1.3 Describe Typical Accounting Activities and the Role Accountants Play in Identifying, Recording, and Reporting Financial Activities

For-Profit Businesses

As the name implies, the primary purpose or mission of a for-profit business is to earn a profit by selling goods and services. There are many reasons why a for-profit business seeks to earn a profit. The profits generated by these organizations might be used to create value for employees in the form of pay raises for existing employees as well as hiring additional workers. In addition, profits can be reinvested in the business to create value in the form of research and development, equipment upgrades, facilities expansions, and many other activities that make the business more competitive. Many companies also engage in charitable activities, such as donating money, donating products, or allowing employees to volunteer in the communities. Finally, profits can also be shared with employees in the form of either bonuses or commissions as well as with owners of the business as a reward for the owners’ investment in the business. These issues, along with others, and the associated accounting conventions will be explored throughout this course.

In for-profit businesses, accounting information is used to measure the financial performance of the organization and to help ensure that resources are being used efficiently. Efficiently using existing resources allows the businesses to improve quality of the products and services offered, remain competitive in the marketplace, expand when appropriate, and ensure longevity of the business.

For-profit businesses can be further categorized by the types of products or services the business provides. Let’s examine three types of for-profit businesses: manufacturing, retail (or merchandising), and service.

Retail Businesses

Manufacturing businesses and retail (or merchandising) businesses are similar in that both are for-profit businesses that sell products to consumers. In the case of manufacturing firms, by adding direct labor, manufacturing overhead (such as utilities, rent, and depreciation), and other direct materials, raw components are converted into a finished product that is sold to consumers. A retail business (or merchandising business), on the other hand, is a for-profit business that purchases products (called inventory) and then resells the products without altering them—that is, the products are sold directly to the consumer in the same condition (production state) as purchased.

Examples of retail firms are plentiful. Automobile dealerships, clothes, cell phones, and computers are all examples of everyday products that are purchased and sold by retail firms. What distinguishes a manufacturing firm from a retail firm is that in a retail firm, the products are sold in the same condition as when the products were purchased—no further alterations were made on the products.

Did you happen to notice that the product examples listed in the preceding paragraph (automobiles, clothes, cell phones, and computers) for manufacturing firms and retail firms are identical? If so, congratulations, because you are paying close attention to the details. These products are used as examples in two different contexts—that is, manufacturing firms make these products, and retail firms sell these products. These products are relevant to both manufacturing and retail because they are examples of goods that are both manufactured and sold directly to the consumer. While there are instances when a manufacturing firm also serves as the retail firm (Dell computers, for example), it is often the case that products will be manufactured and sold by separate firms.

Concepts In Practice

NIKEiD

NIKEiD is a program that allows consumers to design and purchase customized equipment, clothes, and shoes. In 2007, Nike opened its first NIKEiD studio at Niketown in New York City.¹ Since its debut in 1999, the NIKEiD concept has flourished, and Nike has partnered with professional athletes to showcase their designs that, along with featured consumer designs, are available for purchase on the NIKEiD website.

Figure 1.4 NIKEiD Launch Store in Shanghai. (credit: “Nike-id-shanghai-launch” by “All.watson”/Wikimedia Commons, CC BY 2.0)

Assume you are the manager of a sporting goods store that sells Nike shoes. Think about the concept of NIKEiD, and consider the impact that this concept might have on your store sales. Would this positively or negatively impact the sale of Nike shoes in your store? What are steps you could take to leverage the NIKEiD concept to help increase your own store’s sales?

Considerations like this are examples of what marketing professionals would address. Nike wants to ensure this concept does not negatively impact the existing relationships it has, and Nike works to ensure this program is also beneficial to its existing distribution partners.

In Merchandising Transactions you will learn about merchandising transactions, which include concepts and specific accounting practices for retail firms. You will learn, among other things, how to account for purchasing products from suppliers, selling the products to customers, and prepare the financial reports for retail firms.

Service Businesses

As the term implies, service businesses are businesses that provide services to customers. A major difference between manufacturing and retail firms and service firms is that service firms do not have a tangible product that is sold to customers. Instead, a service business does not sell tangible products to customers but rather provides intangible benefits (services) to customers. A service business can be either a for-profit or a not-for-profit business. Figure 1.5 illustrates the distinction between manufacturing, retail, and service businesses.

Examples of service-oriented businesses include hotels, cab services, entertainment, and tax preparers. Efficiency is one advantage service businesses offer to their customers. For example, while taxpayers can certainly read the tax code, read the instructions, and complete the forms necessary to file their annual tax returns, many choose to take their tax returns to a person who has specialized training and experience with preparing tax returns. Although it is more expensive to do so, many feel it is a worthwhile investment because the tax professional has invested the time and has the knowledge to prepare the forms properly and in a timely manner. Hiring a tax preparer is efficient for the taxpayer because it allows the taxpayer to file the required forms without having to invest numerous hours researching and preparing the forms.

The accounting conventions for service businesses are similar to the accounting conventions for manufacturing and retail businesses. In fact, the accounting for service businesses is easier in one respect. Because service businesses do not sell tangible products, there is no need to account for products that are being held for sale (inventory). Therefore, while we briefly discuss service businesses, we’ll focus mostly on accounting for manufacturing and retail businesses.

Figure 1.5 Manufacturing, Retail, and Service. An auto manufacturing plant, a car sales lot, and a taxi represent three types of businesses: manufacturing, retail, and service. (credit left: modification of “Maquiladora” by “Guldhammer”/Wikimedia Commons, CC0; credit center: modification of “Mercedes Benz Parked” by unknown/Pixabay, CC0; credit right: modification of “Taxi Overtaking Bus” by “Kai Pilger”/Pixabay, CC0)

Your Turn

Categorizing Restaurants

So far, you’ve learned about three types of for-profit businesses: manufacturing, retail, and service. Previously, you saw how some firms such as Dell serve as both manufacturer and retailer.

Now, think of the last restaurant where you ate. Of the three business types (manufacturer, retailer, or service provider), how would you categorize the restaurant? Is it a manufacturer? A retailer? A service provider? Can you think of examples of how a restaurant has characteristics of all three types of businesses?

Solution

Answers will vary. Responses may initially consider a restaurant to be only a service provider. Students may also recognize that a restaurant possesses aspects of a manufacturer (by preparing the meals), retailer (by selling merchandise and/or gift cards), and service provider (by waiting on customers).

Governmental Entities

A governmental entity provides services to the general public (taxpayers). Governmental agencies exist at the federal, state, and local levels. These entities are funded through the issuance of taxes and other fees.

Accountants working in governmental entities perform the same function as accountants working at for-profit businesses. Accountants help to serve the public interest by providing to the public an accounting for the receipts and disbursements of taxpayer dollars. Governmental leaders are accountable to taxpayers, and accountants help assure the public that tax dollars are being utilized in an efficient manner.

Examples of governmental entities that require financial reporting include federal agencies such as the Social Security Administration, state agencies such as the Department of Transportation, and local agencies such as county engineers.

Students continuing their study of accounting may take a specific course or courses related to governmental accounting. While the specific accounting used in governmental entities differs from traditional accounting conventions, the goal of providing accurate and unbiased financial information useful for decision-making remains the same, regardless of the type of entity. Government accounting standards are governed by the Governmental Accounting Standards Board (GASB). This organization creates standards that are specifically appropriate for state and local governments in the United States.

Not-for-Profit Entities

To be fair, the name “not-for-profit” can be somewhat confusing. As with “for-profit” entities, the name refers to the primary purpose or mission of the organization. In the case of for-profit organizations, the primary purpose is to generate a profit. The profits, then, can be used to sustain and improve the business through investments in employees, research, and development, and other measures intended to help ensure the long-term success of the business.

But in the case of a nonprofit (not-for-profit) organization the primary purpose or mission is to serve a particular interest or need in the community. A not-for-profit entity tends to depend on financial longevity based on donations, grants, and revenues generated. It may be helpful to think of not-for-profit entities as “mission-based” entities. It is important to note that not-for-profit entities, while having a primary purpose of serving a particular interest, also have a need for financial sustainability. An adage in the not-for-profit sector states that “being a not-for-profit organization does not mean it is for-loss.” That is, not-for-profit entities must also ensure that resources are used efficiently, allowing for inflows of resources to be greater than (or, at a minimum, equal to) outflows of resources. This allows the organization to continue and perhaps expand its valuable mission.

Examples of not-for-profit entities are numerous. Food banks have as a primary purpose the collection, storage, and distribution of food to those in need. Charitable foundations have as a primary purpose the provision of funding to local agencies that support specific community needs, such as reading and after-school programs. Many colleges and universities are structured as not-for-profit entities because the primary purpose is to provide education and research opportunities.

Similar to accounting for governmental entities, students continuing their study of accounting may take a specific course or courses related to not-for-profit accounting. While the specific accounting used in not-for-profit entities differs slightly from traditional accounting conventions, the goal of providing reliable and unbiased financial information useful for decision-making is vitally important. Some of the governmental and regulatory entities involved in maintaining the rules and principles in accounting are discussed in Explain Why Accounting Is Important to Business Stakeholders.