PACE Academic IG

Introduction

For accounting majors, financial accounting is the first course in a journey that they hope leads them to a career in public accounting.  If financial accounting is seen this way, the accounting major will fail to see the completeness in what the course provides.  Financial accounting provides accounting majors with ideas on how to pursue another career that is fulfilling and rewarding, a career in management accounting.  Management accounting provides accounting majors with career opportunities they may have never considered when they chose accounting as their major.  I would like to share my thoughts on how I have organized the teaching of financial accounting to help accounting majors embrace a great alternative to public accounting, management accounting.

Organization

I divide my presentation of financial accounting into 3 areas:

1.     Assessing Financial Health   

2.     Seeing the Complete Transaction

3.     Developing Meaningful Measurements

Assessing Financial Health

Chapter 1 of every financial accounting textbook I have used describes the 4 financial statements: Income Statement, Statement of Stockholders’ Equity, Balance Sheet, and Statement of Cash Flows.  For the non-accounting major, the presentation of the 4 financial statements is a nice way to begin a basic understanding of the course.  For the accounting major, however, chapter 1 provides a great opportunity to not only build but also expand one’s understanding.  The understanding goes beyond the material in the course.  The understanding goes into the connection from the financial statements to the assessment of financial health.

In 1 of the textbooks I have used, chapter 2 lists the 3 elements necessary to assess the financial health of a company, profitability, liquidity, and solvency.  I use the following definitions of each element when teaching.  I define profitability as the ability to earn income from the delivery of products or the provision of services.  I define liquidity as the ability to pay bills.  I define solvency as the ability to exist over the long-term.

I gave profitability the longest definition because a company that is not profitable will, in time, become illiquid and ultimately insolvent.  What I emphasize to students is to understand profitability is to understand the relationship between effort and reward, i.e., the relationship between expenses and revenues on the income statement.  For the accounting major, the income statement can help frame an understanding of how good or bad a company is in creating, distributing, promoting, and supporting what it sells, a framework appearing on the income statement through cost of goods sold, selling expenses, and administrative expenses.  From this framework, the accounting major can expand upon it through courses in data analytics, economics, finance, management, and management.  The expansion, when connected to employment, prepares the accounting major for a fulfilling and rewarding career in management accounting.

Both the balance sheet and the statement of cash flows can be used to assess not only liquidity but also solvency.  The balance sheet can be used to assess liquidity by studying current assets and current liabilities, and the statement of cash flows can be used to assess liquidity by studying net cash provided by operating activities.  The balance sheet can be used to assess solvency by studying long-term assets, long-term liabilities, and stockholders’ equity, and the statement of cash flows can be used to assess solvency by studying net cash flows associated with investing activities and financing activities.  What I want accounting majors to learn about the connections from the balance sheet and statement of cash flows to liquidity and solvency is to explain the importance of the connections to people outside the accounting function, which exists in the classroom because of students who are not accounting majors.  The experience in the classroom can be taken to the job, and that can help accounting majors obtain a fulfilling and rewarding career in management accounting.

Seeing the Complete Transaction

Some textbooks I have used begin the study of transactions in chapter 2, and other textbooks I have used begin the study of transactions in chapter 3.  Regardless of chapter, the study of transactions is what accounting is about.  For the accounting major who may wish to have a career other than one in public accounting, the study of transactions provides a great opportunity to prepare for a fulfilling and rewarding career in management accounting.  Transactions happen anywhere and everywhere in a company but seeing the complete transaction may be easily seen.  This is how an accounting major, through management accounting, can help people make more appropriate decisions inside a company.

I use the system of borrowing money as an example.

Borrowing money involves the borrowing, the repayment, and the cost of borrowing, i.e., interest.  The accounting equation is used to visualize the net effect of each transaction, which is a decrease in assets and a decrease in stockholders’ equity.  The accounting major who becomes a management accountant can help management think better about the decision to raise money by issuing debt as well as how to recover the decreases in assets and stockholders’ equity.  Borrowing money is only one of several transactions that involve several steps, which is why the accounting major as a management accountant can obtain an important seat at a company’s leadership table.  If management fails to see the complete transaction, a company can fail to remain solvent.

Developing Meaningful Measurements

The chapters that I use to present accounts receivable and inventory contain material associated with turnover ratios.  They can be confusing but necessary, and how I eliminate the confusion is to add ratios that measure time, the average collection period for accounts receivable, and the average age of inventory for inventory.  All of us understand time, which means a question about it can be answered more quickly.  For example, asking someone why a customer is taking two weeks longer to pay an inventory or why a product is taking two weeks longer to sell is an easier question to answer instead of why a receivables turnover ratio or inventory turnover ratio went from 10 to 6.  Do not complicate simple, and using time to measure the quality of accounts receivable and inventory can provide more meaningful measurements of liquidity.

The chapter that I use to present liabilities contains material associated with liquidity ratios.  The most common is easiest to calculate is the current ratio, current assets divided by current liabilities.  No measurement is perfect, and the current ratio is an excellent example.  The imperfection of the current ratio is it includes inventory.  Slow moving inventory comprising a large percentage of current assets can create an imperfect understanding of a company’s liquidity.

An additional measurement to assess liquidity is the quick ratio, cash plus marketable securities plus accounts receivable divided by current assets.  For manufacturing and retail companies, using the quick ratio can provide a better understanding of a company’s liquidity because it excludes inventory.  One measurement, however, does not completely answer questions about liquidity.  I encourage the accounting major as a management accountant to use both measures.  By adding perspective, a point of view, the management accountant can better help management make more appropriate decisions.  That leads us to a measurement system that I encourage accounting majors to use, the DuPont System.

The DuPont System measures return on equity by the use of 3 measurements, margin, turnover, and leverage.  Margin is net income divided by net sales, turnover is net sales divided by average total assets, and leverage is average total assets divided by average total stockholders’ equity.  The description of this measurement can lead to separate articles, but I want to emphasize is how this system uses all elements of the income statement and balance sheet.  By using all elements of both financial statements, the accounting major as a management accountant can provide management with measurements that address profitability, liquidity, and solvency.  This system provides meaning to measurement by helping the accounting major as a management accountant inspire questions to be asked about a company’s financial health.

Conclusion

The role of a management accountant is changing and will continue to change.  The accounting major who sees management accounting as a fulfilling and rewarding career can build a foundation from the study of financial accounting.  The study I describe in this article is only the beginning.  The continuation is when the management accountant can inspire management to ask better questions because the right answer to the wrong answer will not dissolve a problem.  Inspiring management to ask better questions is one way to get the most from financial accounting.