Accounting is the systematic process of measuring the economic activity of a business to provide useful information to those who make economic decisions. Accounting information is used in many different situations. Bankers use accounting information when deciding whether or not to make a loan. Stockbrokers and other financial advisers base investment recommendations on accounting information, while government regulators use accounting information to determine if firms are complying with various laws and regulations. This section describes the three major types of accounting.
Management need much more details up-to-date information in order to control the business and plan for the future. They need to be able to cost-out product and production methods assess profitability and so on. In order to facilitate this, management accounts present information in any way which may be useful to management, for example by operating units or product line.management accounting is an integral part of management activity concerned with identifying, presenting and interpreting information used for :-
01 – formulating strategy
02 – planning and controlling activities
03 – decision making
04 – optimising the use of resources
Managers make numerous decisions. These include (1) whether to build a new plant, (2) how much to spend for advertising, research, and development, (3) whether to lease or buy equipment and facilities, (4) whether to manufacture or buy component parts for inventory production, or (5) whether to sell a certain product. Managerial accounting provides information for these decisions. This information is usually more detailed and more tailor-made to decision making than financial accounting information. It is also proprietary; that is, the information is not disclosed to parties outside the firm.
Sterling Collision Centers, Inc. provides a good illustration of managerial accounting at work. Although Sterling only has 18 shops, it hopes to put a major dent in the automotive body shop business through aggressive expansion and the introduction of innovative management techniques. One of its strategies is to use computers to better track repair times, which will provide both standards for different types of repair jobs as well as measures of how individual workers perform relative to the standards. By tying pay to performance, Sterling hopes to improve worker productivity. Knowledge of repair times will also help Sterling to determine estimated bids for its repair jobs. Managerial accountants play a major role in all these activities.
Although distinguishing between financial and managerial accounting is convenient, the distinction is somewhat blurred. For example, financial accounting provides information about the performance of a firm to outsiders. Because this information is essentially a performance report on management, managers are appropriately interested in and influenced by financial accounting information. Accordingly, the distinction between financial and managerial accounting depends on who is the primary user of the information
Financial accounting provides information to decision makers who are external to the business. To understand the role of financial accounting, consider a large corporation such as IBM. The owners of corporations are called shareholders, and IBM has more than 600,000 shareholders. Obviously, each shareholder cannot participate directly in the running of IBM, and because IBM needs to maintain various trade secrets, its many thousands of shareholders are not permitted access to much of the firm’s information. Because of this, shareholders delegate most of their decisionmaking power to the corporation’s board of directors and officers. Figure 1.2 contains an organizational chart for a typical corporation. Shareholders, however, need information to evaluate (1) the performance of the business and (2) the advisability of retaining their investment in the business. Financial accounting provides some of the information for this purpose; such information is also used by potential shareholders who are considering an investment in the business.
Creditors and potential creditors are also served by financial accounting. Firms often seek loans from banks, insurance companies, and other lenders. Although creditors are not internal parties of those firms, they need information about them so that funds are loaned only to credit-worthy organizations. Financial accounting will usually provide at least some of the information needed by these decision makers.
Tax accounting encompasses two related functions: tax compliance and tax planning.Tax compliance refers to the calculation of a firm’s tax liability. This process entailsthe completion of sometimes lengthy and complex tax forms. Tax compliancetakes place after a year’s transactions have been completed.In contrast, tax planning takes place before the fact. A business transaction can bestructured in a variety of ways; a car can be purchased by securing a loan, for example,or it can be leased from the dealer. The structure of a transaction determines its tax consequences. A major responsibility of tax accountants is to provide advice aboutthe tax effects of a transaction’s various forms. Although this activity may seem to bean element of managerial accounting, it is separately classified due to the necessaryspecialized tax knowledge.
Other types of Accounting
A few additional types of accounting exist. Accounting information systems are the processes and procedures required to generate accounting information. These include
- identifying the information desired by the ultimate user,
- developing the documents (such as sales invoices) to record the necessary data,
- assigning responsibilities to specific positions in the firm, and
- applying computer technology to summarize the recorded data.
Another type of accounting deals with non-business (not for profit) organisations. These organizations do not attempt to earn a profit and have no owners. They exist to fulfill the needs of certain groups of individuals. Non-business organisations include hospitals, colleges and universities, churches, the federal, state, and local governments, many other organizations such as museums, volunteer fire departments, and disaster relief agencies.
Nonbusiness organizations have a need for all the types of accounting we have just reviewed. For example, a volunteer fire department might need to borrow money to purchase a new fire truck. Its banker would then require financial accounting information to make the lending decision.
Nonbusiness organizations are fundamentally different from profit-oriented firms: They have no owners and they do not attempt to earn a profit. Because of this, the analysis of the financial performance of business and nonbusiness organizations is considerably different. This text addresses only business organizations. Most colleges and universities offer an entire course devoted to the accounting requirements of nonbusiness organizations.