1.
WHAT IS AN ECONOMIC ENTITY?
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THE PRIME
PURPOSE OF THE FINANCIAL MANAGEMENT PROCESS |
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Accounting
information provides the foundation for key management decisions
in any organization.
The prime purpose of the Financial
Management Process is to develop, implement, and maintain an effective
accounting system within the organization.
The accounting system is designed
to provide quantitative information, primarily financial in nature,
about economic entities that is intended to be useful in making
economic decisions. (2)
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AN ECONOMIC
ENTITY |
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An Economic Entity is an independent business enterprise that
may be organized in one of the following forms as illustrated
below.
Different Forms Of Business Organization
are discussed
in detail later in Tutorial 3.
Note: Non-profit organizations are not discussed in this Tutorial.
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THREE
BASIC FORMS OF
BUSINESS ORGANIZATION
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Sole Proprietorship
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Partnership
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Corporation
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2. WHAT IS ACCOUNTING INFORMATION?
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WHAT IS ACCOUNTING INFORMATION?
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Managers are constantly faced with the necessity of making decisions
pertaining to various activities of their organization. One manager, for example, may want
to know about the company's profitability during a certain operating period, while the
other may seek to determine an adequate selling price for a new product or service.
In
other instances, managers are requested to provide financial information to institutions
when applying for additional funds or when preparing special reports for governmental
organizations. It is apparent that such information, known as Accounting
Information,
plays an integral part in the business process.
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3. TYPES OF ACCOUNTING INFORMATION
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ACCOUNTING INFORMATION
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Accurate Accounting Information is a highly valuable management
tool which is instrumental in coordinating important management
decisions and in undertaking appropriate action in accordance
with the overall objectives of the organization.
An effective financial management system usually provides two
different types of accounting information, as illustrated
below.
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TWO TYPES OF ACCOUNTING INFORMATION
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External Reports
Or
Financial Accounting Reports
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Internal Reports
Or
Management Accounting Reports
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These reports are prepared and presented to existing and potential
shareholders, creditors, and tax authorities.
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These reports are prepared and presented to management for internal
operational use within the organization.
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4. FINANCIAL ACCOUNTING REPORTS
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FINANCIAL ACCOUNTING REPORTS
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External reports, or Financial Accounting Reports,
include three
basic financial statements: the balance sheet, the income statement,
and the statement of cash flows.
Financial accounting reports are usually submitted to company
shareholders, present and potential creditors, e.g. banks and
investors, and tax authorities. These reports provide important
information pertaining to three basic elements of the company's
well-being, as illustrated below.
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THREE BASIC FINANCIAL
STATEMENTS
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Balance
Sheet
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Income
Statement
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Statement
Of Cash Flows
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This statement illustrates how solvent the company
is, i.e. by how much its assets exceed its liabilities,
or net worth.
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This statement illustrates how profitable the
company is, i.e. by how much its revenues exceed its expenditures,
or net income.
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This statement illustrates how liquid the company
is, i.e. whether more cash is flowing into the company
than out of it.
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5. MANAGEMENT ACCOUNTING REPORTS
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MANAGEMENT ACCOUNTING REPORTS
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Internal reports, or Management Accounting Reports, are designed
for use in strategic planning, operational planning, and routine
controlling activities.
Management accounting reports include a broad range of
statements developed by the company's financial executive in accordance
with the specific needs of the organization. Some of the most
popular management accounting reports are illustrated below.
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FOUR BASIC MANAGEMENT ACCOUNTING REPORTS
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Monthly Revenue And Expenditure Statement
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Monthly
Income
Statement
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Monthly
Debtors
Age Analysis
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Monthly
Creditors
Age Analysis
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This statement summarizes monthly and year-to-date
revenues and expenses, compares same with corresponding
budget projections, and determines variances.
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This statement summarizes monthly and year-to-date income
or loss, compares same with corresponding budget
projections, and determines variances.
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This statement summarizes the names of clients (debtors)
who owe money to a company and the actual accounts receivable
on a 1-30, 31-60, 61-90 days basis, or longer.
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This statement summarizes the names of suppliers
(creditors), to whom a company
owes money and the actual accounts payable on
a 1-30, 31-60, 61-90 days basis, or longer.
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6. THE BASIC DIFFERENCES
BETWEEN FINANCIAL AND MANAGEMENT ACCOUNTING REPORTS
The basic differences between Financial
Accounting Reports and Management Accounting Reports are summarized below.
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THE BASIC
DIFFERENCES BETWEEN FINANCIAL AND MANAGEMENT ACCOUNTING
REPORTS
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Financial Accounting Reports
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Management Accounting Reports
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Are
verified by the company's auditors (CPAs) in accordance with
the generally accepted accounting principles (GAAP).
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Provide
formal professional opinion.
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Include
information about the company's solvency, profitability, and
liquidity.
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Cover
the performance of the organization as a whole.
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Are
used mainly by shareholders and external users, e.g. banks,
suppliers, or tax authorities for evaluation purposes.
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Are
prepared by the staff within the company's financial department
in accordance with the specific needs of the organization.
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Provide
informal management opinion.
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Include
information about the company's current performance and provide
comparison between actual and budgeted results.
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Cover
the detailed performance of the organization.
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Are
used mainly by internal users, e.g. top and middle level management
for planning and controlling purposes.
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7. GENERALLY ACCEPTED
ACCOUNTING PRINCIPLES
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GENERALLY ACCEPTED ACCOUNTING PRINCIPLES
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Financial information is
recorded in accordance with particular set of rules known
as the Generally Accepted Accounting Principles. (GAAP).
The American Institute Of Certified Public Accountants (AICPA)
has defined these principles as follows:
"The Generally Accepted Accounting
Principles encompass the conventions, rules, and procedures
necessary to define accepted accounting practice at a particular
time. "(3)
The Generally Accepted Accounting
Principles have been developed by accountants
over a period of many years and are subject to change in
accordance with prevailing conditions and governmental requirements.
Several important organizations, that
constantly influence the generally accepted accounting principles,
are presented below.
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8. WHAT DO ACCOUNTANTS
DO?
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WHO
ARE ACCOUNTANTS?
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Financial accounting reports, or financial statements, are
verified by the company's auditors, who are Certified Public
Accountants (CPA).
Independent CPAs are licensed by each state in a manner
similar to the legal or medical professions. These CPAs are
independent in the sense that
they operate their own accounting practices and are not
directly employed by the company whose statements they examine.
As a part of the service, CPAs
perform an unbiased audit of their clients'
books and other related services, as outlined below.
As a result of the company's audit,
the CPA will be able to express an opinion
about the conformance of the company's financial statement
s to the generally accepted accounting principles. The CPA does not express an opinion as to the
"fairness"
of what the statements represent.
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SERVICES
PROVIDED BY CPAs
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No.
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Details
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1
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Careful examination of the company's
accounting and internal control systems.
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2
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Verification of accounting records.
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3
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Verification of existing inventory.
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Identification of amounts owed to
the company (accounts receivable).
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5
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Identification of amounts owed by
the company (accounts payable)
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6
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Preparation of financial statements.
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7
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Preparations of tax returns.
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Note:
Please consult with your accountant regarding any additional
information.
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9. FOR
SERIOUS BUSINESS OWNERS ONLY |
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Reprinted with permission. |
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