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Old 04-02-2011, 12:44 PM
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Default Accounting Introduction


What is Accounting?
People around the world consider it quite important. Whether you are going to invest in McDonald's stock, buy new equipment, forecast future sales or expenditures, you almost always use accounting information. Why? The answer is because accounting provides information for decision-making in the business world.

Accounting is a service-based profession that provides reliable and relevant financial information useful in making decisions.
Financial information may include sales, expenses, taxes and other figures.
So, how exactly is this information prepared? There are several steps involved. These steps are identification, recording and communication.


First, economic events are identified. A sale at a gas station, payment of taxes by a commercial enterprise, or purchase of insurance are all examples of economic events.


Second, all economic events are recorded. Recording is done to provide a history of a company's financial activities. In this step economic events are also classified and summarized.

Third, information about classified and summarized economic events is communicated to interested parties. Such communication may take several forms. One of them is financial statements about which we will talk later in this chapter.

2. Users of accounting information

Interested parties are also called accounting information users. There are two broad categories of accounting information users:
External users are parties outside the reporting entity (company) who are interested in the accounting information.
Investors (owners) use accounting information to make buy, sell or keep decisions related to shares, bonds, etc. Creditors (suppliers, banks) utilize accounting information to make lending decisions. Taxing authorities (Internal Revenue Service) need accounting information to determine a company's tax liabilities. Customers may need accounting information to decide which products and from which company to buy.

Internal users are parties inside the reporting entity (company) who are interested in the accounting information.
A company's senior and middle management uses accounting information to run business. Employees utilize accounting information to determine a company's profitability and profit sharing.

Financial accounting provides information that is designed to satisfy the needs of external users. Such reporting is usually done in the form of financial statements.

Managerial accounting provides information that is useful in running a company by internal users. Such reporting is usually accomplished through custom designed reports.
See related illustration for the connection between types of accounting and accounting information users.
3. Generally Accepted Accounting Principles (GAAP)

People and organizations make decisions based on financial information prepared by accountants. That is why it is important for these people and organizations to understand how accounting information is measured. To facilitate communication, rules are established that business people can use to ensure they compare oranges to oranges. For example, assume a store sells goods. When should an accountant record the sale, at the moment the goods are shipped (accrual accounting) or at the time cash for these goods is received (cash accounting)? Whether the store owner applies the accrual or cash accounting is not important as long as a third rule is established requiring the owner to disclose the method selected for the reporting purposes. Accounting rules in the USA are grouped and called Generally Accepted Accounting Principles (GAAP).
Generally Accepted Accounting Principles (GAAP) are common standards that indicate how to report economic events.
Financial Accounting Standards Board (FASB) issues Statements of Financial Accounting Standards (SFAS) that comprise a large portion of GAAP. You can find more information about SFAS, their issuance process and current projects on FASB's website. In 2009, all SFAS statements and other pronouncements were included into Accounting Standards Codification (ASC), which is expected to be the single source of authoritative U.S. accounting and reporting standards, other than guidance issued by the SEC. Other organizations playing a significant role in regulating the accounting profession are Securities and Exchange Commission and Public Company Accounting Oversight Board. The last two mostly regulate public companies, while the first one establishes standards for private companies.


4. Financial reporting and financial statements

Businesses communicate accounting information to the public through a process known as financial reporting.
Financial reporting is a process through which companies communicate information to the public.
The central means of external financial reporting is a set of financial statements. The four general-purpose financial statements are the following:
  • Income Statement
  • Statement of Changes in Equity
  • Balance Sheet
  • Statement of Cash Flow

An income statement presents revenues and expenses and resulting net income or loss for a period of time. An income statement is also called Statement of Operations, Earnings Statement, or Profit and Loss Statement (P/L).

A statement of changes in equity shows all changes in owner's equity for a period of time. This statement is also called Owners' Equity Statement.


A balance sheet presents assets, liabilities and owner's equity at a specific date. A balance sheet is also called Statement of Financial Position.


A cash flow statement summarizes information about cash outflows (payments) and inflows (receipts). This statement may also include certain information not related to actual cash flows.


All financial statements consist of classes or categories known as elements. There are ten elements:
assets, l
iabilities,

equity,

contributed capital,

revenue,

expenses,

distributions,

net income,

Gain and losses






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