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ACCOUNTING FOR MANAGERS

(ACFN 501)
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 Accounting has been defined by the American

accounting association committee as:
“The process of identifying, measuring and communicating
economic information to permit informed judgments and
decisions by users of the information”.
Another common definition of accounting:
“Accounting is a service activity. Its function is to provide
quantitative information, primarily financial in nature,
about economic entities that is useful in making economic
decision, in making reasonable choices among alternative
courses of action”.
 Introduction to Accounting
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 Accounting is as old as money itself. It has evolved,

like the other fields of human activity, in response to
the social and economic needs of society.
 As we know, the basic function of any language is to
serve as a means of communication. The same to
that, Accounting is also called as the language of
business.
 This designation is applied to accounting because it
is the method of communicating business
information.
 Cont…

 Accounting Information (AI): A Means to an End

 Accounting information is not an end , but is a

means to an end i.e. its final product is decision
which is ultimately enhanced by the use of
accounting information, whether that decision
made by owners, management, creditors,
government bodies, labor unions ,etc.
Concept Questions

 Why accounting is being called as “the

language of business”?

 Why Accounting information is a means

to an end, not the end in itself?
 Function of Accounting
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 Though accounting is generally associated with

business, it is not only business people who make use
of accounting but also many individuals in non-
business areas that make use of accounting data and
need to understand accounting principles and
terminology.
 Accounting plays an important role in modern society
and broadly speaking all citizens are affected by
accounting in some way or the other.

 The following are the main objectives or functions of

accounting:
 Cont…
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 Keeping Systematic Records:

This is the fundamental function of accounting. The
transactions of the business are properly recorded, classified
and summarized in a systematic manner into financial
statements:- Ascertain profit via income statement and
ascertain financial position via balance sheet.
 Protecting The Business Properties:
It is used to protect the properties of the business by
maintaining proper record of various assets and thus enabling
the management to exercise proper control over them.
Accounting provides protection to business properties from
unjustified and unwarranted use.
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Communicating The Results:

 its third function is to communicate financial information to the
interested parties.
 Reporting of information at the required points of time to the
required levels of authority in order to facilitate rational
decision-making.
 Accountants answer these primary questions with three
major financial statements:
 Balance sheet- Shows financial picture on a given day.
 Income statement- shows performance over a given period.
 Statement of cash flows- shows performance over a given
period.
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 Meeting Legal Requirements:

The fourth and last function of accounting is
to meet the legal requirements. The provisions
of various laws such as the companies act,
income tax act, etc., require the submission of
various statements like income tax returns,
annual accounts and so on. Accounting system
aims at fulfilling this requirement of law.
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 In summary, like any system has three features, viz.,

input, processes and output, Accounting can be also
viewed as an information system, since it has all the
three features i.e., inputs (raw data), processes (men
and equipment) and outputs (reports and
information).
 Accounting information is composed principally of
financial data about business transactions.
 Interested users of Accounting Information
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 There are several groups of people who are

interested in the accounting information relating to
the business enterprise. The following are some of
them:

Shareholders:
Shareholders as owners are interested in knowing
the profitability of the business transactions and the
distribution of capital in the form of assets and
liabilities.
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 Management:
In small businesses, management may include the owners.
In huge organizations, however, management is usually
made up of hired professionals who are entrusted with the
responsibility of planning and controlling day to day
operation of the business. They act as agents of the
owners.
 Potential Investors:
An individual who is planning to make an investment in a
business would like to know about its profitability and
financial position. An analysis of the financial statements
would help them in this respect.
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Creditors:
As creditors have extended credit to the company, they are
much worried about the repaying capacity of the company.
For this purpose they require its financial statements, an
analysis of which will tell about the solvency position of
the company.

Government:
Governing bodies of the state, especially the tax authorities,
are interested in an entity's financial information for
taxation and regulatory purposes. Accounting data are
required for collection of sale-tax, income-tax, excise duty
etc.
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Employees:
Like creditors, employees are interested in the financial
statements in view of various profit sharing and bonus
schemes and the possibility of future remuneration.
. Their interest may further increase when they hold shares
of the companies in which they are employed and in
addition to determine their job security,
Researchers:
Researchers are interested in interpreting the financial
statements of the concern for academic or a given
objective.
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Customers:
Customer or clients may become interested in
knowing whether a company is capable of
continuously providing their needs.

When a customer uses the goods from a particular

company as raw materials or supplies in his own
business or when he is heavily dependent upon the
goods or services of the company.
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 In summary, users of accounting information

basically fall in to two broad categories:

1. Internal users
2. External users

Internal users:
It refer to the members of a company's
management and other individuals who use
financial information in running and managing
the business.
 Cont…
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The internal users of accounting include all

individuals within the company who utilize
financial information in making decisions for the
business.

Because Internal users include all levels of

management (top, middle and lower level
management), it is usually called Management
group.

Example:
CEO, head departments, supervisors etc
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External users:
External users are entities or individuals who do not participate
in running or managing the business but are interested in the
financial information of the company. Unlike internal users,
they do not make decisions for the business.
In other words, an external user is a person outside of an
organization who does not directly run its operations and uses
financial or accounting information about that company to
make decisions.
Example:
Shareholders, creditors (Eg. Bank), potential investors,
government, researchers/financial analyst , customers and
usually employees
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 We can further classify external users in to two sub

groups as:
1. External users with direct interest
2. External users with indirect interest
External users with direct interest:
Users who do not have direct involvement in
managing the business but they provide finance to
the business.
They are also called Financing group.

Example: Shareholders/owners and creditors

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 External users with indirect interest:

Users neither involving in managing the
businesses nor supplying finance to the business
but they are stakeholders (having an interest in the
affairs of the business activities).
They are also called Public Group.

Example: Government, customers, researchers,

media etc
 Forms of Business Organization
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 How many forms of business organization do you

know?
 One of the first decisions that you will have to make as a
business owner is how the business should be structured. All
businesses must adopt some legal configuration that defines
the rights and liabilities of participants in the business’s
ownership, control, personal liability, life span, and financial
structure.
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 There are three basic legal/most common forms of

organization:

1. Sole Proprietorship

2. Partnership

3. Corporation
 Sole Proprietorship
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 It is a form of business is owned by a single person.

 It's easy to form and offers complete control to the
owner. But the business owner is also personally
liable for all financial obligations and debts of the
business.
 Partnership
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 It is a form of business organization owned by two

or more individuals/owners.
 A partnership is the relationship existing between
two or more persons who join to carry on a trade or
business. Each person contributes money, property,
labor or skill, and expects to share in the profits and
losses of the business.
 Corporation
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 Is a form of business with Separate legal entity owned

by stockholders
 The corporation becomes an entity that handles the
responsibilities of the business. Like a person, the
corporation can be taxed and can be held legally
liable for its actions. If you organize your business as
a corporation, you are generally not personally liable
for the debts of the corporation
 Advantages of Sole Proprietorship
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 Ease of formation/Simple to establish

 Low start-up costs/least expensive form of ownership
to organize and low operational overhead.
 Tax advantages: there is no corporate income taxes.
Any income realized by a sole proprietorship is
declared on the owner's individual income tax return.
(i.e. single taxation)
 Disadvantages of Sole Proprietorship
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 Unlimited liability:

Owners who organize their business as a sole proprietorship are

personally responsible for the obligations of the business, including
actions of any employee representing the business.( I.e. Their
business and personal assets are at risk.) i.e.
 Limited life:

In most cases, if a business owner dies, the business dies as well.

 It may be difficult for an individual to raise capital. It's common
for funding to be in the form of personal savings or personal loans.
 Advantages of partnership

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 Synergy:

There is clear potential for the enhancement of value

resulting from two or more individuals combining
strengths. i.e. Broader skills & resources
 Partnerships are relatively easy to form and subject
to fewer regulations than corporations
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 Tax advantages:
There is no corporate income taxes. the partnership pays
no taxes when this partnership tax return is filed. Rather,
the individual partners declare their pro-rata share of the
net income of the partnership on their individual income
tax returns and pay taxes at the individual income tax
rate. (i.e there is single taxation)
 Disadvantages of partnership
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 Unlimited liability. They are responsible for the obligations of

the business, creating personal risk.
 Partners are jointly and individually liable for the actions of the
other partners
 Limited life. A partnership may end upon the withdrawal or death
of a partner.
 There is a real possibility of disputes or conflicts between
partners which could lead to dissolving the partnership.
 Profits must be shared with others.
 Advantages of Corporation

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 Limited liability.

This limited liability is probably the biggest advantage

to organizing as a corporation. Individual owners in
corporations have limits on their personal liability.
Even if a corporation is sued for billions of dollars,
individual shareholder's liability is generally limited to
the value of their own stock in the corporation.
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 Unlimited commercial life.

The corporation is an entity of its own and does not

dissolve when ownership changes.
 Greater flexibility in raising capital through the sale
of stock.
 Ease of transferring ownership by selling stock.
 Disadvantages of Corporation

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 Regulatory restrictions.
Corporations are typically more closely monitored by
governmental agencies, including federal, state, and
local. Complying with regulations can be costly.

 Higher organizational and operational costs.

Corporations have to file articles of incorporation with
the appropriate state authorities. These legal and clerical
expenses, along with other recurring operational
expenses, can contribute to budgetary challenges.
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 Double taxation.
The possibility of double taxation arises when
companies declare and pay taxes on the net income of
the corporation, which they pay through their corporate
income tax returns. If the corporation also pays out
dividends to individual shareholders, those
shareholders must declare that dividend income as
personal income and pay taxes at the individual income
tax rates. Thus, the possibility of double taxation.
 Types of Business Organization
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 The forms of business entities discussed in the

previous section are classified according to the type
of ownership of the business entity. Business entities
can also be grouped by the type of business activities
they perform:
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1. Merchandising companies

2. Service companies, and

3. Manufacturing companies.
 Any of these activities can be performed by
companies using any of the three forms of business
organizations.
 Merchandising companies
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 This type of business operation sells products to its

customers. However, they don’t make the products
they sell; instead, they buy or purchase it from other
business.
 Buys goods for resale purpose with out changing
the basic format of the product to customer.

Eg. Retailers and Whole sellers

 Service companies

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 This type of business operation provides services, instead of

product, to its customers.
 Usually service companies perform services for a fee.

Example:
Professionals such Lawyers, Doctors, Accountant, Engineer, etc.
 Consultation
 Hospital
 Hotel
 Transportation
 Entertainment
 Manufacturing companies

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This type of business operation converts basic inputs,

such as materials, labor and overhead, into finished
products which are sold to customers.
Example:

Textile manufacturing

Brewery manufacturing
 What is finance?
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 Business concern needs finance to meet their

requirements in the economic world. Any kind of
business activity depends on the finance.
 Hence, it is called as lifeblood of business
organization. Whether the business concerns are big
or small, they need finance to fulfil their business
activities.
 Finance can be defined as the art and science of

managing money. It is the management of money, both

the acquisition and investment of money.
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 Finance as a field of study and an area of business,

definitely has strong roots in other scientific fields
such as statistics and mathematics.
 However, there is no denying the fact that the financial
industry also includes non-scientific elements that
relate it to an art.

 For example, it has been discovered that human

emotions (and decisions made because of them) play a
large role in many aspects of the financial world.
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 The financial theories cannot be accurately

compared with the 'Scientific Method' that applies
to physics science. Physics predicts as to what
happens from an action. for example, physics says
that if a ball is thrown upward, that eventually falls
down.

 This is not true in finance. For example, the

financial analyst can predict from the historical
trend that the rate of interest will change in a
definite pattern.
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 But, in reality, the rate of interest may change in

different pattern. Despite this, financial guidelines
and theories are useful in financial decision making,
but any decision should be made by mixing those
guidelines with self-skill.

 According to R.A. Stevenson, in modern time

finance is a 'scientific art'. I.e. 'finance is the science
of knowing how to predict financial consequences
and the art of knowing when to act'.
 Finance and Accounting
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 Finance and accounting functions are closely

related. Finance and accounting are often
considered indistinguishable or at least
substantially overlapping.
Relationship
Accounting is referred to as an input to the finance
functions through the financial statements it
provides. I.e.
“Finance generally begins where accounting
ends.”
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 Difference
Accounting
 The primary objective Finance
of accounting is to  The principal goal of
measure the financial management
performance of the firm is to create shareholder
and assess its financial value by investing in
condition positive net present
value projects and
minimizing the cost of
financing
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 Accounting deals
primarily with the past.  Finance is concerned
It records what has mainly with the future.
happened. It involves decision
making under imperfect
information and
uncertainty. Hence it is
characterized by a high
degree of subjectivity
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 Accounting  The focus of the

prepares/produces the finance manager,
accounting reports however, is on cash
based on the accrual flows. He is concerned
method. about the magnitude,
timing, and risk of cash
flows as these are the
fundamental
determinants of values.
 MANAGEMENT ACCOUNTING AND
FINANCIAL ACCOUNTING

 Financial accounting and management

accounting are closely interrelated since
management accounting is to a large extent
rearrangement of the data provided by
financial accounting.
 In spite of such a close relationship between the
two, there are certain fundamental differences.
These differences can be laid down as follows:
 Comparison of Financial Accounting and Managerial Accounting
Financial Accounting Managerial Accounting

Objective  It is designed to supply  It is designed principally for providing

information in the form of accounting information for internal use
profit and loss account and of the management.
balance sheet accounts.  It is primarily an internal reporting
 It is primarily an external process.
reporting process

Time focus  Financial accounting is  Management accounting is accounting

concerned with the monetary for future and, therefore, it supplies data
record of past events. both for present and future duly
 Historical perspective analysed in detail .
 Future emphasis

Precision  Emphasis on precision Emphasis on timeliness

versus
timeliness
 Financial Accounting Managerial Accounting
Monetary  In financial accounting only  In management accounting,
measurem such economic events find place, management is equally
ent which can be described in interested in non monetary
money. economic events, viz.,
technical innovations,
personnel in the organization,
changes in the value of money,
etc and these events affect
management's decision
Analyzing Financial accounting portrays the Management accounting directs
performa position of business as a whole. The its attention to the various
nce financial statements like income divisions, departments of the
statement and balance sheet report on business and reports about the
overall performance or statues of the
business.
profitability, performance, etc., of
Financial accounting deals with the each of them.
aggregates and, therefore, cannot reveal Management accounting provides
what part of the management action is detailed analytical data for the
going wrong and why. problems.
 Primary focus is on the whole
organization
Focuses on segments of an
organization
 Financial Accounting Managerial Accounting
Periodicity  The period of reporting  Management requires
of reporting is much longer in information at frequent
financial accounting as intervals.
compared to  In management
management accounting there is more
accounting. The Income emphasis on furnishing
Statement and the information quickly and
Balance Sheet are at comparatively short
usually prepared on a intervals as per the
yearly bases or in some requirements or needs of
cases half-yearly. the management.

Accounting  It must follow  Need not follow

principles GAAP/IFRS and GAAP/IFRS and any
prescribed format prescribed format
 Financial Accounting Managerial Accounting
Nature  Financial accounting  Management accounting
is more objective. is more subjective. This is
because management
 It emphasis on accounting is
verifiability fundamentally based on
judgement rather than on
measurement.
 Emphasis on relevance
for planning and control
Legal  Mandatory for  Not mandatory
compulsion/ external report
requirement
 Cont….

 The above points of difference between Financial

Accounting and Management Accounting prove that
Management Accounting has flexible approach as
compared to rigid approach in the case of Financial
Accounting.

 In brief, financial accounting simply shows how the

business has moved in the past while management
accounting shows how the business has to move in
the future.
The End