FABM 2 - Introduction to Accounting and Financial Information PDF

FABM 2 Introduction to Accounting and Financial Information Definition of Accounting American Accounting Association (AAA) Accounting is the process of identifying, measuring and communicating economic information to permit...

FABM 2 Introduction to Accounting and Financial Information Definition of Accounting American Accounting Association (AAA) Accounting is the process of identifying, measuring and communicating economic information to permit informed judgement and decisions by users of the information. American Institute of Certified Public Accountants(AICPA) Accounting as 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 financial character, and interpreting the result thereof. Accounting Standards Council(ASC) Accounting as a service activity. Accounting consist of the following: 1. Input-needed by an accountant are the economic transactions entered into by the business, evidenced by supporting documents. These include capital contribution by owners, rendering of services to customers, and payment of expenses to suppliers. 2. Process-Identification - answers "what transactions/accounts are concerned? Measurement - answers "how much money is involved? Recording - captures the transaction in the book of accounts of the business. 3. Output-Communicating Useful Financial Information Financial Statements are composed of the following: 1. Statement of Financial Position (Balance Sheet) 2. Statement of Comprehensive Income (Income Statement) 3. Statement of Changes in Equity 4. Statement of Cash Flow 5. Notes, comprising a summary of significant accounting policies and another explanatory information Statement of Financial Position * Is like a Static picture of portrait * Presents company's "POSITION" when it comes to the resources it owns (ASSETS), obligations claimed against it (LIABILITIES), and the owner's residual interest (EQUITY). * The date of this statement is always "as at" or "as of". Statement of Comprehensive Income * Is like a moving video clip * Tells the reader about the "performance" and activities of the company for a certain period. * Presents the revenues and expenses incurred by the company for a period of time. * The date of SCI is always " for the period ended" Statement of Changes in Equity * Tells a specific story about the owner's stake in the company. * The SCE tells the reader about the beginning stake of the owner (beginning capital), any additional investments, withdrawal of resources, and share in net income or net loss. * The date of the SCE is similar to SCI. Statement of Cash Flows * Tells a specific story about the cash transactions of the company. * Cash is very vital resource owned and controlled by the business. * Cash is most susceptible to theft and mismanagement. * Cash can be used or derived from operating, investing and or financing activities. Notes, comprising a summary of significant accounting policies and other explanatory information. * Complete set of financial statement also includes explanatory notes. * These notes generally provide additional information needed by the readers but not captured by the first four statements. Explanatory notes information includes: 1. Company information (eg., Operations, legal form, regulatory registrations) 2. Accounting policies used 3. Administrative requirements by regulators (eg. BIR and SEC) 4. Other relevant information Useful Financial Information Not all financial information are useful, just as not all stories are with merit. Therefore, one must always remember that accounting's output or end product is useful financial information. If accounting provides information that is not useful, this will mislead and deceive users of financial information. Owners and creditors might make incorrect and inappropriate business decisions because of misleading information. Useful information is said to be both RELEVANT and FAITHFULLY "represent what it purports to represent" Fundamental Qualitative Characteristics 1. Relevance-Some stories are true but not appropriate for a conversation. The same is true in accounting. Some information are true and yet not significant for user's decision making process. Information is said to be relevant if it can assist a user in predicting a financial situation or scenario (predictive value). Example: Information regarding current year sales can assist the owner in forecasting next year's sales. Information is also relevant if it can confirm predictions and forecasts previously made(confirmatory value). 2. Faithful Representation-Information regarding current year expenses can assist the owners in evaluating whether these are within budgeted limits(did the company overspend for the year?) It has been said that there is a definitive line between a story and a gossip. Accounting information is always concerned about the "true story" rather than "gossip" or "hearsay". Accounting information must "present what it purports to present. Otherwise, users and readers of financial information would be misled. To be considered as faithfully representative, accounting information must be complete, neutral (unbiased), and free from error. Completeness is the reason why additional explanatory notes are included in a complete set of financial statements. Neutral financial information, on the other hand, does not intend to deliberately influence a user's decision. Freedom from error means that the process in arriving at the financial information is indeed free from error. Relevance and faithful representation are used to be fundamental qualitative characteristics, financial information cannot be said to be useful. Enhancing qualitative characteristics are attributes that increase the usefulness of financial information. These characteristics are comparability, verifiability, timeliness and understandability. Enhancing Qualitative Characteristics 1. Comparability-Is similar to the expression "apples to apples" comparison. An entity's information is said to be comparable if such information can be compared to another entity. A company's cash account can be compared to a similar company's cash account like competitor's account. A keen user of financial information can expect that the composition of both cash accounts is comparable and not dissimilar. (eg. such accounts do not include goods for sale) Information is also said to be comparable if it can be compared with the previous year. Example: An entity's sales for the current year can be compared with the sale fro the previous year for percentage increase or decrease, since both of the accounts contain similar transactions. 2. Verifiability-Means that different users can reach an agreement about the financial information. Example: An entity's accountant records a cash receipt transactions of P100,000.00, then another accountant would agree that transaction is indeed for P100,000. Verifiability is about consensus. 3. Timeliness-People make decisions based on what they know at hand. Sometimes, crucial information comes late in the picture and a decision has been made already. Timely financial information ensures that such information is available to the users when they will make might be misinformed. 4. Understandability-In general, business dealings are characterized to be brief, clear and concise. In an organization's day to day operations, information must be clearly and concisely scaled down in order to be understandable. Complex yet relevant information, however, are not to be eliminated. Useful financial information presumes that the users are willing to learn about these complex information. Role of Useful Financial Information in Decision Making The role of an accountant in a business organization can be compared to a game's scorekeeper. The scorekeeper records every point earned in the game. Ultimately, the points tallied by the score keeper will determine whether a team did well or not. The same is true for accountants and business organizations. The accountant is expected to record and keep track of the activities of an organization. The accountant uses the source documents and business transactions as his or her input in the process. He or she then subjects these inputs into the process of identification, measurement and recording. The accountant then prepares the financial statement and communicates the financial information to users and readers of financial information make their decisions based on the information provided by the accountant. These decisions include whether to invest additional capital, sell their investment, or extend additional loan to the business. If an accountant fails to capture useful financial information, then the decisions made by the users could be misinformed and might lead to unforeseen consequences. Therefore, provision of useful financial information is the paramount concern of an accountant.