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University of Bahrain College of Business Administration MGT 131: Introduction to Business Administration Chapter Twelve Understanding Financial Information and Accounting Dr.Mahmood Ali MGT131 1 Chapter Outline • • • • • • • Introduction to Accounting The Importance of Financial Information What is Accounting? Areas of Accounting Managerial and Financial Accounting Auditing The Six-Steps Accounting Cycle Dr.Mahmood Ali MGT131 2 Introduction to Accounting • Learning about accounting is extremely important because as a businessperson you will constantly be dealing in numbers. Thus, some basic information on how businesspeople can use accounting to better understand and control their businesses will be discussed. Dr.Mahmood Ali MGT131 3 Dr.Mahmood Ali MGT131 4 The Importance of Financial Information • All individuals can benefit personally and professionally by having a basic working knowledge of accounting. • In addition, it is important to note that many people use accounting information, not just managers (i.e. suppliers, competitors and employees). Dr.Mahmood Ali MGT131 5 What is Accounting? • Financial information is primarily based on information generated from accounting. • Accounting: recording, classifying, summarizing, and interpreting financial events and transactions to provide management and other interested parties the information they need to make good decisions. • Financial transactions can include such specifics as buying and selling goods and services, acquiring insurance, paying employees, and using supplies. Dr.Mahmood Ali MGT131 6 • Once business transactions have been recorded, they are usually classified into groups that have common characteristics. • The method used to record and summarize accounting data into reports is called and accounting system, which illustrates the operating performance of the firm and from which management can make informed decisions. Dr.Mahmood Ali MGT131 7 • • Another major purpose of accounting is to report financial information to people outside the firm, such as owners, suppliers, creditors, investors, and the government. In sum, accounting is the measurement and reporting of financial information to various users (inside and outside the organization) regarding the economic activities of the firm. Dr.Mahmood Ali MGT131 8 Areas of Accounting • • The accounting profession is divided into five key areas: managerial and financial, auditing, tax, governmental, and not-for-profit. All five areas are important and create career opportunities for students. Managerial and Financial Accounting • • Managerial accounting: provides information and analysis to managers within the organization to assist them in decision making. Financial accounting: generates information for use outside the organization. Dr.Mahmood Ali MGT131 9 • Managerial accounting is concerned with measuring and reporting costs of production, marketing, and other functions; preparing budgets (planning); checking whether or not units are staying within their budgets (controlling); and designing strategies to minimize taxes (i.e., information and analysis for decision makers within the organization). Dr.Mahmood Ali MGT131 10 • • The information and analysis prepared by financial accounting goes not only to the company owners, managers, and employees, but also to creditors and lenders, employee unions, customers, suppliers, government agencies, and the general public. Financial accountants have the important responsibility of preparing annual reports which are yearly statements of the financial condition, progress, and expectations of the organization. Dr.Mahmood Ali MGT131 11 • Private accountant: accountant who works for a single firm, government agency, or nonprofit organization, on the payroll of the company or organization. • Public accountant: accountant who does not work for a specific company. • Public accountants can be hired to help businesses with payroll, taxes and other projects but do not need to be employees of the company. Dr.Mahmood Ali MGT131 12 • It is vital for the accounting profession to ensure users of financial information that the information provided to them is accurate. • The independent Financial Accounting Standards Board defines the set of Generally accepted accounting principles that accountants must follow. • Financial Accounting Standards Board (FASB): the group that oversees accounting practice. • Generally accepted accounting principles (GAAP): a set of principles followed by accountants in preparing reports. Dr.Mahmood Ali MGT131 13 Auditing • • • Auditing: the job of reviewing and evaluating the records used to prepare a company’s financial statements. Accountants within the organization often perform internal audits to ensure that proper accenting procedures and financial reporting are being followed. Public accountants also conduct independent audits of accounting and related records. Dr.Mahmood Ali MGT131 14 • • Independent audit: an evaluation and an unbiased opinion about the accuracy of a company’s financial statements. An accountant who meets educational requirements can be considered for a professional accreditation. The individual receiving this accreditation or certification is called a certified internal auditor (CIA). Dr.Mahmood Ali MGT131 15 The Six-Step Accounting Cycle • The accounting cycle is a six-step procedure that results in the preparation and analysis of the major financial statements. • The accounting cycle generally involves the work of both the bookkeeper and the accountant. • The first three steps are: – Analyzing and categorizing documents – Putting information into journals and – Posting that information into ledgers Dr.Mahmood Ali MGT131 16 Journal: record book in accounting Dr.Mahmood Ali MGT131 17 Ledger: specialized accounting book in which information from accounting journals is recorded into specific categories. Dr.Mahmood Ali MGT131 18 • The fourth step involves preparing a trial balance. • Trial balance: a summary of all the financial data in the account ledgers to check whether the figures are correct and balanced. • If the information in the accountant ledgers is not accurate, it must be corrected before the firms financial statements are prepared and analyzed in the final two steps: Dr.Mahmood Ali MGT131 19 Dr.Mahmood Ali MGT131 20 • Preparing the financial statements, including a balance sheet, income statement, and statement of cash flows • Analyzing the financial statements and evaluating the overall financial condition of the firm. • Computers and accounting software have simplified this process considerably. Dr.Mahmood Ali MGT131 21 Balance sheet: financial statement that reports a firm’s financial condition at a specific time. Dr.Mahmood Ali MGT131 22 Income statement: summarizes all of the resources (revenue) that come into the firm, the money resources that were used up, the expenses incurred in doing business, and resources left after all costs and expenses were paid out. Dr.Mahmood Ali MGT131 23 Statement of cash flows: reports cash receipts and expenses related to operations, investments, and financing activities. Dr.Mahmood Ali MGT131 24 Figure 12.1: The Steps in the Accounting Cycle Dr.Mahmood Ali MGT131 25