Lecture 1 - Intro
Define earnings before tax and interest
Earnings before interest and taxes (EBIT), is a measure of a firm's profit that includes all expenses except interest and income tax expenses. It is the difference between operating revenues and operating expenses.
What is the key difference between the income/profit and cash statements?
For PROFIT MEASUREMENT the cash flow does not have to take place at the same time as the transaction... we use FINANCIAL VALUES rather than pure cash flows
Is wealth maximisation considered on a yearly basis, or is it a long-term thing?
It is important to recognise that generating wealth for the owners is not the same as seeking to maximise the current year's profit. Wealth creation is a longer-term concept, which relates not only to this year's profit but to that of future years as well. In the short term, corners can be cut and risks taken that improve current profit at the expense of future profit. >> HOWEVER, emphasis on short-term profit can be damaging.
What is the 7th step of the business cycle?
The shareholders will discuss with the directors how much the company needs for reinvestment (RESERVES) and how much should be withdrawn (DIVIDENDS OR DRAWINGS) by the owners. What is not withdrawn is retained by the company. Such retentions still belong to the shareholders and are, in effect, an additional investment.
What is the 5th step of the business cycle?
NET PROFIT Accounting = PROFIT BEFORE TAX. >> Profit before taxes equals EBIT minus interest expense (interests on loans) plus interest income from investments and cash holdings, such as bank accounts.
What are the problems with the theoretical cost/benefit analysis?
Practical probelms of establishing the cost and value of information. COST: - The provision of accounting information can be very costly; however, the costs are often difficult to quantify. >> The direct, out-of-pocket, costs such as salaries of accounting staff are not really a problem to identify, but these are only part of the total costs involved. >> There are also less direct costs such as the cost of the user's time spent on analysing and interpreting the information contained in reports. BENEFIT: - The economic benefit of having accounting information is even harder to assess. - It is possible to apply some 'science' to the problem of weighing the costs and benefits, but a lot of subjective judgement is likely to be involved.
If a company is paid on credit terms, what happens to any outstanding invoices at the end of the financial year? E.g. The sales generated by company Y in a financial year total £150,000. All of the sales are on credit terms and by the end of the year. >>> Because bills/invoices are lodged somewhere in a payment process system, only £135,000 of the total sales value of £150,000 has been received in cash. Happens to the 15,000 that have not been recorded?
Profti/Income statement = 150,000 Cash statement = 135,000. For sales, the 'missing' £15,000 does not disappear. At the end of the year it is shown as an ASSET of £15,000 on the BALANCE SHEET.
What is the quality of the acocunting service determined by?
The quality of the service provided is determined by the extent to which the needs of the various user groups have been met. To meet these users' needs, it can be argued that accounting information should possess certain key qualities, or characteristics: relevance, reliability, comparability understandability.
Define balance sheet
***** (STATMENT OF FINANCIAL POSITION) Show the sources of finance and its investment. It lists, at a point in time, financial values of items owned as resources (ASSETS) and amounts owed (LIABILITIES) by outisders nand the investments by the owners of the business (EQUITY).
Discuss the nature of the reports produced for management accounting and financial accounting
1. Nature of the reports produced: - FINANCIAL ACCOUNTing reports tend to be GENERAL purpose, that is, they contain financial information that will be useful for a broad range of users and decisions rather than being specifically designed for the needs of a particular group or set of decisions. - MANAGEMENT ACCOUNTING reports, on the other hand, are often specific-purpose reports. They are designed with a particular decision in mind and/or for a particular manager.
What is a sole partnership business?
A partnership exists where at least two individuals carry on a business together with the intention of making a profit. - Usually small in size. - Easy to set up as no formal procedures are required (and it is not even necessary to have a written agreement between the partners). - The partnership can be restructured or dissolved by agreement between the partners. - The partners of the business usually have UNLIMITED LIABILITY.
How has accounting (both management and financial) changed in response to the change in the environment?
1. CLEAR FRAMEWORK: The changing business environment has given added impetus to the search for a CLEAR FRAMEWORK and principles upon which to base financial accounting reports. Various attempts have been made to clarify the purpose of financial accounting reports and to provide a more solid foundation for the development of accounting rules. 2. ACCOUNTING RULES: accounting rule makers have tried to improve reporting rules to ensure that the accounting policies of businesses are more COMPARABLE and more TRANSPARENT, and that they portray economic reality more faithfully. While this has had a generally beneficial effect, the recent accounting scandals have highlighted the limitations of accounting rules in protecting investors and others.
Give 2 examples of potential conflicts of interest between use groups.
1. CONFLICT BETWEEN MANAGERS AND OWNERS OF A BUSINESS: - Although managers are appointed to act in the best interests of the owners, there is always a danger that they will not do so. >> Instead, managers may use the wealth of the business to award themselves large pay rises, to furnish large offices or to buy expensive cars for their own use. >> Accounting information has an important role to play in reporting the extent to which various groups have benefited from the business. *** Thus, owners may rely on accounting information to check whether the pay and benefits of managers are in line with agreed policy. 2. CONFLICT BETWEEN LENDERS AND OWNERS: - There is a risk that the funds loaned to a business will not be used for purposes that have been agreed. >> Lenders may, therefore, rely on accounting information to check that the funds have been applied in an appropriate manner and that the terms of the loan agreement are not being broken.
Give 2 examples of accounting fraud?
1. ENRON, an energy-trading business based in Texas, which was accused of entering into complicated financial arrangements in an attempt to obscure losses and to inflate profits. 2. WorldCom, a major long-distance telephone operator in the US, which was accused of reclassifying $3.9 billion of expenses so as to falsely inflate the profit figures that the business reported to its owners (shareholders) and to others.
What is the 6th step of the business cycle?
After any tax obligations have been deducted, what remains - the profit after tax, belongs to the owners, the shareholders. This is called the PROFIT FOR YEAR (PAT)
In which financial statement are liabilities and equity reported?
Balance sheet.
What has the high number of scandals led to?
The result of these accounting scandals has been to undermine the credibility of financial statements and to introduce much stricter regulations concerning the quality of financial information.
What is the first step of the business cycle for a business?
Businesses obtain funding (accounting term = FINANCING) from a range of sources. This funding is then used to a) acquire ASSETS - buildings, equipment, motor vehicles as examples, and b) to help pay day to day OPERATING COSTS - salaries, power, insurance, materials as examples.
What is the difference between a creditor and a liability?
CREDTIOR: any person or organization owed money by the business LIABILITY: Suppliers owed money are usually current liabilities and are often referred to as TRADE PAYABLES.
What is the third step of the business cycle?
Day to day operating costs Accounting = operating expenses
Define straight line depreciation
Default method used to deal with long-term assets on the profite/income statement. A straight line basis is a method of computing DEPRECIATION by dividing the difference between an asset's cost and its expected SALVAGE VALUE by the number of years it is expected to be used.
What is the difference between EBIT and profit before tax?
EBIT represents the profit a company generates after paying its operating expenses but before paying income taxes and interest on debt. PROFIT BEFORE TAXES: Profit before taxes equals EBIT minus interest expense (interests on loans) plus interest income from investments and cash holdings, such as bank accounts.
Why do conflicting interests of user groups occur? What can be used to monitor potential conflicts?
Each user group looks at a business from a different perspective and has its own particular interests. This means that there is always the risk that the interests of one group will collide with those of another group. ACCOUNTING INFO. CAN BE USED TO MONITOR POTENTIAL CONFLICTS: allows different user groups to check informaiton about other user groups.
Briefly outline what the statement of financial position/balance sheet is
The statement of financial position provides information concerning the wealth held by a business at a particular point in time and the claims against this wealth.
Is the opening and closing balance the same? Why or why not?
They will likely be DIFFERENT (although they could be the same). This is because during the year there will have been many activities and transactions undertaken by the business. As a consequence, the closing balance sheet is likely to differ from the opening balance sheet.
Briefly outline what the the statement of cashflows is
This financial statement is important in identifying the financing and investing activities of the business over a period. It sets out how cash was generated and how cash was used during a period.
When using the matching principle for the income/profit statement. What happens to the cost incurred that did not directly yiled financial value/sales?
This is referred to as THE MATCHING PRINCIPLE . The table NOT YET SOLD is shown as an ASSET on the balance sheet at the end of the financial period.
Briefly outline what the income statement is
This provides information concerning the wealth created by a business during a period.
Summarise the financial objective of a business
● A business may pursue a variety of objectives but the main objective for virtually all businesses is to enhance the wealth of their owners. This does not mean, however, that the needs of other groups connected with the business, such as employees, should be ignored. ● When setting financial objectives the right balance must be struck between risk and return.
SUMMARISE ACCOUNTING IN VIEW OF A SERVICE
● Accounting can be viewed as a form of service as it involves providing financial information required by the various users. ● To provide a useful service, accounting must possess certain qualities, or characteristics. These are relevance, reliability, comparability and understandability. In addition, accounting information must be material. ● Providing a service to users can be costly and financial information should be produced only if the cost of providing the information is less than the benefits gained.
What is a sole proprietorship?
- An individual is the sole owner of a business - Often small business (easured in terms of sales revenue generated or number of staff employed), however the number of such business is large. Examples are particularly within the service sector, e.g. electrical repaits, picture framing. - Easy to set up, not formal procedures are required and operation can commence immediatley (unless special permission is required because of the nature of the trade or service, such as running licensed premises). Flexibility to restructure or dissolve the business. *** The law does not recognise the sole-proprietor business as being separate from the owner, which means they have UNLIMITED LIABILITY (no distinction between personal wealth and that of the business if there are business debts that must be paid).
What is the accounting information system.
- Another way of viewing accounting is that it is part of the business´total information system. - There are four sequential stages of an accounting information system. The first two stages are concerned with preparation, whereas the last two stages are concerned with using the information collected.
What are the names of fixed assets and long-term liabilities according to acconuting regulaiton for PUBLIC LIMITED COMPANIES?
- Fixed assets = Non-current assets. - Long term liabilities = Non-current liabilities.
What is the company structure of a limited company?
- Owners (shareholders) appoint a board of directors to manage the business on their behalf. - The board is in charge of 3 major tasks: 1. Setting the overall direction and strategy 2. Monitoring & controlling activties 3. communicating with owners and others connected with the business. Chairman: each board has a chairman, elected by the directors, who is responsible for running the board in an efficient manner. CEO: In addition, each board has a chief executive officer (CEO), or managing director, who is responsible for running the business on a dayto-day basis (occasionally the same person as chariman, but generally not prefered to avoid a person with too much power). BoDs hire managers to run the day-to-day business. Each manager is given responsibility for a particular part of the business´s operations.
What is a limited company?
- The number of individuals who subscribe capital and become the owners may be unlimited, which provides the opportunity to create a very large-scale business - The liability of owners, however, is limited (hence 'limited' company), which means that those individuals subscribing capital to the company are liable only for debts incurred by the company up to the amount that they have agreed to invest. >> This cap on the liability of the owners is designed to limit risk and to produce greater confidence to invest.
What are the main differences between management and financial accounting?
1. Nature of the reports produced: - FINANCIAL ACCOUNTing reports tend to be GENERAL purpose, that is, they contain financial information that will be useful for a broad range of users and decisions rather than being specifically designed for the needs of a particular group or set of decisions. - MANAGEMENT ACCOUNTING reports, on the other hand, are often specific-purpose reports. They are designed with a particular decision in mind and/or for a particular manager. 2. Level of detail: - FINANCIAL ACCOUNTing reports provide users with a broad overview of the performance and position of the business for a period. As a result, information is aggregated and detail is often lost. - MANAGEMENT ACCOUNTING reports, however, often provide managers with considerable detail to help them with a particular operational decision. 3. Regulations: - FINANCIAL ACCOUNTing reports, for many businesses, are subject to accounting regulations that try to ensure they are produced with standard content and in a standard format. The law and accounting rule makers impose these regulations. - MANAGEMENT ACCOUNTing reports are for internal use only, there are no regulations from external sources concerning the form and content of the reports. They can be designed to meet the needs of particular managers. 4. Reporting interval - FINANCIAL ACCOUNTing reports, For most businesses, are produced on an annual basis, though some large businesses produce half-yearly reports and a few produce quarterly ones. - MANAGEMENT ACOUNTING reports may be produced as frequently as required by managers. In many businesses, managers are provided with certain reports on a daily, weekly or monthly basis, which allows them to check progress frequently. In addition, special-purpose reports will be prepared when required (for example, to evaluate a proposal to purchase a piece of equipment) 5. Time orientation - FINANCIAL ACCOUNTing reports, reflect the performance and position of the business for the past period. In essence, they are backward looking. - MANAGEMENT ACCOUNTing reports, on the other hand, often provide information concerning future performance as well as past performance. It is an oversimplification, however, to suggest that financial accounting reports never incorporate expectations concerning the future. Occasionally, businesses will release projected information to other users in an attempt to raise capital or to fight off unwanted takeover bids. Even preparation of the routine financial accounting reports typically requires making some judgements about the future. 6. Range and quality of information - FINANCIAL ACCOUNTing reports, concentrate on information that can be quantified in monetary terms. inancial accounting places greater emphasis on the use of objective, verifiable evidence when preparing reports. - MANAGEMENT ACCOUNTing also produces such reports, but is also more likely to produce reports that contain information of a non-financial nature, such as physical volume of inventories, number of sales orders received, number of new products launched, physical output per employee and so on. Management accounting reports may use information that is less objective and verifiable, but nevertheless provide managers with the information they need.
What main types of business ownership exist?
1. Sole proprietorship 2. Partnership 3. Limited company
Define equity and liabilities
1.) Funding from owners, referred to as EQUITY 2.) funding from others such as suppliers and banks, referred to as LIABILITIES. Both are recorded on the balance sheet under funding.
What are the two strands of accounting?
1.) Management accounting, which seeks to meet the accounting needs of managers; and 2.) Financial accounting, which seeks to meet the accounting needs of all of the other users identified earlier. The difference in their targeted user groups has led to each strand of accounting developing along different lines.
Discuss the level of detail of reports produced for management accounting and financial accounting
2. Level of detail: - FINANCIAL ACCOUNTing reports provide users with a broad overview of the performance and position of the business for a period. As a result, information is aggregated and detail is often lost. - MANAGEMENT ACCOUNTING reports, however, often provide managers with considerable detail to help them with a particular operational decision.
Discuss the regualtions of reports produced for management accounting and financial accounting
3. Regulations: - FINANCIAL ACCOUNTing reports, for many businesses, are subject to accounting regulations that try to ensure they are produced with standard content and in a standard format. The law and accounting rule makers impose these regulations. - MANAGEMENT ACCOUNTing reports are for internal use only, there are no regulations from external sources concerning the form and content of the reports. They can be designed to meet the needs of particular managers.
Discuss the RERPOTING INTERVAL of reports produced for management accounting and financial accounting
4. Reporting interval - FINANCIAL ACCOUNTing reports, For most businesses, are produced on an annual basis, though some large businesses produce half-yearly reports and a few produce quarterly ones. - MANAGEMENT ACOUNTING reports may be produced as frequently as required by managers. In many businesses, managers are provided with certain reports on a daily, weekly or monthly basis, which allows them to check progress frequently. In addition, special-purpose reports will be prepared when required (for example, to evaluate a proposal to purchase a piece of equipment)
Discuss the TIME ORIENTATION of reports produced for management accounting and financial accounting
5. Time orientation - FINANCIAL ACCOUNTing reports, reflect the performance and position of the business for the past period. In essence, they are backward looking. - MANAGEMENT ACCOUNTing reports, on the other hand, often provide information concerning future performance as well as past performance. It is an oversimplification, however, to suggest that financial accounting reports never incorporate expectations concerning the future. Occasionally, businesses will release projected information to other users in an attempt to raise capital or to fight off unwanted takeover bids. Even preparation of the routine financial accounting reports typically requires making some judgements about the future.
Discuss the RANGE & QUALITY OF INFORMATION of reports produced for management accounting and financial accounting
6. Range and quality of information - FINANCIAL ACCOUNTing reports, concentrate on information that can be quantified in monetary terms. inancial accounting places greater emphasis on the use of objective, verifiable evidence when preparing reports. - MANAGEMENT ACCOUNTing also produces such reports, but is also more likely to produce reports that contain information of a non-financial nature, such as physical volume of inventories, number of sales orders received, number of new products launched, physical output per employee and so on. Management accounting reports may use information that is less objective and verifiable, but nevertheless provide managers with the information they need.
What is the financial objective of a business?
A business is created to enhance waealth of its owners. - It is assumed that this is the main objective of a business. HOWEVER, there are other objectives that a business may pursue that are related to the needs of others associated with the business. E.g its customers, environment and employees but behaviour of firms with these objectives are CONSISTENT with wealth maximising firms. **** Satisfying the needs of other groups will normally be CONSISTEN with increasing the wealth of the owners over the longer term.
What is the second step of the business cycle?
A business is then required to undertake operations, and make sells with a view to generating profit. >> The second step is to GENERATE REVENUE.
Define dividends or drawings
A dividend is a distribution of a portion of a company's earnings, decided by the board of directors, paid to a class of its shareholders. Dividends can be issued as cash payments, as shares of stock, or other property.
Define balance sheet
A photograph of the financial position at the end of the period. >> Prepared AFTER the cash flow and income statements. It lists, financial values of items owned as resources (ASSETS) and amounts owed (LIABILITIES) by outsiders, and the investments by the owner of a business (EQUITY). The general fomula: ASEETS = LIABILITIES + EQUITY suggests they should balance. It is goverened by (principle of duality) DOUBLE ENTRY BOOK-KEEPING.
What is accounting. Define it.
Accountin is the PROCESS of identifying, collecting, measuring, analysing and communicatin the financial information of an orginization to enable users of the information to make INFORMED JUDGEMENTS & DECISIONS. Accounting provides (collects, analyses and communicates) financial information for a range of users to help them make better judgements and decisions concerning a business. ** Valueable tool for decision-making of various users. It can IMPROVE THE QUALITY of decisions that those users make.
What are the key characteristics accounting must have to be useful for its user groups? Draw the diagram.
Accounting information must have the ability to influence decisions. To do that is MUST: - There must be a clear understanding of FOR WHOM and FOR WHAT purpose the information will be used. >> You could the user group in the middle of the diagram to reflect this. 4 characteristics that make financial informaiton useful: Comparability Reliability Understandability Relevance ADDITIOANLLY, Benefits of providing the informaiton should outweigh the cost Accouting informaiton should be material.
How useful is accounting?
Accounting is still a developing subject and we still have much to learn about user groups needs and the ways in which these needs should be met. Nevertheless, accounting reports should help users make decisions relating to the business. >> The information should reduce uncertainty about the financial position and performance of the business.
Discuss UNDERSTANDIBILITY as a key characteristic of useful accounting information
Accounting reports should be expressed as clearly as possible and should be understood by those at whom the information is aimed. Generally speaking, accounting reports assume that the user not only has a reasonable knowledge of business and accounting but is also prepared to invest some time in studying the reports. Despite this, the onus is clearly on accountants to provide information in a way that makes it as understandable as possible to non-accountants.
Discuss reliability as a key characteristic of useful accounting information
Accounting should be free from significant ERROR or BIAS. It should be capable of being relied upon by managers to represent what it is supposed to represent.
Can we say with certainty how useful accounting reports are to users?
Although there is evidence that accounting reports are perceived as being useful and are used for decision-making purposes, it is impossible to measure just how useful accounting reports are to users. As a result we cannot say with certainty whether the cost of producing those reports represents value for money. >> Accounting information will usually represent only one input (other informaiotn sources) to a particular decision and so the precise weight attached to the accounting information by the decision maker and the benefits which flow as a result cannot be accurately assessed.
Define assets
An asset is a resource with economic value that an individual, corporation or country owns or controls with the expectation that it will provide future benefit. Assets are reported on a company's balance sheet, and they are bought or created to increase the value of a firm or benefit the firm's operations.
Define audit
An official inspection of an organization's accounts, typically by an independent body.
How is an investment of 5,000 in long-term equipment used over the next 5 years reported in the income/profit statement?
As the equipment is to be used over five years the total cost of £5,000 is matched to the periods benefiting from its use, that is, five periods. >> In the case that striaght line depreciation is used. Thus in the specific financial year (1,000) is reported. >> MATCHING PRINCIPLE.
For trading businesses, in which section of the income statement, are investments in inventory/stock reported?
As this is a trading business, buying and reselling goods rather than selling services, the income statement shows a section at the top which details the cost of goods sold MATCHED against the sales achieved for those goods. This section is sometimes referred to as the TRADING SECTION of the income statement. The difference is referred to as gross profit and the business will wish to make enough gross profit to cover the other expenses for the year.
Situation: A trader intends to buy and sell calculators designed for use by those studying accounting. He buys across the year calculators from suppliers, on credit terms, receiving bills totalling £20,000, but by the end of the year 5,000 remains unpaid. Of the calculators the business had purchased for resale, on 75% ( £15,000 of the £20,000 cost) had been sold, with the balance still in the storeroom waiting to be sold in a future period. How is this reported in financial statements?
Cash Statement = (15,000) >> The tangible cash that has been moved in financial time period considerd. Income/profit statement = 15,000 The matching principle: expense cost of the calculators of £15,000 (75% of the total purchased for £20,000) is matched against the sales for this period.
Why do cashflow and income/profit statements often differ?
Cash statement recordes the real tangible cash that has been transacted. Income/profit statement recordes the financial value generated, and MATCHES it to the cost incurred to generate that value. ** MATCHED means that irrespective of whether or not cash has been paid or recieved the amount of the sales and assosciated expenses are recorded in the profit statemetn.
In the balanace sheet what are liabilities usually divided into?
Categorized under FUNDING (equity-owners and liablities-banks) in the balance sheet >> The liabilities may be divided into long term liabilities (payable in more than one year) and current liabilities (payable within one year).
What are the "conventions of acconting"?
Conventions are the generally accepted rules that accountants tend to follow when preparing financial statements.
Imagine the sales generated by company Y in a financial year total £150,000. All of the sales are on credit terms and by the end of the year. Because bills/invoices are lodged somewhere in a payment process system, only £135,000 of the total sales value of £150,000 has been received in cash. This creates a challenge: present sales as £150,000 or as £135,000 on the financial statement?
In fact, both are recorded and presented. On the cash flow statement the £135,000 is recorded. The income statement (also known as the profit statement or profit and loss account) records the financial value of the sales in the period, £150,000
Why has accounting gotten major attention in the recent years?
In recent years, accounting has become front-page news and has been a major talking point among those connected with the world of business. Unfortunately, the attention that accounting has attracted has been for all the wrong reasons >> Fraud in accounting statements/accounting scandals.
Discuss the cost/benefit ratio of useful accounting information. Draw an assosciated graph.
In theory, a particular item of accounting information should only be produced if the costs of providing it are less than the benefits, or value, to be derived from its use. HOWEVER, this means that something useful may still be excluded from an accounting report. The benefits/value of accounting information to decision maker eventually declines (additional info becomes less relevant, processing info become difficult), but the COST continue to increase. ** The optimal level of information provision is where the gap between the value of the information and the cost of providing it is at its greatest.
How do you calculate profit/income for the income statement?
Income less expenses = Profit Expenses are costs which happen as a result of you doing business operations on a day to day basis! e.g. rent, electricity, administration, wages & salaries etc. In calculating profit we count the financial value of sales revenues and expenses of the financial period irrespective of the cash flow status (which is counted in the cash statement.)
Which company ownership does this company concern?
Limited liability company
Define long-term assets How are long-term assets recorded in financial statements? Explain using the example: Imagine our business purchases a piece of equipment for £50,000, and it will be used for five years.
Long-term assets are: Assets that are NOT intended to be turned into cash or be consumed within ONE YEAR of the balance sheet date. E.g. Long-term assets include long-term investments, property, plant, equipment, intangible assets, etc. The cash statement will show a decrease of £50,000. The income statement will, however, NOT show a charge of £50,000. If year 1's income statement were charged with all of the £50,000 it would be somewhat unfair on the measurement of year 1's profit. (years 2, 3, 4 and 5 also benefit from the investment). Instead the 50,000 payment can be spread over the 5 years (e.g. 10,000 per year). This is called STRAIGHT LINE DEPRECIATION.
How has management accounting change in reponse to the increase competition and globilisation?
Management accounting has changed by becoming more OUTWARD LOOKING in its focus. COMPETITIORS: - In the past, information provided to managers has been largely restricted to that collected within the business. TODAY, information about the costs and profits of rival business, which can be used as "benchmarks" is gathered and reported. CUSTOMERS: The attitude and behaviour of customers and rival businesses have now become the object of much information gathering. Increasingly, successful businesses are those that are able to secure and maintain competitive advantage over their rivals. >> To obtain this advantage, businesses have become more 'customer driven' (that is, concerned with satisfying customer needs). This has led to management accounting information that provides details of customers and the market, such as customer evaluation of services provided and market share ALSO CHANGES IN COSTS: To compete successfully, businesses must also find ways of managing costs. The cost base of modern businesses is under continual review and this, in turn, has led to the development of more sophisticated methods of measuring and controlling costs.
What does accounting for non-profit orginisations entail?
NGOs differ from the standard business, in that they do NOT fulfill the assumption of maximizing profits of owners. However, NGOS also need to produce accounting information for decisionmaking purposes. >> Various user groups need accounting information about these types of organisation to help them to make decisions. These groups are often the same as, or similar to, those identified for private-sector businesses. >> They may have a stake in the future viability of the organisation and may use accounting information to check that the wealth of the organisation is being properly controlled and used in a way that is consistent with its objectives.
Define NET BOOK VALUE or, increasingly these days, CARRYING AMOUNT.
Net book value is the value at which a company carries an asset on its BALANCE SHEET. It is equal to the cost of the asset minus accumulated depreciation. >> For the case of long-term assets that are paid of over more than 1 year.
Is the 4 qualities of useful accountant information, sufficient to make it useful?
No. It also needs to be material AND Benefits higher than costs of production.
Discuss accounting as a service
One way of viewing accounting is as a form of service. Accountants provide economic information to their 'clients', who are the various users identified.
Define operating cost/expenses
Operating costs are expenses associated with the maintenance and administration of a business on a day-to-day basis. >>> An operating expense is an expense a business incurs through its normal business operations. ** Operating expenses include rent, equipment, inventory costs, marketing, payroll, insurance and funds allocated toward research and development
What is the fourth step of the business cycle?
Operating profit Accounting = Earnings before interest and tax EBIT. >> The profit generated when day to operating costs are deducted from sales is usually referred to as the operating profit. Thereafter, the business will take account of any INTERST it has PAID or interest it has RECIEVED, producing the net profit.
What other sources of information might, say, an investment analayst use in an attempt to gain an impression of the financial position and performance of a business? What kind of information might be gleaned from these sources?
Other sources of information available include: ● meetings with managers of the business; ● public announcements made by the business; ● newspaper and magazine articles; ● websites, including the website of the business; ● radio and TV reports; ● information-gathering agencies (for example, agencies that assess businesses' creditworthiness or credit ratings); ● industry reports; ● economy-wide reports. However, the various sources of information identified are not really substitutes for accounting reports. Rather, they are best used in conjunction with the reports in order to obtain a clearer picture of the financial health of a business.
What is the mission of sainsbury?
Our objective is to serve customers well and thereby provide shareholders with good, sustainable financial returns. >> maximising wealth for owners.
Why will the owner´s interest usually prevail over other objectives?
Owners interest = maximize wealth. Within a market economy there are strong competitive forces at work that ensure that failure to enhance owners' wealth will not be tolerated for long. Competition for the funds provided by the owners and competition for managers' jobs will normally mean that the owners' interests will prevail.
Is it more helpful to read and compare the 3 income statements of different companies or compare ratios?
Reading the three statements will provide information about the performance and position of a business. It is possible, however, to gain even more helpful insights about the business by analysing the statements using financial ratios and other techniques. Combining two figures in the financial statements in a ratio and comparing this with a similar ratio for, say, another business, can often tell us much more than just reading the figures themselves.
Define reserves
Reserves are portions of a business's profits set aside to strengthen the business's financial position. Reserves are sometimes set up to purchase fixed assets, pay an expected legal settlement, pay bonuses, pay off debt, pay for repairs and maintenance, and so forth. They are the PAT - Dividends. >> Reserves go BACK INTO BUSINESS CYCLE AS FUNDING.
Imagine firm Y has an operating expense of 5,000 each moth (e.g. rent), paid for with one months delay (each month you pay for the previous month). What is recorded in the profit/income statement and what is recorded in the cash statement? What happens to the 5,000 not paid in the financial period/year considered?
The 'missing' £5,000 for the bills not paid appears on the year end BALANCE SHEET as a source of FUNDING. It is a source of funding on the basis that if a supplier provides a business with goods/services and does not receive payment immediately, for the length of time it takes to pay the bill, the business 'holds on' to the money and retains it for a while and is able to use it for other purposes.
Define the cash flow statement
The CASH FLOW STATEMENT summarises ALL cash ins/out in a period. The real tangible transcations THAT HAVE OCCURED IN THE FINANCIAL PERIOD CONSIDERED.
Imagine firm Y has an operating expense of 5,000 each moth (e.g. rent), paid for with one months delay (each month you pay for the previous month). What is recorded on the income/profit statement and what is recorded on the cash statement?
The FINANCIAL VALUE of these particular operating expenses is £60,000 for the year (12 months £5,000) but the TOTAL CASH paid is £55,000. The system records the expenses as £60,000 on the income statement but only £55,000 on the cash statement.
Define the income statement
The INCOME STATEMENT summarises the period's VALUE (irrespective of cash flow timing) of operational transactions. >>>SHOWS THE AMOUNT OF SALES AND ASSOSCIATED EXPENSES ARE RECORDED. * Matching principle governs the statment/applies
When the accuralis concept is used for the profit statment and only movement of cash is shown on the cash statement, what happens to the unpaid bills?
The UNPAID Bill of £2,000 is shown on the balance sheet at the end of the financial period as a short term or long-term liability.
How does accounting relate to the business cycle?
The accountants attach numbers to the boxes and the boxes are grouped together, those groups becoming financial statements
What are the main categories of the balance sheet?
The balance sheet is the 'photograph' of the financial position of the business at the end of the year. It lists the ASSETS and the LIABILITIES. The assets and liabilites are usually divided into: 1. LONG-TERM ASSETS, likely to be used for more than one year (such as equipment and vehicles and buildings), 2. SHORT LIVED ASSETS such as cash, unsold stocks (sometimes called inventories), 3. DEBT OWED by customers (known as TRADE DEBTORE or trade RECIEVABLES). 4. FUNDING (equity-owners and liablities-banks = creditor) >> The liabilities may be divided into long term liabilities (payable in more than one year) and current liabilities (payable within one year).
How do the basic accounting principles for different business structures differ?
The basic accounting principles, are the same for all three types of business: There are no differences in the way that these three forms of business keep their day-to-day accounting records. However, in preparing their periodic financial statements, there are certain differences that need to be considered. These differences are NOT ones of PRINCIPLE, however, but of DEATAIL.
What are the obligations imposed on limited liability companies?
The benefit of limited liability, however, imposes certain obligations on such companies. 1.) To start up a limited company, documents of incorporation must be prepared that set out, among other things, the objectives of the business. 2.) Furthermore, a framework of regulations exists that places obligations on limited companies concerning the way in which they conduct their affairs. >> Part of this regulatory framework requires ANNUAL FINANCIAL REPORTS to be made available to owners and lenders and usually an ANNUAL GENERAL MEETING of the owners has to be held to approve the reports. >> In addition, a copy of the annual financial reports must be lodged with the Registrar of Companies for public inspection. In this way, the financial affairs of a limited company enter the PUBLIC DOMAIN. 3. Audits: With the exception of small companies, there is also a requirement for the annual financial reports to be subject to an audit. This involves an independent firm of accountants examining the annual reports and underlying records to see whether the reports provide a true and fair view of the financial health of the company and whether they comply with the relevant accounting rules established by law and by accounting rule makers.
Where does the finance of the different company structures come from?
The finance comes from the owners (shareholders) both in the form of a DIRECT CASH investment to buy shares (in the ownership of the business) and through the owners allowing past profits, which belong to them, to be REINVESTED in the business. Finance will also come from lenders (banks, for example), who earn interest on their loans and from suppliers of goods and services being prepared to supply on credit, with payment occurring a month or so after the date of supply, usually on an interest-free basis.
What is the relationship between risk and return?
The higher the risk, the higher the POTENTIAL return.
Define THE ACCRUALS CONCEPT
The inclusion of the UNPAID FINANCIAL VALUE in the calculation of profit is known as the accuruals concept. ***The accrual concept in accounting means that EXPENSES and REVENUES are recorded in the PERIOD THEY OCCUR, whether or not cash is involved. >>> The benefit of the accrual approach is that financial statements REFLECT ALL EXPENSES ASSOSCIATED WITH THE REPORTED REVENUES FOR AN ACCOUNTING PERIOD. r
What is the profit/income statement? What does it show?
The income statement (also known as the profit statement or profit and loss account) is prepared NOT on a CASH basis but on the basis of FINANCIAL VALUES of what has TAKEN PLACE IN THE FINANCIAL YEAR, irrespective of whether or not the cash flow takes place at the same time. It shows the VALUE OF TOTAL SALES and MATCHES against the FINANCIAL VALUE of EXPENSES INCURRED (whether paid or not) in generating those sales. >> This is referred to by accountants as the MATCHING PRINCIPLE.
Discuss relevance as a key characteristic of useful accounting information
The information may be relevant to the PREDICTION OF FUTURE events (for example, in predicting how much profit is likely to be earned next year) OR Relevant in helping to CONFIRM PAST EVENTS (for example, in establishing how much profit was earned last year). >>> The role of accounting in confirming past events is important because users often wish to check the accuracy of earlier predictions that they have made. The accuracy (or inaccuracy) of earlier predictions may help users to judge the accuracy of current predictions. To influence a decision, the information must, of course, be available when the decision is being made. Thus, relevant information must be TIMELY.
What are the main advantages and disadvantages that should be considered when deciding between a partnership business and a limited liability company?
The main advantages of a partnership over a limited company are: ● the ease of setting up the business; ● the degree of flexibility concerning the way in which the business is conducted; ● the degree of flexibility concerning restructuring and dissolution of the business; ● freedom from administrative burdens imposed by law (for example, the annual general meeting and the need for an independent audit). The main disadvantage of a partnership compared with a limited company is the fact that it is not possible to limit the LIABILITY of all of the partners.
What are the main advantages and disadvantages that should be considered when deciding between a sole proprietorship and a partnership?
The main advantages of a partnership over a sole-proprietor business are: ● sharing the burden of ownership; ● the opportunity to specialise rather than cover the whole range of services (for example, in a solicitors' practice each partner may specialise in a different aspect of the law); ● the ability to raise capital where this is beyond the capacity of a single individual. The main disadvantages of a partnership compared with a sole proprietorship are: ● the risks of sharing ownership of a business with unsuitable individuals; ● the limits placed on individual decision making that a partnership will impose.
Define matching principles
The matching principle is one of the basic underlying guidelines in accounting. The matching principle directs a company to report an expense on its income statement in the same period as the related revenues. ** MATCHED means that irrespective of whether or not cash has been paid or recieved the amount of the sales and assosciated expenses are recorded in the profit statemetn. >> Accounting principles are used to make financial reporting more TRANSPARENT, UNDERSTANDABLE, COMPARABLE (characteristics of a useful reporting).
What is the problem with relevant AND reliable information?
The problem that we often face in accounting is that information that is highly relevant may not be very reliable. Similarly, that which is reliable may not be very relevant. When seeking to strike the right balance between relevance and reliability, the needs of users should be the overriding consideration.
Draw the diagram showing
The steps between the opening financial position and the closing financial position. Opening financial position = starting/opening balance sheet. How it looks like on day 1. Closing financial position = How it looks like on day x (365)
How does accounting relate to the business cycle?
The task of the accounting process is to account for the FINANCIAL FLOWS - the flow of finance - which ACCOMPANY THE STAGES in the business cycle. In particular, the accounting is concerned with comparing the balance sheet at the start of the financial period at the start of a financial period (perhaps a particular year) with the balance sheet at the end of the financial period).
What are the 3 principal statements of financial accounting?
The three principal financial statements: 1. The statement of financial position (sometimes known as the balance sheet); 2. The income statement (also called the profit and loss account); and 3. The statement of cash flows.
Provide evidence of the importance of accounting information.
There are arguments and convincing evidence that accounting information is at least perceived as being useful to users: 1. Numerous research SURVEYS have asked users to rank the importance of accounting information, in relation to other sources of information, for decision-making purposes. >> Generally, these studies have found that users rank accounting information very highly. 2. There is also considerable evidence that BUSINESS CHOOSE TO PRODUCE ACCOUNTING information that exceeds the minimum requirements imposed by accounting regulations. >> (For example, businesses often produce a considerable amount of accounting information for managers, which is not required by any regulations.) - Presumably, the cost of producing this additional accounting information is justified on the grounds that users find it useful. 3. SHARES: It is normally very difficult to assess the impact of accounting on decision making. - One situation arises, however, where the impact of accounting information can be observed and measured. This is where the shares (portions of ownership of a business) are traded on a stock exchange. >> The evidence reveals that, when a business makes an announcement concerning its accounting profits, the prices at which shares are traded and the volume of shares traded often change significantly. >> This suggests that investors are changing their views about the future prospects of the business as a result of this new information becoming available to them and that this, in turn, leads them to make a decision either to buy or to sell shares in the business.
Who are the users of accounting informaiton?
There are likely to be various groups of people (known as 'USER GROUPS') with an interest in a particular organisation, in the sense of needing to make DECISIONS about it. For the typical PRIVATE-SECTORE business, the more important of these groups are shown in the picture. >> The majority of these groups are OUTSIDE the business, but nevertheless have a stake in it. Not an EXHAUSTIVE list, but the use groups identified are normally the most important.
SUMMARISE the 3 types of business ownership
There are three main forms of business unit: ● Sole proprietorship - easy to set up and flexible to operate but the owner has unlimited liability. ● Partnership - easy to set up and spreads the burdens of ownership, but partners usually have unlimited liability and there are ownership risks if the partners are unsuitable. ● Limited company - limited liability for owners but obligations imposed on the way a company conducts its affairs.
What is the trend in accounting rules across the world?
There has been increasing harmonisation of accounting rules across national frontiers. The internationalisation of businesses has created a need for accounting rules to have an international reach. It can no longer be assumed that users of accounting information relating to a particular business are based in the country in which the business operates or are familiar with the accounting rules of that country.
Discuss comparability as a key characteristic of useful accounting information
This quality will enable users to identify changes in the business over time/TRENDS (for example, the trend in sales revenue over the past five years). COMAPRE ONE PERIOD TO ANOTHER. It will also help them to evaluate the performance of the business in relation to similar businesses. > BENCHMARKING COMPARABILITY IS ACHIEVED BY: 1. Comparability is achieved by TREATING ITEMS (THE SAME) that are basically the same in the same manner for accounting purposes. 2. Comparability may also be enhanced by MAKING CLEAR THE POLICIES that have been adopted in measuring and presenting the information.
What are the implications of risk and return for setting financial objectives of a business?
This relationship between risk and return has important implications for setting financial objectives for a business. The owners will require a minimum return to induce them to invest at all, but will require an additional return to compensate for taking risks; the higher the risk, the higher the required return. >> Managers must be aware of this and must strike the appropriate balance between risk and return when setting objectives and pursuing particular courses of action. Investors calculate risk-rewards to identify where to invest.
What is the quote regarding mis/interpreting financial information?
Turnover is VANITY, profit is SANITY, cash flows is REALITY. Turnover = To get profit, you need revenue. BUT treate revenue with caution. You need to subtract cost and if you have a heavy overhead you deplete profit. Profit = Has the costs removed, so better representation.HOWEVER, there are many different kinds of profit: gross/operating profit, EBIT, net profit etc. Cash = reality. Cash flow is king. BEST representation of FINANCIAL SITUATION.
What are the different users of acounting information called? What is the difference between users? What makes accounting information useful?
User groups. Each user group looks at a business from a DIFFERENT PERSPECTIVE and has its own particular interests. >> This means that there is always the risk that the interests of one group will collide with those of another group- For accounting information to be useful, the accountant must be clear FOR WHOM the information is being prepared and FOR WHAT purpose the information will be used.
What are the reasons for the spate (higher number) of scandals?
Various reasons have been put forward to explain this spate of scandals. 1. Some may have been caused by the pressures on managers to meet unrealistic EXPECTATIONS of investors for continually rising profits, others by the GREED of unscrupulous executives whose pay is linked to financial performance. However, they may all reflect a particular economic environment: >>> Warren Buffett is one of the world's shrewdest and most successful investors. He believes that the accounting scandals mentioned above were perpetrated during the 'new economy boom' of the late 1990s when confidence was high and exaggerated predictions were being made concerning the future.
Discuss the materiality requirement of useful accounting information
We also have to consider whether the information is material, or significant >> aka significant in the eyes of users. This means that we should ask whether its omission or misrepresentation in the accounting reports would really alter the decisions that users make. If the information is not regarded as material, it should not be included within the reports as it will merely clutter them up (information overload) and, perhaps, interfere with the users' ability to interpret the financial results.
Why does the balance sheet balance?
We would expect the values of the ASSETS and LIABILITIES + EQUITY to be equal: to BALANCE. The double entry bookkeeping system of debits and credits (no need to do this just yet...don't worry!) ensures this.
What is the funding section of the balance sheet divided into?
What happens on the balance sheet is that the Funding section is usually divided into 1.) Funding from owners, referred to as EQUITY and 2.) funding from others such as suppliers and banks, referred to as LIABILITIES.
If there is no distinction between owners of a business and the business in a sole proprietyship, how are its financial statements structured?
Where unlimited liability staus exists, although there is no legal distinction between the owner(s) and the business, for accounting purposes the business is treated as an entity, and it is the activities and transactions of the business which are accounted for.
What does it mean when a business "incorporates"
it becomes a limited company, the owners have liability to pay the business' debts limited to the amount invested by them in the company.
SUMMARISE the management accounting and financial accounting and the differences between the two.
● Accounting has two main strands - management accounting and financial accounting. ● Management accounting seeks to meet the needs of the business's managers and financial accounting seeks to meet the needs of the other user groups. ● These two strands differ in terms of the types of reports produced, the level of reporting detail, the time horizon, the degree of standardisation and the range and quality of information provided.
SUMMAIRSE the changes in financial and management accounting over the past years/decades.
● Changes in the economic environment have led to changes in the nature and scope of accounting. ● Financial accounting has improved its framework of rules and there has been greater international harmonisation of accounting rules. ● Management accounting has become more outward looking and new methods for managing costs have emerged.
