Accounting Functions

Historically, accounting has been the function of gathering, compiling, reporting, and storing a firm's business activities. The purpose of this accounting information is to help individuals make decisions. Many different kinds of people depend on the information. For convenience, we categorize those who need accounting information as insiders or outsiders of a firm.

Management accounting is the development of information for the insiders (i.e., company managers). Managers use this information to measure the progress toward their goals and highlight any potential problems in advance. For example, managers want to know which products are selling the best and which are selling poorly, which products tend to sell together, and how inventory is being managed. Managers also want to know about cash ”will the firm have enough cash to pay its upcoming debt payments?

Accountants answer these questions with budgets , variance reports, revenue reports , cost projections, and even competitor analysis. When firms are considering how to expand products and services, managerial accountants help formulate profit projections from revenue and cost projections. In short, managerial accounting has historically played a big part in the control and evaluation of a business and its performance.

Outsiders of the firm also use accounting information. Investors, banks, the government, and other stakeholders have a keen interest in the financial health of a firm. Banks and other creditors want to know if the firm will be able to pay its debts . Investors want to know how much profit the firm is making ”both now and in the future. Employees have a double interest because they have both their career/employment at stake as well as possibly being investors through their retirement plans.

Providing information for outsiders is the purpose of financial accounting. Whereas managerial accounting reports may break down performance for managers by individual products or regions of the country, financial accounting reports summarize the business as a whole, though they can be broken into business segments and regions . These reports are the quarterly and annual financial statements that public firms must file with the SEC.

The three main statements (income statement, balance sheet, and statement of cash flows) are used by outsiders to determine a firm's value, profits, safety ”among other pieces of important information. Outsiders want to be able to easily compare among firms. So, the SEC requires these reports to adhere to generally accepted accounting principles (GAAP). These statements are prepared by the accountants of a firm and reviewed by independent accountants from an auditing firm. (More on auditors later in the chapter.)

Another outsider that requires accounting information is the IRS. The accountants of the firm report the profits to the IRS and determine the tax bill. Interestingly, the accounting methods and record keeping of a business can be very different for reporting to managers (for financial statements) and to the IRS. For example, there are ambiguities for how to record some transactions in GAAP. When reporting the business activities in the annual report, choices are made to maximize earnings. When the IRS forms are being completed, choices are made to minimize earnings in order to minimize taxes. ^[1] A private-sector body, Financial Accounting Standards Board (FASB), sets the rules for financial statements.

The first accounting standard-setting body was the Committee on Accounting Procedure, and it existed from 1939 to 1959. It was replaced by the Accounting Principles Board (APB) in 1959. The SEC recognized the APB as authoritative until 1973, when it was replaced by FASB. The SEC recognizes FASB as authoritative , which means that the SEC recognizes FASB's decisions on creating and amending GAAP. However, the SEC and the U.S. Congress have been able to influence FASB's accounting policies. FASB is sponsored by associations in the accounting profession. To promote independence, its seven board members are required to serve full time and divest their interest in the firms they once worked for. Even non-CPAs serve on the FASB board.