The core ideas (maybe 80%-90%) underlying financial accounting can be summarized very succinctly!

1. Understanding financial accounting Fundamental structure and principles
There are only a (very) small number of fundamental concepts and principles underlying accounting:
● Fundamental accounting concepts and identities
owners' residual
economic non-ownerhsip claims to resources
 
 
resources claims to resources
 
 

ASSETSt  LIABILITIESt  EQUITYt 1  ETt  REVt  EXPt  G L
  t
 
NET INCOMEt
● Historical exchange price principle
FMV(consideration received )  FMV(consideration given )
  
the cleaer of the LHS or RHS is the HEP , quot; historical exchange pricequot;
● Revenue recognition principle
REVt  min(%earnedt , %realizablet )  HEP
● Expense recognition principle
EXPt  % resource consumedt  HEP
● Disclosure principle
Accounting principles and methods used by the firm—as well as descriptions and details of financial statement
components and other financial matters relevant to users—are fully disclosed in the financial statements.
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© 2009 M. J. McLelland

2. Understanding financial accounting Accounting, management, and governance
A model of relationships between accounting, management, and corporate governance:
fundamental management functions

organize/
 
plan control
direct
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  
accounting information system
managerial exchange
managerial
  
decisions events
reporting
entries for
entries financial

ordinary
subject to
 reporting
exchange and
managerial
nonexchange
economic discretion
events
conditions and governmental

 
nonexchange reporting
events
 
 
domain of management control systems domain of internal control systems
 
 
domain of integrated organizational control systems (i.e., quot;corporate governancequot; systems)
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© 2009 M. J. McLelland

3. Understanding financial accounting Ideas from finance and economics
● Under certain assumptions, payoffs to equity holders equal profit generated:
Et  Et 1  EC t  EDt  NI t  Et  DIVt  NI t
   
 
0 profit
 DIVt payoffs to
equity holders
● The value versus the market price of a firm’s equity regarded as functions of NI:
  V   NI t / r
V0  DIV1R 1  ...  FMVT R T  

 
1 T
P  NI t / r 
P0  DIV1R  ...  FMVT R roughly
 
 
● How management creates equity value:
 NI(a) 
V (a)
  
management takes action(s)
 0

  such that
ak ak  r (a) 

 
increasing profits and decreasing risk

… keeping in mind equity value can be created—or destroyed—in other ways, as well.
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© 2009 M. J. McLelland

4. Understanding financial accounting … philosophy
As suggested by the foregoing outline …
To understand accounting in a clear, concise way, we need to use math (specifically,
algebra). To begin to see why this might be so, it’s helpful to consider some philosophy:
quot;If you want literal realism, look at the world around you; if you want understanding,
look at theories.quot; Robert Dorfman
quot;If we spoke a different language, we would perceive a different world.quot;
Ludwig Wittgenstein
quot;Mathematics … [is] a mirror, an incredibly pure mirror, of the relations that link the
facts of our existence.quot; Konrad Knopp
quot;At a more advanced level, we have such tools as the equation or formula which
enable [us] to learn in a few hours fundamental and pervasive features of the
behavior of things which [we] could otherwise learn only imperfectly with great labor
or not at all.quot; E. L. Thorndike

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© 2009 M. J. McLelland