Chapter 4: Understanding Accounting Issues
What is accounting and who uses it?
Accounting: a comprehensive system for collecting, analysing and communicating
Bookkeeping: recording accounting transactions.
Accounting information system (AIS): an organized procedure for identifying,
measuring, recording and retaining financial information so that it can be used in
accounting statements and management reports.
Types of users of accounting information:
Business managers use accounting information to set goals, develop plans, set
budgets and evaluate future prospects.
Employees and unions use accounting information to get paid and to plan for and
receive such benefits as health care, insurance, vacation time and retirement pay.
Investors and creditors use accounting information to estimate returns to
stockholders, to determine a company’s growth prospects, and to decide if the
company is a good credit risk before investing or lending.
Taxing authorities use accounting information to plan for tax inflows, to determine
the tax liabilities of individual and businesses, and to ensure that correct amounts
are paid in a timely fashion.
Government regulatory agencies rely on accounting information to fulfill their
duties; the provincial securities commissions, for example, require firms to file
financial disclosures so that potential investors have valid information about a
company’s financial status.
Who are accountants and what do they do?
Controller: the individual who manages all the firm’s accounting activities.
Financial and Managerial Accounting
Financial accounting system: the process whereby interested groups such as
consumer groups, unions, shareholders and government agencies are kept informed
about the financial condition of a firm.
It prepares and publishes income statements and balance sheets at regular intervals.
All of these documents focus on the activities of the company as a whole, rather
than on individual departments or divisions. In reporting data, financial accountants must conform to standard reporting formats
and procedures imposed by both the accounting profession and government
This requirement helps ensure that users can clearly compare information, whether
from many different companies or from the same company at different times.
The information in such reports is mostly historical: That is, it summarizes financial
transactions that have occurred during past accounting periods.
Managerial accounting system: internal procedures that alert managers to
problems and aid them in planning and decision making.
Managers at all levels need information to make decisions for their departments, to
monitor current projects and to plan for future activities.
Reports to these users serve the company’s individual units, whether they are
departments, projects, plants or divisions.
Internal reports may be designed in any form that will assist internal users in
planning, decision making and controlling.
As projections and forecasts of both financial data and business activities, internal
reports reveal current and future business prospects.
Chartered accountant (CA): an individual who has met certain experience and
education requirements and has passed a licensing examination; acts as an outside
accountant for other firms. About half of all CA work in CA firms that offer
accounting services to the public, while the other half work in government or
industry. CA firms typically provide audit, tax and management services. CAs
focus on external financial reporting for various interested parties (shareholders,
lenders, Canada Customs, and Revenue Agency, etc) that financial records of a
company accurately reflect the true financial condition of the firm.
Certified general accountant (CGA): an individual who has completed an
education program and passed a national exam; works in private industry or a CGA
firm. To be eligible a person must have an accounting job with a company. CGA
were formerly not allowed to audit financial statements belong to publicly held
companies, but due to changing times and policies, they are now allowed do so.
Most CGAs work in private companies, but there are a few CGA firms.
Certified management accountant (CMA): An individual, who has completed a
university degree, passed a national examination and completed a strategic
leadership; works in industry and focuses on internal management accounting.
CMAs works in all kinds and sizes of organization, and focus on applying best
management practices in all operations of a business. CMAs bring a strong market
focus to strategic management and resource deployment, synthesizing and
analyzing financial and non-financial information to help organizations maintain a
competitive advantage. CMA’s emphasize the role of accountants in the planning
and overall strategy of the firm in which they work. Accounting Services
Audit: an accountant’s examination of a company’s financial records to determine
if it used proper procedures to prepare its financial reports. Companies must
normally provide audited financial reports when applying for loans or when selling
stock. They will determine if the firm has controls to prevent errors or fraud from
going undetected, and will also examine receipts and inventories.
Forensic accountants: an accountant who tracks down hidden funds in business
firms, usually as part of a criminal investigation.
Generally accepted accounting principles (GAAP): standard rules and methods
used by accountants in preparing financial reports.
Tax services: include helping clients not only with preparing their tax returns but
also in their tax planning. A CA’s advice can help a business structure or
restructure its operations and investments and save millions of dollars in taxes.
Management consulting services: specialized accounting services to help
managers resolve a variety of problems in finance, production scheduling and other
areas. These services include personal financial planning, planning of corporate
mergers, plant layout and design, marketing studies, production scheduling,
computer feasibility studies and design and implementation of accounting systems.
Private accountants: an accountant hired as a salaried employee to deal with a
company’s day-to-day accounting needs.
Tools of the Accounting Trade
Assets = Liabilities + Owner’s Equity
Asset: anything of economic value owned by a firm or individual.
Liability: any debt owed by a firm or individual to others.
Owner’s equity: any positive difference between a firm’s assets and its liabilities;
what would remain for a firm’s owners if the company if the company was
liquidated, all its assets were sold, and all its debts are paid. It consists of two
sources of capital: the amount that the owners originally invested and the profits
earned by and reinvested in the company.
Owner’s Equity = Assets – Liabilities
Double-entry accounting: a bookkeeping system, developed in the fifteenth
century and still in use, that requires every transaction to be entered in two ways –
how it affects assets and how it affects liabilities and owner’s equity – so that the
accounting equation is always in balance.
When a company operates profitably, its assets increase faster than its liabilities.
Owner’s equity will increase if profits are retained in the business instead of paid
out as dividends to stockholders. Owner’s equity also increases if owner invest more of their own money to increase
Financial statements: any of several types of broad reports regarding a company’s
financial status; most often used in reference to balance sheets, income statements,
and/or statements of cash flows.
Balance sheet: a type of financial statement that summarizes a firm’s financial
position on a particular date in terms of its assets, liabilities and owner’s equity.
Current assets: cash and other assets that can be converted into cash within a year.
Liquidity: the ease and speed with which an asset can be converted to cash; cash is
said to be perfectly liquid.
Accounts receivable: amounts due to the firm from customers who have purchased
goods and services on credit; a form of current asset.
Merchandise inventory: the cost of merchandise that has been acquired for sale to
customers but that is still on hand.
Prepaid expenses: includes supplies on hand and rent paid for the period to come.
Fixed assets: assets that have long-term use or value to the firm such as land,