1 Uses of Accounting

Information and the Financial

Statements
Accounting as an Information System

OBJECTIVE 1: Define accounting and describe

its role in making informed decisions, identify
business goals and activities, and explain the
importance of ethics in accounting.
Figure 1: Accounting as an Information
System
Figure 2: Business Goals and Activities
Accounting as an Information System

Accounting is an information system that measures,

processes, and communicates financial information.
Accounting is a link between business activities and
decision makers.
Management must have a good understanding of accounting
to set financial goals and make financial decisions.
Management must not only understand how accounting
information is compiled and processed but also realize that
accounting information is imperfect and should be
interpreted with caution.
Accounting as an Information System

A business is an economic unit that aims to sell

goods and services to customers at prices that
will provide an adequate return to its owners.
Goals
Profitabilityearning a sufficient return to maintain
owner interest
Liquidityhaving enough cash to pay debts as they
come due
Accounting as an Information System

Activities
Operatingselling goods and services to customers;
employing managers and workers; buying and producing
goods and services; and paying taxes
Investingspending the capital a company receives in
productive ways that help it achieve its objectives
Financingobtaining funds to begin operations and to
continue operating
Accounting as an Information System

Performance measures
Performance measures relate to achieving goals and
assessing the management of business activities.
Financial analysis is the evaluation and interpretation of
the financial statements and related performance
measures.
Performance measures must be crafted to motivate
managers to make decisions that are in the best interest
of the business.
Accounting as an Information System

Categories of accounting
Management accountingaccounting information
for internal decision makers
Financial accountingaccounting information for
external decision makers; reports are called
financial statements.
Accounting as an Information System

Ways in which accounting information is processed

Bookkeeping is the mechanical and repetitive
recordkeeping aspect of accounting.
Computerized accounting
Computerized accounting is useful for routine bookkeeping chores
and complex accounting calculations.
Computerized information is only as useful as the data input into the
system.
A management information system (MIS) consists of the
interconnected subsystems that provide the information
needed to run a business.
Accounting as an Information System

Ethical financial reporting

Ethics is a code of conduct that addresses whether actions
are right or wrong.
Ethics in the preparation of financial reports is important because
users of these reports must depend on the good faith of the people
involved in their preparation.
The intentional preparation of misleading financial statements is
called fraudulent financial reporting.
Fraudulent financial reporting can result from the distortion of
records, falsified transactions, or the misapplication of various
accounting principles.
The motivation for fraudulent financial reporting could be to inflate
the perceived value of a business, meet stockholders and financial
analysts expectations, obtain financing, or receive personal gain.
Accounting as an Information System

Congress passed the Sarbanes-Oxley Act in 2002 to

regulate financial reporting in public corporations.
Decision Makers: The Users of
Accounting Information
OBJECTIVE 2: Identify the users of accounting
information.
Figure 3: The Users of Accounting
Information
Decision Makers: The Users of
Accounting Information
Three major groups use accounting information.
Management (internal users)
Outsiders with a direct financial interest
Present or potential investor
Present or potential creditors
People, organizations, and agencies with an indirect
financial interest
Tax authorities
Regulatory agencies
a Securities and Exchange Commission (SEC)
Other groups (labor unions, financial advisers, economic planners,
etc.)
Decision Makers: The Users of
Accounting Information

Government and not-for-profit organizations

also use financial information.
Accounting Measurement

OBJECTIVE 3: Explain the importance of

business transactions, money measure, and
separate entity.
Table 1: Examples of Foreign Exchange
Rates
Accounting Measurement

Four questions must be answered to make an

accounting measurement.
What is measured?
When should the measurement be made?
What value should be placed on what is measured?
How should what is measured be classified?
Accounting Measurement

A business transaction is an economic event

that affects a businesss financial position.
It may involve an exchange of value (a purchase,
sale, payment, collection, or loan).
Alternatively, it may involve a nonexchange of
value (physical wear and tear or losses from fire,
flood, explosion, and theft).
Accounting Measurement

The money measure concept states that a

business transaction should be recorded in
terms of money.
Transactions between countries must involve the
translation of amounts of money using the
appropriate exchange rate.
Accounting Measurement

In accounting, a business is treated as a

separate entity from its owners, creditors, and
customers.
The Forms of Business Organization

OBJECTIVE 4: Describe the characteristics of a

corporation.
Figure 4: Number and Receipts of U.S.
Proprietorships, Partnerships, and Corporations
The Forms of Business Organization

There are three basic forms of business

organization.
Sole proprietorshipone owner
The owner takes all of the profits or losses of the business
The owner also has unlimited liability
Partnershiptwo or more owners
In a partnership two or more owners share profits or losses
based on a predetermined arrangement
Unlimited liability can be avoided by forming a limited
liability partnership
The Forms of Business Organization

Corporationowned by many owners (the

stockholders) but managed by a board of directors
A corporation is a business unit chartered by the state
(when articles of incorporation are filed) and considered
a separate legal entity from its owners.
The liability of corporate stockholders is limited to their
investment.
A share of stock is a unit of ownership in a corporation.
Common stock is the most universal form of stock.
The Forms of Business Organization

The board of directors sets corporate policy and declares

dividends.
The authority to manage a corporation is given by the
owners and board of directors to the corporate
management. Corporate governance is the oversight of a
corporations management; ethics is the oversight of the
board of directors.
A provision of the Sarbanes-Oxley Act requires boards
of directors to establish an audit committee to ensure
that the board is objective in evaluating management
performance.
Financial Position and the Accounting
Equation
OBJECTIVE 5: Define financial position, and
state the accounting equation.
Figure 5: The Accounting Equation
Financial Position and the Accounting
Equation
A balance sheet discloses a businesss financial
position by showing the relationship among assets,
liabilities, and stockholders equity.
The accounting equation is Assets = Liabilities +
Stockholders Equity.
Assets are a companys economic resources, such as
cash, receivables, inventory, and equipment.
Liabilities are the present obligations of a business,
such as amounts owed to banks, suppliers, employees,
and others.
Financial Position and the Accounting
Equation

Stockholders equity represents the claims of

the owner of a business to the net assets of the
business. It is made up of the stockholders
investment and all earnings not paid back to
the stockholders in the form of dividends.
Net income is the excess of revenues over
expenses; net loss is the excess of expenses
over revenues.
Financial Statements

OBJECTIVE 6: Identify the four basic financial

statements.
Exhibit 1: Income Statement for Weiss
Consultancy, Inc.
Exhibit 2: Statement of Retained Earnings
for Weiss Consultancy, Inc.
Exhibit 3: Balance Sheet for Weiss
Consultancy, Inc.
Exhibit 4: Statement of Cash Flows for
Weiss Consultancy, Inc.
Exhibit 5: Income Statement, Statement of
Retained Earnings, Balance Sheet, and Statement
of Cash Flows for Weiss Consultancy
Financial Statements

There are four basic financial statements that

are interrelated.
Income statement (also known as the statement of
earnings or the profit and loss statement)
Shows revenues earned and expenses incurred for a
period of time
Indicates profit or loss for an accounting period
Statement of Retained Earnings
Shows changes in retained earnings over a period of
time
Financial Statements

Balance sheet (also known as the statement of financial

position)
Usually prepared as of the last day of the accounting period to
show the organizations financial position (or status) as of that
specific date
Reflects the accounting equation in its structure
Statement of cash flows
Presents significant financing, investing, and operating
activities (cash-generating and cash-using activities) during a
given period
Explains the reasons for changes in the organizations cash
during an accounting period
Generally Accepting Accounting
Principles
OBJECTIVE 7: Explain how generally accepted
accounting principles (GAAP) and international
financial reporting standards (IFRS) relate to
financial statements and the independent CPAs
report, and identify the organizations that
influence GAAP.
Table 2: Large International Certified
Public Accounting Firms
Generally Accepting Accounting
Principles

GAAP are the conventions, rules, and

procedures that define acceptable accounting
practice at a particular time.
CPAs perform independent audits of businesses
financial statements.
An audit results in a professional opinion as to
whether the financial statements are in accordance
with GAAP.
Generally Accepting Accounting
Principles

Organizations that issue accounting standards

The FASB is responsible for developing GAAP.
The IASB sets international accounting standards.
More than 40 international financial reporting standards
(IFRS) have been approved.
Generally Accepting Accounting
Principles
Other Organizations that influence GAAP
The AICPA influences GAAP through advisory committees.
The PCAOB is a governmental body created by the
Sarbanes-Oxley Act to regulate the accounting profession.
The SEC sets its own standards for companies whose
securities are listed on the stock exchanges.
The GASB was established to issue accounting standards
for state and local governments.
IRS guidelines are established to collect taxes but play an
influential role in the establishment of accounting practices.
Generally Accepting Accounting
Principles

It is important for CPAs to conform to their code

of professional ethics because the public relies on
them for the following:
Integrity
Objectivity
Independence
Due care
Management accountants have a code of professional
ethics that addresses competence, confidentiality,
integrity, and objectivity.
Exhibit S-1: CVSs Income Statements
Exhibit S-2: CVSs Balance Sheets
Exhibit S-2: CVSs Balance Sheets (contd)
Exhibit S-3: CVSs Statements of Cash
Flows
Exhibit S-3: CVSs Statements of Cash
Flows
Exhibit S-4: CVSs Statements of
Shareholders Equity
Exhibit S-4: CVSs Statements of
Shareholders Equity
Exhibit S-4: CVSs Statements of
Shareholders Equity
Figure S-1: Auditors Report for CVS
Caremark Corporation
Supplement to Chapter 1: How to Read an
Annual Report

Components of an Annual Reports

Letter to the Stockholders
Financial Highlights
Description of the Company
Managements Discussion and Analysis
Supplement to Chapter 1: How to Read an
Annual Report

Financial Statements
Formal financial statements appear in an annual
report, usually in comparative form.
Consolidated financial statements are combined
statements of affiliated companies.
A statement of stockholders equity often replaces
the owners equity statement.
Supplement to Chapter 1: How to Read an
Annual Report

Notes to the Financial Statements

A summary of significant accounting policies
should accompany the financial statements.
Notes to the financial statements interpret portions
of the financial statements.
Corporations frequently issue interim financial
statements that cover less than a year.
Supplement to Chapter 1: How to Read an
Annual Report

An annual report usually includes a report of

managements responsibilities as well as
managements discussion and analysis of
operations.
Supplement to Chapter 1: How to Read an
Annual Report

The independent auditors report accompanies the

financial statements.
The first paragraph identifies the financial statements
and responsibilities.
The scope section describes the extent of the
examination.
The opinion section expresses the fairness of
presentation of the financial statements.
The fourth paragraph identifies any new accounting
standards adopted by the company
The fifth paragraph says the companys internal
controls are effective.