Introduction to Accounting:

The Language of Business

Lesson 1: Introduction to Financial Accounting
Supplemental Textbook
 Accounting defined
The American Accounting Association—one of the accounting organizations discussed later in this Introduction
—defines accounting as "the process of identifying, measuring, and communicating economic information to permit
informed judgments and decisions by the users of the information". 1 This information is primarily financial—stated
in money terms. Accounting, then, is a measurement and communication process used to report on the activities of
profit-seeking business organizations and not-for-profit organizations. As a measurement and communication
process for business, accounting supplies information that permits informed judgments and decisions by users of
the data.

The accounting process provides financial data for a broad range of individuals whose objectives in studying the
data vary widely. Bank officials, for example, may study a company's financial statements to evaluate the company's
ability to repay a loan. Prospective investors may compare accounting data from several companies to decide which
company represents the best investment. Accounting also supplies management with significant financial data
useful for decision making.

Reliable information is necessary before decision makers can make a sound decision involving the allocation of
scarce resources. Accounting information is valuable because decision makers can use it to evaluate the financial
consequences of various alternatives. Accountants eliminate the need for a crystal ball to estimate the future. They
can reduce uncertainty by using professional judgment to quantify the future financial impact of taking action or
delaying action.

Although accounting information plays a significant role in reducing uncertainty within the organization, it also
provides financial data for persons outside the company. This information tells how management has discharged its
responsibility for protecting and managing the company's resources. Stockholders have the right to know how a
company is managing its investments. In fulfilling this obligation, accountants prepare financial statements such as
an income statement, a statement of retained earnings, a balance sheet, and a statement of cash flows. In addition,
they prepare tax returns for federal and state governments, as well as fulfill other governmental filing requirements.

Accounting is often confused with bookkeeping. Bookkeeping is a mechanical process that records the routine
economic activities of a business. Accounting includes bookkeeping but goes well beyond it in scope. Accountants
analyze and interpret financial information, prepare financial statements, conduct audits, design accounting
systems, prepare special business and financial studies, prepare forecasts and budgets, and provide tax services.

Specifically the accounting process consists of the following groups of functions (see Exhibit 1 below):

• Accountants observe many events (or activities) and identify and measure in financial terms (dollars) those
events considered evidence of economic activity. (Often, these three functions are collectively referred to as
analyze.) The purchase and sale of goods and services are economic events.

• Next, the economic events are recorded, classified into meaningful groups, and summarized.

• Accountants report on economic events (or business activity) by preparing financial statements and special
reports. Often accountants interpret these statements and reports for various groups such as management,

1 American Accounting Association, A Statement of Basic Accounting Theory (Evanston, III., 1966), p. 1.

Introduction to Accounting : The Language of Business – Supplemental Textbook

 investors, and creditors. Interpretation may involve determining how the business is performing compared to
prior years and other similar businesses.

Exhibit 1: Functions performed by accountants.

Financial accounting versus managerial accounting

An accounting information system provides data to help decision makers both outside and inside the business.
Decision makers outside the business are affected in some way by the performance of the business. Decision makers
inside the business are responsible for the performance of the business. For this reason, accounting is divided into
two categories: financial accounting for those outside and managerial accounting for those inside.

Financial accounting information appears in financial statements that are intended primarily for external
use (although management also uses them for certain internal decisions). Stockholders and creditors are two of the
outside parties who need financial accounting information. These outside parties decide on matters pertaining to
the entire company, such as whether to increase or decrease their investment in a company or to extend credit to a
company. Consequently, financial accounting information relates to the company as a whole, while managerial
accounting focuses on the parts or segments of the company.

Management accountants in a company prepare the financial statements. Thus, management accountants must
be knowledgeable concerning financial accounting and reporting. The financial statements are the representations
of management, not the CPA firm that performs the audit.

2
 The external users of accounting information fall into six groups; each has different interests in the company
and wants answers to unique questions. The groups and some of their possible questions are:

• Owners and prospective owners. Has the company earned satisfactory income on its total investment?
Should an investment be made in this company? Should the present investment be increased, decreased, or
retained at the same level? Can the company install costly pollution control equipment and still be profitable?

• Creditors and lenders. Should a loan be granted to the company? Will the company be able to pay its
debts as they become due?

• Employees and their unions. Does the company have the ability to pay increased wages? Is the
company financially able to provide long-term employment for its workforce?

• Customers. Does the company offer useful products at fair prices? Will the company survive long enough
to honor its product warranties?

• Governmental units. Is the company, such as a local public utility, charging a fair rate for its services?

• General public. Is the company providing useful products and gainful employment for citizens without
causing serious environmental problems?

General-purpose financial statements provide much of the information needed by external users of financial
accounting. These financial statements are formal reports providing information on a company's financial
position, cash inflows and outflows, and the results of operations. Many companies publish these statements in
annual reports. (See The Limited, Inc., annual report in the Annual report appendix.) The annual report also
contains the independent auditor's opinion as to the fairness of the financial statements, as well as information
about the company's activities, products, and plans.

Financial accounting information is historical in nature, reporting on what has happened in the past. To
facilitate comparisons between companies, this information must conform to certain accounting standards or
principles called generally accepted accounting principles (GAAP). These generally accepted accounting
principles for businesses or governmental organizations have developed through accounting practice or been
established by an authoritative organization. We describe several of these authoritative organizations in the next
major section of this Introduction.

Managerial accounting information is for internal use and provides special information for the managers of a
company. The information managers use may range from broad, long-range planning data to detailed explanations
of why actual costs varied from cost estimates. Managerial accounting information should:

• Relate to the part of the company for which the manager is responsible. For example, a production manager
wants information on costs of production but not of advertising.

• Involve planning for the future. For instance, a budget would show financial plans for the coming year.

• Meet two tests: the accounting information must be useful (relevant) and must not cost more to gather and
process than it is worth.

Introduction to Accounting : The Language of Business – Supplemental Textbook

 Managerial accounting generates information that managers can use to make sound decisions. The four major
types of internal management decisions are:

• Financial decisions—deciding what amounts of capital (funds) are needed to run the business and
whether to secure these funds from owners (stockholders) or creditors. In this sense, capital means money
used by the company to purchase resources such as machinery and buildings and to pay expenses of
conducting the business.

• Resource allocation decisions—deciding how the total capital of a company is to be invested, such as
the amount to be invested in machinery.

• Production decisions—deciding what products are to be produced, by what means, and when.

• Marketing decisions—setting selling prices and advertising budgets; determining the location of a
company's markets and how to reach them.

Development of financial accounting standards

Several organizations are influential in the establishment of generally accepted accounting principles (GAAP) for
businesses or governmental organizations. These are the American Institute of Certified Public Accountants, the
Financial Accounting Standards Board, the Governmental Accounting Standards Board, the Securities and
Exchange Commission, the American Accounting Association, the Financial Executives Institute, and the Institute
of Management Accountants. Each organization has contributed in a different way to the development of GAAP.

The American Institute of Certified Public Accountants (AICPA) is a professional organization of CPAs. Many of
these CPAs are in public accounting practice. Until recent years, the AICPA was the dominant organization in the
development of accounting standards. In a 20-year period ending in 1959, the AICPA Committee on Accounting
Procedure issued 51 Accounting Research Bulletins recommending certain principles or practices. From 1959
through 1973, the committee's successor, the Accounting Principles Board (APB), issued 31 numbered
Opinions that CPAs generally are required to follow. Through its monthly magazine, the Journal of Accountancy,
its research division, and its other divisions and committees, the AICPA continues to influence the development of
accounting standards and practices. Two of its committees—the Accounting Standards Committee and the Auditing
Standards Committee—are particularly influential in providing input to the Financial Accounting Standards Board
(the current rule-making body) and to the Securities and Exchange Commission and other regulatory agencies.

In 1973, an independent, seven-member, full-time Financial Accounting Standards Board (FASB)

replaced the Accounting Principles Board. The FASB has issued numerous Statements of Financial Accounting
Standards. The old Accounting Research Bulletins and Accounting Principles Board Opinions are still effective
unless specifically superseded by a Financial Accounting Standards Board Statement. The FASB is the private
sector organization now responsible for the development of new financial accounting standards.

The Emerging Issues Task Force of the FASB interprets official pronouncements for general application by
accounting practitioners. The conclusions of this task force must also be followed in filings with the Securities and
Exchange Commission.

In 1984, the Governmental Accounting Standards Board (GASB) was established with a full-time
chairperson and four part-time members. The GASB issues statements on accounting and financial reporting in the

4
governmental area. This organization is the private sector organization now responsible for the development of
new governmental accounting concepts and standards. The GASB also has the authority to issue interpretations of
these standards.

Created under the Securities and Exchange Act of 1934, the Securities and Exchange Commission (SEC)
is a government agency that administers important acts dealing with the interstate sale of securities (stocks and
bonds). The SEC has the authority to prescribe accounting and reporting practices for companies under its
jurisdiction. This includes virtually every major US business corporation. Instead of exercising this power, the SEC
has adopted a policy of working closely with the accounting profession, especially the FASB, in the development of
accounting standards. The SEC indicates to the FASB the accounting topics it believes the FASB should address.

Consisting largely of accounting educators, the American Accounting Association (AAA) has sought to
encourage research and study at a theoretical level into the concepts, standards, and principles of accounting. One
of its quarterly magazines, The Accounting Review, carries many articles reporting on scholarly accounting
research. Another quarterly journal, Accounting Horizons, reports on more practical matters directly related to
accounting practice. A third journal, Issues in Accounting Education, contains articles relating to accounting
education matters. Students may join the AAA as associate members by contacting the American Accounting
Association, 5717 Bessie Drive, Sarasota, Florida 34233.

Introduction to Accounting : The Language of Business – Supplemental Textbook

Accounting and its use in business decisions

A career as an entrepreneur
When today’s college students are polled about their long-term career choice, a surprisingly large number
respond that they wish to someday own and manage their own business. In fact, the aspiration to start a business,
to be an entrepreneur, is nearly universal. It is widely acknowledged that a degree in accounting offers many
advantages to a would-be entrepreneur. In fact, if you ask owners of small businesses which skill they wish they had
more expertise in, they will very frequently reply “accounting”. No matter what the business may be, the owner
and/or manager must be able to understand the accounting and financial consequences of business decisions.

Most successful entrepreneurs have learned that it takes a lot more than a great marketing idea or product
innovation to make a successful business. There are many steps involved before an idea becomes a successful and
rewarding business. Entrepreneurs must be able to raise capital, either from banks or investors. Once a business
has been launched, the entrepreneur must be a manager—a manager of people, inventory, facilities, customer
relationships, and relationships with the very banks and investors that provided the capital. Business owners
quickly learn that in order to survive they need to be well-rounded, savvy individuals who can successfully manage
these diverse relationships. An accounting education is ideal for providing this versatile background.

In addition to providing a good foundation for entrepreneurship in any business, an accounting degree offers
other ways of building your own business. For example, a large percentage of public accountants work as sole
proprietors—building and managing their own professional practice. This can be a very rewarding career, working
closely with individuals and small businesses. One advantage of this career is that you can establish your practice in
virtually any location ranging from large cities to rural settings.

The introduction to this text provided a background for your study of accounting. Now you are ready to learn
about the forms of business organizations and the types of business activities they perform. This chapter presents
the financial statements used by businesses. These financial statements show the results of decisions made by
management. Investors, creditors, and managers use these statements in evaluating management’s past decisions
and as a basis for making future decisions.

In this chapter, you also study the accounting process (or accounting cycle) that accountants use to prepare
those financial statements. This accounting process uses financial data such as the records of sales made to
customers and purchases made from suppliers. In a systematic manner, accountants analyze, record, classify,
summarize, and finally report these data in the financial statements of businesses. As you study this chapter, you
will begin to understand the unique, systematic nature of accounting—the language of business.

Forms of business organizations

Accountants frequently refer to a business organization as an accounting entity or a business entity. A
business entity is any business organization, such as a hardware store or grocery store, that exists as an economic
unit. For accounting purposes, each business organization or entity has an existence separate from its owner(s),

6
creditors, employees, customers, and other businesses.2 This separate existence of the business organization is
known as the business entity concept. Thus, in the accounting records of the business entity, the activities of
each business should be kept separate from the activities of other businesses and from the personal financial
activities of the owner(s).

Assume, for example, that you own two businesses, a physical fitness center and a horse stable. According to the
business entity concept, you would consider each business as an independent business unit. Thus, you would
normally keep separate accounting records for each business. Now assume your physical fitness center is
unprofitable because you are not charging enough for the use of your exercise equipment. You can determine this
fact because you are treating your physical fitness center and horse stable as two separate business entities. You
must also keep your personal financial activities separate from your two businesses. Therefore, you cannot include
the car you drive only for personal use as a business activity of your physical fitness center or your horse stable.
However, the use of your truck to pick up feed for your horse stable is a business activity of your horse stable.

As you will see shortly, the business entity concept applies to the three forms of businesses—single
proprietorships, partnerships, and corporations. Thus, for accounting purposes, all three business forms are
separate from other business entities and from their owner(s). Since most large businesses are corporations, we use
the corporate approach in this text and include only a brief discussion of single proprietorships and partnerships.

A single proprietorship is an unincorporated business owned by an individual and often managed by that
same person. Single proprietors include physicians, lawyers, electricians, and other people in business for
themselves. Many small service businesses and retail establishments are also single proprietorships. No legal
formalities are necessary to organize such businesses, and usually business operations can begin with only a limited
investment.

In a single proprietorship, the owner is solely responsible for all debts of the business. For accounting purposes,
however, the business is a separate entity from the owner. Thus, single proprietors must keep the financial activities
of the business, such as the receipt of fees from selling services to the public, separate from their personal financial
activities. For example, owners of single proprietorships should not enter the cost of personal houses or car
payments in the financial records of their businesses.

A partnership is an unincorporated business owned by two or more persons associated as partners. Often the
same persons who own the business also manage the business. Many small retail establishments and professional
practices, such as dentists, physicians, attorneys, and many CPA firms, are partnerships.

A partnership begins with a verbal or written agreement. A written agreement is preferable because it provides a
permanent record of the terms of the partnership. These terms include the initial investment of each partner, the
duties of each partner, the means of dividing profits or losses between the partners each year, and the settlement
after the death or withdrawal of a partner. Each partner may be held liable for all the debts of the partnership and
for the actions of each partner within the scope of the business. However, as with the single proprietorship, for
accounting purposes, the partnership is a separate business entity.

2 When first studying any discipline, students encounter new terms. Usually these terms are set in bold. The
boldface color terms are also listed and defined at the end of each chapter (see Key terms).

Introduction to Accounting : The Language of Business – Supplemental Textbook

 A corporation is a business incorporated under the laws of a state and owned by a few stockholders or
thousands of stockholders. Almost all large businesses and many small businesses are incorporated.

The corporation is unique in that it is a separate legal business entity. The owners of the corporation are
stockholders, or shareholders. They buy shares of stock, which are units of ownership, in the corporation.
Should the corporation fail, the owners would only lose the amount they paid for their stock. The corporate form of
business protects the personal assets of the owners from the creditors of the corporation.3

Stockholders do not directly manage the corporation. They elect a board of directors to represent their interests.
The board of directors selects the officers of the corporation, such as the president and vice presidents, who manage
the corporation for the stockholders.

Accounting is necessary for all three forms of business organizations, and each company must follow generally
accepted accounting principles (GAAP). Since corporations have such an important impact on our economy, we use
them in this text to illustrate basic accounting principles and concepts.

An accounting perspective:

Business insight

Although corporations constitute about 17 per cent of all business organizations, they account for
almost 90 per cent of all sales volume. Single proprietorships constitute about 75 per cent of all
business organizations but account for less than 10 per cent of sales volume.

Types of activities performed by business organizations

The forms of business entities discussed in the previous section are classified according to the type of ownership
of the business entity. Business entities can also be grouped by the type of business activities they perform—service
companies, merchandising companies, and manufacturing companies. Any of these activities can be performed by
companies using any of the three forms of business organizations.

• Service companies perform services for a fee. This group includes accounting firms, law firms, and dry
cleaning establishments. The early chapters of this text describe accounting for service companies.

• Merchandising companies purchase goods that are ready for sale and then sell them to customers.
Merchandising companies include auto dealerships, clothing stores, and supermarkets. We begin the
description of accounting for merchandising companies in Chapter 6.

• Manufacturing companies buy materials, convert them into products, and then sell the products to
other companies or to the final consumers. Manufacturing companies include steel mills, auto
manufacturers, and clothing manufacturers.

3 When individuals seek a bank loan to finance the formation of a small corporation, the bank often requires those
individuals to sign documents making them personally responsible for repaying the loan if the corporation
cannot pay. In this instance, the individuals can lose their original investments plus the amount of the loan they
are obligated to repay.

8
 All of these companies produce financial statements as the final end product of their accounting process. These
financial statements provide relevant financial information both to those inside the company—management—and
to those outside the company—creditors, stockholders, and other interested parties. The next section introduces
four common financial statements—the income statement, the statement of retained earnings, the balance sheet,
and the statement of cash flows.

Introduction to Accounting : The Language of Business – Supplemental Textbook

Stockholders' equity: Classes of capital stock

The accountant as a corporate treasurer

Most people think of the stock market as a place to buy and sell stock. However, few people give much thought
to the other side of this transaction. The original purpose of the stock market is to allow corporations to raise the
money needed to expand into new markets, invent new products, open new stores, and create new jobs. The initial
public issuance of stock (i.e. going public) is one of the most significant milestones in the life of a public company.

For most individual investors, trading is done by stockbrokers. Who handles the stock transactions within a
company? The treasurer or the person that performs the treasury functions is this person. This role requires
someone with a strong background in accounting and finance.

When a company decides to issue bonds or additional shares of stock, the treasurer is the person responsible for
executing the transaction at the lowest cost to the entity. The treasurer works closely with investment bankers and
lawyers to get the stocks or bonds marketed and issued in accordance with state and federal laws. When a company
issues stock for the first time (initial public offering, or IPO), the task requires a thorough review of the financial
position of the company and the public disclosure of this information for perhaps the first time. The
treasurer/accountant must prepare what is called a prospectus. Among other things, the prospectus includes
financial accounting information that is used in setting the price of the IPO.

The treasurer maintains custody of, or has access to, stocks owned by an entity and stock that is under the
control of the entity. The treasurer also plays a pivotal role in the distribution of cash and stock dividends. The
primary function of this position is controlling the cash inflows and outflows of the entity. A career as a corporate
treasurer can involve the oversight of billions of dollars of stock, and the individual can earn a six-figure salary.

In this chapter, you study the corporate form of business organization in greater detail than in preceding
chapters. Although corporations are fewer in number than single proprietorships and partnerships, corporations
possess the bulk of our business capital and currently supply us with most of our goods and services.

This chapter discusses the advantages and disadvantages of the corporation, how to form and direct a
corporation, and some of the unique situations encountered in accounting for and reporting on the different classes
of capital stock. It is written from a US perspective, so you should be aware that laws and common practices may be
different in other countries.

The corporation
A corporation is an entity recognized by law as possessing an existence separate and distinct from its owners;
that is, it is a separate legal entity. Endowed with many of the rights and obligations possessed by a person, a
corporation can enter into contracts in its own name; buy, sell, or hold property; borrow money; hire and fire
employees; and sue and be sued.

Corporations have a remarkable ability to obtain the huge amounts of capital necessary for large-scale business
operations. Corporations acquire their capital by issuing shares of stock; these are the units into which

10
corporations divide their ownership. Investors buy shares of stock in a corporation for two basic reasons. First,
investors expect the value of their shares to increase over time so that the stock may be sold in the future at a profit.
Second, while investors hold stock, they expect the corporation to pay them dividends (usually in cash) in return for
using their money. Chapter 13 discusses the various kinds of dividends and their accounting treatment.

Advantages of the corporate form of business

Corporations have many advantages over single proprietorships and partnerships. The major advantages a
corporation has over a single proprietorship are the same advantages a partnership has over a single
proprietorship. Although corporations have more owners than partnerships, both have a broader base for
investment, risk, responsibilities, and talent than do single proprietorships. Since corporations are more
comparable to partnerships than to single proprietorships, the following discussion of advantages contrasts the
partnership with the corporation.

• Easy transfer of ownership. In a partnership, a partner cannot transfer ownership in the business to
another person if the other partners do not want the new person involved in the partnership. In a publicly held
(owned by many stockholders) corporation, shares of stock are traded on a stock exchange between unknown
parties; one owner usually cannot dictate to whom another owner can or cannot sell shares.

• Limited liability. Each partner in a partnership is personally responsible for all the debts of the business.
In a corporation, the stockholders are not personally responsible for its debts; the maximum amount a
stockholder can lose is the amount of his or her investment. However, when a small, closely held corporation
(owned by only a few stockholders) borrows money, banks and lending institutions often require an officer of
the small corporation to sign the loan agreement. Then, the officer has to repay the loan if the corporation does
not.

• Continuous existence of the entity. In a partnership, many circumstances, such as the death of a
partner, can terminate the business entity. These same circumstances have no effect on a corporation because
it is a legal entity, separate and distinct from its owners.

• Easy capital generation. The easy transfer of ownership and the limited liability of stockholders are
attractive features to potential investors. Thus, it is relatively easy for a corporation to raise capital by issuing
shares of stock to many investors. Corporations with thousands of stockholders are not uncommon.

• Professional management. Generally, the partners in a partnership are also the managers of that
business, regardless of whether they have the necessary expertise to manage a business. In a publicly held
corporation, most of the owners (stockholders) do not participate in the day-to-day operations and
management of the entity. They hire professionals to run the business on a daily basis.

• Separation of owners and entity. Since the corporation is a separate legal entity, the owners do not
have the power to bind the corporation to business contracts. This feature eliminates the potential problem of
mutual agency that exists between partners in a partnership. In a corporation, one stockholder cannot
jeopardize other stockholders through poor decision making.

The corporate form of business has the following disadvantages:

Introduction to Accounting : The Language of Business – Supplemental Textbook

 • Double taxation. Because a corporation is a separate legal entity, its net income is subject to double
taxation. The corporation pays a tax on its income, and stockholders pay a tax on corporate income received as
dividends.

• Government regulation. Because corporations are created by law, they are subject to greater regulation
and control than single proprietorships and partnerships.

• Entrenched, inefficient management. A corporation may be burdened with an inefficient

management that remains in control by using corporate funds to solicit the needed stockholder votes to back
its positions. Stockholders scattered across the country, who individually own only small portions of a
corporation's stock, find it difficult to organize and oppose existing management.

• Limited ability to raise creditor capital. The limited liability of stockholders makes a corporation an
attractive means for accumulating stockholder capital. At the same time, this limited liability feature restrains
the amount of creditor capital a corporation can amass because creditors cannot look to stockholders to pay
the debts of a corporation. Thus, beyond a certain point, creditors do not lend some corporations money
without the personal guarantee of a stockholder or officer of the corporation to repay the loan if the
corporation does not.

Stockholders Stockholders do not have the right to participate actively in the management of the business
unless they serve as directors and/or officers. However, stockholders do have certain basic rights, including the
right to (1) dispose of their shares, (2) buy additional newly issued shares in a proportion equal to the percentage of
shares they already own (called the preemptive right), (3) share in dividends when declared, (4) share in assets
in case of liquidation, and (5) participate in management indirectly by voting at the stockholders' meeting.

The preemptive right allows stockholders to maintain their percentage of ownership in a corporation when
additional shares are issued. For example, assume Joe Thornton owns 10 per cent of the outstanding shares of
Corporation X. When Corporation X decides to issue 1,000 additional shares of stock, Joe Thornton has the right to
buy 100 (10 per cent) of the new shares. Should he decide to do so, he maintains his 10 per cent interest in the
corporation. If he does not wish to exercise his preemptive right, the corporation may sell the shares to others.4

4 Some corporations have eliminated the preemptive right because the preemptive right makes it difficult to issue
large blocks of stock to the stockholders of another corporation to acquire that corporation.

12
 Exhibit 2: Typical corporation's organization chart

Normally, companies hold stockholders' meetings annually. At the annual stockholders' meeting, stockholders
indirectly share in management by voting on such issues as changing the charter, increasing the number of
authorized shares of stock to be issued, approving pension plans, selecting the independent auditor, and other
related matters.

At stockholders' meetings, each stockholder is entitled to one vote for each share of voting stock held.
Stockholders who do not personally attend the stockholders' meeting may vote by proxy. A proxy is a legal
document signed by a stockholder, giving a designated person the authority to vote the stockholder's shares at a
stockholders' meeting.

Board of directors Elected by the stockholders, the board of directors is primarily responsible for
formulating policies for the corporation. The board appoints administrative officers and delegates to them the
execution of the policies established by the board. The board's more specific duties include: (1) authorizing
contracts, (2) declaring dividends, (3) establishing executive salaries, and (4) granting authorization to borrow
money. The decisions of the board are recorded in the minutes of its meetings. The minutes are an important
source of information to an independent auditor, since they may serve as notice to record transactions (such as a
dividend declaration) or to identify certain future transactions (such as a large loan).

Corporate officers A corporation's bylaws usually specify the titles and duties of the officers of a corporation.
The number of officers and their exact titles vary from corporation to corporation, but most have a president,
several vice presidents, a secretary, a treasurer, and a controller.

The president is the chief executive officer (CEO) of the corporation. He or she is empowered by the bylaws to
hire all necessary employees except those appointed by the board of directors.

Most corporations have more than one vice president. Each vice president is responsible for one particular
corporate operation, such as sales, engineering, or production. The corporate secretary maintains the official
records of the company and records the proceedings of meetings of stockholders and directors. The treasurer is
accountable for corporate funds and may supervise the accounting function within the company. A controller
carries out the accounting function. The controller usually reports to the treasurer of the corporation.

Introduction to Accounting : The Language of Business – Supplemental Textbook

 Documents, books, and records relating to capital stock
Capital stock consists of transferable units of ownership in a corporation. Each unit of ownership is called a
share of stock. Typically, traders sell between 100 and 400 million shares of corporate capital stock every business
day on stock exchanges, such as the New York Stock Exchange and the American Stock Exchange, and on the over-
the-counter market. These sales (or trades) seldom involve the corporation issuing the stock as a party to the
exchange. Existing stockholders sell their shares to other individual or institutional investors. The physical transfer
of the stock certificates follows these trades.

A stock certificate is a printed or engraved document serving as evidence that the holder owns a certain
number of shares of capital stock. When selling shares of stock, the stockholder signs over the stock certificate to
the new owner, who presents it to the issuing corporation. When the old certificate arrives, the issuing corporation
cancels the certificate and attaches it to its corresponding stub in the stock certificate book. The issuer prepares a
new certificate for the new owner. To determine the number of shares of stock outstanding at any time, the issuer
sums the shares shown on the open stubs (stubs without certificates attached) in the stock certificate book.

Among the more important records maintained by a corporation is the stockholders' ledger. The stockholders'
ledger contains a group of subsidiary accounts showing the number of shares of stock currently held by each
stockholder. Since the ledger contains an account for each stockholder, in a large corporation this ledger may have
more than a million individual accounts. Each stockholder's account shows the number of shares currently or
previously owned, their certificate numbers, and the dates on which shares were acquired or sold. Entries are made
in the number of shares rather than in dollars.

The stockholders' ledger and the stock certificate book contain the same information, but the stockholders'
ledger summarizes it alphabetically by stockholder. Since a stockholder may own a dozen or more certificates, each
representing a number of shares, this summary enables a corporation to (1) determine the number of shares a
stockholder is entitled to vote at a stockholders' meeting and (2) prepare one dividend check per stockholder rather
than one per stock certificate.

Many large corporations with actively traded shares turn the task of maintaining reliable stock records over to
an outside stock-transfer agent and a stock registrar. The stock-transfer agent, usually a bank or trust company,
transfers stock between buyers and sellers for a corporation. The stock-transfer agent cancels the certificates
covering shares sold, issues new stock certificates, and makes appropriate entries in the stockholders' ledger. It
sends new certificates to the stock registrar, typically another bank, that maintains separate records of the shares
outstanding. This control system makes it difficult for a corporate employee to issue stock certificates fraudulently
and steal the proceeds.

The minutes book, kept by the secretary of the corporation, is (1) a record book of the actions taken at
stockholders' and board of directors' meetings and (2) the written authorization for many actions taken by
corporate officers. Remember that all actions taken by the board of directors and the stockholders must be in
accordance with the provisions in the corporate charter and the bylaws. The minutes book contains a variety of
data, including:

• A copy of the corporate charter.

14
• A copy of the bylaws.

• Dividends declared by the board of directors.

• Authorization for the acquisition of major assets.

• Authorization for borrowing.

• Authorization for increases or decreases in capital stock.

Introduction to Accounting : The Language of Business – Supplemental Textbook

Long-term financing: Bonds

The accountant's role in financial institutions

Companies that require funds to maintain existing operations and expand new operations frequently do not
have the necessary cash available within the company. Therefore, these companies are required to obtain long-term
financing from banks and other financial institutions. The operations of financial institutions are unique from those
of the typical manufacturing or service company. As a result, the accounting measurement and disclosure practices
followed by financial institutions can be quite different from those followed in other industries. In addition to the
more traditional careers in accounting (auditing, professional services, financial reporting, cost accounting, and
taxation), accounting majors with interests in finance may pursue a career in financial institutions.

Accountants in this industry commonly deal with issues related to marketable securities, derivatives, hedging,
sale of receivables, foreign currency exchanges, and loan loss provisions and impairments. In addition, accountants
in this area are being called upon to play an increasing role in the strategic operations of the financial institution.
Not only are accountants needed to account for the institution's transactions, but they are being asked to
recommend new opportunities for growth and to advise on financial risk as well. Some of these new areas include
issues related to asset/liability management, interest rate risk, present value measurements, capital structure, and
key ratio analysis.

Accountants also play a key role in one of the most important decisions of a financial institution—the decision of
whether to lend money to a prospective borrower. The decision to lend money hinges on the ability of the
prospective borrower to pay interest and repay debt. Since accountants have been trained in financial statement
preparation and interpretation, accountants are some of the most sought after professionals for understanding the
financial position and risk of a prospective borrower.

In previous chapters, you learned that corporations obtain cash for recurring business operations from stock
issuances, profitable operations, and short-term borrowing (current liabilities). However, when situations arise that
require large amounts of cash, such as the purchase of a building, corporations also raise cash from long-term
borrowing, that is, by issuing bonds. The issuing of bonds results in a Bonds Payable account.

Introduction to Accounting : The Language of Business – Supplemental Textbook

Managerial accounting concepts/job costing
Learning objectives
After studying this chapter, you should be able to:

• Compare and contrast managerial accounting and financial accounting.

• Describe the basic components of a products cost.

• Explain the difference between product costs and period costs.

• Compare financial reporting by a merchandiser to that of a manufacturer and prepare a statement of cost of
goods manufactured, an income statement, and a balance sheet for a manufacturer.

• Explain the pattern of cost flows for a company.

• Compare and contrast different production methods and accounting systems.

• Describe job cost flows and determine the cost of jobs.

• Explain how and why predetermined overhead rates are computed.

• Describe the differences in net income under absorption costing and variable costing (appendix).

Compare managerial accounting with financial accounting

Whereas financial accounting provides financial information primarily for external use, managerial
accounting information is for internal use. By reporting on the financial activities of the organization, financial
accounting provides information needed by investors and creditors.

Most managerial decisions require more detailed information than that provided by external financial reports.
For instance, in their external financial statements, large corporations such as General Electric Company show
single amounts on their balance sheets for inventory. However, managers need more detailed information about the
cost of each of several hundred products.

We show the fundamental differences between managerial and financial accounting in the chart.
Financial accounting Managerial accounting
Users
External users of information – usually shareholders, Internal users of information – usually managers.
financial analysts, and creditors
Compliance with generally accepted
Accounting Principles
Must comply with generally accepted accounting principles. Need not comply with generally accepted
accounting principles. Internal cost/benefit
evaluation determines how much information is
enough.
Future versus past
Uses historical data. May use estimates of the future for budgeting and
decision making.
Detail presented
Presents summary data, costs, revenues, and profits. More detailed data are presented about product.

Introduction to Accounting : The Language of Business – Supplemental Textbook

This textbook is part of the the Global Text Project. The textbook has been modified by Business Learning Software,
Inc. and Brigham Young University under the creative commons license
(http://creativecommons.org/licenses/by/3.0/). For more information please see: http://globaltext.terry.uga.edu

18