Describe the purpose of accounting, and explain its role in business and society.
Identify the primary users of accounting information.
Describe the environment of accounting, including the effects of generally accepted accounting principles, international business, ethical considerations, and technology.
Analyze the reasons for studying accounting.
During the last half of 2008, a series of events began that resulted in an economic crisis that has been felt around the world. The Dow Jones Industrial Average (a common measure of U.S. stock market performance) dropped 42% in value from July of 2008 to March of 2009. Over the same time period, the major index on the London Stock Exchange dropped 36% in value, and the major stock index in Japan dropped 47%. What brought about this sudden and major drop in the value of these major stock markets? A combination of factors really.
In the United States, a run up in housing prices resulted in everyone wanting to get into the real estate business. Banks, assuming that housing prices would continue to rise and that any increased equity in a home would reduce their potential exposure to credit losses, began providing loans to individuals who, in hindsight, were not creditworthy (these loans would come to be called subprime mortgages). Banks then combined those subprime mortgages into packages (or portfolios) and began selling those portfolios to investors—who also assumed that housing prices would continue to rise. Investment banks, attracted by these high-return mortgage-backed securities, invested heavily in these subprime loan portfolios. And then housing prices began to level off and even fall.
Suddenly, homeowners who had planned on using the increasing equity in their homes to help them make their mortgage payments found their equity vanishing. They could not make their mortgage payments. Banks found themselves with repossessed homes that were worth less than the mortgages on those homes and investment banks were holding mortgage-backed investment securities that were now insolvent. Four of the biggest investment banks in the world were soon out of the investment banking business—Lehman Brothers (founded in 1850), Goldman Sachs (founded in 1869), Bear Sterns (founded in 1923), and Morgan Stanley (founded in 1935) all collapsed or stopped doing investment banking within six months of each other in 2008.
American Insurance Group, Inc. (AIG) was also heavily invested in these subprime mortgages because of the potential for such high returns. On March 2, 2009, AIG reported the largest quarterly loss in history—$61.7 billion, virtually all of it related to the subprime credit crisis. Rather than let AIG (at the time the 18th largest company in the world) collapse, the U.S. government invested billions of dollars into the company, reasoning that AIG's collapse would have long-term ramifications for the global economy. As of March 2009, the U.S. government (and the taxpayers) owned 80% of AIG.
In this textbook, you will begin your study of accounting. You will learn to speak and understand accounting, “the language of business.” Without an understanding of accounting, business investments, taxes, and money management will be like a foreign language to you. In brief, an understanding of accounting facilitates the interpretation of financial information, which allows for better economic decisions.
The major objectives of this text are to provide you with a basic understanding of the language of accounting and with the ability to interpret and use financial information prepared using accounting techniques and procedures. With the knowledge you obtain from this exposure to accounting, you will be able to “read” the financial statements of companies, understand the information that is being conveyed, and use accounting information to make good business decisions. Also, through discussion of the business environment in which accounting is used, you will increase your understanding of general business concepts such as corporations, leases, annuities, leverage, investments, and so forth.
You will become convinced that accounting is not “bean counting.” Time after time, you will see that accountants must exercise judgment about how to best summarize and report the results of business transactions. This judgment was at the heart of the difficulties of Lehman Brothers, Goldman Sachs, Bear Sterns, and Morgan Stanley. As a result, you will gain a respect for the complexity of accounting and develop a healthy skepticism about the precision of any financial reports you see.
Finally, you will see the power of accounting. Financial statements are not just paper reports that get filed away and forgotten. As an example, the $61.7 billion loss reported by AIG resulted in stock markets suffering significant declines around the world, with the Dow Jones Industrial Average reaching its lowest point in 12 years. You will see that financial statement numbers and, indirectly, the accountants who prepare them determine who receives loans and who doesn't, which companies attract investors and which don't, which managers receive salary bonuses and which don't, and which companies are praised in the financial press and which aren't.
So, let's get started.