Riassunto International Accounting prof. Trucco

International accounting

What is accounting?

Accounting is something that is useful for stakeholders. It is the language of the business, it is the language of the firm which is useful for decision makers. Accounting is an information system which you can find inside the firm, and this information system is able to measure business activities or economic transactions in order to process data into final reports (which are useful for decision makers) and communicates results of the performance of the firms (economic, financial, and nowadays also non-financial performances). In other words, accounting is a process of identifying, recording, summarizing, and reporting economic information to decision makers in the form of financial statements.

Final reports are useful for both internal and external stakeholders. Stakeholders make decisions about and for the entity, the business activities of the firm. If they are useful for external stakeholders, you are facing financial accounting, otherwise, we are talking about management accounting. Accounting is a process composed of multiple steps in order to identify, record, collect, summarize, and report economic financial and non-financial information of the firm. Basically, in the financial statement, you can find mostly economic and financial information. If you are an investor, you are interested in this information.

There are some definitions of accounting, among which some are stated by associations and some others are theoretical:

• American accounting association states that “Accounting is the process of identify, measuring and communicating economic information to permit informed judgements and decision by users of the information”.
• The American Institute of Certified Public Accountants states that: “Accounting is a service activity whose function is to provide quantitative information, primarily financial in nature, about economic entities that is intended to be useful in making economic decisions”. The focus is on the fact that economic entities provide information to decision makers who are economic subjects.

Primary functions of accounting

⇨1- Recording data about business or economic transactions: We can use a bar code and scan data into a computer system and store it on a magnetic disk. Economic transactions are all the operations that put the firm in contact with the external environment. It has to be transformed into a number in order to prepare the final report. Every day you need to transform business transactions into final data/reports. So, the first function is recording data about business transactions. You have operations and then numbers or codes.

⇨2- Summarizing results of business activity into useful reports: The balance sheet and income statement have been standard reports for many years. More recently, we added a statement of cash flows. However, managers in today’s environment demand more detailed reports like sales by district or sales by product type. You cannot compare data if they are not inside a final report. A useful report is the financial statement or the annual report. They must be prepared in accordance with some standards or principles, and they follow rules. Some examples of reports useful for management accounting are, for example, budget, forecast, and so on. The financial statement follows rules, whereas reports for management accounting don’t (but they follow the best practice). There are no standards for controllers, no rules for reports useful for management accounting. Inside the financial statement, you will find 4 mandatory documents:

• Balance sheet: inside you can find assets, liabilities, and equity.
• Income statement: inside you can find cost and revenues.
• Notes to the account: inside you can find a qualitative description of data that are in the other three documents.
• Statement of cash flows: inside you can find inflow and outflow of cash. Before this document wasn’t mandatory, but now it is because in this way economists can see the performances of the firm. There is a difference between financial and economic topics, for example, in the short-term it is more important to have a profit or to have cash? Cash, because if you don’t have cash you cannot do anything.

Management’s discussions and analysis are attached to the annual report, but it’s not mandatory. Here you can find future-oriented and forward-looking information, strategic information. For example, expansion if you decide to expand the market. We have mandatory information, but also voluntary information, those information that are in excess of local requirements, for example, the social, environmental, and human and intellectual aspect.

Requirements say that you need to prepare the annual report with all the four-mandatory process, but why do firms and managers decide to prepare and disclose voluntary information? To attract other stakeholders, to improve the reputation of the firm and to reduce the information asymmetry between internal and external stakeholders.

⇨3- Providing assurance that the business is operating as intended and that the assets of the organization are protected: All parties to a business event have looked to accountants to provide assurance that the transaction is properly handled, accurately recorded, and accurately reported. Throughout most of this century, the assurance has been based on a system of internal controls and an audit of the published financial statements. We need assurance that data are reliable because if the final reports are not reliable, it means that the codification, the transcription, the transformation of final data is not reliable, so it means that the business transactions are different from the data that you can find in final reports. If the final reports are not reliable, stakeholders make decisions on the basis of not reliable information, so they are damaged. There is an internal party in charge of providing assurance (internal audit), which is the department inside the firm in charge of providing assurance that all information is reliable, but there are other parties (audit firms) which are external parties, big audit firms such as Deloitte, and they provide assurance that the final report/the financial statements are reliable. It’s clear that if the financial statement is not reliable, it doesn’t mean that the financial performance is not good (they are two different concepts), so you can have a firm with an annual report which is not reliable, but the financial performance is going good and vice versa. External firms support the assurance that the business is operating as intended.

So, the steps of accounting are first of all economic transactions (e.g. If the firms buy goods), then there is the recording of business transactions into data, and finally managers and accountants summarize data into the final reports, useful for users. In this way, users can evaluate the performance of the firm and they can understand the implications of choosing one plan instead of another one.

Accounting and decision making

Accounting helps in decision making by showing where and when money has been spent, by evaluating performance, and by showing the implications of choosing one plan instead of another. Fundamental relationships in the decision-making process:

• Identification of users
• User information needs
• Accountant’s financial analysis and recording
• Economic data and activities
• Accounting system user reports decisions

The flow of accounting information

Business transactions occur. Businesses prepare reports to show the results of their operations. People make decisions. Accounting systems are designed to meet the needs of the decision makers who use the financial information. Every business maintains some type of accounting system. These accounting systems may be very complex or very simple, but the real value of any accounting system lies in the information that the system provides.

Users of accounting information

They are users or stakeholders, so people interested in the life of the business activities and they are:

• Individuals
• Other businesses
• Investors and creditors
• Government regulatory agencies
• Taxing authorities
• Non-profit organizations

The main aim of the firm is the satisfaction of the users’ needs, so firms need to survive in the market among other competitors. So, they need to have a proper economic and financial condition. They need to have a balance between costs and revenues, especially in the long term, so firms in order to survive need to have a balance between cost and revenues in the long-term and firms need money in the short-term. Users of accounting are people, managers, firms.

If you are facing external users, they are:

• Investors
• Creditors
• Regulators
• Customers
• Competitors

External users can analyze just external final reports, so you are facing financial accounting. So, they can read just the information that is written on final reports. If there are internal users like:

• Owners
• Managers
• Employees

They can analyze and use both internal and external final reports. There can be a distinction between managers and owners. Sometimes owners and managers can be the same people, and sometimes they can’t. Managers manage the firm, so they can be the board of the directors, but it is not necessary (they can be inside the board of the directors or not), and they are going to perform the business transactions, activities, they prepare the financial statements and all final reports. Owners are those who have shares and who invest money into the firm.

⇨Managers ≠ Owners: There is a distinction in terms of interest because the manager is an employee, and on the other hand, the owners invest money so their main aim is to have profits in the very short-term. On the other side, managers are employees, they perceive a salary, and they want to have a good reputation on the job market, so they need to improve the reputation of their job on the market/society/community (because today they have this job, tomorrow they could not). The agency theory explains how to solve the potential conflict of interest between managers and owners. The basis of the agency theory is that there is an information asymmetry between managers and owners because managers manage the firm, so they have more information than owners upon the firm. That’s why voluntary information is used to reduce this information asymmetry, because if you disclose more information than your competitor, owners can have more information to analyze so there is a reduction of the information asymmetry.

• ⇨ External users make decisions about the entity of the firm, for example, suppliers, customers because they can decide to increase the relationship with the firm. Competitors make decisions about the entity because they are the other firms that sell similar products, and they can have an impact on the behavior of my firm in terms of the price of my product, so they are interested in the life of the firm because they can decide if they read on the financial statement that this firm wants to invest this money into another branch or another country, competitors can decide to do the same, so the initial firm loses the competitive advantage and the competitor could anticipate my strategy, and in this way, the competitors maybe can have more clients than my firm, so the profits of my competitors at the end increase and mine decrease.
• ⇨ Internal users make decisions for the entity, for example, owners can make decisions for the entity if they want to buy another firm or to increase the productivity of the firm, so they can decide to invest money.

Financial accounting

Financial accounting is a broad research field that focuses on corporate information. This field of study analyzes the whole process of communication between the managers and firms’ stakeholders, such as auditors, information intermediaries, investors, and so on. Furthermore, financial accounting relates the effects produced by regulatory regimes on the overall information process.

Financial accounting in Italy is set by the “Organismo italiano di contabilità”, whereas the international accounting standard is set by the International Accounting Standard Board. Financial accounting information is thus the product of corporate accounting and external reporting systems that measure and disclose both qualitative (notes to the account, in management and discussion analysis) and quantitative (cost and revenues, inflow and outflow of cash, assets, liabilities, and equity) data concerning the financial position and the overall performance of the firm. The main aim is to analyze the financial and economic position of the firm in terms of profits and in terms of assets and the whole performance of the firm, also considering the non-financial performance of the firm.

Financial accounting: An objective perspective

The literature streams on financial accounting have used several terms to identify corporate information, which is the heart of financial accounting. As a matter of fact, terms like financial reporting, financial statement, regulatory filing, annual report, corporate reporting, business reporting, and corporate disclosure are widely used amongst scholars and practitioners. Although these terms are quite similar, some peculiarity may arise depending on the context in which these words are used. For instance:

• Financial reporting, financial statement, and regulatory filing are generally used to identify mandatory documents that companies have to disclose.
• Whereas annual reports, corporate reporting, business reporting, and corporate disclosure are used to identify a wider process of communication between managers and external stakeholders.

Nevertheless, the division between the two groups of words is not so clear and well-defined in the literature, and scholars often use the aforementioned words with interchangeable meaning. With regard to the first narrow meaning, firms are obliged to disclose information through financial reporting or the financial statement, which are traditionally useful in reporting and disclosing business activities that regard a specific accounting period. In general, an accounting period is equal to one year (it starts on the 1st of January and ends on the final day of December), so there is a distinction between listed firms and non-listed firms. There is a distinction in terms of standards and rules for the annual reports:

• Listed firms are obliged to disclose annual reports and to communicate the results of the annual reports to the stock exchange. So, you can find annual reports on the website of the stock exchange for listed firms. It is mandatory for listed firms because there are investors who are interested in the life of the firm, so they need to analyze the annual reports in an easy way, but there is also another reason for which this is mandatory: to control the reliability of the financial statement, so it is a kind of assurance for investors. Firms that are listed are obliged to communicate results and annual reports to the stock exchange, and you can also find final reports on the website of these firms. If you need an annual report of a listed firm, you can find it on the website of the stock exchange website or on the website of the firm because investor relations is a department of investor relator. Listed firms are certified and controlled by external parties, like an audit firm, in a mandatory way and for the same reason (because they have investors who need to have reliable information).
• Non-listed firms are obliged to produce annual reports, but they do not deposit the annual reports on the stock exchange website, but in Italy, they deposit it in the Italian chamber of commerce.

Accounting period is a set of business transactions which regard a specific period with a proper beginning and a proper end (but it is not true in the life of the firm, because the life of the firm goes on). The main purpose of the financial reporting is to define the income and the composition of firms’ capital at the end of the year or at the end of a specific accounting period.

Objectives of financial accounting

Financial accounting information, whose main purpose is to meet the information requirements of external stakeholders, also fulfills the internal need of a company to correctly disclose information to the market about its performance, thereby reducing uncertainties for investors and information asymmetries between investors and managers.

Financial accounting: A subjective perspective

From a subjective viewpoint, financial accounting information is managed by people involved in the processing, preparation, and communication of corporate disclosure. These managerial positions are different depending on whether or not a company is publicly held or non-publicly held. Indeed, in the former kind of company, these managerial positions are mainly covered by the Chief Executive Officer (CEO), the Chief Financial Officer (CFO), and the Investor Relator (IR). In the latter kind of company, the managerial positions involved in the Financial accounting processes are covered by the CEO and CFO, as in the publicly held firms, whereas the IR is not required by law.

• ⇨ Chief Executive Officer (CEO) is generally the most senior corporate officer and typically reports to the board of directors. The CEO should have a collective organizational vision oriented toward the greater value of the firm. He/She is also responsible for corporate disclosure (because he/she approves the corporate disclosure).
• ⇨ Chief Financial Officer (CFO) is responsible for evaluating firms’ financial risks (e.g., bankruptcy) and for record-keeping.