Introduction to Accounting (Lecture 1)
In this free online accounting lesson we define accounting, accounting information and double-entry bookkeeping. We also provide information about the differences between financial and managerial accounting. We then get familiar with four basic financial statements (income statement, statement of cash flows, statement of changes in owners' equity and balance sheet). After that, we define major financial statement components like assets, liabilities, contributed capital, retained earnings, distributions, equity, revenues, expenses, net income, net loss, cash inflows and cash outflows. We then move on to definitions of permanent (real) and temporary (nominal) accounts and learn about the four types of accounting transactions. Accounting examples are provided for most learning objectives.
1.1 Definition of accounting
What is accounting? People around the world consider it quite important. Whether you are going to invest in McDonalds's stock, buy new equipment, forecast future sales or expenditures, you almost always use accounting information. Why? The answer is because accounting provides information for decision-making in the business world.
Accounting is a service-based profession that provides reliable and relevant financial information useful in making decisions.
Financial information may include sales, expenses, taxes and other figures.
So, how exactly is this information prepared? There are several steps involved. These steps are identification, recording and communication.
First, economic events are identified. A sale at a gas station, payment of taxes by a commercial enterprise, or purchase of insurance are all examples of economic events.
Second, all economic events are recorded. Recording is done to provide a history of a company's financial activities. In this step economic events are also classified and summarized.
Third, information about classified and summarized economic events is communicated to interested parties. Such communication may take several forms. One of them is financial statements about which we will talk later in this chapter.
1.2 Users of accounting information
Interested parties are also called accounting information users. There are two broad categories of accounting information users:
- external users
- internal users.
External users are parties outside the reporting entity (company) who are interested in the accounting information.
Investors (owners) use accounting information to make buy, sell or keep decisions related to shares, bonds, etc. Creditors (suppliers, banks) utilize accounting information to make lending decisions. Taxing authorities (Internal Revenue Service) need accounting information to determine a company's tax liabilities. Customers may need accounting information to decide which products and from which company to buy.
Internal users are parties inside the reporting entity (company) who are interested in the accounting information.
A company's senior and middle management uses accounting information to run business. Employees utilize accounting information to determine a company's profitability and profit sharing.
Financial accounting provides information that is designed to satisfy the needs of external users. Such reporting is usually done in the form of financial statements.
Managerial accounting provides information that is useful in running a company by internal users. Such reporting is usually accomplished through custom designed reports.
See related illustration for the connection between types of accounting and accounting information users.
Illustration 1-1: Types of accounting and accounting information users
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