1.2 Purpose of Accounting

Accountants provide useful information for decision making. The information is of importance to a number of users as discussed below. Information provided can be classified into two broad categories:

Information on the financial position of an enterprise

Information on the financial performance of an enterprise

Users of accounting information are interested in the status of an organisation. For instance, if one starts a restaurant, there will be need to determine its financial health, say on a daily, monthly or annual basis. To be more specific, it will be important to ascertain the amount of cash that the business has, the amount of food items that are available, the amount of money owed to suppliers among others. In accounting terms this is referred to as ascertaining the 'state of affairs' of a business which can be done by simply drawing what is often referred to as a 'balance sheet'. The balance sheet will among other things provide details regarding the status of an organisation as at a certain period in time. For instance a balance sheet as at the end of the year will contain information regarding resources that were controlled by an entity (assets), claims to those resources (liabilities) and the stake of owners (capital). Decision makers will also be interested in assessing the performance of an entity over a period of time. There is thus need to assess whether a business is generating profits or losses. Profits or losses in accounting terms refer to the difference between the resources generated vis-á-vis what is consumed in their generation. Where an entity uses more resources than it generates, this is referred to as loss and vice versa for a profit. Some organisations are not in the business of generating profits such as government and public institutions, nongovernmental organisations and other charitable organisations. However, the concept of generating resources that can at least support their expenses is still important even to such organisations

1.2 Purpose of Accounting

An income statement serves the purpose of assessing performance of an enterprise by simply

	evaluating whether generation of resources exceeds expenses utilised. However not all business
	activities are carried out on cash basis though decision makers may be interested in whether cash
	generated is enough to support operations, to fund future growth and meet financial obligations. This
	information is provided by a financial statement referred to as a cash flow statement. This statement
	provides a summary of cash generated from operations, from an entity's investments and from
	financiers net of usage in each of the three categories of activities. Owners of the business will also be
	interested on information regarding changes in their stake (equity) in the business. Such information is
	presented by statement of changes in owners' equity.

A number of accounting reports are prepared to help users make informed decisions. To make it easy

	for the various users to access information that they need, organizations produce general purpose
	financial statements which target an ordinary user. These statements combine all the four statements
	identified above. However, users who have unique needs of accounting data, such as management rely
	on other reports such as management accounts which are not only more detailed, but are mainly a
	reflection of projections into the future unlike financial accounts which are based on past data. The next
	section identifies some of the users of accounting information and their specific needs.

1.2 Purpose of Accounting

Users of accounting information

Accountants generate information that is of use to a myriad of users such as stock holders, potential investors, management, employees, regulatory agencies, and students.

	Stock holders: these are assumed to the owners of an accounting entity. They might be the ones running
	the business or have delegated their responsibility to professional managers. They require accounting
	information to gauge the performance of their organisation in terms of its profitability and the value it
	creates to their wealth. Where they (stock holders) have delegated the management role, accounting
	reports provides a valuable basis for analysis the manner in which their agents (professional managers)
	are carrying out their stewardship roles. Therefore information will be useful in making decisions as to
	whether to inject additional capital to expand the business, retain or separate the managers or even
	close the venture

	Potential Investors: These are parties interested in having a stake in the organisation. They use
	financial accounts to evaluate financial performance and position of an organisation in the past as well
	as in conducting a trend analysis to forecast future performance. Organisations with a track record of
	excellent performance tend to be attractive to investors. Information gained from accounting reports is
	also useful in determining the intrinsic value of stocks which is a useful guide in assessing whether
	prices for a particular stock are under or over priced in the market.

1.2 Purpose of Accounting

	Management: prudent management of an organisation requires sound decision making based on
	timely information. Those in charge of management will be interested in the day to accounting data such
	as on sales volumes, market prices and costs. This information is provided by accountants. Financial
	accounting might not provide adequate information for this group of users and therefore another branch
	of accounting referred to as management accounting is specifically charged with the responsibility of
	providing timely information for management's decision making. The focus of such information is on
	decisions that are current requiring historical, current and futuristic information. This calls for projections
	to be made about future state of affairs.

	Employees: accounting data is also of use to employees in assessing the ability of an entity to continue
	operating into the future and thereby their job security. The data is also used to negotiate for salary hikes
	and bonuses for instance in cases where excellent financial performance has been posted.
	Employees' unions also utilise financial accounting data in sealing collective bargaining agreements.

	Students: Finance students use financial accounts for research. The accounts contain a wealth of
	information regarding an organisation useful in training future business leaders.

	Regulatory agencies: accounting data is of interest to regulators such as capital market authorities in
	assessing the financial health of an organisation for instance those that are interested in listing shares in
	the bourse such as the New York Stock Exchange (NYSE). Other agencies such as tax authorities use...

1.2 Purpose of Accounting

...them in assessing tax liabilities.

Accounting measurement

Measurement is usually based on:

	Transactional values (purchases and sales)
	Present value
	Fair value
	Historical cost
	Replacement cost
	Net book value

Transactional costs:
Purchases and sales are recorded at the amounts which the goods or services are exchanged in the market. Rice (2002) refers to such a transaction as arms length transaction. In this case, to determine amounts of sales generated, quantities of goods or services sold is multiplied with the unit sales price. For instance suppose that McDonalds is retailing chicken pieces at $1.80 and sells 3,000 pieces in a certain outlet in a day. The revenue for the day in respect to sale of these pieces will be $5,400 (3,000 * $1.80). The same concept is used when determining the value of cost of sales and other expenses.

1.2 Purpose of Accounting

Present value:
At the close of the financial period, accounting data is used by decision makers to assess the financial position of an entity. However some elements such as liabilities and investments transcends over a number of accounting periods. This may call for an estimation of their value as at financial year end. For liabilities, this mainly involves deriving the value of future obligations and similarly for assets as at reporting date, it calls for determination of the worth of future expected cash flows as at the date of the financial statements.

Fair value:
similar to present value, fair value is an assessment of the value of assets and liabilities as at the reporting date. However, unlike present value where the future expected cash inflows in case of assets, and outflows in case of liabilities, are discounted to derive the value used in measurement, fair value involves use of ruling market prices less costs that would be reasonably incurred in the course of executing a sale (point of sale costs). This is mainly used in valuation of biological assets.

Historical cost:
this refers to the price that was paid for an asset (economic resource). Where the value of an asset is not expected to vary over a period of time such as freehold land, the reasonable measurement base is its purchase price.

1.2 Purpose of Accounting

Replacement cost:
This is a measurement base mainly used to assess the ability of the organisation to continue operating into the future. Future continuity is probable where the entity has the capacity to purchase new assets in place of those that are worn-out. In this case, an estimation of the cost of having a replica asset is used.

Net book value:
This value or closely related to historical costs in that the asset is measured at its original purchase price. However, under net book value measurement basis, the purchase cost is adjusted periodically on the estimated wear and tear of the asset (depreciation).

Accountants as ethical professionals

Accountants provide valuable information to a number of users as noted earlier. Great value is attached to this information and thus the need for it to be credible cannot be overemphasized. The information should pass the qualitative test of being reliable and relevant being it can serve its purpose of influencing decision making. Accountants are guided by professional ethics which restrain them from providing information that is misleading to decision makers. The rise of corporate frauds such as the infamous Enron Scandal where management was alleged to misstate financial statements underscores the need for accountants to be ethical.

Accounting regulatory bodies such as Malaysian Institute of Certified Public Accountants (MICPA) have developed a code of conduct for practicing accountants requiring them to act in an ethical manner by upholding integrity, confidentiality, independence, and public interest. Accountants are also required to perform their...

1.2 Purpose of Accounting

...duties in a professional manner and maintain high technical standards through continuous professional education.

Accountants have found themselves on the receiving end for failure to oblige to professional code of conduct. For instance, in the case of Enron, the auditor (practicing accountant) was alleged to have colluded with the management in falsifying company's records. This led to the collapse of the accounting firm, Arthur Andersen, which had operations in a number of countries across the globe. This is just one example of the many accountants who have been compromised and negated their professional ethics. Aspiring accountants should take caution against one being guilty of misconduct.