Chapter 2 Understanding Economic Decision Making

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Chapter 2UnderstandingEconomic Decision Making
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Economic Decision Making
The term economic decision making refers to the
process of making business decisions involving
money.
Internal
External
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Economic Decision Making
External Decision Makers make decisions about
the company use Financial Accounting Available
information is limited to what the
company supplies to external users
Internal Decision Makers make decisions for the
company use Managerial Accounting Available
information is limited only by time and the
users position within the company

• Stockholders
• (present and potential)
• Bankers and other lenders
• Bondholders
• (present and potential)
• Suppliers
• Customers

• Marketing managers
• Salespersons
• Production managers
• Strategic planners
• Company president
• Engineers
• Financial officers

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Explain the basic differences between
management accounting and financial accounting.
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Management and Financial Accounting
Management accounting generates information for
use by internal decision makers.
Financial accounting generates information for
use by external parties.
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Contrast of Financial and Management Accounting
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List the three questions all economic decision
makers attempt to answer and explain why
these questions are so important.
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What all Economic Decision Makers Want to Know
Economic decision makers attempt to predict
future cash flow.
Will I be paid?
When will I be paid?
How much will I be paid?
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What all Economic Decision Makers Want to Know
The answer to each question contains two parts
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What all Economic Decision Makers Want to Know
Net cash flow is the mathematical difference
between cash inflows and cash outflows.
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What all Economic Decision Makers Want to Know
Three Big Questions for Economic Decision Makers
1. Will I be paid? 2. When will I be paid? 3.
How much will I be paid?
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What all Economic Decision Makers Want to Know
What are the returns?
Interest Return on investment
200 Principle Return of investment
1,000 Total return
1,200 Less Initial investment
1,000 Profit on investment 200
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Describe the importance of cash as a measure
of business success or failure.
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Cash is the Ball of Business
The secret to becoming a street-smart user
of accounting information is learning to
balance the complexity of business with the
simple rule of keeping your eye on cash flow.
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Describe the basic assumptions and constraints
underlying accounting information and distinguish
accounting information from accounting data.
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Accounting Information
Accounting is a service activity.
Its function is to provide quantitative
information, primarily financial in nature, about
economic entities that is intended to be useful
in making economic decisions.
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Data versus Information
Data are the raw result of transactions.
Data become information only when they are put
into some useful form.
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Assumptions Underlying Accounting Information
Assumptions 1. Economic entity 2. Going
concern 3. Monetary unit 4. Periodicity
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Constraints to Consider in Generating Accounting
Information
Constraints 1. Cost/benefit 2.
Materiality 3. Industry practice 4. Conservatism
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Describe the qualitative characteristics of
useful accounting information and apply them
in decision-making situations.
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Qualitative Characteristics of Useful Accounting
Information
1. Primary qualities A. Relevance (1)
Predictive value (2) Feedback value (3)
Timeliness B. Reliability (1) Representational
faithfulness (2) Verifiability (3)
Neutrality 2. Secondary qualities A.
Comparability B. Consistency
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End of Chapter 2