Accounting for Managers

Module 3: Accounting Theory

Accounting
Roles of Accounting in Business

• Accounting is referred to as language of business, but is more formally described as the

information system that measures business activities, process information into reports, and
communicates results to decision makers
• Balancing checkbook is essential accounting function but is only small piece of accounting
• Stakeholders want to know what business owns, how much debt it has, how much revenue it
generated, how much it cost company to make amount of revenue, etc.
• Stakeholders want to make sure financial reports are accurate
Roles of Accounting in Business (cont.)

• Financial Accounting
• must be useful, understandable, accurate, and accessible, focuses on external users and investors, GAAP
provided set of standard rules for industry to follow
• Managerial Accounting
• includes other sources: marketing, volume, demographic and production data, time and cost budgets, &
cost/benefit analysis, focus on internal users such as production/sales managers, and employees
• Accountants turn data into information which is sorted, compiled and turned into useful
report
• Financing is future focused, data is available to inside users only
Financial Accounting Standards

• Congress created SEC, AICPA, FASB, and GAAP

• all standards that financial accounts rely on to ensure financial statements are understandable and usable
• International financial reporting standards
• more than 116 other nations adopted this standard, which is based on broad principles as opposed to
more specific (GAAP)
• SEC requires publicly traded companies to follow GAAP
• International Revenue Code
• Companies are often subject to variety of state and local taxes with differing rules and
regulations
Ethics and Accounting

• Ethics is the code that provides criteria for evaluating right and wrong
• Accounting’s ethical standards are articulated in published code of ethics which provide
guidance
• Different companies have different codes, but are generally similar
1. Recognize and consider all relevant facts and circumstances
2. Consider ethical issues involved
3. Consider established internal procedures
4. Formulate alternative courses of action
Users of Accounting
Users of Accounting Information

• Most common external user is the investor (institutional or individual)

• SEC requires public traded companies to undergo annual financial audit (examination of
entity’s financial statements and disclosures)
• Lenders require financial statements for any entity, and suppliers may also require them
• Internal users are dipping into real time accounting data
• production managers want to know immediate product costs
• Budget office closes gap by creating budget reports and comparing those to actual results
(audited or not)
Organizational Structure

• Built-in hierarchy that defines roles, responsibilities, and supervision

• centralized (gives most authority to team at the top)
• decentralized (distributes authority at lower levels)
• Functional: marketing, operations, finance, & accounting
• Culture: develops over time and encompasses everyday social interactions among employees
• Sales-driven business model allows sales managers to run unfettered by higher management
• Divisional organizational structure isn’t bad
• Functional and divisional structures part of vast spectrum
Forms of Doing Business

• As business grows, it tends to gravitate toward a divisional structure

• Many small businesses are sole proprietorships, meaning one person is owner and
responsible for the company
• can have employees, secure debt, buy assets, sell goods, etc.
• single drawback is that legal liability for debts and lawsuits lies with owner
• adding additional owner turns proprietorship into partnership
The Annual Report

• Management discussion and analysis: provides overview of previous year’s operations and
how company performed financially
• Audited financial statements:
• balance sheet: assets are what company owns, equity and liabilities show who owns it
• income statement: increases and decreases in net assets
• statement of retained earnings: reconciles net income from year to balance sheet statement of equity
• statement of cash flows: shows transactions that affected cash in operations, investing, and financing
• Footnotes and disclosures, auditor’s reports
Accounting Principles
The Accounting Entity

• Basic underlying assumption of GAAP is that there are boundaries around business
organization that defines single economic reporting entity
• second is that entity observed is a going concern
• Going concern principle: presumes economic entity will remain in operation for foreseeable
future
Basic Accounting Principles

• Consistency: once you adopt an accounting method, continue to follow it consistently in

future accounting periods so that results are comparable
• Full disclosure: in financial statements, all information that would affect a reader’s
understanding of principles is included
• Materiality: accounting standard can be ignored if net impact is so small that reader would
not be misled
• Verifiability: given same data, independent accountant can come up with same result as
company
Basic Accounting Principles (cont.)

• Cost principle: reporting assets at historical cost serves combined principles of consistency,
objectivity, and conservatism
• Objectivity: financial statements of organization are based on solid evidence
• Monetary unit: you only record business transactions that can be expressed in terms of
currency
• Conservatism: if there is doubt between two options, accountant should choose one that
reports lesser assets
Accrual Basis Accounting

• Recognizing revenue as it is earned, as opposed to as it is received

• “Accrual basis”: idea of reporting revenue when it becomes a legally enforceable claim
• Time period concept: causes some differences between internal and external reports
• Fiscal year: allows company to process transactions
Accrual Basis Accounting (cont.)

• Recognized revenue:
• Realized revenue: when there is every good reason to believe revenue will be received
• Matching concept: requires that revenues and related expenses are recognized together in
same period
• goal is to match expenses against the revenues
• requires that revenues and related expenses be recognized together in same period
• Accrual basis accounting requires matching expenses to revenues whenever possible
Quick Review

• Accountants take massive amounts of data and turn it into useful financial information
• Stakeholders want to make sure financial reports are accurate
• Accounting’s ethical standards are articulated in published code of ethics which provide
guidance
• Lenders require financial statements for any entity, and suppliers may also require them
• Basic Accounting Principles: Consistency, Full Disclosure, Materiality, Verifiability, Cost
Principle, Objectivity, Monetary Unit, Conservatism
• Accrual Basis Accounting