SM 131: What is Accounting?
Liabilities
External Claims Against the Assets
Who uses accounting information? (F.A)
External parties: Investors, Creditors, Potential Employees, Government Agencies
Statement of Cash Flows
Financial statement that reports cash receipts and disbursements related to a firm's three major activities: operations, investments, and financing.
Assets
Future economic benefits
What is the focus of accounting? (M.A)
Planning, Directing and Controlling
Net Income
Profit
Setting Prices
Sales Data (quantity, region, competitor) Cost Data (to ensure making profit)
External Controls (who to minimize measurement error/bias)
auditors exchanges regulators institutional investors
Internal Controls (who to minimize measurement error/bias)
board of directors information systems internal auditors
Bonus
directly driven by accounting
Types of Accounting
financial and managerial
Measurement Error
some economic events are hard to measure (but not systematic)
Bias
systematically too low or too high
Steps for the accounting cycle
1. analyze source documents 2. record transactions in journals 3. transfer journal entries to ledger 4. take a trial balance 5. prepare financial statements 6. analyze financial statements
Three key questions in allocating capital (how do investors decide where put $)
1. what does the company have? 2. How has the company performed? 3. How risky is this investment?
balance sheet
A financial statement that reports assets, liabilities, and owner's equity on a specific date.
The Accounting Cycle
A six-step procedure that results in the preparation and analysis of the major financial statements.
ledger
A specialized accounting book/program where all information is in one place
Formula for Accounting
Accounting = Economic Truth + Measurement Error + Bias
balace sheet
Assets = Liabilities + Equity
Incentivizing People and Measuring their Performance
Compensation contracts (Bonus & Stock options)
How minimize measurement error / bias?
Governance (Internal Controls & External Controls)
Economic Truth
Is the center The economic event we wish to capture
Who uses accounting information? (M.A)
Internal parties: CEO's, Operations Managers, Marketing, HR Departments
Why does Accounting matter? (F.A)
Investors face an information asymmetry problem
Use of Resources - what managers do (internal perspective)
Make investments Manage costs Set pricing Incentivize employees
Why does Accounting matter? (M.A)
Managers need to make decisions
Equity
Residual Interest
Formula for income statement
Revenue - Expenses = Net Income
income statement
The financial statement that shows a firm's profit after costs, expenses, and taxes.
Accounting
The language of business A system for recording business transactions A set of rules to standardize investor information A source of data managers use to make decisions Applied information economics
What is the focus of accounting? (F.A)
Transaction Analysis, Financial Reporting, Audit, Tax
URACSI
Use of Resources Allocating Capital Safeguarding Information
Trial Balance
a summary of all the information in the account ledgers
annual report
a yearly statement of the financial condition, progress, and expectations of an organization
Stock options
indirectly driven by accounting
The Accounting System
inputs, processing, outputs
Key things to watch for and read in an annual report
management's discussion and analysis of operations balance sheet income statement statement of cash flows auditor's opinion
Manage costs
o Direct Materials o Direct Labor o Overhead *key components of managerial accounting
Make investments
o Where/how big to make factory o Choice of machine vs labor o Strategic additional investments o Incentivize people
double-entry bookkeeping
record all transactions in two places so they can check one list of transactions against the other for accuracy
