CHAPTER 1

Introduction to accounting

Chapter outline

Economic activity and information needs

Accounting: formal concept
The flow of information
Importance of accounting information
Financial Accounting and Management
accounting
Users of accounting information
How does accounting work?
Requirements of accounting information
Accounting regulation

Economic activity and

information needs
Imagine that you run the business.
You are not so rich, then you need to borrow
from bank or to attract outside investor.

Provide

information to bank or investors

Then, what information? -> Accounting info.

3

Information needs: Shareholders

Accounting The basis of

decision making
Accounting is the language of business
Accounting is the information system that

Measures

business activities
Processes that information into reports
Communicates the results to decision makers

Definition of accounting
Working definition:
A system providing information to managers
and owners in order make business
decisions
Formal definition:
The process of identifying, measuring and
communicating economic information to
permit informed judgements and
decisions by users of the information
6

American Accounting Association (1966),

Statement of Basic Accounting Theory, p.
1

Nature of Accounting

Accounting is about recording, preparing and

interpreting business transactions

Enables key questions to be answered, such as how

much profit have we made?

In small businesses, managers and owners are the

same people

In large businesses, managers and owners will be

different
7

The Accounting System:

The Flow of Information
1. People make decisions

2. Business transactions occur

3. Businesses prepare reports to show the

results of their operations

The Notion of Accounting

Accountants:
measure,
record

Economic
environment

communica
te

USERS

Beliefs &
Perceptions

Accounting as Communication
of Financial Information

Remember that managers and owners will be different

in large businesses because professional managers
tend to work for the benefit of owners.

Academics call this as the separation of ownership and

control.

Through accounting information, managers report their

performance to owners, and owners evaluate
managers.

10

Accounting as Communication
of Financial Information
Management is the
steward to whom
capital suppliers
entrust control over
a portion of their
financial resources

Financial data have

to facilitate
contracting
between parties
such as
management and
investors
11

Purpose of financial
statements is to
provide
a report to capital
suppliers to facilitate
their evaluation of
managements
stewardship

Income
measuremen
t

Financial data have

to facilitate
decisions makers in
selecting the best
action among
available
alternatives

Informationa
l
approach

Importance of Accounting
Information

12

Money makes the world go round

Businesses depend on cash and profit
Unless you understand accounting, you will never
understand business
Need to know basic terminology such as:
Income
Assets
Expenses
Liabilities
Profit
Capital
Cash flow

Internal vs. External Users

Internal : management accounting

More

focused and detailed information

No need to follow accounting
regulation

External : financial accounting

(financial statements)
Global

information
Need to follow accounting
regulation
13

Financial and Management

accounting
Financial accounting
Provision of financial information on a
businesss recent financial performance
targeted at external users such as
shareholders
Backwards-looking
Double-entry bookkeeping
Profit and loss account (income
statement) and balance sheet
14

Financial and Management

accounting
Management accounting
Internal needs of business
Not required by law (unlike financial
accounting)
Management accounting can be split
into cost accounting and decisionmaking
15

Overview Financial and

Management Accounting
Accounti
ng
Financi
al
Profit and
loss
Account

16

Balanc
e
sheet

Manageme
nt
Cash
flow
stateme
nt

Cost
making

Decisio
n
makin
g

Financial vs. Management

accounting

17

Financial accounting serves outsiders

while management accounting serves
insiders
The main work of financial accounting is to
prepare the financial statements
Financial accounting is based upon
double- entry bookkeeping while
management accounting is not
Financial accounting looks backwards
while
management accounting looks forwards

Users of Accounting Information

Outsider
s:
regulato
rs
consume
rs
supplie
rs

Insiders
18
:

FIR
M
Manageme
nt
Employe

Tax
officials
lender
s
Financi
al
market
s

User Information Requirements

User group

Information requirements

Internal users:
1. Management

Information for costing, decision-making,

planning and control

2. Employees

Information about job security and for collective

bargaining

External users
1. Shareholders and
analysts advisers

Information for buying and selling shares

2. Lenders

Information about assets and the companys

cash position

3. Suppliers, and customers Information about long-term prospects and

survival of the business

4. Government and tax

authorities

Information on profits to use as a basis for

calculating tax

5. Public

Information about the social and environmental

impact of corporate activities

19

Financial Statements

20

Understanding the Financial

Statements

21

The income statement reports net income

or net loss for the period. It reflects the
wealth generated by the company in a given
period
The balance sheet reflects the financial
position of the company at the end of a
period (assets and liabilities).
The financial statements help managers
take decisions about the company
(although they may have different
incentives)

Hewlett-Packard shares fall by 10% on lacklustre results

By Scott Morrison in San Francisco, Financial Times
Published: Aug 20, 2003

Hewlett-Packard shares fell 10 per cent in late trading yesterday after the computer and printer
maker reported disappointing third-quarter results.
The failure to meet analysts' expectations was a setback for the company, which has reported
several quarters of operational improvements following its $19bn (12bn) acquisition of
Compaq Computer last year.
HP blamed the results on overly aggressive pricing for personal computers and weak sales of
its corporate computers.
Carly Fiorina, chairman and chief executive, said: "The third quarter is always tough, but we still
should have done better. Nevertheless, we are confident in our strategy and the actions we're
taking. We expect to deliver a strong fourth quarter."
The company reported a net profit of $297m, or 10 cents per share, for the quarter ended July
31, compared with a loss of $2bn, or 67 cents per share, last year which including hefty
restructuring and acquisition charges.
Excluding special items, the company reported earnings of $700m, or 23 cents per share,
compared with a profit of $420m, or 14 cents per share, last year.
Revenue totalled $17.35bn, up 5 per cent from $16.54bn last year and down 4 per cent from the
previous quarter. Analysts had expected earnings of 26 cents per share on revenue of $17.5bn,
according to Thomson First Call.

22

HP's PC unit reported an operating loss of $56m, just one quarter after posting its first profit in
years.
The company
saidaimed
PC sales
fell because
ofgroup
seasonal
factors
gross margins
were
hit
by aggressive
pricing,
at fending
off rival
Dell's
bid forwhile
increased
market share.

The demand and supply of financial

information

The Demand for financial information will

depend upon:

Tastes and preferences (risk attitudes)

Beliefs about the future
Access to financial information

The supply of financial information will depend

upon:

Incentives companies have to voluntarily disclose

financial information
Regulatory framework
23

Need for Regulation

The role of capital
markets as fund
providers

Economic
consequences of
financial information

Managerial
incentives to
suppress
unfavorable
information

Need for regulation

24

Financial Information and Financial

Markets

The relationship between financial information and

security prices can influence investors direct demand
for financial information
Evidence shows:

Annual earnings are not timely information and

are preempted by alternative, more timely
sources
However, significant price reaction was found in the week of
the anouncement of annual earnings
Prices act as if earnings anouncements alter investors
belief
in such a way as to alter the price of security
25

Overview of Information
Characteristics

26

Decision-Making
4.
1.

Information Characteristics
Content
Relevance
- Does it affect users
decisions?
Reliability - Is it representationally faithful, neutral, free
from material error, prudent and complete?

2.

Presentation
Comparable
- Inter-and intra-company comparisons
Understandable - Presented as understandably as possible

Information must also be:

Material

27

Timely

Accounting Principles and

Concepts

Generally accepted accounting principles

(GAAP) are

The rules that govern how accountants

operate
Based upon a conceptual framework

28

Key Spanish Accounting

Organizations

29

ICAC
Treasury Ministry
Bank of Spain
AECA
UE Comission
CNMV

Accounting regulation in Spain

There are two different regulatory regimes in place
in Spain:

INTERNACIONAL
REGULATION
For Group Accounts of listed
companies. The international
regulation is based on the rules
issued by the IASB approved by
the European Commission.

30

NACIONAL REGULATION
For the rest of companies. These
follow the National regulation.

Regulatory Bodies Issuing

Accounting Rules in
Spain
ICAC (Instituto de
Contabilidad y Auditora de
Cuentas)
Public organization linked to
the Ministry of Economy. It
issues regulation (compulsory
for companies).
http://www.icac.meh.es
31

AECA (Asociacin
Espaola de
Contabilidad y
Administracin de
Empresas).
Private body. Profesionals
and academic are part of
this organization which
although it is influencial, it
cannot regulate in
accounting issues.
http://www.aeca.es

International
Accounting
Standards

Since 2005, all quoted companies within the EU have to prepare

their accounts following the International Accounting
Standards issued by the IASB. (CE 1606/2002)

The IASB (International Accounting Standards Board) is the

regulatory body of the IASC (International Accounting
Standards Committee)
http://www.iasb.org
32

International
Accounting
Standards

Until 2001, the standards issued by the IASB are denominated

IAS (or NIC in Spanish). Eg. IAS 2: Inventory
From 2001 the new standards are denomnated IFRS (NIIF
in Spanish). E.g. IFRS Insurance Contracts
Benefits of IAS-General common standards
Need to improve comparability of accounting information
The objective is to have a common standard capital market
Expand investment possibilities of European citizens
Macroeco33nomic benefits: employment, economic growth,
prosperity

Learning outcomes
Nature and importance of accounting
Main users of accounting and their
information needs
Different types of accountancy
Requirements of accounting
information
Main accounting
organizations

34

Bibliography

Harrison and Horngren: Financial Accounting. 6th or 7th

edition (Prentice Hall)
Vilardell, Ortn and Sol: Introduccin a la contabilidad
general (McGraw-Hill)
Jones (2006). Accounting. 2nd Edition. Ed. Wiley
UK GAAP (2000). Ernst and Young, Butterworth

35