III.

Accounting Information

Accounting information can be classified into two categories: financial accounting, consisting of public information, and managerial accounting, consisting of private information. Financial accounting includes information disseminated to parties that are not part of the enterprise proper, such as stockholders, creditors, customers, suppliers, regulatory commissions, financial analysts, and trade associations. Such information relates to the financial position, the liquidity, and the profitability of an enterprise.

Managerial accounting deals with information that is not generally disseminated outside a company, such as salary costs, profit targets, and cost of materials per unit produced. Whereas the general-purpose financial statements of financial accounting are assumed to meet the basic information needs of most external users, managerial accounting provides a wide variety of specialized reports for division managers, department heads, project directors, section supervisors, and other managers within a company.

A.

Specialized Accounting

Of the various specialized areas of accounting that exist, the three most important are auditing, income taxation, and nonbusiness organizations. Auditing is the examination, by an independent accountant, of the financial data, accounting records, business documents, and other pertinent documents of an organization in order to attest to the reasonableness of its financial statements. Businesses and not-for-profit organizations in the United States engage certified public accountants (CPAs) to perform audit examinations. Large private and public enterprises sometimes also maintain an internal audit staff to conduct auditlike examinations, which often are as much concerned with operating efficiency and managerial effectiveness as with the accuracy of the accounting data.

The second specialized area of accounting is income taxation. Preparing an income-tax return by filling out one or more forms entails collecting information and presenting data in a coherent manner; therefore, both individuals and businesses frequently hire accountants to determine their taxes. Tax rules, however, are not identical with accounting practices. Tax regulations are based on laws that are enacted by legislative bodies, interpreted by the courts, and enforced by designated administrative bodies. Much of the information required in calculating taxable income and the amount of tax due, however, is also needed in accounting, and many techniques of computing are common to both areas.

Not all accounting involves for-profit organizations. A third area of specialization is accounting for nonbusiness organizations, such as universities, hospitals, churches, trade and professional associations, and government bodies. These organizations differ from business enterprises in that they receive resources on some nonreciprocating basis—that is, without paying for such resources. They do not have a profit orientation, and they have no defined ownership interests as such. As a result, these organizations call for differences in record keeping, in accounting measurements, and in the format of their financial statements.

B.

Financial Reporting

The traditional function of financial reporting was to provide business owners with information about the companies that they owned and operated. Once the delegation of managerial responsibilities to hired personnel became a common practice, financial reporting began to focus on stewardship—that is, on the managers’ accountability to the owners. Its purpose then was to document how effectively the owners’ assets were managed, in terms of both capital preservation and profit generation.

Once businesses were commonly organized as corporations, the appearance of large multinational corporations and the widespread employment of professional managers by absentee owners brought about a change in the focus of financial reporting. Although the stewardship orientation did not become obsolete, financial reporting beginning in the mid-20th century became somewhat more geared toward the needs of investors. Because both individual and institutional investors view ownership of corporate stock as only one of various investment alternatives, they seek much more future-oriented information than was supplied under the traditional stewardship model. As investors relied more on financial statements to predict the results of investment and disinvestment decisions, accounting became more sensitive to their needs. One important result was an expansion of the information supplied in financial statements.

The proliferation of mandated notes that accompany financial statements is a particularly visible example. Such notes disclose information that is not already included in the body of the financial statement. One of the very first notes identifies the accounting methods adopted when acceptable alternative methods also exist, or when the unique nature of the company's business justifies an otherwise unconventional approach.

The notes also disclose information about lease commitments, contingent liabilities, pension plans, stock options, and the effects of translating foreign currency amounts, as well as details about long-term debt, such as interest rates and maturity dates. A public company having a widely distributed ownership includes among its notes the income amounts that it earned in each three-month fiscal period known as a quarter. It also includes quarterly stock market prices of its outstanding shares of common stock and information about the relative sales and profit contributions of the different operating components that make up a diversified company.