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ACCOUNTING:INFORMATION FOR DECISION MAKING

Chapter

1

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What isAccounting?

What isAccounting?

Accounting does not belong to the physical and natural sciences; not to the exact sciences, like mathematics; not to the social and economic sciences.

Accounting is not a science

Accounting is just: a method, a discipline, a tool, an instrument, which is governed by a set of rules that change over time and space (main determinants of change are: purpose; politics; culture; economy)

In spite of that, every year billions of political, economical and business decisions are made on the basis of the information provided by accounting: i.e. billions of $,€,¥, and £ are used on the basis of ‘accounting information’

Hence, the consequences of accounting information are simply enormous: that’s why it is widely referred to as the language of business

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What does Accounting do?Types of Accounting

What does Accounting do?Types of Accounting

Accounting keeps record of economic events (i.e. transactions) that occur during a specific period of time, in order to provide the outcome of those events at a certain point in time – end of period; end of each quarter, month, week, etc.

EX

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Business Accounting or Accounting for BusinessBusiness Accounting or Accounting for Business

For business people information is relevant as long as it helps to support and evaluate their business decisions

The main source of relevant information for business decisions is business accounting

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Types of (double entry business) Accounting

Types of (double entry business) Accounting

Financial

Managerial

Tax

Provides information primarily for use by internal decision makers to run the business (managers)1. Cost Accounting: to determine the per-unit cost of activities, services and products2. Internal Auditing: to evaluate the efficacy and efficiency of the business operations3. Budgeting and Financial Forecasting: to estimate future outcomes; to set realistic targets

Provides information about the financial resources, obligations, activities and performance of an economic entity, that is intended for use primarily by external decision makers (mainly investors and creditors)

Reorganizes the accounting information to make it compliant with tax reporting requirements as set by the tax regulation, which are different from those set by financial regulation (remember the different purpose). To prepare the several tax returns, and to minimize the impact of the income tax – tax planning. (tax office)

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Information Users

Investors (fin) Creditors (fin) Managers (fin-ma) Owners (fin) Customers (fin) Employees (fi-ma) Regulators - SEC (fin) - IRS (tax) - EPA (man)

• YOURSELF …

Information Users

Investors (fin) Creditors (fin) Managers (fin-ma) Owners (fin) Customers (fin) Employees (fi-ma) Regulators - SEC (fin) - IRS (tax) - EPA (man)

• YOURSELF …

Decisions Supported

Performance evaluations Stock investments Tax strategies Labor relations Resource allocations Lending decisions Borrowing

Decisions Supported

Performance evaluations Stock investments Tax strategies Labor relations Resource allocations Lending decisions Borrowing

Accounting System (financial, managerial, tax)

Accounting System (financial, managerial, tax)

Financial Information

Provided

Profitability / Costs

Financial position

Cash flows

Financial Information

Provided

Profitability / Costs

Financial position

Cash flows

Within this course we willexclusively deal with

Financial Accounting and Financial Accounting Systems

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Basic Functions of a Financial Accounting System

Basic Functions of a Financial Accounting System

produce useful Financial Reports to summarize and

communicate adequate

information to external and

internal decision makers

classify and record those transactions

understand and interpret business

transactions

Cash? Loan?Credit?

Car

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What’s aFinancial Report?

What’s aFinancial Report?

A Financial Report is generally made of the following items:

3 primary financial statements (BS, IS, SCF)

notes to the accounts

managers’ report on operations

a report from external independent auditors

Income Statement

Balance Sheet

Statement of Cash FlowsNotes to the

Accounts

Managers’ Report

Auditors’ Report

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Provide information useful to external users in making investment and credit

decisions

Provide information useful in assessing amount, timing and

uncertainty of future cash flows

Provide information about economic resources, claims to resources, and

changes in resources and claims

Objectives of

Financial

Reporting ( the activity of

preparing Financial Reports

)

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External Users of Financial Reports

External Users of Financial Reports

• Owners

• Banks and Analysts

• Labor unions

• Governmental agencies

• Suppliers

• Customers

• Trade associations

• General public

• YOURSELF

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Characteristics of Externally Reported Financial Information

Characteristics of Externally Reported Financial Information

It is a Means to an End

It is a Means to an End

It is Broader than Financial Statements

It is Broader than Financial Statements

It is Historical in Nature (it tells

about past events)

It is Historical in Nature (it tells

about past events)

It often results from Inexact and Approximate Measures (some degree of judgment and valuation

applies)

It often results from Inexact and Approximate Measures (some degree of judgment and valuation

applies)

Based on General-Purpose Assumption

(it’s appropriate for investors, creditors and

all external users)

Based on General-Purpose Assumption

(it’s appropriate for investors, creditors and

all external users)

Its usefulness is enhanced via Explanations

(notes to accounts, managers’ report ..)

Its usefulness is enhanced via Explanations

(notes to accounts, managers’ report ..)

It needs to be reliable

It needs to be reliable

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Integrity of Accounting Information: the Institutional Framework

Integrity of Accounting Information: the Institutional Framework

Institutional Framework created to ensure those features

Generally Accepted Accounting Principles (GAAP) FASB, Financial Accounting Standards Board (it issues SFAS) SEC, Securities and Exchange Commission Internal Control Structure Audits (internal & external independent) Legislation

To be reliable, accounting information must be based on consistent methodology, ethics, and

more importantly, integrity

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Integrity of Accounting Information: the Role of Legislation

Integrity of Accounting Information: the Role of Legislation

In spite of enormous resources spent by all large companies to implement their Internal Control Structure, cases like

ENRONENRON WORLDCOMWORLDCOM ParmalatParmalat have thought that to prevent fraudulent financial reporting self-discipline must be supported by the legislation through mandatory requirements:

Sarbanes-Oxley Act (SOX) of 2002

SOX requires public companies to perform numerous checks and to provide a double certification:

1.Under their personal liability, managers must certify that the Company internal control system provides reasonable assurance that financial statements are prepared in accordance with laws and regulations governing financial reporting

2.Under their personal liability, a team of external independent auditors must certify whether they believe that the company Internal Control System is effective.

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Management Accounting Information:Objectives

Management Accounting Information:Objectives

It helps to set goals and missions

It helps to set goals and missions

It helps to evaluate and reward

decision makers

It helps to evaluate and reward

decision makers

It helps to assess the efficacy and the effectiveness of the business operations

It helps to assess the efficacy and the effectiveness of the business operations

It helps to achieve goals and missions

It helps to achieve goals and missions

It helps to understand why goals and missions have

not been achieved

It helps to understand why goals and missions have

not been achieved

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Management Accounting Information: Characteristics

Management Accounting Information: Characteristics

It must be Timely - the quest for real

time information

It must be Timely - the quest for real

time information

It must be conveyed to

the right Decision

Maker

It must be conveyed to

the right Decision

Maker

It is oriented towards Future – it is intended to provide basis for future decisions

It is oriented towards Future – it is intended to provide basis for future decisions

It must provide measures of Efficiency &

Effectiveness

It must provide measures of Efficiency &

Effectiveness

It is a Means to an end

It is a Means to an end

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Users of Management Accounting Information

Users of Management Accounting Information

Board of directors Chief executive officer (CEO) Chief financial officer (CFO) Vice presidents Business unit managers Plant managers Store managers Line supervisors YOURSELF

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Why Accounting is Relevant to You?

Why Accounting is Relevant to You?

YOUan informed critical

observer

How much risky is this new venture?

Are they trying to cheat you?

Can you sell on credit to this company? Does this company

have the financial resources to meet

its obligations towards you?

Is your lending bank treating you fairly for the risk

you provide?

Are the accountants

telling the truth?

How solid is your (own) company?

How your (own) company is

doing?

Stock Investment Opportunity (?)

New job offer

Should you lend money to this

business?