The Role of Accounting in Society

1. The Role of Accounting in Society

Figure 1.1 Careers and Accounting. Promotional opportunities throughout a person's career may involve managerial responsibilities and often include responsibility for a portion of the organization's financial performance. Having an understanding of how accounting affects businesses can help the individual to be successful in meeting the organization's strategic and financial goals.

Jennifer has been in the social work profession for over 25 years. After graduating college, she started working at an agency that provided services to homeless women and children. Part of her role was to work directly with the homeless women and children to help them acquire adequate shelter and other necessities. Jennifer currently serves as the director of an organization that provides mentoring services to local youth.

Looking back on her career in the social work field, Jennifer indicates that there are two things that surprised her. The first thing that surprised her was that as a trained social worker she would ultimately become a director of a social work agency and would be required to make financial decisions about programs and how the money is spent. As a college student, she thought social workers would spend their entire careers providing direct support to their clients. The second thing that surprised her was how valuable it is for directors to have an understanding of accounting. She notes, "The best advice I received in college was when my advisor suggested I take an accounting course. As a social work student, I was reluctant to do so because I did not see the relevance. I didn't realize so much of an administrator's role involves dealing with financial issues. I'm thankful that I took the advice and studied accounting. For example, I was surprised that I would be expected to routinely present to the board our agency's financial performance. The board includes several business professionals and leaders from other agencies. Knowing the accounting terms and having a good understanding of the information contained in the financial reports gives me a lot of confidence when answering their questions. In addition, understanding what influences the financial performance of our agency better prepares me to plan for the future".

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1.1. Explain the Importance of Accounting and Distinguish between Financial and Managerial Accounting

Accounting 

Accounting is the process of organizing, analyzing, and communicating financial information that is used for decision-making. Financial information is typically prepared by accountants -those trained in the specific techniques and practices of the profession. This course explores many of the topics and techniques related to the accounting profession. While many students will directly apply the knowledge gained in this course to continue their education and become accountants and business professionals, others might pursue different career paths. However, a solid understanding of accounting can for many still serve as a useful resource. In fact, it is hard to think of a profession where a foundation in the principles of accounting would not be beneficial. Therefore, one of the goals of this course is to provide a solid understanding of how financial information is prepared and used in the workplace, regardless of your particular career path.

Think It Through

Expertise

Every job or career requires a certain level of technical expertise and an understanding of the key aspects necessary to be successful. The time required to develop the expertise for a particular job or career varies from several months to much longer. For instance, doctors, in addition to the many years invested in the classroom, invest a significant amount of time providing care to patients under the supervision of more experienced doctors. This helps medical professionals develop the necessary skills to quickly and effectively diagnose and treat the various medical conditions they spent so many years learning about.

Figure 1.2 College Graduation

Accounting also typically takes specialized training. Top accounting managers often invest many years and have a significant amount of experience mastering complex financial transactions. Also, in addition to attending college, earning professional certifications and investing in continuing education is necessary to develop a skill set sufficient to become experts in an accounting professional field.

The level and type of training in accounting are often dependent on which of the myriad options of accounting fields the potential accountant chooses to enter. To familiarize you with some potential opportunities, Describe the Varied Career Paths Open to Individuals with an Accounting Education examines many of these career options. In addition to covering an assortment of possible career opportunities, we address some of the educational and experiential certifications that are available. Why do you think accountants (and doctors) need to be certified and secure continuing education? In your response, defend your position with examples.

In addition to doctors and accountants, what other professions can you think of that might require a significant investment of time and effort in order to develop expertise?

A traditional adage states that "accounting is the language of business".  While that is true, you can also say that "accounting is the language of life". At some point, most people will make a decision that relies on accounting information. For example, you may have to decide whether it is better to lease or buy a vehicle. Likewise, a college graduate may have to decide whether it is better to take a higher-paying job in a bigger city (where the cost of living is also higher) or a job in a smaller community where both the pay and cost of living may be lower.

In a professional setting, a theater manager may want to know if the most recent play was profitable. Similarly, the owner of the local plumbing business may want to know whether it is worthwhile to pay an employee to be "on call" for emergencies during off-hours and weekends. Whether personal or professional, accounting information plays a vital role in all of these decisions.

You may have noticed that the decisions in these scenarios would be based on factors that include both financial and nonfinancial information. For instance, when deciding whether to lease or buy a vehicle, you would consider not only the monthly payments but also such factors as vehicle maintenance and reliability. The college graduate considering two job offers might weigh factors such as working hours, ease of commuting, and options for shopping and entertainment. The theater manager would analyze the proceeds from ticket sales and sponsorships as well as the expenses for the production of the play and operating the concessions. In addition, the theater manager should consider how the financial performance of the play might have been influenced by the marketing of the play, the weather during the performances, and other factors such as competing events during the time of the play. All of these factors, both financial and nonfinancial, are relevant to the financial performance of the play. In addition to the additional cost of having an employee "on call" during evenings and weekends, the owner of the local plumbing business would consider nonfinancial factors in the decision. For instance, if there are no other plumbing businesses that offer services during evenings and weekends, offering emergency service might give the business a strategic advantage that could increase overall sales by attracting new customers.

This course explores the role that accounting plays in society. You will learn about financial accounting, which measures the financial performance of an organization using standard conventions to prepare and distribute financial reports. Financial accounting is used to generate information for stakeholders outside of an organization, such as owners, stockholders, lenders, and governmental entities such as the Securities and Exchange Commission (SEC) and the Internal Revenue Service (IRS).

Financial accounting is also a foundation for understanding managerial accounting, which uses both financial and non-financial information as a basis for making decisions within an organization with the purpose of equipping decision-makers to set and evaluate business goals by determining what information they need to make a particular decision and how to analyze and communicate this information. Managerial accounting information tends to be used internally, for such purposes as budgeting, pricing, and determining production costs. Since the information is generally used internally, you do not see the same need for financial oversight in an organization's managerial data.

You will also note in your financial accounting studies that there are governmental and organizational entities that oversee the accounting processes and systems that are used in financial accounting. These entities include organizations such as the Securities and Exchange Commission (SEC), the Financial Accounting Standards Board (FASB), the American Institute of Certified Public Accountants (AICPA), and the Public Company Accounting Oversight Board (PCAOB). The PCAOB was created after several major cases of corporate fraud, leading to the Sarbanes-Oxley Act of 2002, known as SOX. If you choose to pursue more advanced accounting courses, especially auditing courses, you will address the SOX in much greater detail.

For now, it is not necessary to go into greater detail about the mechanics of these organizations or other accounting and financial legislation. You just need to have a basic understanding that they function to provide a degree of protection for those outside of the organization who rely on the financial information.

Whether or not you aspire to become an accountant, understanding financial and managerial accounting is valuable and necessary for practically any career you will pursue. Management of a car manufacturer, for example, would use both financial and managerial accounting information to help improve the business. Financial accounting information is valuable as it measures whether or not the company was financially successful. Knowing this provides management with an opportunity to repeat activities that have proven effective and to make adjustments in areas in which the company has underperformed. Managerial accounting information is likewise valuable. Managers of the car manufacturer may want to know, for example, how much scrap is generated from a particular area in the manufacturing process. While identifying and improving the manufacturing process (i.e., reducing scrap) helps the company financially, it may also help other areas of the production process that are indirectly related, such as poor quality and shipping delays.

1.2. Identify Users of Accounting Information and How They Apply Information

The ultimate goal of accounting is to provide information that is useful for decision-making. Users of accounting information are generally divided into two categories: internal and external. Internal users are those within an organization who use financial information to make day-to-day decisions. Internal users include managers and other employees who use financial information to confirm past results and help make adjustments for future activities.

External users are those outside of the organization who use the financial information to make decisions or to evaluate an entity's performance. For example, investors, financial analysts, loan officers, governmental auditors, such as IRS agents, and an assortment of other stakeholders are classified as external users, while still having an interest in an organization's financial information. (Stakeholders are addressed in greater detail in Explain Why Accounting Is Important to Business Stakeholders).

Characteristics, Users, and Sources of Financial Accounting Information

Organizations measure financial performance in monetary terms. In the United States, the dollar is used as the standard measurement basis. Measuring financial performance in monetary terms allows managers to compare the organization's performance to previous periods, to expectations, and to other organizations or industry standards.

Financial accounting is one of the broad categories in the study of accounting. While some industries and types of organizations have variations in how the financial information is prepared and communicated, accountants generally use the same methodologies -called accounting standards- to prepare the financial information. You learn in Introduction to Financial Statements that financial information is primarily communicated through financial statements, which include the Income Statement, Statement of Owner's Equity, Balance Sheet, and Statement of Cash Flows and Disclosures. These financial statements ensure the information is consistent from period to period and generally comparable between organizations. The conventions also ensure that the information provided is both reliable and relevant to the user.

Virtually every activity and event that occurs in a business has an associated cost or value and is known as a transaction. Part of an accountant's responsibility is to quantify these activities and events. In this course, you will learn about the many types of transactions that occur within a business. You will also examine the effects of these transactions, including their impact on the financial position of the entity.

Accountants often use computerized accounting systems to record and summarize financial reports, which offer many benefits. The primary benefit of a computerized accounting system is the efficiency by which transactions can be recorded and summarized, and financial reports prepared. In addition, computerized accounting systems store data, which allows organizations to easily extract historical financial information.

Common computerized accounting systems include QuickBooks, which is designed for small organizations, and SAP, which is designed for large and/or multinational organizations. QuickBooks is popular with smaller, less complex entities. It is less expensive than more sophisticated software packages, such as Oracle or SAP, and the QuickBooks skills that accountants developed at previous employers tend to be applicable to the needs of new employers, which can reduce both training time and costs spent on acclimating new employees to an employer's software system. Also, being familiar with a common software package such as QuickBooks helps provide employment mobility when workers wish to reenter the job market.

While QuickBooks has many advantages, once a company's operations reach a certain level of complexity, it will need a basic software package or platform, such as Oracle or SAP, which is then customized to meet the unique informational needs of the entity.

Financial accounting information is mostly historical in nature, although companies and other entities also incorporate estimates into their accounting processes. For example, you will learn how to use estimates to determine bad debt expenses or depreciation expenses for assets that will be used over a multi-year lifetime. That is, accountants prepare financial reports that summarize what has already occurred in an organization. This information provides what is called feedback value. The benefit of reporting what has already occurred is the reliability of the information. Accountants can, with a fair amount of confidence, accurately report the financial performance of the organization related to past activities. The feedback value offered by the accounting information is particularly useful to internal users. That is, reviewing how the organization performed in the past can help managers and other employees make better decisions about and adjustments to future activities.

Financial information has limitations, however, as a predictive tool. Business involves a large amount of uncertainty, and accountants cannot predict how the organization will perform in the future. However, by observing historical financial information, users of the information can detect patterns or trends that may be useful for estimating the company's future financial performance. Collecting and analyzing a series of historical financial data is useful to both internal and external users. For example, internal users can use financial information as a predictive tool to assess whether the long-term financial performance of the organization aligns with its long-term strategic goals.

External users also use the historical pattern of an organization's financial performance as a predictive tool. For example, when deciding whether to loan money to an organization, a bank may require a certain number of years of financial statements and other financial information from the organization. The bank will assess the historical performance in order to make an informed decision about the organization's ability to repay the loan and interest (the cost of borrowing money). Similarly, a potential investor may look at a business's past financial performance in order to assess whether or not to invest money in the company. In this scenario, the investor wants to know if the organization will provide a sufficient and consistent return on the investment. In these scenarios, the financial information provides value to the process of allocating scarce resources (money). If potential lenders and investors determine the organization is a worthwhile investment, money will be provided, and, if all goes well, those funds will be used by the organization to generate additional value at a rate greater than the alternate uses of the money.

Characteristics, Users, and Sources of Managerial Accounting Information

As you've learned, managerial accounting information is different from financial accounting information in several respects. Accountants use formal accounting standards in financial accounting. These accounting standards are referred to as generally accepted accounting principles (GAAP) and are the common set of rules, standards, and procedures that publicly traded companies must follow when composing their financial statements. The previously mentioned Financial Accounting Standards Board (FASB), an independent, nonprofit organization that sets financial accounting and reporting standards for both public and private sector businesses in the United States, uses the GAAP guidelines as the foundation for its system of accepted accounting methods and practices, reports, and other documents.

Since most managerial accounting activities are conducted for internal uses and applications, managerial accounting is not prepared using a comprehensive, prescribed set of conventions similar to those required by financial accounting. This is because managerial accountants provide managerial accounting information that is intended to serve the needs of internal, rather than external, users. In fact, managerial accounting information is rarely shared with those outside of the organization. Since the information often includes strategic or competitive decisions, managerial accounting information is often closely protected. The business environment is constantly changing, and managers and decision-makers within organizations need a variety of information in order to view or assess issues from multiple perspectives.

Accountants must be adaptable and flexible in their ability to generate the necessary information management decision-making. For example, information derived from a computerized accounting system is often the starting point for obtaining managerial accounting information. But accountants must also be able to extract information from other sources (internal and external) and analyze the data using mathematical, formula-driven software (such as Microsoft Excel).

Management accounting information as a term encompasses many activities within an organization. Preparing a budget, for example, allows an organization to estimate the financial performance for the upcoming year or years and plan for adjustments to scale operations according to the projections. Accountants often lead the budgeting process by gathering information from internal (estimates from the sales and engineering departments, for example) and external (trade groups and economic forecasts, for example) sources. These data are then compiled and presented to decision-makers within the organization.

Examples of other decisions that require management accounting information include whether an organization should repair or replace equipment, make products internally or purchase the items from outside vendors, and hire additional workers or use automation.

As you have learned, management accounting information uses both financial and nonfinancial information. This is important because there are situations in which a purely financial analysis might lead to one decision while considering nonfinancial information might lead to a different decision. For example, suppose a financial analysis indicates that a particular product is unprofitable and should no longer be offered by a company. If the company fails to consider that customers also purchase a complementary good (you might recall that term from your study of economics), the company may be making the wrong decision. For example, assume that you have a company that produces and sells both computer printers and replacement ink cartridges. If the company decided to eliminate the printers, then it would also lose the cartridge sales. In the past, in some cases, the elimination of one component, such as printers, led to customers switching to a different producer for their computers and other peripheral hardware. In the end, an organization needs to consider both the financial and non-financial aspects of a decision, and sometimes the effects are not intuitively obvious at the time of the decision. Figure 1.3 offers an overview of some of the differences between financial and managerial accounting.

Figure 1.3 Comparing Reports between Financial and Managerial Accounting.

1.3. Describe Typical Accounting Activities and the Role Accountants Play in Identifying, Recording, and Reporting Financial Activities

We can classify organizations into three categories: for-profit, governmental, and not-for-profit. These organizations are similar in several aspects. For example, each of these organizations has inflows and outflows of cash and other resources, such as equipment, furniture, and land, that must be managed. In addition, all of these organizations are formed for a specific purpose or mission and want to use the available resources in an efficient manner - the organizations strive to be good stewards, with the underlying premise of being profitable. Finally, each of the organizations makes a unique and valuable contribution to society. Given the similarities, it is clear that all of these organizations have a need for accounting information and for accountants to provide that information.

There are also several differences. The main difference that distinguishes these organizations is the primary purpose or mission of the organization, discussed in the following sections.

For-Profit Businesses

As the name implies, the primary purpose or mission of a for-profit business is to earn a profit by selling goods and services. There are many reasons why a for-profit business seeks to earn a profit. The profits generated by these organizations might be used to create value for employees in the form of pay raises for existing employees as well as hiring additional workers. In addition, profits can be reinvested in the business to create value in the form of research and development, equipment upgrades, facilities expansions, and many other activities that make the business more competitive. Many companies also engage in charitable activities, such as donating money, donating products, or allowing employees to volunteer in the communities. Finally, profits can also be shared with employees in the form of either bonuses or commissions as well as with owners of the business as a reward for the owners' investment in the business. These issues, along with others, and the associated accounting conventions will be explored throughout this course.

In for-profit businesses, accounting information is used to measure the financial performance of the organization and to help ensure that resources are being used efficiently. Efficiently using existing resources allows the businesses to improve the quality of the products and services offered, remain competitive in the marketplace, expand when appropriate, and ensure the longevity of the business.

For-profit businesses can be further categorized by the types of products or services the business provides. Let's examine three types of for-profit businesses: manufacturing, retail (or merchandising), and service.

Manufacturing Businesses

A manufacturing business is a for-profit business that is designed to make a specific product or products. Manufacturers specialize in procuring components in the most basic form (often called direct or raw materials) and transforming the components into a finished product that is often drastically different from the original components.

As you think about the products you use every day, you are probably already familiar with products made by manufacturing firms. Examples of products made by manufacturing firms include automobiles, clothes, cell phones, computers, and many other products that are used every day by millions of consumers.

In Job Order Costing, you will examine the process of job costing, learning how manufacturing firms transform basic components into finished, sellable products and the techniques accountants use to record the costs associated with these activities.

Concepts In Practice

Think about the items you have used today. Make a list of the products that were created by manufacturing firms. How many can you think of? Think of the many components that went into some of the items you use. Do you think the items were made by machines or by hand?

If you are in a classroom with other students, see who has used the greatest number of items today. Or, see who used the item that would be the most complex to manufacture.

If you are able, you might consider arranging a tour of a local manufacturer. Many manufacturers are happy to give tours of the facilities and describe the many complex processes that are involved in making the products. On your tour, take note of the many job functions that are required to make those items – from ordering the materials to delivering them to the customer.

Retail Businesses

Manufacturing businesses and retail (or merchandising) businesses are similar in that both are for-profit businesses that sell products to consumers. In the case of manufacturing firms, by adding direct labor, manufacturing overhead (such as utilities, rent, and depreciation), and other direct materials, raw components are converted into a finished product that is sold to consumers. A retail business (or merchandising business), on the other hand, is a for-profit business that purchases products (called inventory) and then resells the products without altering them – that is, the products are sold directly to the consumer in the same condition (production state) as purchased.

Examples of retail firms are plentiful. Automobile dealerships, clothes, cell phones, and computers are all examples of everyday products that are purchased and sold by retail firms. What distinguishes a manufacturing firm from a retail firm is that in a retail firm, the products are sold in the same condition as when the products were purchased – no further alterations were made to the products.

Did you happen to notice that the product examples listed in the preceding paragraph (automobiles, clothes, cell phones, and computers) for manufacturing firms and retail firms are identical? If so, congratulations, because you are paying close attention to the details. These products are used as examples in two different contexts -that is, manufacturing firms make these products, and retail firms sell these products. These products are relevant to both manufacturing and retail because they are examples of goods that are both manufactured and sold directly to the consumer. While there are instances when a manufacturing firm also serves as the retail firm (Dell computers, for example), it is often the case that products will be manufactured and sold by separate firms.

Concepts In Practice

NIKEiD is a program that allows consumers to design and purchase customized equipment, clothes, and shoes. In 2007, Nike opened its first NIKEiD studio at Niketown in New York City. Since its debut in 1999, the NIKEiD concept has flourished, and Nike has partnered with professional athletes to showcase their designs that, along with featured consumer designs, are available for purchase on the NIKEiD website.

Figure 1.4 NIKEiD Launch Store in Shanghai.

Assume you are the manager of a sporting goods store that sells Nike shoes. Think about the concept of NIKEiD, and consider the impact that this concept might have on your store sales. Would this positively or negatively impact the sale of Nike shoes in your store? What are steps you could take to leverage the NIKEiD concept to help increase your own store's sales?

Considerations like this are examples of what marketing professionals would address. Nike wants to ensure this concept does not negatively impact the existing relationships it has, and Nike works to ensure this program is also beneficial to its existing distribution partners.

In Merchandising Transactions you will learn about merchandising transactions, which include concepts and specific accounting practices for retail firms. You will learn, among other things, how to account for purchasing products from suppliers, selling the products to customers, and preparing the financial reports for retail firms.

Service Businesses

As the term implies, service businesses are businesses that provide services to customers. A major difference between manufacturing and retail firms and service firms is that service firms do not have a tangible product that is sold to customers. Instead, a service business does not sell tangible products to customers but rather provides intangible benefits (services) to customers. A service business can be either a for-profit or a not-for-profit business. Figure 1.5 illustrates the distinction between manufacturing, retail, and service businesses.

Examples of service-oriented businesses include hotels, cab services, entertainment, and tax preparers. Efficiency is one advantage service businesses offer to their customers. For example, while taxpayers can certainly read the tax code, read the instructions, and complete the forms necessary to file their annual tax returns, many choose to take their tax returns to a person who has specialized training and experience in preparing tax returns. Although it is more expensive to do so, many feel it is a worthwhile investment because the tax professional has invested the time and has the knowledge to prepare the forms properly and in a timely manner. Hiring a tax preparer is efficient for the taxpayer because it allows the taxpayer to file the required forms without having to invest numerous hours researching and preparing the forms.

The accounting conventions for service businesses are similar to the accounting conventions for manufacturing and retail businesses. In fact, the accounting for service businesses is easier in one respect. Because service businesses do not sell tangible products, there is no need to account for products that are being held for sale (inventory). Therefore, while we briefly discuss service businesses, we'll focus mostly on accounting for manufacturing and retail businesses.

Figure 1.5 Manufacturing, Retail, and Service. An auto manufacturing plant, a car sales lot, and a taxi represent three types of businesses: manufacturing, retail, and service.

Your Turn

So far, you've learned about three types of for-profit businesses: manufacturing, retail, and service. Previously, you saw how some firms such as Dell serve as both manufacturers and retailers.

Now, think of the last restaurant where you ate. Of the three business types (manufacturer, retailer, or service provider), how would you categorize the restaurant? Is it a manufacturer? A retailer? A service provider? Can you think of examples of how a restaurant has characteristics of all three types of businesses?

Solution

Answers will vary. Responses may initially consider a restaurant to be only a service provider. Students may also recognize that a restaurant possesses aspects of a manufacturer (by preparing the meals), retailer (by selling merchandise and/or gift cards), and service provider (by waiting on customers).

Governmental Entities

A governmental entity provides services to the general public (taxpayers). Governmental agencies exist at the federal, state, and local levels. These entities are funded through the issuance of taxes and other fees.

Accountants working in governmental entities perform the same function as accountants working at for-profit businesses. Accountants help to serve the public interest by providing to the public an accounting for the receipts and disbursements of taxpayer dollars. Governmental leaders are accountable to taxpayers, and accountants help assure the public that tax dollars are being utilized in an efficient manner.

Examples of governmental entities that require financial reporting include federal agencies such as the Social Security Administration, state agencies such as the Department of Transportation, and local agencies such as county engineers.

Students continuing their study of accounting may take a specific course or courses related to governmental accounting. While the specific accounting used in governmental entities differs from traditional accounting conventions, the goal of providing accurate and unbiased financial information useful for decision-making remains the same, regardless of the type of entity. Government accounting standards are governed by the Governmental Accounting Standards Board (GASB). This organization creates standards that are specifically appropriate for state and local governments in the United States.

Not-for-Profit Entities

To be fair, the name "not-for-profit" can be somewhat confusing. As with "for-profit" entities, the name refers to the primary purpose or mission of the organization. In the case of for-profit organizations, the primary purpose is to generate a profit. The profits, then, can be used to sustain and improve the business through investments in employees, research, and development, and other measures intended to help ensure the long-term success of the business.

But in the case of a nonprofit (not-for-profit) organization, the primary purpose or mission is to serve a particular interest or need in the community. A not-for-profit entity tends to depend on financial longevity based on donations, grants, and revenues generated. It may be helpful to think of not-for-profit entities as "mission-based" entities. It is important to note that not-for-profit entities, while having a primary purpose of serving a particular interest, also have a need for financial sustainability. An adage in the not-for-profit sector states that "being a not-for-profit organization does not mean it is for-loss". That is, not-for-profit entities must also ensure that resources are used efficiently, allowing for inflows of resources to be greater than (or, at a minimum, equal to) outflows of resources. This allows the organization to continue and perhaps expand its valuable mission.

Examples of not-for-profit entities are numerous. Food banks have as a primary purpose the collection, storage, and distribution of food to those in need. Charitable foundations have as a primary purpose the provision of funding to local agencies that support specific community needs, such as reading and after-school programs. Many colleges and universities are structured as not-for-profit entities because the primary purpose is to provide education and research opportunities.

Similar to accounting for governmental entities, students continuing their study of accounting may take a specific course or courses related to not-for-profit accounting. While the specific accounting used in not-for-profit entities differs slightly from traditional accounting conventions, the goal of providing reliable and unbiased financial information useful for decision-making is vitally important. Some of the governmental and regulatory entities involved in maintaining the rules and principles in accounting are discussed in Explain Why Accounting Is Important to Business Stakeholders.

Your Turn

Think of the various organizations discussed so far. Now try to identify people in your personal and professional network who work for these types of agencies. Can you think of someone in a career at each of these types of organizations?

One way to explore career paths is to talk with professionals who work in the areas that interest you. You may consider reaching out to the individuals you identified and learning more about the work that they do. Find out about the positive and negative aspects of the work. Find out what advice they have relating to education. Try to gain as much information as you can to determine whether that is a career you can envision yourself pursuing. Also, ask about opportunities for job shadowing, co-ops, or internships.

Solution

Answers will vary, but this should be an opportunity to learn about careers in a variety of organizations (for-profit including manufacturing, retail, and services; not-for-profit; and governmental agencies). You may have an assumption about a career that is based only on the positive aspects. Learning from experienced professionals may help you understand all aspects of the careers. In addition, this exercise may help you confirm or alter your potential career path, including the preparation required (based on advice given by those you talk with).

1.4. Explain Why Accounting Is Important to Business Stakeholders

The number of decisions we make in a single day is staggering. For example, think about what you had for breakfast this morning. What pieces of information factored into that decision? A short list might include the foods that were available in your home, the amount of time you had to prepare and eat the food, and what sounded good to eat this morning. Let's say you do not have much food in your home right now because you are overdue on a trip to the grocery store. Deciding to grab something at a local restaurant involves an entirely new set of choices. Can you think of some of the factors that might influence the decision to grab a meal at a local restaurant?

Your Turn

Many academic studies have been conducted on the topic of consumer behavior and decision-making. It is a fascinating topic of study that attempts to learn what type of advertising works best, the best place to locate a business, and many other business-related activities.

One such study, conducted by researchers at Cornell University, concluded that people make more than 200 food-related decisions per day.

This is astonishing considering the number of decisions found in this particular study related only to decisions involving food. Imagine how many day-to-day decisions involve other issues that are important to us, such as what to wear and how to get from point A to point B. For this exercise, provide and discuss some of the food-related decisions that you recently made.

Solution

In consideration of food-related decisions, there are many options you can consider. For example, what types, in terms of ethnic groups or styles, do you prefer? Do you want a dining experience or just something inexpensive and quick? Do you have allergy-related food issues? These are just a few of the myriad potential decisions you might make.

It is no different when it comes to financial decisions. Decision-makers rely on unbiased, relevant, and timely financial information in order to make sound decisions. In this context, the term stakeholder refers to a person or group who relies on financial information to make decisions, since they often have an interest in the economic viability of an organization or business. Stakeholders may be stockholders, creditors, governmental and regulatory agencies, customers, management and other employees, and various other parties and entities.

Stockholders

A stockholder is an owner of stock in a business. Owners are called stockholders because, in exchange for cash, they are given an ownership interest in the business, called stock. Stock is sometimes referred to as "shares". Historically, stockholders received paper certificates reflecting the number of stocks owned in the business. Now, many stock transactions are recorded electronically. Introduction to Financial Statements discusses stock in more detail. Corporation Accounting offers a more extensive exploration of the types of stock as well as the accounting related to stock transactions.

Recall that organizations can be classified as for-profit, governmental, or not-for-profit entities. Stockholders are associated with for-profit businesses. While governmental and not-for-profit entities have constituents, there is no direct ownership associated with these entities.

For-profit businesses are organized into three categories: manufacturing, retail (or merchandising), and service. Another way to categorize for-profit businesses is based on the availability of the company stock (see Table 1.1). A publicly-traded company is one whose stock is traded (bought and sold) on an organized stock exchange such as the New York Stock Exchange (NYSE) or the National Association of Securities Dealers Automated Quotation (NASDAQ) system. Most large, recognizable companies are publicly traded, meaning the stock is available for sale on these exchanges. A privately held company, in contrast, is one whose stock is not available to the general public. Privately held companies, while accounting for the largest number of businesses and employment in the United States, are often smaller (based on value) than publicly traded companies. Whereas financial information and company stock of publicly traded companies are available to those inside and outside of the organization, financial information and company stock of privately held companies are often limited exclusively to employees at a certain level within the organization as a part of compensation and incentive packages or selectively to individuals or groups (such as banks or other lenders) outside the organization.

Publicly Held versus Privately Held Companies

Table 1.1

Whether the stock is owned by a publicly-traded or privately held company, owners use financial information to make decisions. Owners use the financial information to assess the financial performance of the business and make decisions such as whether or not to purchase additional stock, sell existing stock, or maintain the current level of stock ownership.

Other decisions stockholders make may be influenced by the type of company. For example, stockholders of privately held companies often are also employees of the company, and the decisions they make may be related to day-to-day activities as well as longer-term strategic decisions. Owners of publicly traded companies, on the other hand, will usually only focus on strategic issues such as the company leadership, purchases of other businesses, and executive compensation arrangements. In essence, stockholders predominantly focus on profitability, expected increase in stock value, and corporate stability.

Creditors and Lenders

In order to provide goods and services to their customers, businesses make purchases from other businesses. These purchases come in the form of materials used to make finished goods or resell, office equipment such as copiers and telephones, utility services such as heating and cooling, and many other products and services that are vital to running the business efficiently and effectively.

It is rare that payment is required at the time of the purchase or when the service is provided. Instead, businesses usually extend "credit" to other businesses. Selling and purchasing on credit, which is explored further in Merchandising Transactions and Accounting for Receivables, means the payment is expected after a certain period of time following receipt of the goods or provision of the service. The term creditor refers to a business that grants extended payment terms to other businesses. The time frame for extended credit to other businesses for purchases of goods and services is usually very short, typically thirty-day to forty-five-day periods are common.

When businesses need to borrow larger amounts of money and/or for longer periods of time, they will often borrow money from a lender, a bank or other institution that has the primary purpose of lending money with a specified repayment period and stated interest rate. If you or your family own a home, you may already be familiar with lending institutions. The time frame for borrowing from lenders is typically measured in years rather than days, as was the case with creditors. While lending arrangements vary, typically the borrower is required to make periodic, scheduled payments with the full amount being repaid by a certain date. In addition, since the borrowing is for a long period of time, lending institutions require the borrower to pay a fee (called interest) for the use of borrowing. These concepts and the related accounting practices are covered in Long-Term Liabilities. Table 1.2 summarizes the differences between creditors and lenders.

Creditor versus Lender

Table 1.2

Both creditors and lenders use financial information to make decisions. The ultimate decision that both creditors and lenders have to make is whether or not the funds will be repaid by the borrower. The reason this is important is because lending money involves risk. The type of risk creditors and lenders assess is repayment risk-the risk the funds will not be repaid. As a rule, the longer the money is borrowed, the higher the risk involved.

Recall that accounting information is historical in nature. While historical performance is no guarantee of future performance (repayment of borrowed funds, in this case), an established pattern of financial performance using historical accounting information does help creditors and lenders to assess the likelihood the funds will be repaid, which, in turn, helps them to determine how much money to lend, how long to lend the money for, and how much interest (in the case of lenders) to charge the borrower.

Sources of Funding

Besides borrowing, there are other options for businesses to obtain or raise additional funding (also often labeled as capital). It is important for the business student to understand that businesses generally have three ways to raise capital: profitable operations is the first option; selling ownership-stock-which is also called equity financing, is the second option; and borrowing from lenders (called debt financing) is the final option.

In Introduction to Financial Statements, you'll learn more about the business concept called "profit". You are already aware of the concept of profit. In short, profit means the inflows of resources are greater than the outflow of resources, or, stated in more business-like terms, the revenues that the company generates are larger or greater than the expenses. For example, if a retailer buys a printer for $150 and sells it for $320, then from the sale it would have revenue of $320 and expenses of $150, for a profit of $170. (Actually, the process is a little more complicated because there would typically be other expenses for the operation of the store. However, to keep the example simple, those were not included. You'll learn more about this later in the course.)

Developing and maintaining profitable operations (selling goods and services) typically provides businesses with resources to use for future projects such as hiring additional workers, maintaining equipment, or expanding a warehouse. While profitable operations are valuable to businesses, companies often want to engage in projects that are very expensive and/or time-sensitive. Businesses, then, have other options to raise funds quickly, such as selling stock and borrowing from lenders, as previously discussed.

An advantage of selling stock to raise capital is that the business is not committed to a specific payback schedule. A disadvantage of issuing new stock is that the administrative costs (legal and compliance) are high, which makes it an expensive way to raise capital.

There are two advantages to raising money by borrowing from lenders. One advantage is that the process, relative to profitable operations and selling ownership, is quicker. As you've learned, lenders (and creditors) review financial information provided by the business in order to make assessments on whether or not to lend money to the business, how much money to lend, and the acceptable length of time to lend. A second, and related, advantage of raising capital through borrowing is that it is fairly inexpensive. A disadvantage of borrowing money from lenders is the repayment commitments. Because lenders require the funds to be repaid within a specific time frame, the risk to the business (and, in turn, to the lender) increases.

These topics are covered extensively in the area of study called corporate finance. While finance and accounting are similar in many aspects, in practicality finance and accounting are separate disciplines that frequently work in coordination in a business setting. Students may be interested to learn more about the educational and career options in the field of corporate finance. Because there are many similarities in the study of finance and accounting, many college students double major in a combination of finance, accounting, economics, and information systems.

Concepts In Practice

What is profit? In accounting, there is general consensus on the definition of profit. A typical definition of profit is, in effect, when inflows of cash or other resources are greater than outflows of resources.

Ken Blanchard provides another way to define profit. Blanchard is the author of The One Minute Manager, a popular leadership book published in 1982. He is often quoted as saying, "profit is the applause you get for taking care of your customers and creating a motivating environment for your people [employees]". Blanchard's definition recognizes the multidimensional aspect of profit, which requires successful businesses to focus on their customers, employees, and the community.

Governmental and Regulatory Agencies

Publicly traded companies are required to file financial and other informational reports with the Securities and Exchange Commission (SEC), a federal regulatory agency that regulates corporations with shares listed and traded on security exchanges through required periodic filings Figure 1.6. The SEC accomplishes this in two primary ways: issuing regulations and providing oversight of financial markets. The goal of these actions is to help ensure that businesses provide investors with access to transparent and unbiased financial information.

Figure 1.6 Securities and Exchange Commission.

As an example of its responsibility to issue regulations, you learn in Introduction to Financial Statements that the SEC is responsible for establishing guidelines for the accounting profession. These are called accounting standards or generally accepted accounting principles (GAAP). Although the SEC also had the responsibility of issuing standards for the auditing profession, they relinquished this responsibility to the Financial Accounting Standards Board (FASB).

In addition, you will learn in Describe the Varied Career Paths Open to Individuals with an Accounting Education that auditors are accountants charged with providing reasonable assurance to users that financial statements are prepared according to accounting standards. This oversight is administered through the Public Company Accounting Oversight Board (PCAOB), which was established in 2002.

The SEC also has responsibility for regulating firms that issue and trade (buy and sell) securities – stocks, bonds, and other investment instruments.

Enforcement by the SEC takes many forms. According to the SEC website, "Each year the SEC brings hundreds of civil enforcement actions against individuals and companies for violation of the securities laws. Typical infractions include insider trading, accounting fraud, and providing false or misleading information about securities and the companies that issue them". Financial information is a valuable tool that is part of the investigatory and enforcement activities of the SEC.

Concepts In Practice

You may have heard the name Bernard "Bernie" Madoff. Madoff (Figure 1.7) was the founder of an investment firm, Bernard L. Madoff Investment Securities. The original mission of the firm was to provide financial advice and investment services to clients. This is a valuable service to many people because of the complexity of financial investments and retirement planning. Many people rely on financial professionals, like Bernie Madoff, to help them create wealth and be in a position to retire comfortably. Unfortunately, Madoff took advantage of the trust of his investors and was ultimately convicted of stealing (embezzling) over $50 billion (a low amount by some estimates). Madoff's embezzlement remains one of the biggest financial frauds in US history.

Figure 1.7 Bernie Madoff. Bernie Madoff's mugshot upon being arrested in March 2009.

The fraud scheme was initially uncovered by a financial analyst named Harry Markopolos. Markopolos became suspicious because Madoff's firm purported to achieve for its investors abnormally high rates of return for an extended period of time. After analyzing the investment returns, Markopolos reported the suspicious activity to the Securities and Exchange Commission (SEC), which has enforcement responsibility for firms providing investment services. While Madoff was initially able to stay a few steps ahead of the SEC, he was charged in 2009 and will spend the rest of his life in prison.

There are many resources to explore the Madoff scandal. You might be interested in reading the book, No One Would Listen: A True Financial Thriller, written by Harry Markopolos. A movie and a TV series have also been made about the Madoff scandal.

In addition to governmental and regulatory agencies at the federal level, many state and local agencies use financial information to accomplish the mission of protecting the public interest. The primary goals are to ensure the financial information is prepared according to the relevant rules or practices as well as to ensure funds are being used in an efficient and transparent manner. For example, local school district administrators should ensure that financial information is available to the residents and is presented in an unbiased manner. The residents want to know their tax dollars are not being wasted. Likewise, the school district administrators want to demonstrate they are using the funding in an efficient and effective manner. This helps ensure a good relationship with the community that fosters trust and support for the school system.

Customers

Depending on the perspective, the term customers can have different meanings. Consider for a moment a retail store that sells electronics. That business has customers that purchase its electronics. These customers are considered the end-users of the product. The customers, knowingly or unknowingly, have a stake in the financial performance of the business. The customers benefit when the business is financially successful. Profitable businesses will continue to sell the products the customers want, maintain and improve the business facilities, provide employment for community members, and undertake many other activities that contribute to a vibrant and thriving community.

Businesses are also customers. In the example of the electronics store, the business purchases its products from other businesses, including the manufacturers of the electronics. Just as end-user customers have a vested interest in the financial success of the business, business customers also benefit from suppliers that have financial success. A supplier that is financially successful will help ensure the electronics will continue to be available to purchase and resell to the end-use customer, investments in emerging technologies will be made, and improvements in delivery and customer service will result. This, in turn, helps the retail electronics store remain cost-competitive while being able to offer its customers a wide variety of products.

Managers and Other Employees

Employees have a strong interest in the financial performance of the organizations for which they work. At the most basic level, employees want to know their jobs will be secure so they can continue to be paid for their work. In addition, employees increase their value to the organization through their years of service, improving knowledge and skills, and accepting positions of increased responsibility. An organization that is financially successful is able to reward employees for their commitment to the organization through bonuses and increased pay.

In addition to promotional and compensation considerations, managers and others in the organization have the responsibility to make day-to-day and long-term (strategic) decisions for the organization. Understanding financial information is vital to making good organizational decisions.

Not all decisions, however, are based on strictly financial information. Recall that managers and other decision-makers often use nonfinancial, or managerial, information. These decisions take into account other relevant factors that may not have an immediate and direct link to the financial reports. It is important to understand that sound organizational decisions are often (and should be) based on both financial and nonfinancial information.

In addition to exploring managerial accounting concepts, you will also learn some of the common techniques that are used to analyze the financial reports of businesses. Appendix A further explores these techniques and how stakeholders can use these techniques for making financial decisions.

IFRS Connection

Introduction to International Financial Reporting Standards (IFRS)

In the past fifty years, rapid advances in communications and technology have led the economy to become more global with companies buying, selling, and providing services to customers all over the world. This increase in globalization creates a greater need for users of financial information to be able to compare and evaluate global companies. Investors, creditors, and management may encounter a need to assess a company that operates outside of the United States.

For many years, the ability to compare financial statements and financial ratios of a company headquartered in the United States with a similar company headquartered in another country, such as Japan, was challenging, and only those educated in the accounting rules of both countries could easily handle the comparison. Discussions about creating a common set of international accounting standards that would apply to all publicly traded companies have been occurring since the 1950s and post–World War II economic growth, but only minimal progress was made. In 2002, the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) began working more closely together to create a common set of accounting rules. Since 2002, the two organizations have released many accounting standards that are identical or similar, and they continue to work toward unifying or aligning standards, thus improving financial statement comparability between countries.

Why create a common set of international standards? As previously mentioned, the global nature of business has increased the need for comparability across companies in different countries. Investors in the United States may want to choose between investing in a US-based company or one based in France. A US company may desire to buy out a company located in Brazil. A Mexican-based company may desire to borrow money from a bank in London. These types of activities require knowledge of financial statements. Prior to the creation of IFRS, most countries had their own form of generally accepted accounting principles (GAAP). This made it difficult for an investor in the United States to analyze or understand the financials of a France-based company or for a bank in London to know all of the nuances of financial statements from a Mexican company. Another reason common international rules are important is the need for similar reporting for similar business models. For example, Nestlé and the Hershey Company are in different countries yet have similar business models; the same applies to Daimler and Ford Motor Company. In these and other instances, despite the similar business models, for many years these companies reported their results differently because they were governed by different GAAP-Nestlé by French GAAP, Daimler by German GAAP, and both the Hershey Company and Ford Motor Company by US GAAP. Wouldn't it make sense that these companies should report the results of their operations in a similar manner since their business models are similar? The globalization of the economy and the need for similar reporting across business models are just two of the reasons why the push for unified standards took a leap forward in the early twenty-first century.

Today, more than 120 countries have adopted all or most of IFRS or permit the use of IFRS for financial reporting. The United States, however, has not adopted IFRS as an acceptable method of GAAP for financial statement preparation and presentation purposes but has worked closely with the IASB. Thus, many US standards are very comparable to international standards. Interestingly, the Securities and Exchange Commission (SEC) allows foreign companies that are traded on US exchanges to present their statements under IFRS rules without restating to US GAAP. This occurred in 2009 and was an important move by the SEC to show solidarity toward creating financial statement comparability across countries.

Throughout this text, "IFRS Connection" feature boxes will discuss the important similarities and most significant differences between reporting using US GAAP as created by FASB and IFRS as created by IASB. For now, know that it is important for anyone in business, not just accountants, to be aware of some of the primary similarities and differences between IFRS and US GAAP because these differences can impact analysis and decision-making.