Chapter 1 - Introduction To Accounting

Question 1

Why study accounting?

Answer 1

Accounting is vital to informed decision making about all the processes that keep businesses and organizations working and producing wealth to pay wages and other forms of return to those who invest their time and resources in that endeavor.

Question 2

What is accounting? Definition 1 (American Institute of Certified and Public Accountants)

Answer 2

the art of recording, classifying and summarizing, in a significant manner and in terms of money, transactions and events which are in part at least, of a financial character, and interpreting the results thereof.

Question 3

What is accounting? Definition 2 (AICPA)

Answer 3

the collection, measurement, recording, classification and communication of economic data relating to an enterprise, for purposes of reporting, decision making and control.

Question 4

What is accounting? Definition 3

Answer 4

a discipline which provides financial and other information essential to the efficient conduct and evaluation of the activities of any organization.

Question 5

What is accounting? Definition 4

Answer 5

a service activity. Its function is to provide quantitative information, primarily financial in nature, about economic entities that is intended to be useful in making economic decisions, in making reasoned choices among alternative courses of action.

Question 6

What is accounting?

Answer 6

• accounting is generally about quantitative information
• the information is likely to be financial
• it should be useful for making decisions

Question 7

What is the purpose of accounting?

Answer 7

Individual: planning, controlling and decision support (internal activities)
Enterprise: planning, controlling, decision making and external activities such as providing information to people outside the enterprise

Question 8

Difference between management accounting & financial accounting

Answer 8

• Management accounting is directed towards providing information of specific use to managers
• Financial accounting information has many users apart from managers

Question 9

Who are the users of accounting information and which accounting reports do they normally use?

Answer 9

Internal users: mangers/owner

External users: Management - various reports including specialist reports
Owners - annual report Lenders - cash flow statement, income statement, statement of financial position
Suppliers - annual report, statem. of f. p.
Customers - income statement, statem. of f. p.
Employees - profitability –> income statement
Government - income statement
The general public - profitability –> income statement, also environmental and other information therefore specialist reports plus the narrative part of the annual report.

Question 10

What are the internal needs (of managers)?

Answer 10

Planning –> The need to plan activities
Control –> e.g identifying where targets have and have not been met to identify reasons of failure
Decision making –> e.g.Make or Buy?

Question 11

Key Concept of financial accounting:

Answer 11

Financial accounting can broadly be thought of as that part of the accounting system that tries to meet the needs of the various external user groups for decision useful information. This it does by means of the annual financial report which usually takes the form of a statement of financial position also commonly referred to as the balance sheet, the income statement(/profit & loss account) and the cash flow statement.

Question 12

What do owners/shareholders need to know?

Answer 12

• whether the enterprise has done as well as it should have done
• whether the managers have looked after, and made good use of, the resources of the enterprise
• how the enterprise is going to fare in the future

Question 13

Key financial statements within the annual report:

Answer 13

• the statement of financial position or balance sheet
• the income statement or profit and loss account
• the cash flow statement

Question 14

Although it is clear that accounting provides some information that is useful to decision makers, we must bear in mind:

Answer 14

• that the information is only part of that necessary to make ‘effective’ decisions
• that accountancy is as yet an inexact science and depends on a number of judgements, estimates, etc.
• that the end result of the accounting process can only be as good as the inputs and in times of rising prices some of these inputs are of dubious value
• that accounting systems can be counterproductive, e.g. the maximization of a division’s profit may not always ensure the maximization of the profit of the enterprice

Question 15

True or false? There is no perfect accounting report that will meet the needs of all users.

Answer 15

TRUE.

Question 16

True or false? The needs of users vary depending on the purpose to which the report is put.

Answer 16

TRUE. E.g. A small business owner may wish to show a low profit to reduce the potential tax bill but may need to show a high profit in order to convince the banker to lend the business money.

Question 17

For what purposes is accounting information used?

(a) by the individual
(b) by the enterprise

Answer 17

(a) To help them control the level of their expenditure, to assist in planning future levels of expenditure, to help them raise additional finance (e.g. mortgages, hire purchase,…) and to help them decide the best way to spend their money.
(b) To control the activities of the organization, to plan future activities, to assist in raising finance and to report upon the activities and performance of the enterprise to interested parties.

Question 18

It was pointed out that accounting information is only a part of the input to the decision-making process. For the situation below

(a) identify the accounting information that would be relevant
(b) identify any other information that would be relevant

Head&Co is in business making navigation equipment and wishes to diversify into the production of hang-gliders. The existing business is based in London but the owners may be willing to move. The owners have little knowledge about the market for hang-gliders but feel that there is money to be made in that field.

Answer 18

(a) Examples are: selling price, costs of manufacture, set-up costs, marketing costs, etc.
(b) Examples are: size of market, competitors, technical specifications, etc.