1. McGraw-Hill/Irwin
Chapter 1
The Nature and
Purpose of
Accounting
Copyright © 2011. The McGraw-Hill Companies. All Rights Reserved.

2. What Accounting Does
• Accounting is a system that provides
information on:
– Amounts of resources.
– How resources were financed.
– Results achieved by using resources.
• For either:
– Parties inside or outside of organization.
– Profit and nonprofit organizations.
1-2

3. Categories of Accounting
Information
• Operating
• Financial accounting.
• Management accounting.
• Tax accounting.
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4. Operating Information
• Needed to conduct day-to-day
activities.
• Largest quantity of accounting data.
• Examples:
– Hours worked by employees.
– Inventory on hand.
– Amounts owed by customers.
– Amount of money in bank.
1-4

5. Financial Accounting Information
• For external users (investors) and managers.
• Used by investors to make decisions to buy,
sell, or hold shares of a company.
• Annual report and its financial statements.
– Common rules used so investors can compare
with other companies’ financial statements.
– No “tailor-made” information
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6. Management Accounting
Information
• For internal users such as president,
marketing manager, production
manager, etc.
• Used for three management functions:
– Planning.
– Implementation.
– Control.
1-6

7. Planning
• Deciding what actions should be taken.
• Decision making involves:
1. Identify problem or opportunity.
2. Specify and rank criteria.
3. Identify alternatives.
4. Analyze alternatives.
5. Compare alternatives and select best.
1-7

8. Planning
• Budgeting
– Process of planning for a specified time,
often for one year.
– Objective is to coordinate plans to provide
consistency
1-8

9. Implementation
• Actions to provide human and other
resources to achieve planned results.
• Requires supervision by managers.
• Must change plans as conditions
require.
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10. Control
• Process to ensure employees perform
properly.
• Accounting information is used to:
– Communicate plans and expected actions.
– Motivate employees to act consistently with
organization’s goals.
– Focus attention on problem areas (via
feedback).
– Appraise performance of managers and other
employees.
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11. Tax Accounting Information
• Prepare returns for taxing authorities:
– Federal
– State
– Local
– International
• Tax accounting rules can differ from
financial accounting rules.
1-11

12. Definition of Accounting
• Process of:
– Identifying
– Measuring
– Communicating
• Economic information.
• To make decisions.
1-12

13. Accountants in Organizations
• Bookkeepers and other data entry
personnel.
– Maintain detailed operating records.
• Staff accountants.
– Prepare and interpret reports.
– Design and operate information systems.
– Ensure accuracy of information.
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14. Certified Public Accountants
(CPAs)
• Independent public accountants.
• Audit publicly owned companies and
provide other services.
• Licensed by state.
• Work in large firms, small firms,
independent practices.
• American Institute of CPAs (AICPA).
1-14

15. Public Company Accounting
Oversight Board (PCAOB)
• Monitors auditors of public companies.
• Has power to:
– Set auditing standards.
– Discipline auditors who do not follow
standards.
1-15

16. Other Professional Organizations
and Designations
• Institute of Management Accountants (IMA).
– Certified Management Accountants (CMAs).
• Institute of Internal Auditors (IIA).
– Certified Internal Auditors (CIAs).
• American Accounting Association (AAA).
– Academic accountants.
1-16

17. Role of Controller
• Top accounting manager.
• Oversees:
– Accounting professionals in areas of
management accounting, financial accounting,
and tax accounting.
– Requests for information and reports.
– Compliance with applicable rules and
regulations.
– Design, installation, and operation of
information systems. 1-17

18. Approaches to Study
Accounting
• Viewpoint of accountant (preparer).
– Collecting, summarizing and reporting accounting
information.
• Viewpoint of user.
– Understanding, analyzing, and interpreting
accounting reports to make decisions.
• Our authors:
– Emphasize perspective of current and potential
future users.
– However, recognize need for some knowledge of
how accounting reports are prepared.
1-18

19. Misconceptions about
Accounting
• Actual value or “worth” of a business
may not be included in usual financial
reports.
• Not all resources (assets) of
organizations are (or can be) measured
and reported.
– e.g., knowledge and skills of employees.
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20. Plan of Book/Course
• Part One: Financial Accounting
– Chapters 1-4: Overview of basic structure
underlying all accounting.
– Chapters 5-14: Reviews same material in more
detail.
• Part Two: Management Accounting
– Chapters 15-28.
– Often uses same or similar information as
financial accounting.
– But tailor-made to meet the needs of a specific
organization. 1-20

21. Financial Accounting Rules
• Terminology, rules and conventions
evolved over centuries.
• Rules that worked and were useful
were kept.
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22. Accounting:
The Language of Business
• But like any language:
– Many words have similar, but not same,
meaning.
– Some rules are definite others are not.
– Rules continue to evolve.
– Differing presentations.
• XBRL (extensible business reporting
language).
– Helps adjust for presentational differences.
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23. Accounting Principles
• General rule or law.
• Flexibility.
• Evolutionary.
• Criteria:
– Relevance. Useful and meaningful.
– Objectivity. Reliable and verifiable.
– Feasibility. Implemented without undue cost.
• Trade-off among criteria. 1-23

24. Generally Accepted Accounting
Principles (GAAP)
• Currently established by Financial
Accounting Standards Board (FASB).
– 7 member board with diverse
backgrounds.
– Supported by professional staff.
– Nongovernmental organization.
– Due process procedure to establish
standards.
1-24

25. Generally Accepted Accounting
Principles (GAAP)
• Not legally required.
• Emerging Issues Task Force for “quick
decisions”
• FASB Accounting Standards Codification
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26. Securities Exchange Commission
(SEC)
• U.S. agency empowered by Congress to
protect investors.
• Jurisdiction over publicly traded
companies.
• Enhances accounting rules through
Regulation S-X, Financial Reporting Series
Releases, and Staff Accounting Bulletins.
• Delegated authority for GAAP to FASB.
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27. International Accounting
Standards Board (IASB)
• International Financial Reporting
Standards (IFRS)
• No authority to require compliance.
• But, required by European Union (EU)
for listed companies.
• Similar to US GAAP in many ways.
• Convergence project with FASB.
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28. Financial Statements Required
by GAAP
• Statement of Financial Position (Balance
Sheet).
• Income Statement.
• Statement of Cash Flows.
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29. Status vs. Flow
• Status Report: Resources and
obligations at a point in time:
– Balance sheet.
• Flow Report: Activity over a period of
time:
– Income statement.
– Statement of cash flows.
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30. Sources of Financial Statements
• Company websites:
– www.cocacola.com
– www.ge.com
– www.microsoft.com
• SEC’s EDGAR:
– www.sec.gov
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31. Balance Sheet
Assets = Liabilities + Owners’ equity
Resources Sources of financing
1-31

32. Balance Sheet
• Assets: Resources of entity.
– Cash.
– Accounts Receivable.
– Inventory.
– Equipment.
– Investments.
– etc.
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33. Balance Sheet
• Liabilities: Claims by creditors.
– Accounts payable.
– Notes payable.
• Owners’ Equity: Claims by investors.
– Amounts provided directly by equity
investors (Paid-in-capital).
– Amounts retained from earnings, i.e.
profits (Retained earnings).
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34. Fundamental Accounting
Equation
• Assets = Liabilities + Owners’ Equity.
• Every accounting transaction maintains
equality of equation.
• Purchase $20,000 of equipment for cash.
– Increase Equipment (asset) by $20,000 and
decrease Cash (asset) by $20,000. No net change
to assets.
• Purchase $20,000 of equipment on credit.
– Increase Equipment (asset) by $20,000 and
increase Notes Payable (liability) by $20,000.
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35. Income Statement
• Summaries results of operating activity
over a period of time.
• Revenues – Expenses = Net Income.
• Net income (or net loss) is the amount
added to (subtracted from) Retained
earnings.
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36. Financial Statement
Objectives
• Is useful for investment decisions. (All
financial statements).
• Is comprehensible. (All financial statements).
• Shows economic resources and claims on
resources (Balance Sheet).
• Shows financial performance during a period
(Income Statement).
• Shows cash flows (Statement of Cash Flows).
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37. Sarbanes-Oxley Act (2002)
• Chief executives and chief financial
officers of public companies certify
financial statements filed with SEC are
materially accurate and complete.
• Potential civil and criminal liability.
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38. Financial vs. Income Tax vs.
Management Reporting
• Operating information summarized under
three different sets of rules.
• Differences among:
– Financial Reporting (GAAP).
– Income Tax Reporting (Congress and IRS).
– Management Reporting (Top management).
• Similarities tend to be greater than
differences.
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