Accounting is an information system. It gathers, manipulates and translates business transactions into organized, reliable, timely and understandable information from which users can make informed decisions.
The accounting process begins and ends with people making decisions.
1.) Individuals – like you and me use accounting to make everyday decisions. 2.) Investors and Creditors – Investors use accounting information to determine if and how much of return can be expected by investing in a company. - Creditors use accounting information to determine whether a Company is a good credit risk (i.e. – can we lend money or provide good and services prior to receiving payment from the Company). 3.) Regulatory Bodies – the IRS and other state & local governments are interested in accounting information for collecting various types of taxes. The SEC (Securities Exchange Commission) is interested in accounting information for those Companies wishing to have their stocks listed on the Exchange and insuring that once listed that the Company files the appropriate documents in a timely manner. 4.) Nonprofit Organizations - these entities make most of their budgetary and operational decisions from accounting information. Additionally, they are also required to file various reports to governmental agencies.
Several differences between Financial and Managerial Accounting: Financial Accounting Managerial Accounting 1.) Focuses on external users. 1.) Reports to managers inside the organization for planning, controlling and decision making. 2.) Emphasizes past financial activity. 2.) Emphasizes decisions affecting the future. 3.) Emphasizes objectivity and verifiability. 3.) Emphasizes relevance. 4.) Emphasizes precision. 4.) Emphasizes timeliness. 5.) Companywide reports. 5.) Segment reports. 6.) Must follow GAAP / IFRS. 6.) Does not have to e GAAP/ IFRS compliant. 7.) External reports are mandatory. 7.) External reports are not mandatory.
1.) Also known as “Sole Proprietorships”. 2.) Does not have to file existence with any governmental agency; no formal documents or agreements required. 3.) Taxes for income flow through the individuals personal tax return on either Schedule C or Schedule E.
1.) As the term partnership implies, it requires two or more co-owners to be a partnership. 2.) Two types of partnerships: General and Limited (Limited Liability). 3.) Although partnerships are required to file a tax return, it is not a taxpaying entity. Income passes through to the personal tax return via a Form K-1 and income is generally reported on Schedule E. 4.) All partnership should be governed by an agreement. 5.) In a general partnership, there exists mutual agency which means any of the partners can act on behalf of the entity. In a limited partnership, limited partners generally CANNOT act on behalf of the entity. They exchange their right of management for having limited personal liability or credit risk exposure of the partnership. They are “silent partners”. 6.) Are general partners have unlimited personal liability for the debts of the partnership. 7.) Unless stipulated in the partnership agreement, the partnership dissolves when a partner leaves the partnership or one partner becomes deceased.
1.) Owners in a LLC are known as members, not partners. 2.) Although LLCs are required to file a tax return, it is not a taxpaying entity. Income passes through to the personal tax return via a Form K-1 and income is generally reported on Schedule E. 4.) All LLC should be governed by an agreement and many states require this document to be filed with the Secretary of State’s office. 5.) This form of business is much more popular than a partnership because members enjoy limited liability as well as paying lower taxes due to the fact that income is paid through the personal return. 6.) This entity does survive if one of the members wants out of the LLC or becomes deceased.
Relevance – capable of making a difference to the decision maker. Faithful Representation – information must be: 1.) complete; 2.) accurate (w/o material error) and neutral (free from bias). In other words, the information must be reliable. Materiality - an accounting item is material if its inclusion or omission would influence the decision making of the person using the accounting information. Materiality accounting relieves companies of the need to record immaterial items, as is required by other accounting principles. Comparability – the accounting information must be prepared in a manner that allows it to be compared similarly to previous periods the entity has reported and has also can to compared to similar entities within an industry. Verifiability – information must be able to be checked for accuracy, completeness and reliability (this is typically done by internal and external auditors). Timeliness – information must be available to users within a timeframe where the information is pertinent and useful in their making decisions. Understandability – must be sufficiently transparent so as to make sense to reasonably informed users of the information. Constraint – anything that prevents you from getting more of want you want.
The Historical Cost Principle in Accounting conflicts with the position that many Economists and Financial Professional take in regarding an asset’s value. The latter takes the position that the asset’s value is what the current market value is for the asset today.
Assets – what you have Liabilities – what you owe Owner’s Equity – what you own