UNIT 2
The accounting profession
Positions in the field of accounting may be divided into .several areas. Two general classifications are public accounting and private accounting. Public accountants are those who serve the general public and collect professional fees for their work, much as doctors and lawyers do. Their work includes auditing, income tax planning and preparation, and management consulting. Public accountants are a small fraction (about 10 percent) of all accountants. Those public accountants who have met certain professional requirements are designated as Certified Public Accountants (CPAs).
Private accountants work for a single business, such as a local department store, the McDonald's restaurant chain, or the Eastman Kodak Company. Charitable organizations, educational institutions, and government agencies also employ private accountants. The chief accounting officer usually has the title of controller, treasurer, or chief financial officer. Whatever the title, this person usually carries the status of vice-president.
Some public accountants pool their talents and work together within a single firm. Most public accounting firms are also called CPA firms because most of their professional employees are CPAs. CPA firms vary greatly in size. Some are small businesses, and others are medium-sized partnerships. The largest CPA firms are worldwide partnerships with over 2,000 partners. Such huge firms are necessary because some of their clients are so large and their operations are so complex. For instance, Price Waterhouse, one of the eight largest American CPA firms, has reported that its annual audit of one particular client would take one accountant 630,720 hours of effort - that equals 72 years of nonstop work! Another Price Waterhouse client owns 300 separate corporate entities. All their records are combined into a single set of financial statments. Such time consuming tasks make a large staff of accountants a necessity.
Public accounting
Auditing is the accounting profession's most significant service to the public. An audit is the independent examination that assures the reliability of the accounting reports that management prerares and submits to investors, creditors, and others outside the business. In carrying out an audit, CPAs from outside a business examine the business's financial statements. If the CPAs believe that these documents are a fair presentation of the business's operations, the CPAs give a professional opinion stating that the firm's financial statements are in accordance with generally accepted accounting principles, which is the standard. Why is the audit so important? Creditors considering loans want assurance that the facts and figures the business submits are reliable. Stockholders, who have invested in the business, need to know that the financial picture management shows them is complete. Government agencies need accurate information from businesses.
Tax accounting has two aims: complying"with the tax laws and minimizing taxes to be paid. Because income tax rates range as high as 28 percent for individuals and 34 percent for corporation, reducing income tax is an important management consideration. ' Tax work by accountants consists of preparing tax returns and planning business transactions in order to minimize taxes. CPAs advise individuals on what types of investments to make and on how to structure their transactions.
Management consulting is the catcall term that describes the wide scope of advice CPAs provide to help managers run a business. As CPAs conduct audits, they look deep into a business's operations. With the insight they gain, they often make suggestions for improvements in the business's management structure and accounting systems. (We discuss these areas of accounting in the next section). Management consulting is the fastest-growing service provided by accountants.
Private accounting
Cost accounting analyzes a business's cost to help managers control expense. Traditionally, cost accounting has emphasized manufacturing costs, but it is increasingly concerned with the cost of selling the goods. Good cost accounting records guide managers in pricing their products to achieve greater profits. Also, cost accounting information shows management when a product is not profitable and should be dropped.
Budgeting sets sales and profit goals and develops detailed plans - called budgets - for achieving those goals. Many companies regard their budgeting activities as one of the most important aspects of their accounting systems. Some of the most successful companies in the United States have been pioneers in the field of budgeting - Procter & Gambele and General Electric, for example.
Information systems design identifies the organization's information heeds, both internal and external. It then develops and implements the system to met those needs. Accounting information systems help control the organization's operations. Flow charts and manuals that describe the various functions of the business and the placement of responsibility with specific employees are parts of system design.
Internal auditing is performed by a business's own accountants. Many large organizations - Motorola, Bank of America, and 3M among them - maintain a staff of internal auditors. These accountants evaluate the firm's own accounting and management systems. Their aim is to improve operating efficiency and to ensure that employees and departments follow management's procedures and plans.
Financial accounting provides information to people outside the firm. Creditors and stokholderd, for example, are not part of the day-to-day management of the company. Likewise, government agencies, such as the SEC, and the general public are external users of a firm's accounting information.
Management accounting generates confidential information for intenal decision makers, such as top executieves, department heads, college deans, and hospital administrators.
UNIT 3
The accounting equation and the balance sheet
Accounting is often said to be the language of business. It is used in the business world to describe the transactions entered into by all kinds of organizations. Accounting terms and ideas are therefore used by people associated with business, whether they are managers, owners, investors, bankers, lawyers, or accountants. As it is the language of business there are words and terms that mean one thing in accounting, but whose meaning is completely different in ordinary language usage. Fluency comes, as with other languages, after a certain amount of practice. When fluency has been achived, that person will be able to survey the transactions of businesses, and will gain a greater insight into the way that business is transacted and the methods by which business decisions are taken.
The actual record-making phase of accounting is usually called book-keeping. However, accounting extends far beyond the actual making of records. Accounting is concerned with the use to which these records are put, their analysis and interpretation. An accountant should be concerned with more than the record-making phase. In particular he should be interested in the relationship between the financial results and the events which have created them. He should be studying the various alternatives open to the business, and be using his accounting experience in order to aid the management to select the best plan of action for the business. The owners and managers of a business will need some accounting knowledge in order that they may understand what the accountant is telling them. Investors and others will need accounting knowledge in order that they may read understand the financial statements issued by the business, and adjust their relationships with the business accordingly.
Probably there are two main question that the managers or owners of a business want to know: first, whether or not the business is operating at a profit; second, they will want to know whether or not the business will be able to meet its commitments as they fall due, and so not have to close down owing to lack of funds. Both of these questions should be answered by the use of the accounting data of the firm.
UNIT 4
The double - entry system for assets and liabilities.
It has been seen that each transaction affects two items. To show the full effect of each transaction, accounting must therefore show its effect on each of the two items, be they assets, capital or liabilities. From this need arose the double-entry system where to show this twofold effect each transaction is entered twice, one to show the effect upon one item, and a second entry to show the effect upon the other item.
It may be thought that drawing up a new balance sheet after each transaction would provide all the information required. However, a balance sheet does not give enough information about the business. It does not, for instance, tell who the debtors are and how much each one of them owes the firm, nor who the creditors are and the details of money owing to each of them. Also, the task of drawing up a new balance sheet after each transaction becomes an impossibility when there are many hundreds of transactions each day, as this would mean drawing up hundreds of balance sheets daily. Because of the work involved, balance sheets are in fact only drawn up periodically, at least annually, but sometimes half-yearly, quarterly or monthly.
The double-entry system has an account (meaning details of transactions in that item) for every asset, every liability and for capital. Thus, there will be a Shop Premises Account (for transactions in shop premises), and so on for every asset, liability and forcapital.
Each account should be shown on a separate page. The double-entry system divides each page into two halves. The left-hand side of each page is called the debit side, while the right-hand side is called the credit side. The title of each account is written across the top of the account at the centre.
It must not be thought that the worlds "debit" and "credit" in book-keeping mean the same as the words "debit" or "credit" in normal language usage. Anyone who does will become very confused.
If you have to make an entry of $10 on the debit side of the account, the instructions could say "debit the account with $10" or "the account needs debiting with $ 10".
PART III
AUDITING
Different types of audits and the purposes of audits have evolved over many years, and this evolution is still taking place. Accordingly, auditing should be defined broadly enough to cover the various types and purposes of audits. The definition of auditing that appeared in A Statement of Basic Concepts, published in 1973 by the American Accounting Association (AAA) Committee on Basic Auditing Concepts, embraces both the process and purposes of auditing.
Auditing is a systematic process of objectively obtaining and evaluating evidence regarding assertions about economic actions and events to ascertain the degree of correspondence between those assertions and established criteria and communicating the results to interested users.
The AAA Committee noted that its definition was intentionally quite broad to cover "the many different purposes for which as audit might be conducted and the variety of subject matter that might be focused on in a specific audit engagement". The following discussion of each key phrase in the definition is couched primarily in the context of an audit of the financial statements of a business organization, usually referred to as a financial audit.
Assertions About Economic Actions and Events. The assertions of management that are embodied in a set of financial statements are the subject matter of an audit of those statements. For example, the item "inventories ... $5,426,000" in a balance sheet of a manufacturing company embodies the following assertions, among others: The inventories physially exist; they are held for sale or use in operations; they include all products and materials; $5,426,000 is the lower of their cost or market value (as both terms are defined under generally accepted accounting principles); they are properly classified on the balance sheet; and appropriate disclosures related to inventories have been made, such as their major categories and amounts pledged or assigned. Comparable assertions are embodied in all the other specific items and amounts in financial statements. Those assertions can be conveniently grouped into a few broad categories.
The assertions are made by the prepaper of the financial statements - management - and communicated to the readers of the statements; they are not assertions by the auditor. The auditor's responsibility is to express an opinion on management's assertions in the context of the financial statements taken as a whole, and to communicate that opinion to the readers in the form of the auditor's report. Similar assertions are also the subject matter of compliance and performance audits.
Since the subject matter of auditing usually is information about economic actions and events, assertions must be quantifiable to be auditable. Building costs are quantifiable, as is the number of stock options outstanding; the morale of employees is not. Information that is quantifiable is also generally verifiable; information that is not verifiable is by definition not auditable. Information is verifiable if it "provides results that would be substantially duplicated by independent measures using the same measurement methods".