The Accounting Environment: What Is Accounting and Why Is It Done?
A variety of answers are possible but the essential elements are the production and communication of information so that stakeholders can make decisions.
Economic consequences are the impacts on wealth caused by choosing among available alternatives in business. Accounting has economic consequences because how an entity does its accounting (policy choices, estimates) can affect the wealth of different stakeholders. For example, you may be able to choose between two acceptable ways to account for an economic event. The choices may affect, for example, the amount of tax a company pays, bonuses managers receive or the price a business is sold for.
Accounting information can provide insight into how much cash you are retaining/spending as well as cash that could be available to repay debt. It can also provide information on items that could be pledged as security (if the lender requires this).
Different stakeholders make different decisions that require different information. For example, lenders want to know whether the company will be able to repay its loans but the Canada Revenue Agency (CRA) wants to know the amount of taxes that should be paid for the current year. Much of the information the lenders would request, such as who are the company’s major customers and the amounts they owe the company, would be of no interest to the CRA. The CRA is simply interested in compliance with the income tax act.
It’s not possible to make a general statement about which stakeholder is most important—the answer depends on the entity and its needs. A private company with no external stakeholders would likely focus on CRA as the most important stakeholder. For a private company in need of a loan would a prospective lender would be most important. From a particular stakeholder’s perspective he/she is the most important stakeholder.
A corporation is a separate legal entity with many of the rights and responsibilities of an individual. Some of the attractive features of a corporation are limited liability and the ease of transferring ownership.
The shares of a public corporation are widely held and can be bought or sold in a public market (stock exchange) by any interested investor without the consent or agreement of existing shareholders. Ownership of the shares of private corporations is limited. They can only be purchased with the agreement of the existing shareholders.
Information is crucial for decision-making. Without information decision making is simply guessing. Relevant information lets us know which alternatives are preferable based on the criteria being used to make the decision. Information lets decision makers know what the alternatives are and the strengths and limitations of each alternative.
When making a decision people gather information so that the decision is more informed and therefore better. However, each additional item of information has a cost, whether it’s the time to obtain the information or to consider its implications for the decision at hand, or the amount of money that has to be paid for the information. While more information will lead to better decisions, it’s necessary to consider the cost of the information. There is no point spending a dollar for information that will give you a benefit of $0.50. While this comparison is expressed in dollar terms, the idea applies to all costs (monetary, time, etc.) and all benefits (monetary, satisfaction, etc.).
A stakeholder’s objectives may not be the same as management’s. Managers make choices that affect how and when economic activity is reported in financial statements. For example, when preparing financial statements managers may have choices that could affect the net income of the entity, which in turn could impact the amount of bonus paid to managers. If the main...
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