P

Financial and Managerial

Accounting

PART I: CONTEXT OF
ACCOUNTING.
Introduction to Accounting
 Introduction

This chapter introduces accounting and

provides a short history of management
accounting.
It describes the early role of the management
accountant and recent developments that have
influenced the role of non-financial managers
in relation to the use of financial information.
The chapter concludes with a critical
perspective on accounting history.
Introduction (Contd…)
Businesses exist to provide goods or
services to customers in exchange for a
financial reward.
Public-sector and not-for-profit
organizations also provide services,
although their funding comes not from
customers but from government or
charitable donations.
 Accounting: Definition

The American Accounting Association

defined accounting in 1966 as:
◦ The process of identifying, measuring
and communicating economic
information to permit informed
judgements and decisions by users of
the information.
What is Accounting?
Illustration
Three Activities The activities of the
accounting process

The accounting process includes

the bookkeeping function.

Financial Accounting and Management Accounting

 Accounting (Contd…)
This is an important definition because:

◦ It recognizes that accounting is a process: that

process is concerned with capturing business
events, recording their financial effect,
summarizing and reporting the result of those
effects, and interpreting those results;
◦ It is concerned with economic information;
◦ Its purpose is to support ‘informed judgements
and decisions’ by users:
Accounting (Contd…)

Accounting is a collection of systems

and processes used to record, report
and interpret business transactions.
Accounting is generally termed as the
language of business throughout the
world.
 Accounting(Cond.)
The final function of accounting is the
interpretation of the summarized data
in such a manner that the end-user can
make meaningful judgments about the
financial condition or the profitability
of the business operations or can use the
data in preparing future plans and
laying down policies to execute such
plans.
 A Short History of Accounting
Accounting has evolved through different
stage of development at different parts of the
world and at different periods of time
depending on the economic development of
the society.
The gradual increase in production and
economic transactions from time to time has,
depending on technological enhancement,
created difficulty to memorize and manage
all these economical events and compel
people to record.
 …. History of accounting

 According to Alexander (2002), people

started recording economic transactions for
the first time on clay in Mesopotamia and
then advanced to record on Papyrus in Egypt.
In the 5th century B.C., Greece used "public
accountants" to allow its citizenry to maintain
real authority and control over their
government's finances.
Perhaps the most important Greek
contribution to accountancy was its
introduction of coined money about 600 B.C.
… History of Accounting
 The innovative Italians of the
Renaissance (14th -16th century) are
widely acknowledged to be the fathers of
modern accounting.
Luca Pacioli was an Italian man, who is
known as the father of modern
accounting, invented the double-entry
system and published in book entitled
Summa de arithmetica, geometria,
Proportioni et proportionalita in 1494.
 History of Accounting….

The first professional accounting body was

formed in Venice in 1581.
The early accountants were ‘scribes’ who
also practiced law.
Stone (1969) noted that in ancient Egypt in
the pharaoh’s central finance department . . .
“Scribes prepared records of receipts and
disbursements of silver, corn and other
commodities.”
 The Accounting Equation

Assets = Liabilities + Stockholders’ equity

Economic Claims to
Resources Economic
Resources
 Functions of Accounting

Accounting is expected to perform the following, besides

book-keeping and reporting functions:
 To provide the means of guiding and controlling the business
activities;
 To analyze and interpret the results enabling the management
to find out what has happened, what is happing, what is going
to happen in the future and what ought to happen in the
interest of the company;
 To look into the future by providing the guidelines for
making wise decisions to achieve the corporate objective, etc.
 Functions of Accounting (Contd…)

Accounting as a
recordkeeping device.
Accounting as an
information system.
Accounting as a
service activity.
 Nature of Accounting
Accounting as a process.
Stewardship
function.
Accounting as a
means to an end.
 Objectives of Accounting
 To measure the resources held by
the entity.
Protection of equities, i.e., to
measure the claim against those
resources by the owners and out-
siders,
To measure the results and financial
condition of business.
 The General Objectives of Accounting: According to APB.
1. To provide quantitative financial information about a business enterprise that is useful to
the users, particularly the owners and creditors, in making economic decisions.
2. To provide reliable financial information about economic resources and obligations of a
business enterprise.
3. To provide reliable information about changes is not resources of an enterprise that
result from its profit directed activities.
4. To provide other needed information that assists in estimating the earning potential of
the enterprise.
5. To provide other needed information about changes in economic resources and
obligation.
6. To disclose, to the extent possible, other information related to the financial statements
that is relevant to the user.s needs.
Branches of Accounting

According to the purpose and level of

objectives, thus the general branch of
accounting may be classified into the
following:
 Financial Accounting,
 Cost Accounting,
 Management Accounting, etc
 Financial Accounting:

It is a branch of accounting which

aims at the supply of information to
the interested parties or decision
makers who are external to the
organizations including the owners
and the employees.
◦ The internal parties (management)
can also use these bits of
information.
Financial Accounting(Contd..)

However, financial Accounting is

primarily concerned with the recording
of day-to-day transactions –
◦ Both financial and operational –
◦ And also the preparation of financial
statements(viz., Profit and Loss
account, and Balance Sheet) which
form a prominent and compulsory part
of external reports(i.e. Annual
Reports.
 Cost Accounting

According
to the Chartered Institute of
Management Accountants (CIMA),
◦ Cost Accounting is the process of accounting
for cost from the point at which expenditure is
incurred or committed to the establishment of
its ultimate relationship with the cost centers
and cost units.
◦ In its widest usage, it embraces the preparation
of statistical data, the application of cost
control methods and the ascertainment of the
profitability of activities carried out or
planned.
 Management Accounting
The process of identification,
measurement, accumulation, analysis,
preparation, interpretation and
communication of financial information
used by management to plan, evaluate
and control with in organisation and to
assure appropriate use of and
accountability for its resources.
 Management Accounting(Contd…)
It deals with the internal reporting and
primarily with the furnishing of required and
relevant data to the managerial personnel for
the purpose of planning, controlling, and
decision making.
The type of accounting information required
by the management differs
◦ from one type of decision to another, and
◦ also from one level of management to
another.
The Role of Management Accounting
Financial, Managerial, and Cost Accounting
 Strategic Cost Management
and the Balanced Scorecard
Strategic cost management is an approach to
reducing costs while strengthening the
organization’s strategic position.
The balanced scorecard can be used to
formalize strategic cost management efforts
by detailing financial and nonfinancial
benchmarks for all segments of the
organization.
 Users of Accounting Information

There are two types of

users,
◦External Users
◦Internal Users
 Who Uses Accounting Data
Internal Users
Management IRS

Human Resources Investors

There are two broad groups of users of

financial information: internal users Labor Unions
and external users.
Finance

Creditors
Marketing
SEC
Customers External
Users
Scope of Accounting
It can be used to deal with
◦ Any organisational unit, whether business,
Governments, nations or individuals and
◦ It can be concerned equally with the
measurement of the flow of socio-economic
activities, whether or not expressed in
financial terms.
Uses of Accounting

Managerial Decisions
Managerial Planning
Managerial Control
Performance Evaluation
Assistance to External
Parties
 Fundamental Accounting Concepts and Principles.

“Accounting” is based on a number of rules or

conventions, which have evolved over time. These
principles are known as Generally Accepted
Accounting Principles (GAAPs).
Generally Accepted Accounting Principles
(GAAP) may be defined as those rules of action or
conduct, which are derived from experience and
practice, and when they prove useful, they are
accepted as principles of accounting.
 IFRSs
InternationalFinancial
Reporting Standards include:
◦IAS issued by IASC (from
1973 to 2001).
◦IFRS being issued by
IASB(since 2001.
1. GAAP…
 I. Assumptions

A.Business Entity
A. Going-Concern
B. Monetary Unit measurement
II. Concepts

A.Accounting Period
Concept.
B.The Objectivity
Concept.
C.The Dual-Aspect
Concept.
III. Principles

A. HistoricalCost Principle
B. Revenue Realization
Principle
C. Matching Principles
D. Full-Disclosure Principles
IV. Constraints

A.Materiality
B.Consistency
C.Conservatism
D.Cost-Benefit
Basis of Accounting

A basis of accounting can be

defined as the time various
financial transactions are
recorded.
1. Cash Basis of Accounting
2. Accrual Basis of Accounting
3. Hybrid Basis of Accounting
 1.9. Basic Financial Statements
The term financial statement refers to an
organized collection of data on the basis of
accounting principles and conventions to
disclose its financial information. The
following are the four basic financial
statements:
1. Income Statements (or Profit and Loss
Account)
2. Balance Sheet
3. Statement of Retained Earnings
4. Statement of Cash Flow
The Financial Statements

Income • Reports revenue and expenses

• Determines net income
statement

Balance • Reports assets, liabilities and

stockholders’ equity
sheet

Statement of • Reports changes in cash caused by

operating, financing, and investing
cash flows activities.
Objectives of Financial Statements.
The following are, among others, the important objectives of
financial statements:
 1) To provide adequate information about the source of
finance and obligations of the finance firm.
 2) To provide reliable information about the financial
performance and financial soundness of the concern.
 3) To provide sufficient information about results of
operations of business over a period of time.
 4) To provide useful information about the financial
conditions of the business and movement of resources in
and out of business.
 5) To provide necessary information to enable the users to
evaluate the earning performance of resources or managerial
performance in forecasting the earning potentials of
business.
 Accounting and its Relationship to Shareholder
Value and Corporate Governance.

• Accounting plays a vital role in

enhancing shareholder value and
corporate governance of share companies
through designing and implementing
adequate internal control in corporate
companies.
Corporate Governance

• Corporate Governance is the system of rules,

practices and processes by which a firm is directed
and controlled.
• Corporate Governance essentially involves
balancing the interests of a company's many
stakeholders, such as shareholders, management,
customers, suppliers, financiers, government and
the community.
 Corporate Governance
• Since the seventeenth century, companies have
been formed by shareholders in order to
consolidate resources and invest in opportunities.

• Shareholders had limited liability through which

their personal liability in the event of business
failure was limited to their investment in shares.
 Corporate Governance
• Shareholders have few direct rights in
relation to the conduct of the business.
• Their main powers are to elect the
directors and appoint the auditors in an
annual general meeting of shareholders.
• They are also entitled to an annual
report containing details of the
company’s financial performance.
 Capital Market

• The market in which investors buy and sell the

shares of companies is called the capital market,
which is normally associated with the Stock
Exchange.

• Companies obtain funds raised from shareholders

(equity) and borrowings from financiers (debt).

• Both of these constitute the capital employed in the

business.
 Capital Market (Contd…)

• The cost of capital represents the cost incurred by

the organization to fund all its investments,
comprising the cost of equity and the cost of debt
weighted by the mix of debt and equity.

• The cost of debt is interest, which is the price

charged by the lender.

• The cost of equity is partly dividend.

 Product Market

• Companies use their capital to invest in technologies,

people and materials in order to make, buy and sell
products or services to customers.

• This is called the product market.

• The focus of shareholder wealth, according to Rappaport

(1998), is to obtain funds at competitive rates from
capital markets and invest those funds to exploit
imperfections in product markets
 Accounting and strategy.
• Accounting is treated as part of the broader business context of
strategy, marketing, operations and human resources.

• The focus of accounting in business organizations is shareholder

value – increasing the value of the business to its shareholders–
through dividends from profits and/or through capital growth.

• Strategy both influences and is influenced by shareholder value.

• Strategy is reflected in the functional business areas of marketing,

operations and human resources, through the actions the business
wants to take to achieve, maintain and improve competitive
advantage.
 Shareholder value, Strategy and Accounting
• Their Relationship is depicted as
follow:

Shareholder Accounting
Strategy Value
 Shareholder value, Strategy and
Accounting
• A strategy is a “game plan” that enables a company to
attract customers by distinguishing itself from
competitors. The focal point of a company’s strategy
should be its target customers.
• A company can only succeed if it creates a reason for
customers to choose it over a competitor. These reasons,
or what are more formally called customer value
propositions , are the essence of strategy.
• Customer value propositions tend to fall into three broad
categories— customer intimacy, operational excellence,
and product leadership.
 A cross-functional orientation that seeks to improve the
business processes that deliver customer value.
A value chain, as shown in Exhibit 1–5, consists of
the major business functions that add value to a
company’s products and services.
 ROLE OF THE AIS IN THE
VALUE CHAIN
• Value is provided by performing a series of
activities referred to as the value chain.
These include:
• Primary activities
• Support activities
• These activities are sometimes referred to as
“line” and “staff” activities respectively.
THE AIS AND CORPORATE
STRATEGY
• The AIS should help a company adopt
and maintain its strategic position.
• Requires that data be collected about
each activity.
• Requires the collection and integration
of both financial and nonfinancial data.
END!