Chapter One

Accounting: Information for Decision-

Making
 Chapter Outline
o Accounting as an Information System
o Business Goals, Activities, and Performance Measures
o Financial and management Accounting
o Basic Functions of an Accounting System
o Accounting Vs. Bookkeeping
o Decision-Makers: The Users of Accounting Information
o Types of Business Organizations
o The Corporate form of Business
o Accounting Measurement
o Financial Position and the Accounting Equation
o Communications through Financial Statements
o Objectives of Financial Reporting
o Objectives of Managerial Reporting
o International Financial Reporting Standard (IFRS)
Overview of Accounting as an Information System
The American Institute of Certified and Public
Accountants Committee on Terminology defined
accounting as: “Accounting is 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”.
From the above the following attributes of
accounting emerge :
Recording: It is concerned with the recording of
financial transactions in an orderly manner, soon after
their occurrence In the proper books of accounts.

Classifying: It Is concerned with the systematic

analysis of the recorded data so as to accumulate the
transactions of similar type at one place.
 Summarizing: It is concerned with the preparation and

presentation of the classified data in a manner useful to the

users. This function involves the preparation of financial

statements such as Income Statement, Balance Sheet,

Statement of Changes in Financial Position, Statement of Cash

Flow, Statement of Value Added.

 Interpreting: The accountants should interpret the statements

in a manner useful to action. The accountant should explain

not only what has happened but also

 what is likely to happen under specified conditions.
 why it happened, and what would be the possible outcome and action to be taken
 Accounting provides an account – an explanation or report
in financial terms – about the transactions of an
organization.

 Accounting enables managers to satisfy the stakeholders in

the organization (owners, government, financiers, suppliers,
customers, employees etc.) that they have acted in the best
interests of stakeholders rather than themselves.
 Paul M. Collier (2003) also defined Accounting as a “A
collection of systems and processes used to record, report
and interpret business transactions.”
 Any system has three features viz. input, processes and
output.
 Accounting as a social science can be viewed

as an information system since it has all the three feature:

 inputs (raw data),

 processes (men and equipment)

 outputs (reports and information).

The types of accounting information may be classified
into four categories:
1. Operating information
2. Financial accounting information
3. Management accounting information and
4. Cost accounting information.
 Basic Functions of an Accounting System
Accounting which is so important to all, discharges
the following vital functions:
Keeping systematic records
Protecting the business properties
Communicating the results
Meeting legal requirements
Facilitate managerial decision making
Accounting Vs. Bookkeeping
Book-keeping is a part of accounting and is
concerned with the recording of transactions
which is often routine and clerical in nature,
whereas accounting performs other functions as
well, viz., measurement and communication,
besides recording.
An accountant is required to have a much higher
level of knowledge, conceptual understanding and
analytical skill than is required of the book-keeper.
An accountant
 designs the accounting system,

 supervises and checks the work of the book-keeper,

 prepares the reports based on the recorded data and

interprets the reports
 take part in matters of management, control and
planning of economic resources.
 Financial Accounting and management Accounting
Financial accounting is the branch of accounting
intended for users outside the business itself
Financial accounting is concerned on recording
business events and preparation of annual financial
statements
Management accounting is that branch of
accounting concerned with the provision of
information intended to be useful to management
within the business.
Management accounting is mainly concerned with
facilitate proper managerial decision making
 Discussion point

Discus the similarities and differences between

financial and management Accounting?
 Financial Accounting
 Financial accounting is the language that translates
economic events into uniform and comprehensive
information, understandable by OUTSIDE observers

 It is concerned with the recording of transactions for a

business enterprise and the periodic preparation of various
reports from such records

 The financial accounting information system is designed to

provide financial information for various users
A standard financial reports, though primary designed
provide information for investor and financers, is
believed to help others users, including the
management

Financial accounting is used for both prediction and

control
Communications through Financial Statements
 Types of Business Organizations
Organization can be classified based on
 Based on type of business operation
 Legal ownership status
 Area of operation
Factors to be considered in deciding type of business
ownership
 Extent of liability
 Tax advantage
 Ease of formation
 Longevity or continuity
 Control
 Ability to comply with annual reporting requirement
 Legal formation of business and Information Demand

 based on the need for accounting information and legal

reporting requirement firms can be grouped into two
I. Privately Held Firms:

1. Proprietorship—typically a small firm with one specific

owner

2. Partnership—typically medium-sized firms with shared

ownership

II. Publicly Held (or Traded) Firms:

3. Corporation—typically large firms with diverse ownership

Why do publicly-traded companies/Corporations have
to issue financial reports? Monitoring
 Separation of ownership (shareholders) and control (hired
managers) presents a classic principal-agent problem
(agency theory)

 Agency theory suggests that, without proper monitoring and

incentives, agents will extract privileges (Jensen and
Meckling, 1976)

 Financial reports are one mechanism to help monitor ing

managers’ actions
 Why do publicly-traded Corporations have to Issue financial
reports? Investing
 investors and creditors asses future financial viability of
company with the help of financial analysts.

 Financial analysis is a way to anticipate future economic

events from information about past ones.

 Financial analysis doesn’t tell what will happen, but it tells

you what can happen. There is a chance of things going
wrong. This chance defines risk and it can be measured.
 Risk vs Return: Equity vs Credit Investors
 Investors may share more risk and become a partner of the firm, want to
know the potential growth of the firm
 basically they want to know all the info they can get to be an equity
investor!
 Others who want to limit their risk may finance the firm as a creditor

 creditors are concerned with the potential ability of the firm to repay the
debt,
 n between there is a rich palette of different flavors of investors,
concerned with accurate information for their investments
Accounting Standards, GAAP,IFRS
For communicating the results of business to outside
world, it should be based on certain uniform and
scientifically laid down principles or postulates.

Accounting principles mean “those rules of conduct or

procedures which are adopted by accountants
universally while recording the accounting transactions
and preparing financial reports.
 Accounting Concepts
 Accounting Concepts includes those basic assumptions or
conditions upon which the science of accounting is based.
 Important accounting concepts are:

1. Business Entity Concept

 Entity is different from it’s owner for accounting purposes
2. Dual aspect Concept

Recording simultaneously debits and credits

The accounting equation:
Equities/Capital+ Liabilities = Assets
3. Cost Concept :
Assets are normally recorded basis of historical cost
i.e. acquisition cost.
Market value immaterial, except on concepts of
revaluation.
4. Going Concern Concept
Always on anticipation that a business will continue
for long and will not be liquidated
5. Money Measurement Concept
 only transactions which are expressed in money terms
are recorded.
6. Realization Concept
Revenue is recognized only when, sale is made.
Exceptions may be on certain businesses such on
HP/sale on contract etc.

7. Monetary Value Concept

Assumptions on constant value of dollar/Birr/rupee
8. Accrual Concept
under this concept, the effects of transactions and
other events are recognized on mercantile basis i.e.
when they occur (and not as cash received or paid)
 9. Consistency
In order to achieve comparability of the financial
statements of a enterprise through time, the
accounting policies are followed consistently from the
one period to another, a change in an accounting
policy is made only in certain exceptional
circumstances.
 Accounting Standard
 Accounting Standard are written policy document issued by
professional accounting body or by government or regulatory body
covering the aspects of recognition, treatment, measurement,
presentation and disclosure of accounting transaction and events
in the financial statements.
 Accounting standards (ASs) provide framework and standard
accounting policies so that financial statements of different
enterprises become comparable.
 statements of an enterprise should give a true and fair view of its
financial position and working results.
 Accounting Standards (AS) need to have:
 Uniformity
 Rationalization
 Comparability
 Transparency
 Adaptability in Financial Statements.
 International Accounting Standards (IAS)
International Accounting Standards Committee (IASC) was
constituted in 1973 to formulate accounting standards.
Barring Canada, Japan and US all countries have
accepted these standards.
To give proper direction and interpretations Standards
Interpretations Committee was formed in 1997
IASB was constituted in 2001 to prescribe norms for
treatment of several items on preparation and
presentation of Financial statements.
 ISAB adopted all 41 standards issued by IASC.
 The US Financial Accounting Standards Board (FASB) and
IASB are in process of eliminating differing in some
standards.
IASB publishes its Standards in a series of
pronouncements called International Financial Reporting
Standards (IFRSs). It has also adopted the body of
Standards issued by the Board of the International
Accounting Standards Committee (IASC).
Those pronouncements are designated "International
Accounting Standards" (IASs).
International Financial Reporting Standard (IFRS)
 IFRS Defined in (IAS 1.7, IAS 8.5 ,IFRS 1 is Standards
and Interpretations adopted by the International
Accounting Standards Board (IASB).
 They comprise :
International Financial Reporting Standards
International Accounting Standards; and
Interpretations developed by the International
Financial Reporting Interpretations Committee
(IFRIC) and
Former Standing Interpretations Committee
(SIC)
 Accounting Measurement
 Financial statements include descriptions and amounts for
items that fit the definitions of elements of financial
statements and that meet the recognition criteria.
 Measurement, as the term is used in accounting is the
process of determining which amounts to present on the
face of each financial statement (and in some case in
notes to financial statements).
 The term measures refers to those amounts presented or
disclosed.
 Measurement methods
a) cost-based measures;
b) fair value and other current market prices; and
c) other measures based on estimated cash flows
 Cost-based measures
the cost based measure is applicable
 IAS 2, Inventories

 IAS 16, Property, Plant and Equipment,

 IAS 38, Intangible Assets

 IAS 40, Investment Property

 The cost is defined as the amount of cash or cash equivalents paid or the
fair value of the other consideration given to acquire an asset at the time of
its acquisition or construction, or, when applicable, the amount attributed to
that asset when initially recognized in accordance with the specific
requirements of other IFRSs, eg IFRS 2.
Subsequent Adjustment of cost measures
The initial measures at cost of assets and liabilities are
adjusted over time in a variety of ways.
The most common reasons are:
i. depreciation or amortization;
ii. accrual of interest, accretion of discount, or
amortization of premium;
iii. impairment of assets or increases to the
carrying amount of liabilities that have
become more onerous.
According to IAS 2 the cost of inventory is the cost of
purchase or conversion and all other costs incurred in
bringing inventories to their present location and
condition
 Measuring at Fair Value
 IFRS 13 defines fair value as the ‘price that would be
received to sell an asset or paid to transfer a liability in an
orderly transaction between market participants at the
measurement date’.
Other measurement methods based on
estimated future cash flows
 A few measurement methods used in existing IFRSs are
neither fair value nor cost-based but are based on
estimates of future cash flows.

 For example the best (and honest) estimate (at present

value) can be used to measure
 Asset impairment

 Net realizable value of inventories

 Provisions
 Management Accounting
 Management Accounting: Management accounting employs
both historical and estimated data in assisting management
in daily operations and in planning for future operations.
 It deals with specific problems that confront enterprise
managers at various organizational levels.
 The management accountant is frequently concerned with
identifying alternative courses of action and then helping to
select the best one.
management accounting information system intends
to provide timely and accurate information to
facilitate efforts to control costs, to measure and
improve productivity, and to devise improved
production processes.
Functions of Management Accounting
The Chartered Institute of Management Accountants’
definition of the core activities of management
accounting includes:
 participation in the planning process at both strategic and

operational levels,

 involving the establishment of policies and the formulation

of budgets;
 the initiation of and provision of guidance for management

decisions, involving the generation, analysis, presentation

and interpretation of relevant information;

 contributing to the monitoring and control of performance

through the provision of reports including comparisons of

actual with budgeted performance, and their analysis and
interpretation.
Decision-Makers: The Users of Accounting Information
 Accounting as an information system facilitates managerial
decision making

 The most important financial information needed in the

process of business decision comes from accounting.

 Every business has some sort of accounting system

designed to meet the needs of the decision makers.

 Accounting basically, processes or gathers and studies

“raw data” and converts them into suitable
information in the process of decision making
 Managerial Decision Making Model
A decision model is a specific set of procedures that

produces a decision, can be used to structure the

decision maker’s thinking and to organize the
information to make a good decision.
 The following is an outline of one decision-making model:
 Step 1. Recognize and define the problem.

 Step 2. Identify alternatives as possible solutions to the problem.

Eliminate alternatives that clearly are not feasible.
 Step 3. Identify the costs and benefits associated with each
feasible alternative. Classify costs and benefits as relevant or
irrelevant, and eliminate irrelevant ones from consideration.
 Step 4. Estimate the relevant costs and benefits for each feasible
alternative.
 Step 5. Assess qualitative factors.

 Step 6. Make the decision by selecting the alternative with the

greatest overall net benefit
 Discussion Point

 Identify managerial decisions and discus the

related accounting information.