Chapter 1

Financial
Accounting
and Its
Environment
What is Accounting?
Why Does it Exist?
 Bookkeeping

• The preservation of a systematic,

quantitative record of an entity
• Mechanical in nature

Financial Accounting, 6e Stice/Stice/Diamond, 2001 © Thomson 3

 Accounting System

Step 1: Bookkeeping (keep track

of information)

Step 2: Analysis (organize and

evaluate accounting
information)
Financial Accounting, 6e Stice/Stice/Diamond, 2001 © Thomson 4
 Accounting

A system providing quantitative

information...

Numbers are easily tabulated and summarized.

Does not capture qualitative information.

Financial Accounting, 6e Stice/Stice/Diamond, 2001 © Thomson 5

 Accounting
Accounting

A system providing quantitative

information, primarily financial in
nature...
Accounting does not capture non-financial
information.

Financial Accounting, 6e Stice/Stice/Diamond, 2001 © Thomson 6

 Accounting
Accounting

A system providing quantitative

information, primarily financial in
nature, about economic entities that
is intended to be useful in making
economic decisions.
Although historical in nature, it is useful
only if future decisions are impacted by it.
Financial Accounting, 6e Stice/Stice/Diamond, 2001 © Thomson 7
 Financial Statement Users

Internal Users External Users

Managerial/Tax Financial
accounting accounting
• Managers • Lenders
• Executives • Investors

Financial Accounting, 6e Stice/Stice/Diamond, 2001 © Thomson 8

 Financial
Statements
 Types of Financial
Statements
• Balance sheet
• Income statement
• Statement of cash
flows

Financial Accounting, 6e Stice/Stice/Diamond, 2001 © Thomson 10

 Balance Sheet

Assets = Liabilities + Equity

Financial Accounting, 6e Stice/Stice/Diamond, 2001 © Thomson 11

 Income Statement

Revenue

- Expenses

Net Income
Financial Accounting, 6e Stice/Stice/Diamond, 2001 © Thomson 12
 Statement of Cash
Flows

• Cash from operating activities

• Cash from investing activities
• Cash from financing activities

Financial Accounting, 6e Stice/Stice/Diamond, 2001 © Thomson 13

 Who Uses Financial
Accounting Information
 Who Uses
Financial Accounting
Information?
• Lenders • Competitors
• Investors • Government
• Management agencies
• Suppliers and • Politicians
customers • The press
• Employees

Financial Accounting, 6e Stice/Stice/Diamond, 2001 © Thomson 15

The Need for Financial
Accounting Standards
 Financial Accounting
Standards Board (FASB)

• Sets accounting standards in the

United States
– Generally Accepted Accounting Principles
– GAAP
• Established in 1973
• Is a private sector regulatory
authority
Financial Accounting, 6e Stice/Stice/Diamond, 2001 © Thomson 17
 Other Accounting-
Related Organizations
 Other Accounting-Related
Organizations

• Securities and Exchange Commission

• American Institute of Certified Public
Accountants (AICPA)
• Public Company Accounting Oversight
Board (PCAOB)
• Internal Revenue Service
• International Accounting Standards Board
Financial Accounting, 6e Stice/Stice/Diamond, 2001 © Thomson 19
 The External Audit

Financial Accounting, 6e Stice/Stice/Diamond, 2001 © Thomson 20

 The External Audit
• Provides an independent outside opinion
from a CPA firm that
– The statements are prepared in accordance
with GAAP
– The audit was conducted using generally
accepted auditing standards
• Not a guarantee!
• The SEC requires all publicly traded
companies to provide potential investors
with audited financial statements
Financial Accounting, 6e Stice/Stice/Diamond, 2001 © Thomson 21
 Economic consequences
of accounting principles
• Accounting principles have economic
consequences because of
implementation costs, compensation
plans, debt contracts, and political
costs.
• Care must be taken in interpreting both
financial statements and managers’
recommendations about accounting
standards.
Financial Accounting, 6e Stice/Stice/Diamond, 2001 © Thomson 22
 Importance of ethics in
accounting
• Accountants have an important
responsibility to the public that arises
because financial statements are used
by large numbers of people for a
variety of purposes.
• It is essential that accountants adhere
to the highest levels of ethical
conduct.
Financial Accounting, 6e Stice/Stice/Diamond, 2001 © Thomson 23
 In Summary ...

• Three primary financial statements

– Income Statement
– Balance Sheet
– Statement of Cash Flows
• Users of financial data
• United States GAAP from the FASB
• Other accounting-related organizations:
AICPA, SEC, PCAOB, IRS, IASB
• Factors impacting changes in accounting
Financial Accounting, 6e Stice/Stice/Diamond, 2001 © Thomson 24