The Environment of Accounting

UNIT 1:

Fair presentation of financial affairs is the essence of accounting theory and practice.  With the increasing size and complexity of business enterprises and the increasing economic role of government, the responsibility placed on accountants is greater today than ever before.  If accountants are to meet this challenge, they must have a logical and consistent body of accounting theory to guide them.  This theoretical structure must be realistic in terms of the economic environment and must be designed to meet the needs of users of financial statements.

Financial statements and reports prepared by accountants are vital to the successful working of society.  Economists, investors, business executives, labor leaders, bankers, and government officials all rely on these financial statements and reports as fair and meaningful summaries of day-to-day business transactions In addition, these groups are making increased use of accounting as a base for forecasting future economic trends.

 

Accounting, like other social science disciplines and human activities, is largely a product of its environment.  The environment of accounting consists of social-economic – political- legal conditions, constraints, and influences which have varied from time to time. Accounting theory and practices have evolved to meet changing demands and influences. Modern accounting is the product of many influences and conditions, three of which deserve special consideration.

First, accounting recognizes that people live in a world of scarce resources.  Because resources exist in limited supply, people try to concern them, to use them effectively and efficiently, and to identify and encourage those who can make effective and efficient use of them.  Accounting plays a useful role in obtaining a higher standard of living because it helps to identify efficient & inefficient users of resources.

Second, accounting recognizes and accepts society’s current and ethical concepts of property and other rights when determining equity among the varying interests in an enterprise or entity.  Accounting looks to its environment for direction with regard to what property rights society protects, what society recognizes as value, and what society acknowledges as equitable & fair.

Third, accounting recognizes that in highly developed, complex economic systems, some (owners and investors) entrusts the custodianship of and control over property to others (managers).  One of the results of the corporate form of organization has been the tendency in large enterprises to divorce ownership and management

 Thus, the function of measuring and reporting information to absentee investors (eg. Share holders) has been added to that of recording and presenting financial data for owner – manager use.  This development greatly increased the need for accounting standards (rules of practice governing the contents, measurements, and disclosures in financial statements).

 

For purposes of study and practice, the discipline of accounting is commonly divided into the following areas or subsets: financial accounting, managerial (cost) accounting, tax accounting, and not- for- profit (public sector) accounting.  This book concentrates on financial accounting.  Financial accounting has been characterized as “that branch of accounting concerned with the classification, recording, analysis, and interpretation of the overall financial position and operating results of an organization.  Financial accounting encompasses the process and decisions that culminate in the preparation of financial statements relative to the enterprise as a whole for use by parties both internal and external to the enterprise.  These statements provide a continual history qualified in money terms of economic resources and obligations of a business enterprise and of economic activities that change these resources and obligations.  The following four environmental factors, although not as basic as the three aspects described in environmental factors that influence accounting, shape financial accounting to a significant extent:

• The many users and uses that accounting serves
• The nature of economic activity
• The economic activity in individual business enterprises
• The means of measuring economic activity.

 

The basic assumptions that underlie current accounting practice have evolved over many years in response to the needs of various users of accounting information.  The users of accounting information may be divided into two broad groups: internal users and external users.

Internal users include all the management personnel of a business enterprise who use accounting information either for planning and controlling current operations or for formulating long-range plans and making major business decisions.  The term managerial accounting relates to internal measurements and reporting; it includes the development of detailed current information helpful to all levels of management in decision making designed to achieve the goals of the enterprise. 

External users of accounting information include stock-holders, bondholders, potential investors, bankers and other creditors, financial analysts, economists, labor unions, and numerous government agencies.  The field of financial accounting is directly related to external reporting because it provides investors and other outsiders with the financial information they need for decision making.

 

Certain professional organizations, governmental agencies, and legislature acts have been extremely influential in shaping the development of the existing body of financial accounting theory.  Among the most important of these have been the International Accounting standards, the financial Accounting standards in U.K., the American Institute of certified public Accountants, the Association of chartered certified Accountants (ACCA) in U.K., the American Accounting Association etc.

Awareness of the roles of these in situational forces is helpful in gaining an understanding of current accounting principles and practices.   Efforts to improve existing principles of accounting will have a better chance of success if they are made with full recognition of the needs of the various groups that use accounting information.          

In this course, we will depend on the laws or principles established by financial Accounting standards Board (FASB).  So, let us see what FASB is.

Financial Accounting standards Board (FASB)

The financial Accounting standard Board was established in 1972 to develop financial accounting standards for business enterprises and nonprofit organizations.  This independent body consisted of seven full- time members and a large supporting staff.          

Lending support and counsel to the FASB are the Financial Accounting Foundation, which appoints members of the FASB and raises funds for its operations, the Financial Accounting Standards Adivisory Council, a screening committee on Emerging problems, and numerous taskforces consisting of financial executives, accounting educators, lawyers, and CPAs(Certified public Accountants)          

The FASB is authorized to issue statements of financial Accounting standards, as well as Interpretations and Technical Bulletins, to guide individuals and organizations in preparing and auditing financial statements.  Before a formal statement is drafted, the FASB frequently issues a Discussion Memorandum that identifies and analyses the issues to be considered.  Public learning then are held on the issues identified in the Discussion Memorandums.  Next, an Exposure Draft of the proposed statement is circulated.  These procedures are designed to encourage the widest participation possible by all interested parties before a new financial accounting standard is issued.  As of the beginning of 1985 the FASB had issued 82 statements.  Those statements dealing with the subject matter of Intermediate Accounting have been incorporated in this book to the maximum extent possible.

 

The purpose of this chapter has been to provide a perspective, which can serve as a starting point for understanding financial accounting and as a base for doing it.  Basically, we have described the nature of financial accounting, the environmental factors, which have influenced its development, the useful role it can play in influencing the environment, the many users of accounting information, and the organizations, which influence financial accounting.  From this description, it is a means to an end rather than an end in itself.  Because the environment with in which accounting exists is constantly changing, one can expect accounting to continue to evolve in response to this changes. Indeed continuous evolution has been a constant theme throughout the history of accounting.