What Is Accounting?
Why is accounting so
popular? What consistently ranks as one of the top career opportunities in
business? What frequently rates among the most popular majors on campus? What
was the undergraduate degree chosen by Nike founder Phil Knight, Home Depot
co-founder Arthur Blank, former acting director of the Federal Bureau of
Investigation (FBI) Thomas Pickard, and numerous members of Congress?
Accounting. Why did these people choose accounting? They wanted to understand
what was happening financially to their organizations. Accounting is the financial
information system that provides these insights. In short, to understand your
organization, you have to know the numbers.
Accounting
consists of three basic activities—it identifies, records, and communicates the economic events of an organization to interested users.
Let’s take a closer look at these three activities.
Three Activities
As a starting point to
the accounting process, a company identifies the economic events
relevant to its business. Examples of economic events are the sale
of snack chips by PepsiCo, providing of telephone services by AT&T, and
payment of wages by Ford Motor Company. Once a company like PepsiCo identifies
economic events, it records those events in
order to provide a history of its financial activities. Recording consists of keeping
a systematic, chronological diary of events, measured in
dollars and cents. In recording, PepsiCo also classifies and summarizes
economic events.
Finally, PepsiCo communicates the collected information to interested users by
means of accounting reports. The most common of these
reports are called financial statements. To make
the reported financial information meaningful, PepsiCo reports the recorded
data in a standardized way. It accumulates information resulting from similar
transactions. For example, PepsiCo accumulates all sales transactions over a
certain period of time and reports the data as one amount in the company’s financial
statements. Such data are said to be reported in the aggregate.
By presenting the recorded data in the aggregate, the accounting process
simplifies a multitude of transactions and makes a series of activities
understandable and meaningful.
A vital element in
communicating economic events is the accountant’s ability to analyze and
interpret the
reported information. Analysis involves use of ratios, percentages, graphs, and
charts to highlight significant financial trends and relationships. Interpretation
involves explaining the uses, meaning, and limitations of reported
data. Appendix A of this textbook shows the financial statements of
PepsiCo, Inc.; Appendix B illustrates the financial statements of The Coca-Cola
Company. We refer to these statements at various places throughout the text. At
this point, they probably strike you as complex and confusing. By the end of
this course, you’ll be surprised at your ability to understand, analyze, and
interpret them.
You should understand
that the accounting process includes the bookkeeping function.
Bookkeeping usually involves only the recording of economic events. It is therefore
just one part of the accounting process. In total, accounting involves the entire
process of identifying, recording, and communicating economic events.
Who Uses Accounting Data
The information that a
user of financial information needs depends upon the kinds of decisions the
user makes. There are two broad groups of users of financial information:
internal users and external users.
1. INTERNAL USERS
Internal users of accounting
information are managers who plan, organize, and run the business. These
include marketing managers, production supervisors, finance directors, and
company officers. In running a business, internal users must answer many
important questions, as shown in Illustration 1-2.
To answer these and
other questions, internal users need detailed information on a timely basis. Managerial accounting provides internal reports to help users make decisions about their
companies. Examples are financial comparisons of operating alternatives,
projections of income from new sales campaigns, and forecasts of cash needs for
the next year.
2. EXTERNAL USERS
External users are individuals and
organizations outside a company who want financial information about the
company. The two most common types of external users are investors
and creditors. Investors (owners) use accounting
information to make decisions to buy, hold, or sell ownership shares of a
company. Creditors (such as suppliers and bankers) use accounting information
to evaluate the risks of granting credit or lending money. Illustration 1-3
shows some questions that investors and creditors may ask.
Financial accounting answers these questions.
It provides economic and financial information for investors, creditors, and
other external users. The information needs of external users vary
considerably. Taxing authorities, such as the Internal
Revenue Service, want to know whether the company complies with tax laws. Regulatory agencies, such as the Securities and Exchange Commission
or the Federal Trade Commission, want to know whether the company is operating
within prescribed rules. Customers are interested
in whether a company like General Motors will continue to honor product
warranties and support its product lines. Labor unions such as the Major League
Baseball Players Association want to know whether the owners have the ability
to pay increased wages and benefits.
