Accounting and Its Environment

This Chapter Explains:
The purpose of accounting and its role in business and society.
Who the primary users of accounting information are.
The distinction between financial and managerial accounting.
Some of the basic concepts and assumptions that underlie financial accounting.
The development of generally accepted accounting principles (GAAP).
Career opportunities in accounting.

“What is accounting and why is it important?”
“How is accounting related to other areas of business?”
“Why should I study accounting?”
This chapter answers these questions and provides a perspective for your study of accounting by describing briefly the accounting profession, its past and present. This background should make it easier for you to understand the concepts and techniques that will be examined in later chapters.

The Role of Accounting
Making good decision is vital for success in any enterprise. When an important decision must be made, one involving the livelihood of many people, it becomes essential to use a rational decision-making process. The process is essentially the same no matter how complex the issue. First, the problem or question must be clearly identified. Next, the facts surrounding the situation must be gathered and analyzed. Finally, several alternative courses of action should be considered before a decision or judgment is reached.

When the matter to be determined has a financial aspect-when, for example, it involves how best to employ the limited resources available to a government, a business, or an individual-accounting is involved. This is because accounting is a system of ideas and procedures that guides us in the task of gathering, measuring, and communicating the information we need to make knowledgeable financial decisions.

The information supplied by accounting is in the form of quantitative data, primarily financial in nature, and is concerned with economic entities. An economic entity may be an individual; a business, such as a grocery store or a car dealership or a steel plant, that strives to make a profit; or a nonprofit organization, such as a hospital or a school or a government agency, that has as its goal the providing of service in an effective and efficient manner. Or it could be the total economy of a nation. Every entity, regardless of its size or purpose, must have a means of keeping track of its economic activities and measuring how well it is accomplishing its goals. Accounting provides the rules and the system for keeping score.

Without accounting information, investors, for example, would have no way of telling a profitable company from a failing one, bankers couldn’t distinguish between a sound loan and a foolhardy one, corporate managers would have no way of controlling costs, setting prices, or preparing budgets, and governments would have no basis for taxing income. No list of examples could fully represent the pervasive use of accounting information and ideas throughout the fabric of our economic, social, and political institutions. When accounting information is used effectively as a basis for making decisions, limited resources are utilized efficiently. This results in an improved economy and a higher standard of living.

Thus accounting is a service activity designed to accumulate, measure, and communicate economic data to various decision makers, some of whom (management) work within the economic entity and some of whom (investor and creditors, for example) do not.

The Relationship of Accounting to Business
Business is the general term applied to the production and distribution of goods and services. Some of the specific functions of business are the manufacturing and marketing of goods and the raising of capital by organizations that produce and sell those goods. Accounting is related to these functions because it is used to communicate financial information within a business and between businesses. As a result, accounting is often called the language of business; it provides the means of recognizing and recording the financial successes and failures of organizations.

All organizations have some activities in common. As depicted in exhibit 1-1, one common activity is the accumulation of money resources. These resources come from investors and creditors, and from the business itself in the form of earnings that have been retained. For many nonprofit organizations, the resources come from tax appropriations. Once resources are obtained, they are used to buy land, buildings, and equipment; to purchase material and supplies; to hire employees; and to meet any other expenses involved in the production and marketing of goods or services. When the product or services is sold. The revenues generated by a business are converted to money resources that can be returned to owners or used to pay off loan and to pay taxes. In addition, some resources may be retained in the business activity. The results of these activities are measured and communicated by accountants, who thus provide a basis for judging whether the entity has attained its financial objectives.

In order to measure these results as accurately as possible, accountants follow a standard set of procedures, usually referred to as the accounting process, or the accounting cycle. The cycle includes several steps, which involve analyzing, recording, classifying, summarizing, reporting, and interpreting accounting data. These steps are explained in detail in Chapter 3.

To Summarizing
Accounting is a service activity designed to accumulate, measure, and communicate economic information. It provides quantitative data, primarily financial in nature, about economic entities-business and nonprofit organizations. Its purpose is to provide information that leads to intelligent decisions about how best to use limited resources. Accounting is often called the language of business since it provides the means of recognizing and recording the financial status and operating results of business entities.