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ACC3000 Topic 1 Notes
Financial Managerial and Cost Accounting Concepts (ACC 3000)
Utah Valley University
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ACC-3000 Topic 1 Lecture and Textbook Notes
- TOPIC 1: THE NATURE AND PURPOSE OF FINANCIAL ACCOUNTING Table of Contents
- Slides
- What is Accounting and Why Does it Exist?
- Financial Statements
- The Need for Financial Accounting Standards
- Other Important Accounting-Related Organizations
- An Exciting Time to Study Accounting
- 1 The Nature and Purpose of Financial Accounting
- 1 What is Accounting and Why Does it Exist?
- 1 Quick Check
- 1 Financial Statements
- 1 Quick Check
- 1 Who Uses Financial Accounting Information?
- 1 Quick Check
- 1 The Need for Financial Accounting Standards
- 1 Quick Check
- 1 Other Important Accounting-Related Organizations
- 1 Quick Check
- 1 Right Now is an Exciting Time to be Studying Accounting
- 1 Quick Check
- 1 Review of Key Points
- Slides
1 The Nature and Purpose of Financial Accounting
Slides
What is Accounting and Why Does it Exist?
● Bookkeeping ○ Preservation of a systematic, quantitative record of an activity ■ Phone records ■ Apartment rent payment records ■ Class grading records ■ Sports statistics ● What if the following were to disappear tonight? ○ All novels ○ All college professors ○ => Horrible loss, but normal life would continue. ● What if the following were to disappear? ○ All bank records ○ All business account records ○ All college grading records ○ => Societal gridlock! How Old is Accounting? ● Clay tokens in Mesopotamia 7,000 years ago. ● Counting wheat and sheep ● Bookkeeping may be the earliest form of writing. A Practical Example: Your Checking Account ● Bookkeeping ○ Recording each transactions (date, payee, amount) ● Accounting ○ Use judgement in categorizing transactions ○ Analysis of non-routine events ○ Producing relevant reports to ■ Analyse the past ■ Assist in forecasting the future Dual Function of an Accounting System
○ How much profit did we make? ○ Net Income = Revenues > Expenses ● Statement of Cash Flows ○ For a period of time (such as a year) ○ Where did our cash come from? Where did it go? ○ Activities ■ Inflows of Cash (Receipts) ● Operating activities: ○ Selling goods ○ Providing services ● Investing activities: ○ Selling buildings ○ Selling land ● Financing activities: ○ Borrowing money ○ Receiving investments from owners ■ Outflows of Cash (Payments) ● Operating activities: ○ Paying wages ○ Paying utilities ○ Paying taxes ● Investing activities: ○ Purchasing buildings ○ Purchasing land ● Financing activities: ○ Repaying loans ○ Distributions to owners ● Provide information about the past that will help decision makers. ○ Evaluate the results of past decisions ○ Project the effect of future decisions
1 Who Uses Financial Accounting Information?
● Key External Users of Financial Accounting Data ○ Lenders
■ Will the loan be repaid? ■ Current income ■ Existing obligations ■ Existing assets ○ Investors ■ Is the business profitable now? ■ What is the potential for the future? ○ Suppliers (Can you pay?) ○ Customers (Will you be around in the future?) ○ Employees (Able to pay? Around for the long Term?) ○ Competitors (Where are you strong? Why? Weaknesses?) ○ Government Agencies (Regulation, Compliance) ○ Politicians (Making a point) ○ The Press (Background, Investigation Trigger) ● Key Internal Users of Financial Accounting Data ○ Management (of the company) ■ Planning ■ Daily monitoring ■ Evaluation ■ Uses both: ● Managerial accounting information ● Financial accounting information
The Need for Financial Accounting Standards
How to Report Land ● Should land be reported at ○ its original purchase price or ○ its current market price? ● Should each company choose how they want to report their land? What is Compensation Expense? ● A cash salary of $80, ● A new car with a value of $30, ● An option to become a 10% owner of the company in one year in exchange for an investment of $200,
● Created with the Securities Act of 1933 and the Securities Exchange Act of 1934 ● In response to ‘inventive’ disclosures that led, in part, to the stock market crash of 1929. ● Registration statements (prospectus) ○ Required before new debt or stock can be issued to the public ● Form 10-K ○ Filed annually ○ Includes audited financial statements ● Form 10-Q ○ Filed quarterly ○ Not formally audited ● Schedule 14A (proxy statement) ○ Filed annually (in advance of the shareholders’ meeting) ○ Executive compensation disclosure; shareholder proposals ● Broad Enforcement Powers ○ Alter or supplement rules of operation for stock exchanges ○ Suspend trading of a company’s stock ○ ‘De-list’ any security ○ Suspend brokers and dealers from working in the securities market ○ Investigate any suspected violation of SEC rules ○ Establish accounting rules and disclosure requirements American Institute of Certified Public Accountants (AICPA) ● Auditing standards ● Continuing education services ● Code of professional conduct for its members ● CPA Exam ● Certified Public Accountant (CPA) ○ Only a CPA can sign an audit report The Sarbanes-Oxley Act ● The period of late 2001 through early 2002 was an accounting nightmare ○ Enron ○ WorldCom ● Senator Paul Sarbanes ● Representative Michael G. Oxley
● July 2002 ● ‘SOX’ ● The most comprehensive legislation affecting financial reporting since the creation of the SEC in 1933 and 1934. ● PCAOB (Public Company Accounting Oversight Board) ○ Under the supervision of the SEC ■ Appoints members ■ Approves actions ○ Governmental standards for audits ○ Inspections ○ Investigations ● Constraints on Auditors ● Constraints on Management Internal Revenue Service (IRS) ● U. government agency that collects and regulates income taxes. ● Thor Power Tool (1979) ○ The primary goal of financial accounting is to provide useful information to management, shareholders, creditors, and other properly interested; the major responsibility of the accountant is to protect these parties from being misled. The primary goal of the income tax system, in contrast, is the equitable collection of revenue. International Accounting Standards Board (IASB) ● IASB (in London) establishes financial accounting rules for the world, except ● FASB (outside New York) establishes financial accounting rules for the U.
An Exciting Time to Study Accounting
Hot Topics in Accounting ● International Accounting Convergence ○ Will the U. Congress allow the financial accounting rules for its constituents to be set in London? ○ How about the Ministry of Finance in China - Will they allow accounting rules for Chinese state-owned enterprises to be set in London? ○ Enforcement and national politics are the remaining barriers to complete international convergence. ■ Possible Compromise: Condorsement
● In sum, an accounting system is used by a business (1) to handle routine bookkeeping tasks and (2) to structure the information so it can be used to evaluate the performance and status of the business. Dual Function of an Accounting System Step 1: Bookkeeping (keep track of information) → Step 2: Analysis (organize and evaluate accounting information) ● Accounting: A system of providing quantitative information, primarily financial in nature, about economic entities that is intended to be useful in making economic decisions. ● The key features of this definition are the following: ○ Numbers: Accounting is quantitative. This is a strength because numbers can be easily tabulated and summarized. It is a weakness because some important business events, such as a toxic waste spill and the associated lawsuits and countersuits, cannot be easily described by one or two numbers. ○ A financial dimension: The status and performance of a business is affected by and reflected in many dimensions—financial, personal relationships, community and environmental impact, and public image. Accounting focuses on just the financial dimension. ○ Usefulness: The practice of accounting is supported by a long tradition of theory; U. accounting rules in fact have a theoretical conceptual framework, and some people actually make a living as accounting theorists. However, in spite of its theoretical beauty, accounting exists only because it is useful. ○ Future decisions based on past information: Although accounting is the structured reporting of what has already occurred, this past information can only be useful if it impacts decisions about the future.
1 Quick Check
- Which of the following is NOT a function of accounting? a. Accumulating economic information about organizations b. Measuring economic information about organizations c. Executing sales transactions for organizations d. Communicating economic information about organizations
- Which of the following is true about the double-entry system of bookkeeping? a. It was developed in the 1300s-1400s in Italy. b. It was developed in the 1800s in Italy.
c. It was developed in the 1300s-1400s in France. d. It was developed in the 1800s in the United States. 3. Which of the following is the most correct definition of accounting? a. The preservation of a systematic, quantitative record of an activity. b. A system for providing quantitative information, primarily financial in nature, about economic entities that is intended to be useful in making economic decisions. c. The procedures and processes used by a company to analyze transactions and handle routine bookkeeping tasks. d. An entity without a profit objective, oriented toward providing services efficiently and effectively. 4. Which of the following is NOT typically true of accounting information? a. The information is quantitative in nature. b. The information is primarily financial in nature. c. The information relates to future time periods. d. The information relates to specific accounting entities. 5. Which of the following is NOT a key component of the definition of accounting?
Financial Statements
b. Qualitative c. Decision-Oriented d. Useful
1 Financial Statements
● Users of accounting information can be divided into two major groups: 1. Internal users, such as managers and executives who actually work in the company 2. External users, such as potential lenders and investors ● This textbook focuses on financial accounting. ○ Financial Accounting: The name given to accounting information provided for and used by external users. ● Managerial Accounting: The name given to accounting systems designed for internal users. ● From an accounting standpoint,the crucial difference between internal users and external users is that internal users, because the y work within the company, have the power to custom design accounting reports to meet their specific needs. External users typically must rely on general purpose financial information provided by the company.
Statement of Cash Flows ● Statement of Cash Flows: Reports the amount of cash collected and paid out by a company in the following three types of activities: operating, investing, and financing. ● The statement of cash flows is the most objective of the financial statements because it involves a minimum of accounting estimates and judgments. ● Example of statement of cash flows:
○ Note that no detail about cash from operations is given reason is that because of some traditional accounting reporting practices, companies are not required to report cash expenditures by category, such as cash paid to employees, cash paid for rent, and the like.
1 Quick Check
- Which of the following is NOT one of the three primary financial statements? a. Statement of retained earnings b. Balance sheet c. Statement of cash flows d. Income statement
- Which of the following financial statements reports a company’s resources, obligations, and owner’s equity? a. Statement of retained earnings b. Balance sheet c. Statement of cash flows d. Income statement
● Financial statements, coupled with a knowledge of business plans, market forecasts, and the character of management, can aid investors in assessing future cash flows, such as dividends to be received. ● Obviously, millions of Americans invest in McDonald’s, Microsoft, and so on without ever seeing the financial statements of these companies. ● Investors can feel justifiably safe in doing this because large companies are followed by armies of financial analysts who would quickly blow the whistle if they found information suggesting that investors in these companies were at serious risk. ● But how about investing in a smaller company? In cases such as these, investing without looking at the financial statements is like jumping off the high diving board without looking first to see if there is any water in the pool. Management ● Managers and executives who work inside a company have access to specialized managerial accounting information that is not available to outsiders. ● In addition to managerial accounting information, managers of a company can use the general financial accounting information that is also made available to outsiders. Company goals are often stated in terms of financial accounting numbers such as a target of sales growth in excess of 5 percent. ● Reported net income is frequently used in calculating management bonuses. Managers of a company can analyze its general purpose financial statements to pinpoint areas of weakness requiring more detailed managerial accounting information. Suppliers and Customers ● In some settings, suppliers and customers are interested in the long-run staying power of a company. ○ For example, on the supplier side, if Boeing receives an order from an airline for 30 new 787s over the next 10 years, Boeing wants to know whether the airline will be around in the future to take delivery of (and pay for) the planes. ○ On the customer side, a homeowner who has foundation repair work done wants to know whether the repair company will be around for the next 50 years to honor its 50-year guarantee. ● Financial statements provide information that suppliers and customers can use to assess the long-run prospects of a company. Employees
● Employees are interested in financial accounting information for a variety of reasons. ● Financial statement data are used in determining employee bonuses. ● In addition, financial accounting information can help an employee evaluate the employer’s ability to fulfill its long-run promises, such as for pensions and retiree health care benefits. ● Financial statements are also important in contract negotiations between labor and management, as illustrated by the continuing cycle of negotiations and strikes in major league baseball. If the teams are profitable, the players can ask for more salary money. If the teams are losing money, the players’ salary demands must be tempered. ● Financial statements are keys at the bargaining table. Competitors ● Caution: Financial accounting information is not used to compute taxable income. Tax returns filed with the Internal Revenue Service (IRS) are prepared under a separate set of rules. ● If you were a manager at PepsiCo, you would be interested in the relative profitability of Coca-Cola operations. That information could help you identify strategic opportunities for marketing pushes where potential profits are high or where your competitor is weak. ● Whenever accounting rules are changed to require companies to publicly disclose more information, companies complain that they are being required to tell their secrets to their competitors. One of the challenges in setting accounting standards is ensuring that companies reveal enough information to be useful to outsiders without also requiring them to harm their competitive position by making confidential data available to competitors. Government Agencies ● Federal and state government agencies make frequent use of financial accounting information. For example, in order to make sure that investors have sufficient information to make informed investment decisions, the Securities and Exchange Commission (SEC) monitors the financial accounting disclosures of companies (both U. and foeign) whose stocks trade on U. stock exchanges. ● The International Trade Commission uses financial accounting information to determine whether importation of Ecuadorian roses or Chinese textiles is harming U. companies through unfair trade practices. The Justice Department uses financial statement data to evaluate whether companies (such as Microsoft or Google) are earning excess monopolistic profits. State agencies, such as public utility commissions and insurance commissions, use financial statements and other accounting information in setting and/or approving utility and insurance rates. Politicians
1 The Need for Financial Accounting Standards
● Imagine a company that compensates a key employee in the following ways: ○ A cash salary of $80, ○ A new car with a value of $30, ○ An option to become a 10 percent owner of the company in one year in exchange for an investment of $200, ● If the company does well in the coming year, the company will increase in value, the $200, price tag for 10 percent ownership will look like a great deal, and the employee will exercise the option. If the company does poorly, it will decline in value, the $200,000 price will be too much, and the employee will throw the option away and forget the whole thing. The company also sells these ownership options to interested outside investors for $25,000. ● How would you summarize in one number the company's compensation cost associated with this employee? We would probably all agree to include the $110,000 ($80,000 + $30,000) compensation cost from the cash salary and the new car. What about the option? The following two arguments could be put forward: ○ If the employee were to buy the option from the company just like any other outside investor, the employee would have to pay $25,000. Therefore, giving the option to the employee is just like paying them $25,000 cash. The $25,000 value of the option should be added to compensation cost. ○ The option doesn't cost the company a thing. In fact, the option merely increases the probability that the employee will invest $200,000 in the company in the future. The option doesn't add a penny to the compensation cost. ● So which argument is right? Should each company decide for itself whether to include the $25,000 option value as part of compensation cost, or should there be an overall accounting standard followed by all companies? And if there is a standard, who sets it? ● The option compensation issue created a huge controversy in the U. in 1994. ● Because financial accounting information is designed to be used by people outside a company, it is important that outsiders understand the rules and assumptions used by the company in constructing its financial statements. A company’s rules and assumptions would be extremely difficult and costly for outsiders to discover if every company formulated its own set of accounting rules.
○ In most countries in the world, a committee or board exists to establish the accounting rules for that country. Financial Accounting Standards Board (FASB) ● Financial Accounting Standards Board (FASB): Sets the accounting standards in the United States. ● Based in Norwalk, Connecticut; its seven full-time members are selected from a variety of backgrounds—professional accounting, business, government, and academia. ● It receives most of its $36 million annual operating budget through annual accounting support fees from public companies, as required under the Sarbanes-Oxley Act. The remainder is generated through donations and through sales of publications and other services. ● The FASB is not a government agency; it is a private body established and supported by the joint efforts of the U. business community, financial analysts, and practicing accounts. ● Because the FASB is not a government agency, it lacks the legal power to enforce the accounting standards it sets. ● Maintains its influence as the accounting standard-setter for the U. (and the most influential accounting body in the world) by carefully protecting its prestige and reputation for setting good standards. ○ FASB must walk a fine line between constant improvement of accounting practices to provide fuller and fairer information for external users and practical constraints on financial disclosure to appease businesses that are reluctant to disclose too much information to outsiders. ○ To balance these opposing forces, the FASB seeks consensus by requesting written comments and sponsoring public hearings on all of its proposed standards. ○ The end result of this public process is a set of accounting rules described as being “generally accepted accounting principles” (GAAP). ● FASB: ○ Established in 1973 ○ Appointed its first female board member in 2001 ○ Pays each board member around $300,000 per year. ● The FASB replaced the previously existing accounting standards body, the Accounting Principle Board, which had lost its credibility as it was seen as being completely controlled by accountants. ● The FASB has deliberated over the correct way to compute motion picture profits, the appropriate treatment of the cost of dismantling a nuclear power plant, the best approach for reflecting the
ACC3000 Topic 1 Notes
Course: Financial Managerial and Cost Accounting Concepts (ACC 3000)
University: Utah Valley University
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