Management Concepts &

Accounting
Prof. Priti Rachayeeta
Objectives
• What is accounting?
• Explain the role and nature of accounting and
finance.
• Explain the role of accounting in planning and
controlling a business.
• Identify and discuss the possible objectives of a
business
• Distinguish between financial and management
accounting.
Nature and role of accounting
• Accounting is often called the language of
business.
• Accounting is the common language used to
communicate financial information from one
person to another in the world of industry and
commerce.
Accounting is :
• Concerned with the collection, analysis and
communication of economic information.
• It is useful to those who need to make decisions
and plans about businesses and for those who
need to control those businesses.
• The ultimate purpose of the accountant’s work is
to influence the decisions of users of the
information produced.
• Accounting provides “information that is useful
in making business and economic decisions for
making reasoned choices among alternative uses
of scarce resources in the conduct of business
and economic activities.
Main users of financial information
relating to business organization.
• Customers
• Suppliers
• Government
• Owners
• Lenders
• Employees (non management)
• Investment analysts
• Community representatives
• Managers
• Why do each of the user groups identified above
need accounting information relating to a
business?
User group Use
• Customers : To assess the ability of the business
to continue in business and to supply the needs
of customers.
• Suppliers: To assess the ability of the business to
pay for the goods and services supplied.
• Government: To assess how much tax the
business should pay, whether it complies with
agreed pricing policies, whether financial
support is needed etc..
• Owners: To assess how effectively the managers are
running the business and to make judgments about
likely levels of risk and return in the future.
• Lenders: To assess the ability of the business to
meet its obligations and to pay interest and to repay
the principal.
• Employees (non management): To assess the ability
of the business to continue to provide employment
and to reward employees for their labour.
• Investment analysts: To assess the likely risks
and returns associated with the business in
order to determine its investment potential and
to advise clients accordingly.
• Community representatives: To assess the ability
of the business to continue to provide
employment for the community and use
community resources, to help fund for
environmental improvements , etc.
• Managers: To help them to make decisions and
plans for the business and to help them to
exercise control to try to ensure that plans come
to fruition.
Accounting as an information System
• Identifying and capturing relevant economic
information
• Recording the information collected in a
systematized manner.
• Analyzing and interpreting the information
collected.
• Reporting the information in a manner which
suits the need of users.
Accounting as a service function
• In order to meet the needs of users, accounting
information must should possess certain key
characteristics:
▫ Relevance: Accounting information must have
the ability to influence decisions. Unless this
characteristic is present, there really is not any
point in producing the information.
▫ The information may be relevant to the prediction
of future events or relevant in helping confirm
past events.
• Reliability: Accounting information should be
free from any material error or bias.
• Comparability: Items which are basically the
same should be treated in the same manner for
measurement and presentation purposes.
• Understandability. Accounting reports should be
expressed as clearly as possible and should be
capable of being understood by those for whom
the information is intended.
Costs and benefits of accounting
information
• Suppose that you wish to buy a portable radio
which you have seen in a local shop for sale at
$20.
• You believe that other local shops may have the
same model of radio on offer for as little as $19.
• The only ways in which you can find out the
prices at other shops is either to telephone them
or visit them.
• Telephone costs money and involve some time.
• Visiting the shops may not involve money but
more of you time will be involved.
• Is it worth the cost of finding out the price of the
radio at various shops?
• The answer is, of course, that if the cost of
discovering the price is less than the potential
benefit, it is worth having that information.
• Supplying accounting information to users is
similar.
• The provision of accounting information costs
money.
• If no accounting information were produced, no
accounting staff would need to be employed.
• In order to be worth having, the potential
benefits from having the information need to
outweigh the cost of producing it.
Portable radio example….
• Going back to the portable radio, identifying the
cost of finding the various selling prices before
you actually set out to do so is problematical.
• It will probably involve considerations of the
following factors:
• How many shops will you phone or visit?
• What will be the cost of each phone call?
• How long will it take you to make a call of the
phone calls or to visit all of the shops?
• How much do you value your time at?
• The economic benefit of having the information on
the price of radios is probably even harder to assess,
the following probably being relevant:
• What is the cheapest price which you might be
quoted for the radio?
• How likely is it that you will be quoted prices
cheaper than $20?
• Decision whether it is economically advantageous to
discover other prices for the radio is very difficult.
• It is exactly the same with decisions on producing
accounting information in a business context.
Decision making and planning
• It is vitally important that businesses plan their
future.
• Planning is vital for businesses of all sizes.
• Closely linked to planning is decision making.
• Planning involves making decisions about what
course of action is best to plan for.
Steps in the planning process
• Setting the objectives or mission of the business,
i.e. what the particular business is basically
trying to achieve.
• For most private sector businesses, wealth
generation is likely to be the main
financial/economic objective.
• Businesses tend to take actions which will have
the effect of increasing the wealth of the
business.
• Increases in wealth may be paid to the govt in
taxes, paid to the owners, paid to employees,
reinvested in the business or deployed in some
other way.
• In practice therefore, any decision is likely to be
the result of a compromise between more than
one objective.
• Setting long term plans. These are plans setting out
how the business will work towards achievement of
its objectives over a period of, say five years. They
are likely to deal with such matters as:
▫ Type of products and services to be offered by the
business.
▫ Amounts and sources of finance needed to be raised by
the business.
▫ Capital investments (e.g. in new plant and machinery)
needing to be made;
▫ Sources of raw materials;
▫ Labor requirements.
• Setting detailed short term plans or budgets.
Budgets are financial plans for the short term,
typically one year.
• They are likely to be expressed mainly in
financial terms.
• Their role is to convert the long term plans into
actionable blueprints for the immediate future.
• Budgets usually define precise targets in areas
like:
▫ Cash receipts and payments;
▫ Sales, broken down into amounts and prices for
each of the products or services provided by the
business;
▫ Detailed stock requirements;
▫ Detailed labor requirements;
▫ Specific production requirements.
Control
• Control can be defined as compelling events to
conform to plan.
• For example, when we walk about controlling a
motor car we mean making the car do what we
plan that it should do.
• In the case of a car the plan may only be made
split-seconds before being enacted, but if the car
is in control it is doing what the driver intended
that it should do.
Decision making, planning and control
process
• Identify objectives
• Consider options
• Evaluate options and make a selection
• Prepare budgets
• Perform and collect information on actual
performance
• Respond to divergences between plans and
actuals and exercise control
• Revise plans (budgets) if necessary.
Assumptions underlying accounting
measurement
• Accounting measures events only if they affect
the financial position of the enterprise.
• As a result, important events affecting a
business, such as the launching of new brands by
its competitors, will not find a place in
accounting records.
• Four major assumptions that underlie all
accounting measurement are:
1. Accounting entity
2. Going concern
3. Periodicity
4. Money measurement
Accounting Entity
• Accountants treat a business as an accounting
entity that is distinct and separate from its
owners and other firms.
• Without the entity assumption, the personal
financial affairs of the owners and the activities
of other enterprises would be mingled with the
transactions of the business,
• and no meaningful financial information about
the business can be produced.
Going Concern
• Unless there is substantial evidence to the
contrary, accountants assume that the business
is a continuing enterprise, or a going concern.
• The assumption makes sense because many
business enterprises survive difficult economic
circumstances.
• The going concern assumption justifies an
accounting system based on historical cost.
• If we were to assume imminent liquidation of a
business, historical cost would be irrelevant.
Periodicity
• We assume a long life for a business.
• But investors , creditors, government, and others
cannot wait indefinitely for information for
making decisions.
• The periodicity assumption requires that the
activities of an enterprise be divided into
artificial time periods, usually as long as a year,
but sometimes as short as a quarter.
Money Measurement
• Under the money measurement assumption, we
express and record all business transactions in
terms of money.
• Therefore, if we cannot measure something in terms
of money, it will have no place in accounting.
• Money is the only common denominator for all
businesses.
• The use of money as the unit of measurement
enables us to compare financial information of
different enterprises.
• In India, rupee is the monetary unit.
Test your understanding
What, if at all, is wrong with the following
accounting practices?
• A business recorded an expense for the electricity
charges for the owner’s home.
• A business bought a car at an auction for Rs 40,000
and recorded it at that amount. One week later, the
price of the car went up to Rs. 50, 000 and the
business recorded the car at the new market value.
• A business recorded a DVD player purchased for the
owner’s personal use as an asset of the business.
Generally Accepted Accounting
Principles
• The information contained in financial reports
should be reliable and intelligible.
• Besides, we should be able to make meaningful
comparisons between a firm’s past financial
history and the financial information of other
enterprises.
• Therefore, we need a body of broad concepts and
detailed practices to guide business enterprises
in preparing financial reports.
• The set of conventions, rules, and
procedures that define accepted
accounting practice is referred to as
generally accepted accounting principles
(GAAP).
• GAAP represents the fundamental positions that
have been generally agreed upon, by accountants
and encompasses contemporary permissible
accounting practice.
Institutions that Influence GAAP
• Indian organizations
• The Ministry of Corporate Affairs (MCA)
• Securities Exchange Board of India (SEBI)
• Institute of Chartered Accountants of India
(ICAI)
• Income Tax Department
• Reserve Bank of India (RBI)
• Insurance Regulatory and Development
Authority (IRDA)
• Comptroller and Auditor-General of India (CAG)
International organizations
• The International Accounting Standards Board
(IASB), is committed to developing a single set
of accounting standards that will eventually be
acceptable worldwide as the basis for listing of
securities.
• The IASB works with national accounting
standard setters to achieve convergence in
accounting standards around the world.
• The International Federation of Accountants
(IFAC) is primarily concerned with bringing
about greater international harmony in matters
such as education, ethics, and auditing practices.
• The International Organization of Securities
Commissions (IOSCO) is an association of
securities regulators, such as SEBI and the US
Securities and Exchange Commission (SEC).
• It plays an imp role in improving accounting and
disclosure regulation in securities markets
around the world.
Accounting Standards and Policies
• An accounting standard specifies the acceptable
methods from the wide array of accounting
choices.
• Accounting policies comprise the principles,
bases, conventions, rules and procedures that
enterprises adopt in preparing and presenting
financial statements.
• Companies should disclose their accounting
policies.
Principle-based and rule-based
standards
• Depending on the level of detail, accounting
standards are referred to as principle –based or
rule-based.
• The principle-based standards lay down the
broad principles that govern the accounting and
disclosure requirements.
• In contrast, rule-based standards prescribe
detailed conditions and stipulations.
• Many consider US GAAP to be rule-based and IFRS
to be principle based.
• It would be fair to say that in the continuum from
details to principles, US GAAP is closer to details.
• Because of the US legal environment, American
managers and auditors face a much greater risk of
shareholder lawsuits and the use of prescriptive
standards makes it easier to defend management’s
and auditor’s assumptions and judgments.
Financial analysis-US GAAP and IFRS
• Most Indian companies prepare their financial
statements according to Indian GAAP.
• A number of them provide supplementary
financial statements applying IFRS and US
GAAP.
• Examples of Indian companies that provide US
GAAP or IFRS statements include Infosys,
Wipro, Dr. Reddy’s laboratories, Bharti Airtel,
Tata Motors, and TCS.
Forms of business organization
• The common forms of business are sole
proprietorship, partnership and limited
company.
• In sole proprietorship, a single individual carries
business.
• He gets to keep all the profits the business earns.
• The sole proprietor’s liability is unlimited, that
is, if the business doesn’t do well, he is
personally liable for paying off the debts.
• He could lose his shirt.
Partnership
• A partnership comprises between two and
twenty persons trading together as one firm and
sharing profits and losses.
• Each partner has unlimited liability for all the
debts and obligations of the firm and is
responsible for the liabilities in the firm of his
fellow partner or partners as well as his own.
• The Indian Partnership Act regulates
partnership business, but the regulation is
minimal.
• Professional practices , such as those of
architects, lawyers, and accountants , are usually
partnership firms.
Limited company
• A limited company is a legal entity, unlike a sole
proprietorship or partnership.
• Under the law, it has most of the rights of a
natural person.
• The law lays down rules for the functioning of
companies.
• Limited companies can either be public or
private.
Limited liability partnership (LLP)
• A LLP differs from a partnership in that a
partner of an LLP is generally not bound by
anything done by other partners.
• It has perpetual succession and separate legal
existence similar to a limited company.
• Also, only individuals can be partners in a
partnership; but an LLP can have individuals or
corporate bodies.
• It is a body corporate having perpetual
succession and a separate legal entity.
• It must have a minimum of two partners; there
is no maximum.
• The LLP form is essentially suitable for
professional services firms.
• In order to meet competition from international
firms, indian forms should become bigger and
that mena they should be able to have more than
20 partners (the limit for partnership).
• Also, the partner of an LLP will have protection
from professional negligence litigation.
• An LLP combines the flexibility and tax status of
a partnership with limited liability for its
partners.
• The Limited Liability Partnership bill introduced
in parliament in 2006 has not yet become law.