McGraw.Hill.-.Financial.Accounting.Information.For.Decisions.By.Ingram.pdf

A CCOUNTING AND

O RGANIZATIONS

What do we need to know to start a business?

sell cookies made using their mother’s recipes. To honor their mother, they decided

to call the business Mom’s Cookie Company. Realizing they did not have much money

and had little business experience, the brother and sister made plans to start with a small

company. They hope the business will grow as more customers become aware of their prod-

ucts. Maria and Stan know that accountants provide advice to help managers of companies

better understand their businesses. Because they had never started a company before, they made

an appointment with Ellen Coleman, an accountant who had provided helpful business advice to

several of their friends.

FOOD FOR THOUGHT

Suppose you were in Maria and Stan’s position. What would you want to know in order to start a

business? What goals would you have for the business, and how would you plan to reach those goals?

What resources would you need in your business, and how would you finance those resources? How

would you organize your company? Who would your customers be? How would you know whether you

are reaching your goals or not? These are issues Ellen poses to Maria and Stan.

Ellen: Creating a successful business is not an easy task. You need a good product, and you need a plan to

produce and sell that product.

Maria: Stan and I think we have an excellent product. We don’t have a lot of money for equipment and other

resources, but we have identified a bakery that could produce our products using our recipes and

according to our specifications.

Stan: Also, we have spoken with several local grocery chains that have been impressed with samples and have

agreed to sell our products.

Ellen: Good. A primary goal of every successful business is to create value for customers. If you focus on

delivering a product that customers want at a price they are willing to pay, you are also likely to create

value for yourselves as owners of the company. You have to make sure you know what it will cost to run

your company and decide how you will obtain the money you need to get started.

Stan: We have some money in savings, and we plan to obtain a loan from a local bank. Those financial

resources should permit us to rent a small office and purchase equipment we need to manage the

company. Also, we will need to acquire a truck for picking up the cookies from the bakery and delivering

them to the grocery stores.

Ellen: You will need a system for measuring your costs and the amounts you sell. That system is critical for

helping you determine whether you are accomplishing your goals.

Maria: Stan and I don’t know much about accounting. Can you help us get started?

Ellen: I’ll be happy to help you. First, let’s explore in more detail some of the issues you need to consider.

I n December of 2003, Maria and Stan were very excited about starting a company to

Accounting and Organizations

CHAPTER F1: Accounting and Organizations

OBJECTIVES

Once you have completed this chapter, you

should be able to:

1 Identify how accounting information helps

decision makers.

2 Compare major types of organizations and

explain their purpose.

3 Describe how businesses create value.

4 Explain how accounting helps investors

and other decision makers understand

businesses.

5 Identify business ownership structures and

their advantages and disadvantages.

6 Identify uses of accounting information for

making decisions about corporations.

7 Explain the purpose and importance of

accounting regulations.

8 Explain why ethics are important for

business and accounting.

I NFORMATION FOR D ECISIONS

All of us use information to help us make decisions. Information includes facts, ideas,

and concepts that help us understand the world. To use information, we must be able

to interpret it and understand its limitations. Poor information or the improper use of

information often leads to poor decisions.

As an example, assume you wish to drive from Sevierville to Waynesville. The drive

will take several hours and require several turns on unfamiliar secondary roads. There-

fore, you use a map, as illustrated in Exhibit 1, to provide information to help guide

you along the way.

Exhibit 1

Map from Sevierville to

Waynesville

441

446

Townsend

Sevierville

Binfield

Nough

Why is the map useful? The map can help you plan your trip. You have selected a

primary goal: arrive at Waynesville. You may have other goals as well, such as getting

there as quickly as possible. Or perhaps you wish to stop at various points along the

way. The map provides information about alternative routes so that you can select the

OBJECTIVE 1

Identify how accounting

information helps

decision makers.

SECTION F1: The Accounting Information System

Accounting and Organizations

INTERNATIONAL

one that is shortest, fastest, or most scenic. Using the map along the way helps you

make decisions about where to turn or stop. It helps you determine how far you have

traveled and how much farther you have left to go. It helps you decide whether you are

on the right road or where you made a wrong turn. It helps you decide where you are,

how you got there, and where you are going.

Accounting provides information to help in making decisions about organizations.

This information is like a map of an organization. Accounting information helps de-

cision makers determine where they are, where they have been, and where they are

going. Rather than measuring distances in miles or kilometers, accounting measures an

organization’s activities by the dollar amounts associated with these activities. The pri-

mary measurement unit for accounting information is dollars in the United States or

the local currency for other countries.

Maria and Stan have decided to start a business selling cookies. Their company will

pay a bakery to produce the cookies and will sell the cookies to local grocery stores. An

early decision they have to make is to identify the resources they will need to start and

run their business. They will need merchandise (cookies) to sell and will purchase those

products from a supplier (the bakery). They will need a place to operate the business

and someone to pick up the products and deliver them to sellers (grocery stores). They

will need money to pay for the merchandise, rent for their office, wages, equipment,

and miscellaneous costs such as supplies and utilities.

As an initial step in deciding whether to start the business, Maria and Stan might

consider how much they expect to sell. Suppose that after discussing this issue with gro-

cery store owners, they determine that the company will sell about $12,000 of mer-

chandise each month.

Next, they consider how much money they will need to operate their business. A

discussion with the bakery indicates the cost of the merchandise will be $8,000 each

month. After consideration of their other needs, they calculate their monthly costs

will be:

Merchandise $ 8,000

Wages

1,000

Rent

600

Supplies

300

Utilities

200

Total

$10,100

From this information, they decide they should expect to earn a profit of $1,900

($12,000 – $10,100) each month as shown in Exhibit 2. Profit is the amount left over

after the cost of doing business is subtracted from sales.

Exhibit 2

Expected Monthly

Earnings for Mom’s

Cookie Company

Sales

Costs of Resources Used

Sales of merchandise $12,000

Merchandise sold

Wages

Rent

Supplies

Utilities

Total

$ 8,000

1,000

600

300

200

$10,100

Profit $1,900

Accounting and Organizations

CHAPTER F1: Accounting and Organizations

Does this appear to be a good business for Maria and Stan? Suppose they each have

$5,000 to invest in the business. They will use this money to purchase merchandise and

to pay for rent, wages, and the miscellaneous costs for the first month. Would invest-

ing their money in the business be a good idea?

If they don’t invest in the business, they could earn interest of about $50 a month

on their $10,000 of combined savings. The expected profit of $1,900 is considerably

larger. However, they also should consider the wages they could earn if they worked

for someone else instead of working in their own company. Additionally, they should

consider how certain they are about the amount they can earn from their business and

how much risk they are willing to take. Investing in a business is always risky. Risk is

uncertainty about an outcome, such as the amount of profit a business will earn. If the

company sells less than Maria and Stan expect, its earnings also will be less than ex-

pected. If the company does not do well, they could lose their investments. Are they

willing to take that risk? Accounting can help with these decisions by providing in-

formation about the results that owners and other decision makers should expect will

occur. Decision makers then have to evaluate that information and make their decisions.

Accounting is a way of looking at a business. It measures the activities of a busi-

ness by the dollars it receives and spends. It helps decision makers determine where

they started and where they should end up. It helps determine whether expectations are

being met. In the case of Mom’s Cookie Company, accounting identifies the company’s

starting point by the $10,000 Maria and Stan invest in their business. It identifies an

expected ending point as the amount of profit of $1,900 they expect to earn each month.

It provides a means of determining whether expectations are being met by measuring

business activities each month to determine whether the company is actually earning

$1,900 each month. Like a map, accounting can help decision makers determine that

they are not where they want to be. It can help them determine what went wrong and

what they might do to get back on the proper route.

Accounting provides a model of a business by measuring the business activities in

dollar amounts. Underlying this model is an information system. This system provides

a process for obtaining facts that can be converted into useful information. Under-

standing the system and its processes will help you understand the information pro-

vided by accounting.

The purpose of accounting is to help people make decisions about economic ac-

tivities. Economic activities involve the allocation of scarce resources. People allocate

scarce resources any time they exchange money, goods, or services. These activities are

so common that almost every person in our society uses the accounting process to as-

sist in decision making.

Accounting provides information for managers, owners, members, and other stake-

holders who make decisions about organizations. Stakeholders include those who have

an economic interest in an organization and those who are affected by its activities.

An organization is a group of people who work together to develop, produce, and/or

distribute goods or services. The next section of this chapter discusses the purpose of

organizations and the role of accounting in organizations.

T HE P URPOSE OF O RGANIZATIONS

Many types of organizations exist to serve society. Why do these organizations exist?

Most exist because people need to work together to accomplish their goals. The goals

are too large, too complex, or too expensive to be achieved without cooperation. All

organizations provide goods and/or services. By working together, people can produce

more and better goods and services.

Organizations differ as to the types of goods or services they offer (Exhibit 3). Mer-

chandising (or retail ) companies sell to consumers goods that are produced by other

companies. Grocery, department, and hardware stores are examples. Mom’s Cookie

Company is a merchandising company. It purchases merchandise from a bakery and

OBJECTIVE 2

Compare major types of

organizations and explain

their purpose.

SECTION F1: The Accounting Information System

Accounting and Organizations

sells the merchandise to grocery stores. Manufacturing companies produce goods that

they sell to consumers, to merchandising companies, or to other manufacturing com-

panies. Examples include automobile manufacturers, petroleum refineries, furniture

manufacturers, computer companies, and paper companies. The bakery from which

Mom’s Cookie Company purchases its cookies is a manufacturing company. Service

companies sell services rather than goods. These companies include banks, insurance

companies, hospitals, universities, law firms, and accounting firms. Some companies

may be a combination of types. For example, many automobile dealers are both retail

and service companies. Restaurants are both manufacturing and service companies.

Exhibit 3

Types of Organizations

Business

Nonbusiness

Retail

Manufacturing

Government

Service

Other Nonprofit

Organizations may be classified by whether or not they attempt to earn a profit.

Profits result from selling goods and services to customers at prices greater than the

cost of the items sold. Organizations that sell their goods and services to make a profit

are business organizations. Governmental and nonprofit organizations, sometimes re-

ferred to as nonbusiness organizations, provide goods or, more typically, services

without the intent of making a profit. Nonbusiness organizations include civic, social,

and religious organizations. Some types of services, such as education and healthcare

services, are provided by both business and nonbusiness organizations. Although the

products are similar, the goals of the organizations providing these services are differ-

ent. Nevertheless, all organizations need accounting information for decision making.

This book focuses primarily on accounting for business organizations.

Transformation of Resources

A common purpose of organizations is to transform resources from one form to a dif-

ferent, more valuable, form to meet the needs of people. Resources include natural re-

sources (such as minerals and timber), physical resources (such as buildings and

equipment), management skills, labor, financial resources, legal rights (such as patents

and trademarks), information, and the systems that provide information. The trans-

formation process combines these resources to create goods and services. Transforma-

tion may involve making goods or services easier or less expensive for customers to

obtain, as in most merchandising and service companies. Or it may involve physically

converting resources by processing or combining them, as in manufacturing compa-

nies. An easy way to understand the transformation of resources is by thinking about

how a bakery takes resources like flour and sugar and transforms them through the

mixing and baking process to become cookies. Exhibit 4 illustrates this transformation

process.

Organizations are created because many transformations are too difficult or too ex-

pensive for individuals to accomplish without working together. By combining their

managerial skills, labor, and money, individuals create organizations to provide value

that otherwise would be unavailable. Value is added to society when an organization

transforms resources from a less desirable form or location to a more desirable form

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