Management Concepts &

AccountingProf. Priti Rachayeeta

Objectives

• What is accounting?

• Explain the role and nature of accounting and finance.

• Explain the role of accounting in planning and controlling a business.

• Identify and discuss the possible objectives of a business

• Distinguish between financial and management accounting.

Nature and role of accounting

• Accounting is often called the language of business.

• Accounting is the common language used to communicate financial information from one person to another in the world of industry and commerce.

Accounting is :

• Concerned with the collection, analysis and communication of economic information.

• It is useful to those who need to make decisions and plans about businesses and for those who need to control those businesses.

• The ultimate purpose of the accountant’s work is to influence the decisions of users of the information produced.

• Accounting provides “information that is useful in making business and economic decisions for making reasoned choices among alternative uses of scarce resources in the conduct of business and economic activities.

Main users of financial information

relating to business organization.• Customers

• Suppliers

• Government

• Owners

• Lenders

• Employees (non management)

• Investment analysts

• Community representatives

• Managers

• Why do each of the user groups identified above need accounting information relating to a business?

User group Use

• Customers : To assess the ability of the business to continue in business and to supply the needs of customers.

• Suppliers: To assess the ability of the business to pay for the goods and services supplied.

• Government: To assess how much tax the business should pay, whether it complies with agreed pricing policies, whether financial support is needed etc..

• Owners: To assess how effectively the managers are running the business and to make judgments about likely levels of risk and return in the future.

• Lenders: To assess the ability of the business to meet its obligations and to pay interest and to repay the principal.

• Employees (non management): To assess the ability of the business to continue to provide employment and to reward employees for their labour.

• Investment analysts: To assess the likely risks and returns associated with the business in order to determine its investment potential and to advise clients accordingly.

• Community representatives: To assess the ability of the business to continue to provide employment for the community and use community resources, to help fund for environmental improvements , etc.

• Managers: To help them to make decisions and plans for the business and to help them to exercise control to try to ensure that plans come to fruition.

Accounting as an information System

• Identifying and capturing relevant economic information

• Recording the information collected in a systematized manner.

• Analyzing and interpreting the information collected.

• Reporting the information in a manner which suits the need of users.

Accounting as a service function

• In order to meet the needs of users, accounting information must should possess certain key characteristics:

▫ Relevance: Accounting information must have the ability to influence decisions. Unless this characteristic is present, there really is not any point in producing the information.

▫ The information may be relevant to the prediction of future events or relevant in helping confirm past events.

• Reliability: Accounting information should be free from any material error or bias.

• Comparability: Items which are basically the same should be treated in the same manner for measurement and presentation purposes.

• Understandability. Accounting reports should be expressed as clearly as possible and should be capable of being understood by those for whom the information is intended.

Costs and benefits of accounting

information• Suppose that you wish to buy a portable radio

which you have seen in a local shop for sale at $20.

• You believe that other local shops may have the same model of radio on offer for as little as $19.

• The only ways in which you can find out the prices at other shops is either to telephone them or visit them.

• Telephone costs money and involve some time.

• Visiting the shops may not involve money but more of you time will be involved.

• Is it worth the cost of finding out the price of the radio at various shops?

• The answer is, of course, that if the cost of discovering the price is less than the potential benefit, it is worth having that information.

• Supplying accounting information to users is similar.

• The provision of accounting information costs money.

• If no accounting information were produced, no accounting staff would need to be employed.

• In order to be worth having, the potential benefits from having the information need to outweigh the cost of producing it.

Portable radio example….

• Going back to the portable radio, identifying the cost of finding the various selling prices before you actually set out to do so is problematical.

• It will probably involve considerations of the following factors:

• How many shops will you phone or visit?• What will be the cost of each phone call?• How long will it take you to make a call of the

phone calls or to visit all of the shops?• How much do you value your time at?

• The economic benefit of having the information on the price of radios is probably even harder to assess, the following probably being relevant:

• What is the cheapest price which you might be quoted for the radio?

• How likely is it that you will be quoted prices cheaper than $20?

• Decision whether it is economically advantageous to discover other prices for the radio is very difficult.

• It is exactly the same with decisions on producing accounting information in a business context.

Decision making and planning

• It is vitally important that businesses plan their future.

• Planning is vital for businesses of all sizes.

• Closely linked to planning is decision making.

• Planning involves making decisions about what course of action is best to plan for.

Steps in the planning process

• Setting the objectives or mission of the business, i.e. what the particular business is basically trying to achieve.

• For most private sector businesses, wealth generation is likely to be the main financial/economic objective.

• Businesses tend to take actions which will have the effect of increasing the wealth of the business.

• Increases in wealth may be paid to the govt in taxes, paid to the owners, paid to employees, reinvested in the business or deployed in some other way.

• In practice therefore, any decision is likely to be the result of a compromise between more than one objective.

• Setting long term plans. These are plans setting out how the business will work towards achievement of its objectives over a period of, say five years. They are likely to deal with such matters as:▫ Type of products and services to be offered by the

business.▫ Amounts and sources of finance needed to be raised by

the business.▫ Capital investments (e.g. in new plant and machinery)

needing to be made;▫ Sources of raw materials;▫ Labor requirements.

• Setting detailed short term plans or budgets. Budgets are financial plans for the short term, typically one year.

• They are likely to be expressed mainly in financial terms.

• Their role is to convert the long term plans into actionable blueprints for the immediate future.

• Budgets usually define precise targets in areas like:

▫ Cash receipts and payments;

▫ Sales, broken down into amounts and prices for each of the products or services provided by the business;

▫ Detailed stock requirements;

▫ Detailed labor requirements;

▫ Specific production requirements.

Control

• Control can be defined as compelling events to conform to plan.

• For example, when we walk about controlling a motor car we mean making the car do what we plan that it should do.

• In the case of a car the plan may only be made split-seconds before being enacted, but if the car is in control it is doing what the driver intended that it should do.

Decision making, planning and control

process• Identify objectives

• Consider options

• Evaluate options and make a selection

• Prepare budgets

• Perform and collect information on actual performance

• Respond to divergences between plans and actuals and exercise control

• Revise plans (budgets) if necessary.

Assumptions underlying accounting

measurement• Accounting measures events only if they affect

the financial position of the enterprise.

• As a result, important events affecting a business, such as the launching of new brands by its competitors, will not find a place in accounting records.

• Four major assumptions that underlie all accounting measurement are:

1. Accounting entity

2. Going concern

3. Periodicity

4. Money measurement

Accounting Entity

• Accountants treat a business as an accounting entity that is distinct and separate from its owners and other firms.

• Without the entity assumption, the personal financial affairs of the owners and the activities of other enterprises would be mingled with the transactions of the business,

• and no meaningful financial information about the business can be produced.

Going Concern

• Unless there is substantial evidence to the contrary, accountants assume that the business is a continuing enterprise, or a going concern.

• The assumption makes sense because many business enterprises survive difficult economic circumstances.

• The going concern assumption justifies an accounting system based on historical cost.

• If we were to assume imminent liquidation of a business, historical cost would be irrelevant.

Periodicity

• We assume a long life for a business.

• But investors , creditors, government, and others cannot wait indefinitely for information for making decisions.

• The periodicity assumption requires that the activities of an enterprise be divided into artificial time periods, usually as long as a year, but sometimes as short as a quarter.

Money Measurement

• Under the money measurement assumption, we express and record all business transactions in terms of money.

• Therefore, if we cannot measure something in terms of money, it will have no place in accounting.

• Money is the only common denominator for all businesses.

• The use of money as the unit of measurement enables us to compare financial information of different enterprises.

• In India, rupee is the monetary unit.

Test your understanding

What, if at all, is wrong with the following accounting practices?

• A business recorded an expense for the electricity charges for the owner’s home.

• A business bought a car at an auction for Rs 40,000 and recorded it at that amount. One week later, the price of the car went up to Rs. 50, 000 and the business recorded the car at the new market value.

• A business recorded a DVD player purchased for the owner’s personal use as an asset of the business.

Generally Accepted Accounting

Principles

• The information contained in financial reports should be reliable and intelligible.

• Besides, we should be able to make meaningful comparisons between a firm’s past financial history and the financial information of other enterprises.

• Therefore, we need a body of broad concepts and detailed practices to guide business enterprises in preparing financial reports.

• The set of conventions, rules, and procedures that define accepted accounting practice is referred to as generally accepted accounting principles (GAAP).

• GAAP represents the fundamental positions that have been generally agreed upon, by accountants and encompasses contemporary permissible accounting practice.

Institutions that Influence GAAP

• Indian organizations• The Ministry of Corporate Affairs (MCA)• Securities Exchange Board of India (SEBI)• Institute of Chartered Accountants of India

(ICAI)• Income Tax Department• Reserve Bank of India (RBI)• Insurance Regulatory and Development

Authority (IRDA)• Comptroller and Auditor-General of India (CAG)

International organizations

• The International Accounting Standards Board (IASB), is committed to developing a single set of accounting standards that will eventually be acceptable worldwide as the basis for listing of securities.

• The IASB works with national accounting standard setters to achieve convergence in accounting standards around the world.

• The International Federation of Accountants (IFAC) is primarily concerned with bringing about greater international harmony in matters such as education, ethics, and auditing practices.

• The International Organization of Securities Commissions (IOSCO) is an association of securities regulators, such as SEBI and the US Securities and Exchange Commission (SEC).

• It plays an imp role in improving accounting and disclosure regulation in securities markets around the world.

Accounting Standards and Policies

• An accounting standard specifies the acceptable methods from the wide array of accounting choices.

• Accounting policies comprise the principles, bases, conventions, rules and procedures that enterprises adopt in preparing and presenting financial statements.

• Companies should disclose their accounting policies.

Principle-based and rule-based

standards• Depending on the level of detail, accounting

standards are referred to as principle –based or rule-based.

• The principle-based standards lay down the broad principles that govern the accounting and disclosure requirements.

• In contrast, rule-based standards prescribe detailed conditions and stipulations.

• Many consider US GAAP to be rule-based and IFRS to be principle based.

• It would be fair to say that in the continuum from details to principles, US GAAP is closer to details.

• Because of the US legal environment, American managers and auditors face a much greater risk of shareholder lawsuits and the use of prescriptive standards makes it easier to defend management’s and auditor’s assumptions and judgments.

Financial analysis-US GAAP and IFRS

• Most Indian companies prepare their financial statements according to Indian GAAP.

• A number of them provide supplementary financial statements applying IFRS and US GAAP.

• Examples of Indian companies that provide US GAAP or IFRS statements include Infosys, Wipro, Dr. Reddy’s laboratories, Bharti Airtel, Tata Motors, and TCS.

Forms of business organization

• The common forms of business are sole proprietorship, partnership and limited company.

• In sole proprietorship, a single individual carries business.

• He gets to keep all the profits the business earns.• The sole proprietor’s liability is unlimited, that

is, if the business doesn’t do well, he is personally liable for paying off the debts.

• He could lose his shirt.

Partnership

• A partnership comprises between two and twenty persons trading together as one firm and sharing profits and losses.

• Each partner has unlimited liability for all the debts and obligations of the firm and is responsible for the liabilities in the firm of his fellow partner or partners as well as his own.

• The Indian Partnership Act regulates partnership business, but the regulation is minimal.

• Professional practices , such as those of architects, lawyers, and accountants , are usually partnership firms.

Limited company

• A limited company is a legal entity, unlike a sole proprietorship or partnership.

• Under the law, it has most of the rights of a natural person.

• The law lays down rules for the functioning of companies.

• Limited companies can either be public or private.

Limited liability partnership (LLP)

• A LLP differs from a partnership in that a partner of an LLP is generally not bound by anything done by other partners.

• It has perpetual succession and separate legal existence similar to a limited company.

• Also, only individuals can be partners in a partnership; but an LLP can have individuals or corporate bodies.

• It is a body corporate having perpetual succession and a separate legal entity.

• It must have a minimum of two partners; there is no maximum.

• The LLP form is essentially suitable for professional services firms.

• In order to meet competition from international firms, indian forms should become bigger and that mena they should be able to have more than 20 partners (the limit for partnership).

• Also, the partner of an LLP will have protection from professional negligence litigation.

• An LLP combines the flexibility and tax status of a partnership with limited liability for its partners.

• The Limited Liability Partnership bill introduced in parliament in 2006 has not yet become law.