1.1. Accounting Is Not Just for Accountants
One main source of accounting information is in the form of financial statements that are packaged with other information in a financial report. Accountants keep the books and record the financial activities of an entity (such as a business). From these detailed records the accountant prepares financial statements that summarize the results of the activities.
Financial statements are sent to people who have a stake in the outcomes of the activities. If you own stock in General Electric, for example, or you have money in a mutual fund, you receive regular financial reports. If you invest your hard-earned money in a private business or a real estate venture, or you save money in a credit union, you receive regular financial reports. If you are a member of a nonprofit association or organization, you're entitled to receive regular financial reports.
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In summary, one important reason for studying accounting is to make sense of the financial statements in the financial reports you get. I guarantee that Warren Buffett knows accounting and how to read financial statements. I sent him a copy of my How To Read A Financial Report (Wiley). In his reply, he said he planned to recommend it to his "accounting challenged" friends.
1.1.1. Affecting both insiders and outsiders
People who need to know accounting fall into two broad groups: insiders and outsiders. Business managers are insiders; they have the authority and responsibility to run a business. They need a good understanding of accounting terms and the methods used to measure profit and put values on assets and liabilities.
Accounting information is indispensable for planning and controlling the financial performance and condition of the business. Likewise, administrators of nonprofit and governmental entities need to understand the accounting terminology and measurement methods in their financial statements.
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The rest of us are outsiders. We are not privy to the day-to-day details of a business or organization. We have to rely on financial reports from the entity to know what's going on. Therefore, we need to have a good grip on the financial statements included in the financial reports. For all practical purposes, financial reports are the only source of financial information we get directly from a business or other organization.
By the way, the employees of a business — even though they obviously have a stake in the success of the business — do not necessarily receive its financial reports. Only the investors in the business and its lenders are entitled to receive the financial reports. Of course, a business could provide this information to those of its employees who are not shareowners, but generally speaking most businesses do not. The financial reports of public businesses are in the public domain, so their employees can easily secure a copy. However, financial reports are not automatically mailed to all employees of a public business.
In our personal financial lives, a little accounting knowledge is a big help for understanding investing in general, how investment performance is measured, and many other important financial topics. With some basic accounting knowledge, you'll sound much more sophisticated when speaking with your banker or broker. I can't promise you that learning accounting will save you big bucks on your income taxes, but it can't hurt and will definitely help you understand what your tax preparer is talking about.
Keep in mind that this is not a book on bookkeeping and recordkeeping systems. I offer a brief explanation of procedures for capturing, processing, and storing accounting information in Chapter 3. Even experienced bookkeepers and accountants should find some nuggets in that chapter. However, this book is directed to users of accounting information. I focus on the end products of accounting, particularly financial statements, and not how information is accumulated. When buying a new car, you're interested in the finished product, not details of the manufacturing process that produced it.
1.1.2. Overcoming the stereotypes of accountants
I recently saw a cartoon in which the young son of clowns is standing in a circus tent and is dressed as a clown, but he is holding a business briefcase. He is telling his clown parents that he is running away to join a CPA firm. Why is this funny? Because it plays off the stereotype of a CPA (certified public accountant) as a "bean counter" who wears a green eyeshade and has the personality of an undertaker (no offense to morticians). Maybe you've heard the joke that an accountant with a personality is one who looks at your shoes when he is talking to you, instead his own shoes.
Like most stereotypes, there's an element of truth in the preconceived image of accountants. As a CPA and accounting professor for more than 40 years, I have met and known a large number of accountants. Most accountants are not as gregarious as used-car sales people (though some are). Accountants certainly are more detail-oriented than your average person. However, you don't have to be good at mathematics to be a good accountant. Accountants use very little math (no calculus and only simple algebra). Accountants are very good at one thing: They want to see both sides of financial transactions: the give and take. Accountants know better than anyone that, as economists are fond of saying, there's no such thing as a free lunch.
If you walked down a busy street in Chicago, New York, or Los Angeles, I doubt that you could pick out the accountants. I have no idea whether accountants have higher or lower divorce rates than others, whether they go to church more frequently, whether most are Republicans or Democrats, or if they generally sleep well at night. I do think that accountants are more honest in paying their income taxes than other people, although I have no proof of this.
1.1.3. Relating accounting to your personal financial life
I'm sure you know the value of learning personal finance and investing fundamentals. (I can recommend Personal Finance For Dummies and Investing For Dummies by Eric Tyson, MBA, both published by Wiley.) Well, a great deal of the information you use in making personal finance and investing decisions is accounting information. One knock I have on books in these areas is that they often don't make clear that you need a basic understanding of accounting terminology and valuation methods in order to make good use of the financial information.
You have a stake in the financial performance of the business you work for, the government entities you pay taxes to, the churches and charitable organizations you donate money to, the retirement plan you participate in, the businesses you buy from, and the healthcare providers you depend on. The financial performance and viability of these entities has a direct bearing on your personal financial life and well-being.
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We're all affected by the profit performance of businesses, even though we may not be fully aware of just how their profit performance affects our jobs, investments, and taxes. For example, as an employee your job security and your next raise depend on the business making a profit. If the business suffers a loss, you may be laid off or asked to take a reduction in pay or benefits. Business managers get paid to make profit happen. If the business fails to meet its profit objectives or suffers a loss, its managers may be replaced (or at least not get their bonuses). As an author, I hope my publisher continues to make profit so I can keep receiving my royalty checks.
Your investments in businesses, whether direct or through retirement accounts and mutual funds, suffer if the businesses don't turn a profit. I hope the stores I trade with make profit and continue in business. The federal government and many states depend on businesses making profit to collect income taxes from them.