Accounting CH1 Pages 17-28
Management Accounting Characteristics and Decision-Making
Primary Purpose of Management Accounting Information:
Accounting information created and used by internal management is designed primarily for planning and control decisions.
Because internal management accounting information serves different purposes than externally reported financial accounting information, its inherent characteristics differ significantly.
Impact of External Financial Reporting on Management Strategy:
Financial reporting practices and structure can heavily dictate corporate strategy.
Pension Obligations Example: External financial reporting standards mandate that companies disclose pension-related obligations on their financial statements. As a direct result, management monitors these obligations closely, influencing labor negotiations and broader labor-related corporate strategies.
Profit Center Structuring: Internal decision-making structures often organize operating units into profit centers whose internal financial reports mirror external financial reporting requirements.
Key Characteristics of Management Accounting Information:
Importance of Timeliness:
To maintain controlled ongoing business processes, accounting information must be provided on a timely basis.
Hyper-competitive market environments require immediate access to real-time data.
Enterprises utilize computerized databases linking external industry association forecasts directly to internal suppliers and buyers.
Shorter product and service development/launch lifecycles elevate quick access to information into a primary corporate priority.
Timely monitoring prevents processes from going out of control, thereby avoiding severe financial costs such as expensive product recalls. Preventing low-quality or defective products from reaching customers yields substantial financial savings.
Alignment with Decision-Making Authority:
Information produced for monitoring and control must be directed specifically to individuals holding the authority to correct operational problems.
Reporting scrap and rework metrics to assembly line workers who lack the authority to modify equipment or processes is counterproductive.
Providing a self-directed work team with decision-making responsibility over equipment and work activities enables them to significantly reduce scrap and rework when controlling problem-causing processes.
Future Orientation:
While financial accounting information is historical, the fundamental purpose of generating management accounting information is to influence future outcomes.
The goal is to motivate managerial decisions that align with the enterprise's mission, goals, and strategic objectives.
Measures of Efficiency and Effectiveness:
Management accounting measures efficiency and effectiveness by tracking resource usage.
By comparing enterprise resource inputs against output measures of effectiveness and efficiency, stakeholders can assess managerial success in achieving organizational goals.
Money serves as the standard common unit of measurement to conduct these comparisons.
A Means to an End:
Management accounting information is a tool used to accomplish business objectives, not an end in itself.
The ultimate objective is designing and utilizing an accounting system that drives the achievement of corporate goals.
Financial Reporting Standards and Institutional Features
Definition and Enhancement of Integrity:
Integrity is defined as complete, unbroken, unimpaired, sound, honest, and sincere.
Financial information requires integrity because investors, creditors, and internal managers rely on it to make critical financial decisions.
Accounting information integrity is bolstered through three primary pillars:
Institutional Features: Frameworks including official standards for information preparation, robust internal control structures, and independent financial statement audits.
Professional Accounting Organizations: Professional bodies that establish standards, research practices, and enforce professional ethics.
Personal Attributes: The technical competence, professional judgment, and ethical behavior of individual practitioners.
Generally Accepted Accounting Principles (GAAP):
GAAP encompasses the broad principles of measurement and presentation alongside specific detailed rules used by accountants to prepare financial reports.
GAAP establishes a common, standardized framework so that financial statements are understood by both preparers and external users.
Accounting principles do not exist in nature like physical laws; they are human-designed rules created to fulfill financial reporting objectives.
Analogy to Sports Rules: Like the rules of baseball or basketball, accounting principles:
Originate from a combination of tradition, practical experience, and official decree.
Require authoritative support and enforcement mechanisms.
Can contain arbitrary elements.
Evolve over time as rule shortcomings come to light.
Must be clearly understood and observed by all system participants.
The Securities and Exchange Commission (SEC) and Accounting Standard-Setting
Role and Powers of the SEC:
The Securities and Exchange Commission (SEC) is a United States governmental agency possessing explicit legal authority to establish accounting principles and financial reporting requirements for publicly owned corporations.
Publicly owned corporations are entities whose ownership shares are bought and sold via public stock exchanges or over-the-counter markets.
Relationship between the SEC and Private Sector Rulemaking:
Historically, the SEC has elected to adopt standard recommendations from the private sector (specifically the FASB) rather than issuing its own distinct set of accounting principles.
Accounting principles develop primarily within the private sector, but carry the force of federal law because the SEC relies on FASB standard development and enforces compliance.
The SEC works closely with the FASB to ensure broad acceptance of newly developed standards.
The SEC reviews financial filings of public companies to ensure compliance. In cases of non-compliance, the SEC can initiate legal action against companies and responsible corporate officers.
The EDGAR System:
The SEC maintains the Electronic Data Gathering, Analysis, and Retrieval (EDGAR) system, an extensive public source of financial statements and corporate filings accessible at
sec.gov.
Financial Accounting Standards Board (FASB) and International Accounting
Financial Accounting Standards Board (FASB):
The FASB is an independent private-sector rulemaking body that serves as the primary authoritative source of US GAAP.
Board Composition: Consists of drawn from the accounting profession, industry, financial statement user communities, and accounting education. Supported by an advisory council and staff.
Accounting Standards Codification: Compiles all current standards from FASB and its predecessor organizations into a structured codification that receives periodic official updates.
Conceptual Framework: FASB developed a conceptual framework outlining financial reporting objectives, desired information characteristics, elements of financial statements, valuation/measurement standards, and disclosure criteria for statement notes.
International Accounting Standards Board (IASB) and Global Convergence:
Cross-border trade and financing create comparability issues across national accounting systems.
The IASB is an independent panel based in London, United Kingdom, that issues International Financial Reporting Standards (IFRS).
IFRS is mandatory for listed companies in the European Union, Australia, Canada, and over .
The SEC permits foreign issuers listed on US stock exchanges to submit financial statements prepared under IFRS.
The American Institute of CPAs (AICPA) recognizes both FASB and IASB as authoritative standard-setting bodies.
2012 SEC Report on IFRS: While endorsing global convergence in principle, a SEC report highlighted major hurdles to adopting IFRS in the US:
IASB reliance on funding from major public accounting firms.
Massive conversion costs for US private industry.
Structural rule differences (e.g., IFRS mandates identical accounting treatment for similar transactions across an entire enterprise, requiring inventorying of all transaction types, which US GAAP does not require).
Public Company Accounting Oversight Board (PCAOB) and Auditing Standards
Establishment and Mandate:
Created by the Sarbanes-Oxley Act of , the PCAOB began formal operations in the spring of as a quasi-governmental body oversight board for public accounting.
Headquartered in Washington, DC, with regional offices across the United States.
All accounting firms that audit publicly traded companies must formally register with the PCAOB.
Core Responsibilities and Powers:
Establishes official auditing standards for audits of public companies (a function previously managed within the private sector by professional associations).
Conducts regular quality control inspections of public accounting firms.
Performs investigations and administers disciplinary penalties for substandard audit work.
Governance and Funding:
Governed by serving (eligible for re-appointment once).
To ensure independence, no more than can be Certified Public Accountants (CPAs).
Funded by mandatory financial assessments levied on public companies, calculated based on each firm's market capitalization relative to total US equity market value.
Sarbanes-Oxley Act and Professional Accounting Organizations
Sarbanes-Oxley Act of 2002 Key Provisions:
Created the PCAOB.
Banned external auditing firms from providing many non-audit services (e.g., consulting) to audit clients to eliminate conflicts of interest and preserve objectivity.
Imposed formal oversight obligations on corporate Boards of Directors and independent Audit Committees regarding external auditors.
Mandated that Chief Executive Officers (CEOs) and Chief Financial Officers (CFOs) personally certify the accuracy and fairness of quarterly and annual financial statements.
Key Professional Accounting Bodies:
American Institute of CPAs (AICPA):
National professional association for CPAs providing advocacy, research, and technical guidance.
Auditing Standards Board (ASB): Sets auditing standards for private companies.
Prepares and grades the official Uniform CPA Examination.
Provides continuing professional education (CPE).
Institute of Management Accountants (IMA):
Dedicated to management accounting and financial management professionals.
Sponsors national seminars, research, and self-study courses.
Grants the Certified Management Accountant (CMA) credential.
Institute of Internal Auditors (IIA):
International association representing over in over .
Sponsors the Certified Internal Auditor (CIA) designation.
Maintains the IIA Research Foundation and issues professional practice standards and benchmarking tools.
American Accounting Association (AAA):
Composed primarily of accounting educators and academic researchers.
Advances accounting practice through academic research, publication, and teaching innovation.
Committee of Sponsoring Organizations of the Treadway Commission (COSO):
Formed in August to sponsor the National Commission on Fraudulent Financial Reporting (chaired by former SEC Commissioner James C. Treadway Jr.).
Sponsoring entities include: AAA, AICPA, Financial Executives International (FEI), IIA, and IMA.
Authored the Internal Control – Integrated Framework (2013), which serves as the leading global benchmark for evaluating internal controls under Sarbanes-Oxley compliance.
COSO Framework, Internal Control, and Ethical Conduct
Role of Internal Control Frameworks:
Under Sarbanes-Oxley, public enterprises must conduct annual evaluations of internal control over financial reporting.
Independent external auditors must separately attest to and report on management's assessment of internal controls using COSO framework standards.
AICPA Code of Professional Conduct:
Directs CPA moral and professional obligations to the public, clients, and colleagues.
Article II – The Public Interest: Members must act to serve the public interest, honor public trust, and demonstrate professional commitment.
Article III – Integrity: Requires the highest sense of integrity to maintain public confidence.
Objectivity and Independence: Members must remain free from conflicts of interest and maintain independence in fact and appearance when delivering audit services.
Article IV – Due Care: Members must observe technical and ethical standards, continuously improve competence, and perform to the best of their ability.
Article V – Scope and Nature of Services: Members in public practice must observe all conduct principles when deciding which services to offer.
Accounting Competence, Licensing, and Professional Integrity
Nature of Professional Judgment:
Accounting is not a mechanical or clerical task that can be fully automated or delegated to clerical staff.
Requires applying professional judgment to complex, uncertain real-world dilemmas, such as:
Accounting for long-term construction contracts (e.g., interstate highways, aircraft, cruise ships).
Determining adequate disclosures for complex financial arrangements.
Evaluating whether financial distress threatens an entity's going-concern status.
Distinguishing legitimate financial presentation improvements from unethical "window dressing" or misleading statement manipulation.
Professional Licensing and Certification Requirements:
Certified Public Accountant (CPA):
Licensed by (, District of Columbia, Guam, Puerto Rico, Northern Mariana Islands, and US Virgin Islands).
Requirements: Good moral character, completion of of college education with an accounting concentration, passing the computer-based CPA exam, and completing qualified practical work experience.
Continuing Education: Most states mandate at least of continuing professional education (CPE).
Certified Management Accountant (CMA) & Certified Internal Auditor (CIA):
Voluntary professional certifications administered by the IMA and IIA, respectively, demonstrating advanced competence in internal management accounting and auditing.
Accounting Career Pathways and Specializations
Characteristics of the Accounting Profession:
Shares foundational traits with medicine, law, engineering, and theology.
Defined by a complex body of knowledge, reliance on individual professional judgment, and a primary public service obligation to prevent association with misleading financial information.
Four Major Specialization Tracks:
Public Accounting:
Practitioners work within CPA firms or individual practices.
Provide auditing, tax planning/compliance, and management advisory (consulting) services covering mergers, production processes, and product launches.
Management Accounting:
Practitioners work within a single private or public enterprise.
Led by the Chief Accounting Officer (CAO) or Controller, who forms part of the top executive team.
Under federal securities law, public company Form 10-K filings must be signed by the CEO, CFO, and CAO/Controller.
Specializations include financial forecasting, cost accounting, and internal auditing.
Governmental Accounting:
Government Accountability Office (GAO): Audits federal agencies and private contractors, reporting findings directly to Congress.
Internal Revenue Service (IRS): Audits tax filings submitted by individuals and corporate entities.
Other Agencies: SEC, FBI, US Treasury Department, and FDIC utilize specialized accountants for regulatory enforcement and fraud investigation.
Accounting Education:
Focuses on university instruction, academic research, and consulting, driving the development of future accounting professionals.
Distinction Between Bookkeeping and Accounting:
Bookkeeping: The routine, clerical recording of daily financial transactions, primarily handled by automated computer software or clerical staff.
Professional Accounting: Focuses on analyzing, interpreting, and applying financial data, evaluating operational efficiency, forecasting, auditing, tax planning, and designing information systems.
Corporate Governance, Fraud, and Non-Accounting Major Relevance
Corporate Scandals and Governance Breakdown:
The early experienced major corporate collapses driven by fraudulent financial reporting, including Enron, WorldCom, HealthSouth, Adelphia Communications, Tyco, Qwest, and Parmalat (Italy).
Management Involvement: A study revealed that a company's CEO or CFO was actively involved in () of SEC financial fraud enforcement actions.
Corporate Governance: Systems, structures, and oversight mechanisms utilized by Boards of Directors to oversee executive actions and ensure management acts in shareholders' best interests.
Relevance to Non-Accounting Business Majors:
Executive Leadership: Management trainees must understand accounting metrics to control operational units. CAOs, CFOs, and CEOs bear direct civil and criminal liability under Sarbanes-Oxley for certifying inaccurate statements.
Marketing Executives: Must understand revenue recognition concepts to avoid illegal revenue recognition schemes.
Supply Chain & Analytics: Rely heavily on accounting inputs to optimize logistics and corporate performance metrics.
Personal Financial Decisions: Accounting concepts apply directly to personal budgeting, retirement and college planning, lease vs. purchase evaluations, mortgage loan terms, and investment appraisal.
SEC Investor Findings: Studies show retail investors exhibit low financial literacy regarding basic financial concepts and fraud prevention, reinforcing the lifelong utility of accounting knowledge.