Financial Accounting:

A Managerial Perspective
Third Edition

Prepared by
R. Narayanaswamy
Indian Institute of Management Bangalore

© PHI Learning, 2008. All rights reserved. 1

Accounting and Economic
Decisions

Chapter 1

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 Chapter 1
The Aim of the Course
1. Appreciate the information needs of
different categories of users of company
financial reports.
2. Understand the significance of accounting
principles and the systems and processes
involved in preparing and presenting
financial reports.
3. Analyse and interpret financial reports.

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 Chapter 1
The Approach in this Book
1. Understanding the economic basis of accounting
2. Connecting accounting to capital market and
corporate governance
3. Emphasis on principles
4. Student-friendly presentation, easy-to-read style
5. Real-world applications
6. Integrating preparation and use of financial
statements
7. Linking accounting theory, empirical research and
practice
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 Chapter 1
Understanding Business Organizations
 What do business organizations do?
 e.g., Apollo Hospitals, Amazon.com, Bharti
Airtel, Tata Motors
 Types of business organizations
 Merchandising or trading
 Manufacturing
 Service
 Business organizations are “cash
machines”
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 Chapter 1
What is Accounting
 Accounting is the language of business
 Accounting provides information for
making decisions
 Accounting is an information system
 Accounting and economic decisions
 Why should managers and other decision-
makers know accounting?

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 Chapter 1

The Accounting Information System

Inputs Processing Outputs Users

Business Accounting Financial Investors,

transactions principles statements lenders,
and events and procedures and reports
managers

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 Chapter 1
Users of Accounting Information
 Investors
 Lenders
 Security analysts and advisers
 Managers
 Employees and trade unions
 Suppliers and other trade creditors
 Customers
 Government authorities and regulators
 The public
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 Chapter 1
Major Branches of Accounting
Financial Accounting Management Accounting
 For external users  For internal users
 Historical information  Future-oriented
 Standardized format  Flexible format
 Laws and conventions  Context-specific
 Summarized  More detailed
 Income statement;  Product cost statement;
Balance sheet; Cash flow Standard costs; Budgets;
statement; Accounting Variances; Performance
policies reports

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 Chapter 1
Accounting Measurement
 Accounting records the effect of economic
activities
 Internal events
 External events: transactions
 exchange (e.g., purchase of goods)
 one-way transfer (e.g., donations, thefts)
 Other external events
 no exchange or transfer (e.g., floods,
earthquakes)

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 Chapter 1
Assumptions Underlying Accounting
Measurement
 Accounting entity
 Business is distinct from owner
 Going concern
 Business is a continuing enterprise
 Periodicity
 Business activities divided into periods
 Money measurement
 Money is a stable measurement unit

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 Chapter 1

Generally Accepted Accounting

Principles
 What is GAAP?
 Importance of GAAP
 Institutions that influence GAAP
 Government
 Accounting profession
 Securities regulators
 Other regulators
 International organizations

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 Chapter 1
Institutional Environment in India
 Ministry of Corporate Affairs
 National Advisory Committee on Accounting Standards
 Securities and Exchange Board of India
 Institute of Chartered Accountants of India
 Central Board of Direct Taxes
 Reserve Bank of India
 Insurance Regulatory and Development Authority
 Comptroller and Auditor-General of India
 International Organizations
 International Accounting Standards Board
 International Federation of Accountants
 International Organization of Securities Commissions

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 Chapter 1

Accounting Standards and Policies

 Accounting standards
 Accounting policies
 Why does accounting practice differ?
 Need for accounting standards
 Principle-based and rule-based standards
 Standard-setting mechanism in India

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 Chapter 1
Forms of Business Organization
 Sole proprietorship
 Single individual
 Partnership
 A few individuals
 Limited company
 Numerous individuals, often strangers
 Large business
 Limited liability
 Limited liability partnership
 Legal formalities for a limited company
 The corporate organization structure
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 Chapter 1

Accounting, Capital Market, and

Corporate Governance
 The capital market: savers and
entrepreneurs
 The “lemons principle” and market
breakdown
 Signalling and capital market
 Corporate governance
 Accounting disciplines managerial actions

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 Chapter 1
The Accounting Equation
Economic Resources = Claims

Assets = Liabilities + Equity

Capital + Revenues – Expenses – Drawings – Dividends

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 Chapter 1

Assets
 Probable future economic benefits
 What a business owns
 Examples
 Cash
 Financial investments
 Land
 Buildings
 Plant and machinery
 Patents and copyrights
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 Chapter 1
Liabilities
 Probable future sacrifices of economic
benefits
 What a business owes
 Contractual, statutory, or constructive
 Examples
 Loans payable
 Salaries payable
 Warranty obligations
 Pensions payable
 Income tax payable
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 Chapter 1
Equity
 Residual interest of owners
 Examples
 Share capital
 Share premium
 Revenues
 Expenses
 Dividends
 Retained profit

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 Chapter 1
Financial Statements
 Profit and loss account
 Statement of financial performance
 Revenues; Expenses
 Balance sheet
 Statement of financial position
 Assets; Liabilities; Equity
 Cash flow statement
 Statement of cash receipts and cash payments
 Activities: Operating; Investing; Financing
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 Chapter 1
Fields of Accounting Activity
 Public accounting
 Auditing
 Tax
 Management advisory services
 Small business services
 Private accounting
 Management accounting
 Internal auditing
 Information systems
 Government accounting
 Central
 State
 Local
 Not-for-profit accounting
 Accounting as an academic discipline
© PHI Learning, 2008. All rights reserved. 22
 Chapter 1
Ethical Issues in Accounting
 Business and ethics
 Why do people bend the accounting rules
 GAAP is of little help
 Whistle-blowing
 Ethical conduct brings success in the long
term

© PHI Learning, 2008. All rights reserved. 23