost
2. Going concern
2. Revenue recognition
3. Monetary unit 2. Materiality Third
4. Periodicity 3. Expense recognition
level
5. Accrual 4. Full disclosure

QUALITATIVE ELEMENTS
CHARACTERISTICS 1. Assets
1. Fundamental 2. Liabilities
3. Equity Second level
qualities
4. Income
2. Enhancing qualities
Illustration Framework 5. Expenses
for Financial Reporting
OBJECTIVE
Provide information
about the reporting
entity that is useful First level
to present and potential
equity investors,
lenders, and other
creditors in their
 First Level: Basic Objective

OBJECTIVE
“To provide financial information about the reporting entity
that is useful to present and potential equity investors, lenders,
and other creditors in making decisions in their capacity as
capital providers.”
 Provided by issuing general-purpose financial statements.
 Assumption is that users have reasonable knowledge of business
and financial accounting matters to understand the information.

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 Second Level: Fundamental Concepts
Qualitative Characteristics of Accounting Information

IASB identified the Qualitative Characteristics of accounting information

that distinguish better (more useful) information from inferior (less useful)
information for decision-making purposes.

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 Second Level: Fundamental Concepts

Illustration Hierarchy of
Accounting Qualities

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 Second Level: Fundamental Concepts

Fundamental Quality - Relevance

Relevance is one of the two fundamental qualities that make
accounting information useful for decision-making.

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 Second Level: Fundamental Concepts

Fundamental Quality – Faithful Representation

Faithful representation means that the numbers and
descriptions match what really existed or happened.

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 Second Level: Fundamental Concepts

Enhancing Qualities
Distinguish more-useful information from less-useful
information.

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 Second Level: Basic Elements

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 Third Level: Recognition, Measurement, and Disclosure
Concepts
These concepts explain how companies should recognize,
measure, and report financial elements and events.
Recognition, Measurement, and Disclosure Concepts
ASSUMPTIONS PRINCIPLES CONSTRAINTS
1. Economic entity 1. Measurement 1. Cost
2. Going concern 2. Revenue recognition 2. Materiality
3. Monetary unit 3. Expense recognition
4. Periodicity 4. Full disclosure
Illustration 5. Accrual
Framework for
Financial Reporting

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 Third Level: Assumptions

Basic Assumptions
1. Economic Entity – company keeps its activity separate from its owners and
other business unit.
2. Going Concern - company to last long enough to fulfill objectives and
commitments.
3. Monetary Unit - money is the common denominator.
4. Periodicity - company can divide its economic activities into time periods.
5. Accrual Basis of Accounting – transactions are recorded in the periods in
which the events occur.
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 Third Level: Principles
Principles
Measurement

Cost is generally thought to be a faithful representation of the amount paid

for a given item.
Fair value is “the amount for which an asset could be exchanged, a liability
settled, or an equity instrument granted could be exchanged, between
knowledgeable, willing parties in an arm’s length transaction.”

IASB has taken the step of giving companies the option to use fair value as
the basis for measurement of financial assets and financial liabilities.

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 Third Level: Principles
Revenue Recognition - revenue is to be recognized when it
is probable that future economic benefits will flow to the company
and reliable measurement of the amount of revenue is possible.
Illustration Timing of Revenue
Recognition

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LO 7 Explain the application of he basic principles of accounting.
 Third Level: Principles
Expense Recognition - outflows or “using up” of assets or
incurring of liabilities (or a combination of both) during a period
as a result of delivering or producing goods and/or rendering
services. Illustration Expense
Recognition

“Let the expense follow the revenues.”

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 Third Level: Principles
Full Disclosure – providing information that is of sufficient
importance to influence the judgment and decisions of an
informed user.
Provided through:

Financial Statements
Notes to the Financial Statements
Supplementary information

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 Third Level: Constraints

Constraints
Cost – the cost of providing the information must be weighed
against the benefits that can be derived from using it.

Materiality - an item is material if its inclusion or omission would

influence or change the judgment of a reasonable person.

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 Type of Business Organizations
We can classify business organizations in
various types based on:
a.Ownership
b.Activities

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 a. Based on Ownership

Sole
Sole Proprietorship
Proprietorship Partnership
Partnership Corporation
Corporation

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 b. Activity performed

(1) Service businesses

 Ethiopian Air Lines (transportation services)
 Ethio-telecom (Telecommunication services)
 Rift valley University (Educational Services) etc
(2) Merchandising businesses
 Shewa Super Market
 KAKI General Trading etc
(3) Manufacturing businesses
 Debra Cement Factory
 Kombolcha Textile Factory etc. . .
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Business Goals and Activities
Business Goals
1.Profit Maximization .. . Wealth Maximization
Profit maximization means increasing profit as much as
possible or producing a level of output which brings the
most profit for the business. . . for private sector
. . . . short term Vs long term profit maximization
2. Liquidity
A business must have enough funds available to pay
debts when they are due. . . . so as to satisfy the
equities of creditors.
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Business Goals, Activities . . .

Business Goals Business Activities

Profitability Financing operating

Liquidity Investing

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 The three Business Activities . . .
1) Financing Activities:
 Obtaining capital from owners and creditors
 Repaying creditors and a return to owners.
2) Investing Activities:
 Spending the capital it receives in ways that are productive
and will help the business achieve its objectives.
 Buying and selling long-term assets to be used in the business.
3) Operating Activities:
 Selling of goods and services to customers.
 Employing managers and workers, buying and producing goods
and services, and paying taxes.
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Business Goals, Activities Cont’d)
Performance Measures:
Indicate whether or not managers are achieving the business
goals and if they are managing business activities well.
Performance measures include:
 Earned income or profit
 Cash flow
 Ratio of expenses to revenues
 Ratio of money owed to total resources controlled.
Note: Managers should understand these measures.
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 End of Part I

Part II: SUMMARY OF ACCOUNTING

PROCESS