Which accounting information system component provides information to external users?

1 Accounting Information for Decision Making

Information that is provided to external parties who have an interest in a company is sometimes referred to as financial accounting information. Information used internally by management and others is commonly referred to as managerial accounting information.

As we begin the study of accounting, keep in mind that business does not exist solely to earn a return for its investors and creditors that supply a company's financial resources. Business also has a responsibility to operate in a socially responsible manner and to balance its desire for financial success within this broader social responsibility.

1.1 Accounting Information: A Means to an End

The primary objective of accounting is to provide information that is useful for decision making purposes. From the very start, we emphasize that accounting is not an end, but rather it is a means to an end. The final product of accounting information is the decision that is enhanced by the use of that information.

Because accounting is widely used to describe all types of business activity, it is sometimes referred to as the language of business.

ACCOUNTING FROM A USER'S PERSPECTIVE

Accounting information is the means by which we measure and communicate economic events.

Our primary goal in this book is to develop your ability to understand and use accounting information in making economic decision. To do this, you need to understand the following:

• The nature of economic activities that accounting information describes.
  
• The assumptions and measurement techniques involved in developing accounting information.
  
• The information that is most relevant for making various types of decision.
  

The accounting process produces accounting information used by decision makers in making economic decisions and taking specific actions. These decisions and actions result in economic activities that continue the cycle.

TYPES OF ACCOUNTING INFORMATION

The terms financial accounting, management accounting, and tax accounting often are used in describing three types of accounting information that are widely used in the business community.

Financial Accounting

Financial accounting refers to information describing the financial resources, obligations, and activities of an economic entity (either an organization or an individual). Accountants use the term financial position to describe an entity's financial resources and obligations at a point in time and the term results of operations to describe its financial activities during the year.

Financial accounting information is designed primarily to assist investors and creditors in deciding where to place their scarce investment resources.

In fact, financial accounting information is used for so many different purposes that it often is called "general-purpose" accounting information.

Management Accounting

Management (or managerial) accounting involves the development and interpretation of accounting information intended specifically to assist management in operating the business.

Much management accounting information is financial in nature but is organized in a manner relating directly to decision at hand.

Tax Accounting

To a great extent, tax returns are based on financial accounting information. However, the information often is adjusted or reorganized to conform with income tax reporting requirements.

1.2 Accounting Systems

An accounting systems consists of the personnel, procedures, technology, and records used by an organization. The basic purpose of the accounting system remains the same: to meet the organization's needs for information as efficiently as possible.

Describing accounting as an information system focuses attention on the information accounting provides, the users of the information, and the support for financial decisions that is provided by the information.

DETERMINING INFORMATION NEEDS

The types of accounting information that a company develops vary with such factors as the size of organization, whether it is publicly owned, and the information needs of management. The need for some types of accounting information may be prescribed by law.

Other types of accounting information are required as matters of practical necessity.

THE COST OF PRODUCING ACCOUNTING INFORMATION

Accounting systems must be cost-effective—that is, the value of the information produced should exceed the cost of producing it.

BASIC FUNCTIONS OF AN ACCOUNTING SYSTEM

In developing information about the activities of a business, every accounting system performs the following basic functions:

1. Interpret and record the effects of business transactions.
2. Classify the effects of similar transactions in a manner that permits determination of the various totals and subtotals useful to management and used in accounting reports.
3. Summarize and communicate the information contained in the system to decision makers.

WHO DESIGNS AND INSTALLS ACCOUNTING SYSTEMS?

Thus accounting systems generally are designed and installed by a team of people with many specialized talents.

COMPONENTS OF INTERNAL CONTROL

Internal control is a process designed to provide reasonable assurance that the organization produces reliable financial reports, complies with applicable laws and regulations, and conducts its operations in an efficient and effective manner.

The five components of internal control are the control environment, risk assessment, control activities, information and communication, and monitoring.

An organization's control environment is the foundation for all other elements of internal control, setting the overall tone for the organization. Factors that affect a company's control environment are: (1) the organization's commitment to integrity and ethical values, (2) the independence of the board of directors from management, and the board's oversight of internal control, (3) management assignment , with board oversight, of appropriate levels of authority and responsibility, (4) an organizational commitment to attract, develop, and retain competent individuals, and (5) individuals being held accountable for the performance of their control responsibilities. The control environment is particularly important because fraudulent financial reporting often results from an ineffective control environment.

Risk assessment involves identifying, analyzing, and managing those risks that pose a threat to the achievement of the organization's objectives.

Control activities are the policies and procedures that management puts in place to address the risks identified during the risk assessment process.

Information and communication involves developing information systems to capture and communicate operational, financial, and compliance-related information necessary to run the business.

All interna control systems need to be monitored, Monitoring activities enable the company to evaluate the effectiveness of its system of internal control over time.

Section 404 of SOX

1.3 Financial Accounting Information

EXTERNAL USERS OF ACCOUNTING INFORMATION

External users of accounting information are individuals and other enterprises that have a current or potential financial interest in the reporting enterprise, but that are not involved in the day-to-day operations of that enterprise.

Each of these groups of external decision makers requires unique information to be able to make decisions about the reporting enterprise.

For these reasons, we sometimes refer to investors and creditors as the primary external financial information users.

OBJECTIVES OF EXTERNAL FINANCIAL REPORTING

These general objectives are best understood if studied from the bottom up—from general to specific.

The first objective is the most general and is to provide information that is useful in making investment and credit decisions.

The second objective, which is more specific than the first, is to provide information that is useful in assessing the amount, timing, and uncertainty of future cash flows.

The most specific objective of external financial reporting is to provide information about the enterprise's resources, claims to those resources, and how both the resources and claims to resources change over time.

The primary financial statements are the following:

• Statement of financial position (balance sheet). The balance sheet is a position statement that shows where the company stands in financial terms at a specific date.
• Income statement. The Income statement is an activity statement that shows details and results of the company's profit-related activities for a period of time.
• Statement of cash flows. The statement of cash flows is an activity statement that shows the details of the company's activities involving cash during a period of time.

CHARACTERISTICS OF EXTERNALLY REPORTED INFORMATION

Financial Reporting—A Means

Financial information is a means to an end, not an end in and of itself. The ultimate outcome of providing financial information is to improve the quality of decision making by external parties. Financial statements themselves are simply a means by which that end is achieved.

Financial Reporting versus Financial Statements

Financial reporting is broader than financial statements. Stated another way, financial statements are a subset of the total information encompassed by financial reporting.

Historical in Nature

Externally reported financial information is generally historical in nature. It looks back in time and reports the results of events and transactions that already have occurred.

Inexact and Approximate Measures

Externally reported financial information may have a look of great precision, but in fact much of it is based on estimates, judgments, and assumptions that must be made about both the past and future.

General-Purpose Assumption

We assume that, by providing information that meets the needs of investors and creditors, we also meet the information needs of other external parties.

Usefulness Enhanced via Explanation

The value of externally reported financial information is enhanced by including explanations from management. This information is often nonquantitative and helps to interpret the financial numbers that are presented.

1.4 Management Accounting Information

Internal decision makers employed by the enterprise, often referred to as management, create and use internal accounting information not only for exclusive use inside the organization but also to share with external decision makers.

####USERS OF INTERNAL ACCOUNTING INFORMATION

Every employee of the enterprise uses internal accounting information.

Employees have different specific goals and objectives that are designed to help the enterprise achieve its overall strategies and mission. A snapshot look inside a firm will demonstrate the diversity of accounting information generated and used in the decision-making processes of employees.

Many enterprises use a database warehousing approach for the creation of accounting information systems.

OBJECTIVES OF MANAGEMENT ACCOUNTING INFORMATION

Enterprises design and use their internal accounting information systems to help them achieve their stated goals and missions. To motivate managers to achieve organizational goals, the internal accounting system is also used to evaluate and reward decision-making performance.

CHARACTERISTICS OF MANAGEMENT ACCOUNTING INFORMATION

The accounting information created and used by management is intended primarily for planning and control decisions.

Importance of Timeliness

In order to plan for and control ongoing business processes, accounting information needs to be timely.

Identity of Decision Maker

Information that is produced to monitor and control processes needs to be provided to those who have decision-making authority to correct problems.

Oriented toward the Future

The objective is to motivate management to make future decisions that are in the best interest of the enterprise, consistent with its goals, objectives, and mission.

Measures of Efficiency and Effectiveness

Accounting information measures the efficiency and effectiveness of resource usage. By comparing the enterprise’s resource inputs and outputs with measures of competitors’ effectiveness and efficiency, an assessment can be made of how effective management is in achieving the organization’s mission. The accounting system uses money as a common unit to achieve these types of comparisons.

Management Accounting Information—A Means

Management accounting information is a means to an end, not an end in and of itself. The ultimate objective is to design and use an accounting system that helps management achieve the goals and objectives of the enterprise.

1.5 Integrity of Accounting Information

The word integrity refers to the following qualities: complete, unbroken, unimpaired, sound, honest, and sincere.

The integrity of accounting information is enhanced in three primary ways. First, certain institutional features add significantly to the integrity of accounting information. These features include standards for the preparation of accounting information, an internal control structure, and audits of financial statements. Second, several professional accounting organizations play unique roles in adding to the integrity of accounting information. Finally, and perhaps most important, is the personal competence, judgment, and ethical behavior of professional accountants. These three elements of the accounting profession come together to ensure that users of accounting information—investors, creditors, managers, and others—can rely on the information to be a fair representation of what it purports to represent.

INSTITUTIONAL FEATURES

Standards for the Preparation of Accounting Information

Accounting information that is communicated externally to investors, creditors, and other users must be prepared in accordance with standards that are understood by both the preparers and users of that information. We call these standards generally accepted accounting principles, often shortened to GAAP. These principles provide the general framework for determining what information is included in financial statements and how this information is to be prepared and presented. GAAP includes broad principles of measurement and presentation, as well as detailed rules that are used by professional accountants in preparing accounting information and reports.

Accounting principles are developed by people, in light of what we consider to be the most import objectives of financial reporting.

Securities and Exchange Commission

The Securities and Exchange Commission is a governmental agency with the legal power to establish accounting principles and financial reporting requirements for publicly owned corporations.

Financial Accounting Standards Board

Today, the most authoritative source of generally accepted accounting principles is the Financial Accounting Standards Board. The FASB is an independent rule-making body.

The FASB has compiled all of its standards, and those of its predecessors, in an Accounting Standards Codification. The FASB periodically issues updates to its codification. The codification represents official expressions of generally accepted accounting principles.

International Accounting Standards Board

As a result of increasing cross-border activities, efforts are under way to harmonize accounting standards around the world. The International Accounting Standards Board (IASB) is playing a leading role in the harmonization process.

The IASB issues International Financial Reporting Standards (IFRSs).

Public Company Accounting Oversight Board

The Public Company Accounting Oversight Board (PCAOB) is a quasi-governmental body charged with over- sight of the public accounting profession.

The PCAOB sets auditing standards for audits of publicly traded companies.

Audits of Financial Statements

An audit is an investigation of a company’s financial statements, designed to determine the fairness of these statements. Accountants and auditors use the term fair in describing financial statements that are reliable and complete, conform to generally accepted accounting princi- ples, and are not misleading.

In the auditing of financial statements, generally accepted accounting principles are the standard by which those statements are judged.

Legislation

Congress passed the Sarbanes-Oxley Act in 2002. Sarbanes-Oxley also places additional responsibilities on corporate boards of directors and audit committees with regard to their oversight of external auditors, and it places responsibil- ity on chief executive officers and chief financial officers of companies to certify the fairness of the company’s financial statements.

PROFESSIONAL ORGANIZATIONS

American Institute of CPAs (AICPA)

The American Institute of CPAs is a pro- fessional association of certified public accountants. Its mission is to provide members with the resources, information, and leadership to enable them to provide valuable services in the highest professional manner to benefit the public, employers, and clients.

Institute of Management Accountants (IMA)

The mission of the Institute of Management Accountants is to provide members personal and professional development opportunities through education, association with business professionals, and certification.

Institute of Internal Auditors (IIA)

The Institute of Internal Auditors is the primary international professional associa- tion dedicated to the promotion and development of the practice of internal auditing.

American Accounting Association (AAA)

Membership in the American Accounting Association is made up primarily of accounting educators. The mission of the AAA includes advancing account- ing education and research, as well as influencing accounting practice.

Committee of Sponsoring Organizations of the Treadway Commission (COSO)

COSO is a voluntary private sector organization dedicated to improving the quality of financial reporting through business ethics, effective internal controls, organizational governance, and enterprise risk management.

COSO is best known for its work in developing the standards for evaluating internal control— particularly internal control over financial reporting. The standard for evaluating the effectiveness of internal control over financial reporting is contained in COSO's 2013 publication, Internal Control-Integrated Framework: 2013.

COMPETENCE, JUDGMENT, AND ETHICAL BEHAVIOR

A characteristic common to all recognized professions, including medicine, law, and accounting, is the need for competent individual practitioners to solve problems using their professional judgment and applying strong ethical standards.

Judgment always involves some risk of error. Some error occur simply because future events are uncertain and do not work out as expected when the information was prepared.

Integrity in accounting requires honesty and a strong commitment to ethical conduct—doing the right thing. For a professional accountant, ethical behavior is just as important as competence. However, it is far more difficult to test or enforce.

While the institutional features and professional organizations that were discussed earlier are important parts of the financial reporting system, the personal attributes of competence, professional judgment, and ethical behavior ultimately ensure the quality and reliability of accounting information.

###1.6 Carers in Accounting

First, all professions involve a complex and evolving body of knowledge.

Second, in all professions, practitioners must use their professional judgment to resolve problems and dilemmas.

Of greatest importance, however, is the unique responsibility of professionals to serve the public’s best interest, even at the sacrifice of personal advantage.

####PUBLIC ACCOUNTING

Certified public accountants offer a variety of accounting services to the public.

The work of public accountants consists primarily of auditing financial statements, income tax work, and management advisory services (management consulting).

A great many CPAs move from public accounting into managerial positions with organizations.

####MANAGEMENT ACCOUNTING

In contrast to the public accountant who serves many clients, the management accountant works for one enterprise. Management accountants develop and interpret accounting informa- tion designed specifically to meet the various needs of management.

The chief accounting officer of an organization usually is called the chief accounting officer (CAO) or controller.

In addition to developing information to assist managers, management accountants are responsible for operating the company’s accounting system, including the recording of transactions and the preparation of financial statements, tax returns, and other accounting reports. Because the responsibilities of management accountants are so broad, many areas of specialization have developed. Among the more important are financial forecasting, cost accounting, and internal auditing.

GOVERNMENTAL ACCOUNTING

Governmental agencies use accounting information in allocating their resources and in controlling their operations.

#####The GAO: Who Audits the Government?

The Government Accountability Office (GAO) audits many agencies of the federal government, as well as some private organizations doing business with the government. The GAO reports its findings directly to Congress, which, in turn, often discloses these findings to the public.

GAO investigations may be designed either to evaluate the efficiency of an entity’s operations or to determine the fairness of accounting information reported to the government.

The IRS: Audits of Income Tax Returns

Another governmental agency that performs extensive auditing work is the Internal Revenue Service (IRS). The IRS handles the millions of income tax returns filed annually by individuals and business organizations and frequently performs auditing functions to verify data contained in these returns.

The SEC: The "Watchdog" of Financial Reporting

The SEC works closely with the FASB in establishing generally accepted accounting principles. Most publicly owned corporations must file audited financial statements with the SEC each year.

ACCOUNTING EDUCATION

A position as an accounting faculty member offers opportunities for teaching, research, consulting, and an unusual degree of freedom in developing individual skills.

WHAT ABOUT BOOKKEEPING?

Bookkeeping is the clerical side of accounting—the recording of routine transactions and day-to-day record keeping.

Professional accountants are involved more with the interpretation and use of accounting information than with its actual preparation. Their work includes evaluating the efficiency of operations, resolving complex financial reporting issues, forecasting the results of future operations, auditing, tax planning, and designing efficient accounting systems.

ACCOUNTING AS A STEPPING-STONE

An accounting background is invaluable in such positions, because top management works continuously with issues defined and described in accounting terms and concepts.

Public accountants have the unusual opportunity of getting an inside look at many different business organizations, which makes them particularly well suited for top management positions in other organizations.

BUT WHAT ABOUT ME? I'M NOT AN ACCOUNTING MAJOR

Accounting is the language of business.

How does accounting information help external users needs?

What are the components of accounting information system?

What is internal and external users of accounting information?