Financial & Managerial Accounting

CHAPTER ONE
INTRODUCTION TO FINANCIAL
ACCOUNTING

The Basis for Business Decisions

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 Contents:

Definition of accounting

Accounting information

User of accounting information

Integrity of accounting information

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 Chapter
1 What is Accounting?
The systematic recording, reporting, and analysis of financial transactions
of a business.

• Which type of organisation need accounting?

– Sole trader. This means one person who runs a business on their own, or
perhaps with a few employees. The main aim is to make a profit.
– Partnership. This is two or more people who carry on a business in
common, intending to make a profit.
– Limited company. A limited company is a legal organisation set up under
the Companies. The owners are called the shareholders, and it
is run by directors, who are appointed by the shareholders.
– Public sector bodies. Traditionally, these bodies have not existed to make a
profit, but to provide a service.
– Clubs and societies. Again the intention club is not to make a profit, but to
provide services for members.
• All of these organisations require some form of accounting

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 What are the reasons that Accounting is undertaken by
these organisations?
• To record what money has come into the
organisation and what has gone out.
• To tell other people about the activities and
consequent profit or loss of the organisation during
the past year, or other period.
• To tell other people about the present financial state
of the organisation.
• To provide a basis for taxation.
• To provide a basis for planning future activities etc.
• To help managers make decisions about how to run
the organisation.
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 • If this is the concern of accounting,
simply accounting presents the
information to those who are
interested in the welfare of the
organisation.

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 Accounting Information :

What is information?

– It is a stimuli that has meaning in some context for its user.

– When it is entered into and stored in a computer, it is

generally referred to as data.

– The output data can again be perceived as information.

• Thus, the first objective of accounting is to provide

information that is useful for decision making purpose.

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 ........
• To make economic decision based on accounting
information, we need to understand the following
points
A. The nature of economic activities that
accounting information describes.

B. The assumptions and measurement

techniques involved in developing accounting
information.

C. The information that is most relevant for

making various type of decisions.

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 Types of Accounting Information
• The terms financial accounting, management accounting and tax accounting often are used
in describing the three types of accounting information that are widely used in the business

Financial Accounting
• It describes financial resources, obligations and activities of an economic activities
• it helps investors and creditors to make decisions
• it also helps managers and others
• in fact it is used for many purposes “general purpose”.

Managerial Accounting
• It involves the development and interpretation of accounting information intended to
assist management in operating the business.
• it helps to set overall goals, to evaluate performance, to decide to introduce new line
of product, etc

Tax Accounting
• Financial accounting information is a base to prepare tax return
• This information, however is adjusted or reorganized in line with the income tax reporting
requirements

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 Accounting Information System
• AIS is methods, procedures, and standards followed
in accumulating, classifying, recording, and reporting
business events and transactions.
• It is a system of collection, storage and processing of
financial and accounting data that is used by decision
makers
• Accounting system includes the formal records and
original source data.
• The information should meet the needs of users of
information

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 The Three Basic Functions Performed by an AIS

1 To collect and store data about the organization’s

business activities and transactions efficiently and
effectively: (Record & interpret the effect of business transactions)
– Capture transaction data on source documents.
– Record transaction data in journals, which present a
chronological record of what occurred.
– Post data from journals to ledgers, which sort data by
account type.

What sorts of transaction does an accountant record.doc

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 2. Classify the effects of similar transactions in a
manner that permits determination of the
various totals and subtotals useful to
management and used in accounting reports

3. Summarize and communicate the information

contained in the system to decision makers
– In manual systems, this information is provided in
the form of reports that fall into two main
categories:
– financial statements
– managerial reports
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 The Accounting information system

1) Income Statement
Inputs Process Outputs 2)
3)
Balance Sheet
Cash Flow

1. Accounts
2. Journal
3. General
Ledger
4. Trial Balance

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 Financial Accounting Information
• Financial accounting provides information
about the financial resources, obligations
and activities of an enterprises that is
intended for use primarily by external
decision makers.

• Users of accounting information can be divided into two

A. External and
B. Internal users

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 External Users of accounting Information
• External users of accounting information are individuals and other
enterprises that have a financial interest in the reporting enterprises, but
they are not involved in the day to day operations of that enterprise.
• External users of financial accounting information include the following
users with a direct & indirect Financial Interest
 Investors
 Creditors They have direct interest
 Labor union
 Governmental Agencies.
 suppliers They have indirect interest
 Customers.
 General public, etc

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 Objectives of external financial Reporting
• The accounting profession has identified certain objectives of
external reporting to guide its efforts to refine and improve
the reporting of information to external decision makers.
• These general objectives are
 The first objective and the most general is to provide
information that is useful in making investment and credit
decision.
 The second objective is more specific than the first objective,
is to provide information that is useful in assessing the
amount, timing and uncertainty of future cash flow.
 The most specific objective of external financial reporting is to
provide information about the enterprise’s resources, claims
to those resources and how both the resources and claims to
resources change over time.
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 The primary financial statements

Balance Sheet These statements are used

to meet the objectives of
Income Statement external financial reporting

Statement of Cash Flows

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 These Financial
Statements are Lens to
View Business

Financial
Statements

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 Characteristics of Externally Reported
Information
A Means to
an End
Usefulness Broader than
Enhanced via Financial
Explanation Statements

Based on
Historical in
General Purpose
Nature
Assumption

Results from Inexact and

Approximate Measures
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 Management Accounting Information
• Management accounting is the preparation &
use of accounting information systems to
achieve the organization's objectives by
supporting decision makers inside the
organization.

• Internal decision makers are employed by the

organization

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 Internal Users of Accounting Information
• Every internal employee of the organization
uses accounting information.
• Example of internal users of accounting
information system are
 Board of directors
 Chief executive officer (CEO)
 Chief finance officer (CFO)
 Business unit managers
 Plant managers
 Store managers
 Line supervisors etc

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 Objectives of Management accounting information

 It helps the organization to achieve its mission

and goals
 It helps to assess both the past performance
and the future directions of the enterprise and
 It helps the decision making authority to make
decision and to evaluate and make reward for
better performance

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 INTEGRITY OF ACCOUNTING INFORMATION

• Accounting information integrity - integrity

refers to the following qualities: Complete,
unbroken, unimpaired, honest, and sincere
– It enables investors and creditors to rely on
financial accounting information without fear
– Helps the management to be sure that
internally generated information is free
from bias

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 Integrity of Accounting information is
enhanced in three primary ways
• First certain institutional futures add significantly to the integrity
of accounting information.
– These features like -standards for the preparation of accounting
information, an internal control structure and audits of financial
statements
• Institutional Features
– Generally Accepted Accounting Principles (GAAP)
– Financial Accounting Standards Board
– Securities and Exchange Commission
– Internal Control Structure
– Audits

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 • Second, several professional accounting
organizations play unique roles in adding to
the integrity of accounting information.

• These Professional Organizations are

– American Institute of Certified Public Accountants

– Institute of Management Accountants

– Institute of Internal Auditors

– American Accounting Association

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 • Finally, and perhaps most important, is the personnel
competence, judgment and ethical behavior of
professional accountants.
• Competence, Judgment and Ethical Behavior include
– Certified Public Accountants (CPAs)
– Certificate in Management Accounting (CMA)
– Certificate in Internal Auditing (CIA)
– Code of Professional Conduct

• These three elements of the accounting

profession come together to ensure that users
of accounting information can rely on the
information to be fair representation of what it
asserts
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 Exercise one:
Assume you are a loan officer at a bank that makes
loans to individuals to help finance for purchases such
as automobile. You are considering an application from
a customer who needs to purchase a new car. The
customer requesting a loan of 100, 000 which allows
the customer to meet her/his needs.
What are your expectations with regard to repayment
of the loan, and what information would help you to
decide whether the customer is good credit risk for
your bank?

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