Text 3. Accounting and the needs of internal stockholders

Internal stakeholders such as managers and employees need accounting information to help plan the business activities required to meet the business's goals and to evalu­ate whether the goals are being met. Thus, internal stakeholders use accounting in­formation primarily to make decisions about future business operations. This con­trasts with the primary use of information by stockholders and other external parties whose decisions are made primarily about how the business operated in the past.

Internal stakeholders have wide-ranging needs for accounting information. Al­though they have access to and use the same information generated by the account­ing subsystems for external stakeholders, much of their information needs are not captured in the financial statements generated for external stakeholders. Their infor­mation needs are met by the management accounting subsystem.

For example, assume that the production management team at Walt Disney stu­dios has to make decisions about what costumes and sets to use for a new motion pic­ture. The team needs information to determine whether to make the costumes and sets internally or whether to hire an outside company to provide these items. This decision requires the accounting department to gather the relevant information, such as the expected cost of making the sets internally versus the expected cost of buying them from an external supplier. Regardless of the decision reached by the production managers, it is necessary, at some point, to evaluate their decision to assess the results and determine whether the correct decision was made. This type of evaluation re­quires accounting information as its basis. For example, assume the production team decides to make the costumes and sets internally. The evaluation process would in­clude comparing the actual cost of making these items to the estimated cost of buy­ing them. Such evaluation of the actual results becomes an important part of plan­ning effectively for the future.

Text 4. The accounting information system

To ensure that users get the type of information they need, when they need it, the accounting information system has four related subsystems designed to provide rele­vant information to external and internal users. The accounting subsystems are:

The financial accounting subsystem, designed to communicate financial information to external users, primarily stockholders and creditors.

The management accounting subsystem, designed to provide information to internal users, primarily employees and managers.

The tax accounting subsystem, designed to provide tax and other information regarding taxes to governments.

The regulatory accounting subsystem, designed to provide required information (reports) to regulatory agencies such as the SEC.

The purpose of the financial accounting subsystem is to communicate relevant infor­mation to users through a company's financial statements. Both the form and content of these financial statements is determined by generally accepted accounting princi­ples. The four primary financial statements of concern to external users are (1) the income statement, (2) the statement of owners' equity, or the statement of retained earnings, (3) the balance sheet (statement of financial position), and (4) the statement of cash flows. In addition, the annual report, which contains the financial statements, also includes notes to the financial statements, which provide supplementary information vital to the understanding of the statements.

Income Statement. The purpose of the income statement is to report to external users the revenues, expenses, and resulting net income for a particular period of time. External users often want to compare the results of one time period with those of previous periods. Therefore, companies often publish comparative financial state­ments that show the results of operations for three to five consecutive periods.

This statement is called a consolidated statement of income because it represents the income generated from many different companies in one total set of (consolidated) numbers.

Notice that the income statement reports other revenue and expense items such as interest expense and investment and interest income. These items represent revenues and expenses from sources other than continuing business operations.

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Statement of Owners' Equity. The statement of owners' equity is designed to show external users the changes that occurred in owners' equity for the period of time covered by the income statement. The statement of owners' equity provides a link between the income statement and the balance sheet. The income (loss) shown on the income statement is also presented in the statement of owners' equity as an in­crease (decrease) in owners' equity during the period. The ending balance in own­ers' equity is shown on the balance sheet. Sometimes companies do not present the changes in owners' equity as a formal statement. Rather, they present such information in the footnotes to the financial statements.

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Other corporations present a statement of retained earnings rather than a state­ment of owners' equity. The statement of retained earnings shows only the changes that affected retained earnings during the period. Those changes affecting con­tributed capital are not shown.

Balance Sheet (Statement of Financial Position). The purpose of the balance sheet, or statement of financial position, is to show the assets, liabilities, and owners' equity that exist at the end of the period covered by the income statement. The balance sheet, then, is a snapshot of the company at a particular point in time. The balance sheet illustrates the accounting equation: Assets = Liabilities + Owners' equity.

Statement of Cash Flows. The statement of cash flows is designed to show the business's cash inflows and cash outflows as well as the net change in the business's cash balance for the same time period as the income statement. The cash inflows and out­flows are divided into three sections depending on their source: (1) net cash flows from operating activities (activities required for the actual operations of the business), (2) net cash flows from investing activities.