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Slide 1(:11s) Welcome to Introduction to Accounting for a User’s Perspective
What are the two general types of accounting and which one of them has developed a conceptual framework?

Slides 2 (:58s) So, what are the two general types of accounting and which one of them has developed a conceptual framework? The short answer to this question is that there are two general types of accounting: financial accounting, for external decision makers, and managerial accounting, for internal decision makers, but only financial accounting has developed and follows generally accepted accounting principles (GAAP) and a conceptual framework that helps provide theoretical support and guidance to help when new GAAP is developed.

Because prior videos have already introduced you to both financial and managerial accounting, I won’t spend too much time describing them here, but I will at least summarize them in this topic and discuss how each of them either has or has not developed a GAAP and related conceptual framework.

Slides 3-4 (:37s) Financial accounting: Financial accounting is the accounting performed to create and distribute general purpose financial statements to help meet the information needs of external “financial” decision makers, such as creditors and investors.

The culmination of the financial accounting process is the creation and distribution of the general purpose financial statements, particularly an income statement, a statement of equity, a balance sheet, a statement of cash flows and the related footnote disclosures.

Slide 5 (:43s) As you can imagine, before investors make equity financing decisions, they like to first receive and study financial information. For example, Warren Buffett, arguably the most successful investor of all time, is notorious for fully studying company financial statements, including the footnotes, before making long-term investment decisions. For example, he might study General Motors’ (GM) financial statements to see whether GM has a profitable and defendable market position in the industry that could lead to increasing profits in the future thus resulting in an increase in GM’s stock or an increase in the dividends it pays out.

Slide 6 (:22s) On the other hand, GM’s creditors might want financial information to help them determine whether GM should be allowed to receive a multi-billion dollar loan, which it would promise to pay off, with interest, over the next thirty years. Or, maybe GM wants to purchase inventory today on credit to be paid off 30 days later.

Slides 7-9 (1:20s) External creditors and investors normally do not have any direct internal access to their lendees’ or investees’ original accounting data and cannot specify the format of the financial reports they receive.

As a result, external creditors and investors, through their requests for company information to help them make decisions, have influenced the creation of independent accounting standard-setting bodies, such as the Financial Accounting Standards Board (FASB) in the US and the International Accounting Standards Board (IASB) internationally, who have stepped in to define what information companies should provide to external creditors and investors. The standards they have developed to guide companies in preparing their external financial reports are called US Generally Accepted Accounting Principles (US GAAP) and International Financial Reporting Standards (IFRS or IGAAP). Both US GAAP and IFRS are examples of sets of rules and principles that public companies follow, depending on the country where the financial statements will be made public for external use.

In addition, private companies can also be required to follow GAAP if they have a private creditor or investor that requires it.

Slides 10-11 (1:03s) US GAAP & IFRS, and the reports that they require, have been significantly influenced by the informational needs, and demands, expressed by creditors and investors. In addition to standard US GAAP, the Securities and Exchange Commission (SEC) has added an additional layer of accounting rules and regulations that public companies must follow when issuing their financial statements.

The SEC enforces GAAP compliance of publicly-held companies because when all publicly traded companies follow the same rules and principles to prepare their financial statements, the measurements included in the financial statements become more comparable to each other (i.e. apples to apples) thus enabling external decision makers to make better lending and investing choices between companies. Just a side note, the SEC allows international companies to submit their financial statements according to IFRS, they do not have to follow US GAAP.

Slides 12-13 (:56s) Managerial accounting: Managerial accounting is the accounting performed and the reports generated in order to serve the needs of internal “managerial” decision makers, such as chief executive officers, marketing managers, warehouse supervisors, chief product engineers, directors of human resources, and many other executives, managers, and employees.

Is there a set of US GAAP or IFRS for managerial accounting that companies must follow? NO! There is no such thing as a standard set of “general purpose managerial accounting reports” that are generated and disseminated by all public companies each year like what occurs in financial accounting. In fact, some large organizations create and update various managerial accounting reports every second of every day to help managers manage the company on a real-time basis.

Slide 14 (:55s) For example, one interesting, and regularly updated, customized managerial accounting report that executives use is called an “Executive Dashboard”. In essence, they are used just like a jet pilot would use all of the readings in the cockpit to know how to adjust his flight path. Executive Dashboards are regularly updated, single-screen, summary reports of multiple managerial accounting reports that executives use to quickly help them see and evaluate their company’s current performance in a variety of different areas. Often these results are compared to their planned results to obtain variances and manage by exception. Executives regularly review these reports so that they can quickly recognize areas that need their attention. You can review sample dashboards at inetsoft or at The Dashboard Spy.

Slide 15 (:31s) Here are some questions that managerial accounting might be called upon to answer. How many surfboards do we need to sell this year to break-even? Should we make our own ice cream or should we just purchase it from Häagen-Dazs and then resell it? Should we pay $1.2 m for a Super Bowl ad? What should our new smartphone’s sales price be? What percentage of the visitors to the Polynesian Cultural Center was extremely satisfied with the Aloha Luau last year? What is our best mix of product sales?

Slides 16-18 (:55s) As you can see, although much of managerial accounting involves financial computations, not all managerial accounting is financial in nature, for example customer satisfaction is not a financial computation, it will affect a company’s finances, but it is not a financial computation by itself.

In addition, managerial accounting has no such thing as a conceptual framework or GAAP to provide it guidance and structure like financial accounting does.

Why? Because managers have direct access to the data they need and can generate the reports they want. They don’t need some external rule maker (such as FASB) to specify on their behalf what information they will receive and in what format they will receive it in. They personally have the power and authority to request whatever reports, in whatever format they need it in, as long as such are within their areas of stewardship.

Slides 19-21 (:48s) The key constraint on managerial accounting reports is that, at a minimum, the benefit of creating and using a given report should exceed the cost of creating it.

In some ways, managerial accounting is still a bit like the Wild West in that it has no external rules such as GAAP from the FASB that says “You must create XYZ report for internal purposes”. The key point, subject to the cost-benefit constraint, is that managerial accounting can encompass any report, in any format that an internal manager might find to be helpful in making business-related decisions; therefore, no overriding conceptual framework or GAAP exists for managerial accounting.