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1.1 Accounting: The Language of Business
Understanding the Role of Accounting
Accounting is an information system that measures and records business activities. The
role of accounting is to identify, record, and measure the transactions or activities in a
business to be able to evaluate its performance and assess its financial health
(Harrison et al., 2018, p. 3)
This information is communicated to stakeholders using financial statements that contain useful information to
help them make rational economic decisions. Financial statements are prepared based on a set of accounting rules,
such as Generally Accepted Accounting Principles (GAAP) or International Financial Reporting Standards (IFRS);
these help standardize accounting across businesses. Review the flow of accounting information diagram below.
This diagram illustrates the flow of accounting information and helps illustrate accountings role in business. The
accounting process begins and ends with people making decisions.
Lets apply the flow of accounting information to a real business: Apple Inc.
The Four Financial Statements
The flow of accounting results in transactions that are recorded and presented using four important financial
statements to report the results to various stakeholders. We will explore these four financial statements further in
the next topic.
Note: The order is important! The first is income statements, then statement of retained earnings, balance sheet,
and lastly statement of cash flow.
Users of Financial Information
These financial statements are used by different stakeholders. So, who are the users of financial information?
Managers: set goals, evaluate those goals, and take corrective action.
Most companies hire managers to oversee the day-to-day operations of the business (i.e., operating activities).
Managers make many business decisions using accounting info:
Should they build a new product line?
Should they open a regional sales office?
Should they acquire a competitor?
Should they extend credit to their major customers?
Investors: decide whether to invest in a business or evaluate an investment.
Investors are individuals/groups who provide capital to finance a businesss activities by purchasing
ownership interest. They own shares of the business and are called shareholders.
Investors look for two sources of possible gain:
Sell ownership interest in the future for more than they paid.
Receive a portion of the companys earnings in cash (dividends).
Investors (shareholders) use accounting information to find out how much income they can expect to earn on
their investment and where to invest their money.
You too are an investor if you buy stocks, debt, or real estate! Financial information can help you decide where
to invest your money.
Creditors: evaluate a borrowers ability to make required payments.
Creditors provide capital to finance a businesss activities by lending money. Unlike investors, creditors do not
own a share of the company.
For example, a bank lends funds to a company in the form of a loan that must be repaid by the company in the
future along with interest.
Government and regulatory bodies such as Canada Revenue Agency (CRA): ensure organizations pay the correct
amount of taxes.
Government and regulatory bodies use accounting information for taxation and regulation of the stock
markets.
For example, the CRA uses financial information to compute the sales and business taxes owed by a business
and the Ontario Securities Commission requires periodic financial information from companies that are stock
listed on the Toronto Stock Exchange (TSX).
Individuals: make investment decisions and/or manage a bank account.
Individuals like you and me use financial information to make daily purchasing decisions.
Do you budget your annual, monthly, or weekly spending? Even high-level budgeting of your tuition, rent,
food, and transportation is, in a way, using financial information to determine your financial needs.
Not-for-profit organizations: use accounting information in virtually the same way as for-profit organizations.
Like for-profit companies, not-for-profit organizations use financial information to make decisions about
their operations and investments, and to report financial information to their users.
Users of financial information for a not-for-profit organization include board members, managers, and the
CRA.
The CRA has a designated non-taxable business status for approved not-for-profit organizations. These
designated organizations need to comply with reporting requirements and do not have to pay regular business
taxes like for-profit companies.
Financial vs. Management Accounting
Since different users have different reporting needs and underlying reasons for financial information, there are two
types of accounting information:
Financial Accounting
Financial accounting provides information for different internal and external users:
Internal users
Managers
Investors
External users
Creditors
Government
Public
Financial accounting is the focus of our course!
Management Accounting
Management accounting provides the following information for internal users only:
Budgets
Forecasts
Projections
Detailed product level/department level information
This is most likely your next accounting course!
Types of Business Organizations
There are three main forms of business organizations: proprietorship, partnership, and corporation.
Proprietorship Partnership Corporation
Owner(s) Single owner known as the
proprietor
Generally two or more partners
are co-owners
Owned by shareholders and
legally formed under federal
or provincial law:
Public company: many
shareholders (i.e. Apple)
Private company: small
number of shareholders
(i.e. a small business)
Personal
liability of
owner(s) for
business
debts
Proprietor is personally liable Partners are
usually personally liable
Shareholders are not
personally liable
Life of entity Limited by owners choice or
death
Limited by owners choice or
death
Indefinite (owned by
shareholders)
Tax structure Included in personal taxes of
the proprietor
Doesnt pay taxes as income
flows through to individual
partners and is taxed at their
personal tax rate
Corporation pays taxes and
any dividends paid to
shareholders are taxed at
their personal tax rate
Examples Common business structure
for self-employed, small retail
stores, or professional service
providers:
Lawyers
Accountants
The Big Four accounting
companies are all partnerships:
PwC LLP
KPMG LLP
Deloitte LLP
EY LLP
Public companies:
Apple Inc.
Alphabet Inc.
Amazon Inc.
Wal-Mart Inc.
Private companies:
IKEA
Koch Industries
Bechtel
(Adapted from Harrison et al., 2018, p. 5)
Speed
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The Flow of Accounting Information. People make decisions, business transactions occur,
companies report their results. The process is cyclical.
(Harrison et al., 2018, p. 4)
In this diagram, it begins with production. Apple Inc. produces a new annual line up of its iPhone.
Then, it moves to purchasing. Customers make purchases at the store. From there is reporting.
Revenues from the product and expenses from operating the store are reported in Apples quarterly
and annual reports. These financial results inform managers decisions regarding product line,
stocking, etc. This brings us back to production.
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Income Statement flows into Statement of Retained Earnings, which flows into the Balance Sheet,
which flows into the Statement of Cash Flow.
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Banks loan companies funds, but must be repaid with interest.
Course Author(s) and University of Waterloo
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