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Accounting For Decision Making Notes - Lecture notes,
lectures 1 - 13
Accounting for Decision Making (James Cook University)
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Accounting For Decision Making
Accounting is the process of identifying, measuring and communicating economic information about
an entity to a variety of users for decision-making purposes.
IDENTIFYING
Transactions that
must be able to be
reliably measured
and recorded
MEASURING
Analysis, recording and
classifying
transactions.
COMMUNICATING
Via income statements,
balance sheets and
statements of cash flow
DECISION -MAKING
Used for a range of
decisions by external and
internal users.
Identifying transactions
Business transactions
- External exchange of something of value between two or more entity’s
- Affects assets, liabilities and equity
- Can be reliably measured and recorded
Relevant information
- Information that makes a difference in decision making
Accounting Role in Decision – Making
Accounting information is designed to meet the needs of both:
- Internal users (Management)
- External users (stakeholders)
External users include:
- Investors – both current and prospective
- Suppliers and banks
- Government authorities
Financial accounting vs Management accounting
Financial accounting is the preparation and presentation of financial statements to allow users
(external in particular) to make economic decisions about the entity.
Financial statements consist of:
- Statement of cash flows
- Balance sheet
- Income statement
- Statement of changes in equity
Management accounting – provides economic information for internal users that is then reflected in
financial accounting statements for external users.
Core activities include:
- Formulating plans and budgets
- Providing information to be used in monitoring and control within the entity.
Globalisation of accounting
-
Entities have become larger, more diversified and multinational, this has lead to a need for
globalised accounting standards. Australia adopted international financial reporting standards
(IFRS) from Jan 1 2005. This ensures corporation that operate in Australia and internationally
comply with internationally agreed principles, standards and codes of best practice.
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The Conceptual Framework
- There is a need for guidance
- Must be consistent and meet needs of user and preparers
Conceptual framework is intended to:
- Develop logical, constant standards
- Provide guidance where no standard exists
- Enhance understanding of users
Objective of Financial reporting – To provide financial information about an entity, to assist users in
making decisions about providing recourses to the entity.
The framework – Qualitative Characteristics of Financial Information.
- Relevance – information must have a qualitative characteristics of financial information
Fundamental characteristics:
- Relevance – information must have a quality that enables users to form future predictions of
confirm/ correct past evaluations
- Materiality – material if omission/misstatement can adversely affect users decisions
- Faithful representation – information must be complete, neutral and free from material error.
Enhancing qualitative characteristics:
- Comparability: ability to compare information over time
- Consistently: Use of the same methods to account for the same items from one period to the
next.
- Verifiability: different knowledgeable and independent observers could reach consensus that a
piece of information is an accurate representation.
- Understand ability: users can understand reports given
Definition of the elements
Asset
Key points – control, future economic benefits and past event
i.e bank, accounts receivable, inventory, vehicle
Tangable or intangible
Ranked in order of liquidity on balance sheet
Liability
Key points – present obligation, future sacrifice and past event
i.e. bank overdraft, creditors, loans, mortgage
involves and external party
Requires payment, cash, transfer of assets or performance of services to cancel the debts.
Equity
Key points – depends on definition of assets and liabilities.
i.e. capital, drawings, retained profits.
- Creditors have legal precedence in debt repayment over owners
- manipulation of accounting equation: OE = A-L
Revenue/Income
Key points – Assets go up or liabilities go down, no capital contribution.
i.e. revenue, sales, interest received, commission revenue.
Expense
Key points – Assets go down, or liabilities go up, no drawings.
i.e. wages, rent, cost of goods sold, rates, insurance, interest.
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Limitations of Accounting Information
-
Time Lag in the distribution of information to users, therefore affecting its accuracy
Historical information based on past data and is often out-dated
Subjectivity of information refers to choice involved in inclusion of items to be reported and
choice of accounting policies to adopt
Cost of providing information
Topic Two: Corporate Governance and business structure
Sole trader – definition and features
Definition – a sole trader is an individual who control and manages a business
Features:
- The business is not a separate legal entity
- The owner is fully liable for all debts
- The general registration requirements involve applying for an ABN
Sole trader advantages:
- Quick, inexpensive and easy to establish and inexpensive to wind down
- Not subject to company regulation
- Owner has total autonomy over business decisions
- Owner claims all the profits of the business and after tax gains is business is sold
Partnerships - definition and features
Definition – an association between two or more persons who carry on a business as partners and
share profits or losses according to the partnership agreement
Features:
- Enables sharing of ideas, skill and resources
- Cheap and easy to establish
- No separate taxation payable, individual partner lodger personal income tax return with the
ATO
- Some partnerships have a written agreement, other don’t
Partnership advantages
- Relatively easy and simple to set up
- Informal business structure, not bound by accounting standards
- Ability to share capital, skills, talent, workload and knowledge between 2 or more people
Partnership disadvantages
- Unlimited liability for business debts and obligations by all partners
- Limited life – if one partner dies or withdraws from the business then the partnership dissolves
- Mutual agency – each partner is seen as being an agent for the business and so is bound by any
partnership contract
- Many partnership disputes arise from profit sharing and decision making issues
Companies – definition and features
Definition – business where the owners, shareholders are separated from the management of the
business
Features:
- Independent legal entity (i.e. separate form the people who own, control and manage it)
- Shareholders have limited liability – for the purchase of there shares only
- A company has unlimited life – does not dissolve when owners die or change
Company advantages
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Limited liability for shareholders
Taxation rate (30%) lower that top personal rate
Business expansion network made easier due to legal structure
Can raise additional equity (capital) through public share offerings
Company continues operation regardless of changes in ownership
Company disadvantage
- More time consuming and costly to set up
- Taxed from the first dollar of profit
- Limited liability aspects may cause problems – banks often prefer to have directors personal
guarantees instead
- Separation of ownership and control
Corporate Governance
- Refers to the direction, control and management of an entity
- This includes the rules, procedures and structures upon which the organisation seeks to meet
its objective
- Organisation for economic co-operation and development States:
Well run companies will prosper, this will also affect the market confidence and will attract
investors and hence additional capital to finance faster growth.
Legal duties
Specifically, directors owe the following legal duties to their company:
- To act in good faith, in the best interest of the company
- To act with care and diligence
- To avoid improper use of information or position
- To avoid conflicts, between their role as a director and any other personal interest
Corporation act also identifies numerous duties, responsibilities and potential liabilities, i.e. directors
risk personal liability if they allow their company to trade while insolvent
Topic 3: Business Transactions
-
Business transactions are occurrences that affect the assets, liabilities and equity items in an
entity
A business transaction is recorded when:
It can only be reliability measured in monetary terms
Its occurs at arm’s length
Accounting Entity Concept: Every entity must keep records of its business transactions separate
from any personal transactions of the owner
Examples of business transactions: cash sales, cash purchases, payment of advertising.
Personal Transactions & Business Events
Personal transactions: are transactions of the owners, partners of shareholders that are unrelated to
the operation of the business (accounting entity concept)
Business events: are occurrences that will probably effects the entity in some way, but are not
recorded as business transaction until an exchange of goods between an entity and an
outside/external entity.
Accounting Equation
ASSETS = LIABILITY + EQUITY
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Assets = resources controlled by entity
Liability = External sources of funds (present obligation)
Equity = Internal sources of funds (from owners)
Assets need to be funded by owners and leaders
Example: JL has assets totalling $2.8 million and liabilities of $2 million then equity must be $800,000
A=L+OE
2,800,000 = $2,000,000 + OE
2,800,000 – 2,000,000 = 800,000
Concepts of Duality or double entry accounting
The accounting equation must be kept in balance after a transaction is enterd
i.e. , Assets MUST = Liability + Equity
In order to keep the equation in balance, a transaction must have two sides or have a positive &
negative effect on the one side, thereby resulting in no change to the overall value of the
equation.
A transaction has a dual effect on the equation
- Cash movement effect
- Category of transaction effect
-
Accounting Errors
-
Errors may occur when the recording process evidenced by the accounting equation not
balancing
Duality must always apply – a transaction must always have two sides
Single Entry Error – Occurs when only 1 side of a transaction is recorded
Transposition error – When two recorded digits are transposed or switched e.g. 7800 instead
of 8700.
Incorrect entry – Accounting equation is out of balance
Topic 4: Balance sheets
Nature and purpose of balance sheets
The balance sheet is a financial statement that details the entities assets, liabilities and equity
as at a particular point in time usually at the end of a reporting period
The balance sheet is a financial statement that shows:
- What the entity owns (or controls) as at a particular date: The assets
- The external claims on the entity’s assets: The liabilities (owe)
- The internal claim on the entity’s assets: The equity (owners)
-
Accounting policy choices, estimates and Judgements
There are choices in recording transaction that will involve estimates and judgements by
preparers
Examples of policy choices:
- Method of costing inventory
- Measurement of property, plant and equipment
- Method of calculating depreciation
- Development expenditure – capitalise or expense
Example of estimation
- Impairment of accounts receivable (doubtful debts)
- Employee benefits – long service leave and sick leave
-
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Accounting policy choices – discussed in the first notes to the financial statements
Definition and Recognition of assets
The essential characteristics of an asset are:
1. Future economic benefit
2. Control by the entity
3. Result of a past event
Recognition criteria
1. Probable
2. Reliable
Assets – Future Economic benefit
- Items must provide benefits to the entity that uses them in order to be regarded as assets
- Benefit can be cash or in another form of resources
Assets – control
- An entity must control the item for that item to be considered as an and recognised on the
balance sheet
- The concept of controls refers to the capacity of the entity to benefit from the asset in the
pursuit of its objectives, and to deny or regulate the access of others to the benefit
Assets – Past event
Probable
- It is more likely that the future economic benefit will flor from the asset to the business
controlling it.
Reliably measured
- The value of the asset can be reliably measured
- May involve the use of estimates
Definition and Recognition of Liabilities
1. Present obligation
2. An outflow of resources to pay for the obligation
3. Result of a past transaction or event
Recognition Criteria
1. Probable occurance
2. Reliable measurement
Liabilities – Present obligation
- A commitment to another entity to provide resources to that entity
- Can be formal (legal) or informal
- Entity may not be known
Liabilities – Outflow of resources
- Future sacrifices of economic benefit are associated with adverse financial consequences for
the entity
- Once resources flow out of business they cannot be used to generate revenue or obtain assets
in the future
Liabilities – Past event
- The obligation must have arisen as a result of a past event
- Can be obligation arising in the future if the event is currently occurring eg. Court case
- Cannot be obligation you intend to get
Liabilities – Recognition
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Probable
- It is more likely that the future economic benefits will flow from the business to another entity
Reliably measured
- The value of the liability can be measured reliably
- Involves the use of estimates
Definition and nature of equity
Essential characteristics
- Dependent on the definition of assets
- Dependent on the definition of liabilities
- Measured by accounting equation
Recognition criteria
- Probable occurrence
- Reliable measurement
Equity comprises various items, including capital contributed by owners (shareholders) and profits
retained in the entity
Current and non current assets and liabilities
-
Distinction between current and non-current classification is based on timing
Current – if the economic benefit (of assets) or outflow of resources (for liability) are expected
to be realised in the next reporting period, i.e. cash, accounts receivable, bank
Non-current – if economic benefit (of asset) or outflow of resources (liability) are expected
beyond next the reporting period i.e. long term loan, mortgage, debentures
Presentation and disclosure of assets
Assets are classified according to their nature or function
Classification can reflect
- Liquidity
- Marketability
- Physical characteristics
- Purpose
Presentation and disclosure of Liability
Liability are classified according to their nature
Classification may be based on:
- Liquidity
- Source
- Expected timing of future sacrifice
- Condition attached to the liability
Presentation and disclosure of equity
-
Depending on the entity structure, the terminology and equity classification appearing on the
balance sheet will vary between entities
Sole traders and partners will have profit/loss and drawings contributing directly to equity
Companies will have direct retained earnings and reserves
Potential Limitation of the Balance Sheet
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1. Shows asset, liability and equity values at a particular point in time and may not be
representative of other points in time.
2. The entities value is not reflected due to:
- Items that generate future sacrifices not satisfying definition and/or recognition criteria
- The historical nature (or combination of cost and fair values) of the balance sheet
3. Preparing the balance sheet involves
- Management choices
- Estimates
- Judgement
Topic 5: Income Statement
Purpose and Importance of measuring financial performance
- The income statement reflects the accounting return for an entity over a specified time period
NET PROFIT (LOSS) = REVENUE – EXPENSE
- But not all value changes result in income or expenses that are recognised in the income
statement
- Entity’s often articulate their governance, environmental and social policies and report on their
environmental and social performance in addition to their financial performance. This is
known as the triple bottom line.
Models of Accounting – Cash vs Accrual
-
Accounting standards require financial statements to be prepared on the basis of accrual
accounting
Accrual Accounting: is a system in which transaction and events are recorded in the periods
they occur, rather then in the periods the entity receives or pays the cash.
A cash accounting system would determine profit or loss as the difference between the cash
received in relation to income items and the cash paid for expenses.
Accrual Accounting
Under accrual accounting, the following may occur:
- Income is recognised without receipt of cash
- Cash is received, but income is not recognised because the goods or service has not been
provided
- Expense has been incurred without payment of cash
- Item is paid but not recognised as an expense i.e not used or consumed.
Depreciation
-
Depreciation (amortisation) is the systematic allocation of the cost of a tangible (intangible)
asset over its variable
It does not represent the loss in the assets value during the reporting period.
It does not involve cash flows
Accumulated depreciation represents the total depreciation that has been charged to the
income statement in relation to an asset.
cost of asset −expected residual value
To calculate depreciation ¿
assets expected useful life
Reducing balance method
n r
Depreciation rate: 1−
r
√
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Where:
n = estimated useful life (in years)
r = estimated residual value (in dollars)
c = original cost of asset (in dollars)
Units of production
- Charge deprecation on the basis of activity.
cost of asset−expected residual value
Annual depreciation expense=
assets expected life based on output
Prescribed format for reporting entities
-
The following must be represented on the income statement
Revenue
Finance costs
Shared profit of loss of associates and joint ventures if equity accounted
Tax expenses
Profit or loss
Topic 6: Statement of Cash FLows
Introduction to the statement of cash flows
-
Reports information regarding cash inflows and cash outflows of a particular period of time
Prepared on cash basis, not an accrual basis
The statement of cash flows helps ascertain the cash generation from the operating cycle and
whether or not the entity is collecting its receipts in a timely manner.
Cash Operating Cycle
-
The number of time an entity can cycle through this process generally the profit it can make (as
long as prices are set appropriate)
There is normally an outflow of inventory and wages before a sale is made
Cash flow statements helps to determine if cash is collected in a timely manner
Why we have a statement of cash flows in an accrual reporting system
To provide information about:
- Cash receipts
- Cash payments
- Net change in cash resulting from operating, investing and financing activities
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To ensure that an entity has enough cash on hand to meet its financial commitments in a timely
fashion
Relationship of Statement of Cash Flows to the Financial Statements
The financial statements comprise:
1. The income statement
2. The balance sheet
3. The statement of changes in equity
4. The statement of cash flows
- First three statements only show part of the activities of the business.
Cash flow Statements gives additional information to assist decision makers in assessing an
entity’s ability:
- Generate cash flows
- Meet financial commitments as they fall due
- Fund changes in scope and/or nature of activities
- Obtain external finance
Classified into three main sections reflecting the major cash flow activities
- Operating activities
- Investing activities
- Financing activities
Statement of Cash Flows
Operating activities
- Activities relating to provision of goods and services and other activities that are neither
investing or financing activities
- Activities reported in the income statement are adjusted form accrual to cash basis
Cash from operating activities shows ability to:
- Generate cash
- Meet short term obligations
- Continue as a going concern
- Expand
Investing activities
Consist of those activities that relate to the acquisition and/or disposal of:
- Non-current assets (including property, plant and equipment, and other productive assets)
- Investments (such as securities) not falling within the definition of cash
These items allow users to analyse future directions of the entity by studying major asset acquisition
and disposals.
Financial activities
Consist of:
- Activities that change the size and/or composition of the financial structure of the entity
(including equity),
- Borrowings not falling within definition of cash
Usually associated with changes in non- current liabilities and equity
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Topic 7: Analysis and Interpretation of Financial Statements
Users and decision-making
The users of financial reports can be categorized as:
- Resource providers e.g. creditors, lenders, shareholders, employees.
- Recipient of goods and services i.e. customers and debtors
- Parties performing an overview of regulatory function e.g. tax, office, corporate regulator, and
statistics bureaus.
- Internal management to assist in their decision making duties
Nature and Purpose of financial statement analysis
Financial analysis involves expressing the reported number in relative terms rather than
relying n the absolute numbers
- This can highlight the strengths and weaknesses of firms
- By evaluating an entities financial past users are in a better position to form an opinion as to
the entity’s future financial wealth
It is essential in financial analysis to compare figures with:
- The equivalent figures from previous years (rather than one years absolute terms)
- Other figure in financial statements
-
Analytical Methods
Horizontal Analysis
- Compares reported numbers in different reporting periods to highlight magnitude and
significance of changes
Dollar change is calculated by :
Accounting number in current period – Accounting number in the previous period
Trend analysis
- Tries to predict the future direction of various items on the basis of the direction of the past.
- To calculate a trend, it is necessary to have at least 3 years of data
Vertical Analysis
Involves comparing the items in a financial statement to an anchor items in the same financial
statement
- Revenue and expense items are expressed as a percentage change of sales or revenue.
- A, L and Equity item expressed as a percentage of the total assets.
When expressed this way, the financial statement are often referred to as common size statements.
Topic 8: Analysis & Interpretation of Financial Statements
Part 2 – Analysis, calculation, relationships & limitations
Ratio Analysis
Is an expression of one item in the financial statements as another item in the financial
statements – one item is divided by another by another to create the ration
- The ratio comparison can be between two different statements
Ration analysis is a 3-step process
1. Calculate a meaningful ratio by expression $ amount of an item by $ amount of another
2. Compare the ratio with a benchmark
3. Interpret the ration and seek and explain why it is different from previous years, comparative
entities or industry averages
-
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Ration Analysis Aspects
- Ratios in various categories help user in their decision making
Profitability Ratio – Inform user as to the profit associated with their equity investment
Efficiency Ratio – Measures the effectiveness in managing the assets of the entity
Liquidity Ratio – Indicate the entity’s ability to meet its short-term commitments
Capital Structure Ratio – Indicate the long-term stability to a financing decision, how assets are
financed.
Marketing Performance ratio (relevant to companies listed on the ASX) – relate to the entities
financial numbers to the entity’ share price.
Profitability Analysis
Return on Equity (ROE)
- Captures profitability, efficiency and capital structure
- Upward trend is advantageous for an entity
- But a sustained high ROE attracts new competitors to industry and eventually erodes excess
ROE
Profit available
¿
Return on Euity=¿ owners
×100=x 1
Average owner equity
Return on Assets (ROA)
Reflects the results of entities ability
- To convert sales revenue to profit
- To generate income form its assets investments
Return on Assets=
Earningsbefore interest∧tax (EBIT )
×100=x 1
Average assets
Profit Margin Ratio
- Ratio that relate profit sale revenue generated by the entity include the gross profit margin and
net profit margin
Gross Profit margin=
Profit margin=
Gross profit
× 100=x 1
sales revenue
Net Profit
×100=x 1
Sales revenue
cash flow
¿
Cash Flow ¿ sales ratio=¿∨
×100=x 1
sales revenue
Dividend payout ratio
- Measures the percentage of profit distributed in the form of dividends
Dividend Payout ratio=
dividends
×100=x 1
Profit
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Asset Efficiency Analysis
Asset turnover ratio
- Shows on entity’s overall efficiency in generating income per dollar of investments in assets
- Value will depend on the efficiency with which it manages its current and non-current
investments
Asset turnover ratio=
sales revenue
=x׿
average total assets
Days inventory ratios
- Days inventory ratio indicates the average period of time it take to sell inventory
Daysinventory =
average inventory
× 365=x days
cost of sales
Day’s debtor’s ratio
- Days debtors ratio indicates average period of time it takes to collect the money from its trade
related to accounts receivable
Days debtors=
Average accounts receivable
× 365=x days
sales revenue
¿ inventory turnover =
¿ debtors turnover=
cost of sales
=x׿
Average inventory
sales revenue
=x׿
average accounts receivable
Day’s inventory and day’s debtor’s turnover can be considered together to reflect the entities activity
cycle (also referred to as the operating cycle).
Liquidity Analysis
-
The survival of the entity depends on its ability to pay debts when they fall due (its liquidity)
An entity must have sufficient working capital to satisfy its short term requirements and
obligations
But excess working capital is undesirable because the funds could be invested in other assets
that would generate higher returns
Current ratio
- Current ratio (or working capital ratio) indicates $ of current assets per $ of current liabilities
Current Ratio=
Current assets
=x׿
current liabilites
Quick ratio
- Quick asset (or acid test ratio) measures amount of current assets available (excluding
inventory) to service each $ of current liability
Quick Raio=
Current Assets−inventory
=x׿
Current Liability
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Cash Flow Ratio
- Indicates an entity’s ability to cover current obligations from operating activity cash flows
- The higher the better to met cash flows
Net cash flow
¿
Cash flow ratio=¿∨
=x׿
Current liabilities
Capital Structure Analysis (Gearing)
-
An entity’s capital structure is the proportion of debt financing relative to equity financing, and
reflects the entity’s financing decision
Investments in assets are funded externally by liability, or internally by owners as shown in
accounting equation
Debt ¿ euity ratio=
Debt ratio=
total liabilities
×100=x 1
total equity
total liability
×100=x 1
total assets
Equity ratio=
total equity
×100=x 1
total assets
Interest Servicing ratio
- The financial risk of the entity can also be assessed through the interest coverage (also referred
to as times interest earned)
Interest coverageration=
EBIT
=x׿
Net financial costs
Debts coverage ratio
- Debts needs to be serviced from cash flow, so it is useful to relate the entity’s cash generating
capacity to its long term debts
Net cash flows by ∨¿=x׿
NC liabilities
Debt coverageratio=
¿
Market Performance Analysis
-
Provides an indication of the book value of the entity’s tangible assets (as reported in the
balance sheet) per ordinary share per issuer
Net tangible asset backing per share=
Shareholders equity−¿ tangible assets
=x cents/ share
No .ordinary shares on issue at year end
Net cash flows
¿
Earnings per share=¿∨−Preference dividends
= x cents per /share
Weighted no . of ordinary share on issues
dividend paid
¿
dividend per share=¿ shareholders∈current period
=x׿
Weighted no . of ordinary share on issues
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Price earnings ration (PER)
- A market value indicator that reflects the number of years of earnings that investors are
prepared to pay to acquire a share at its current market price.
Price earning s ratio=
Current market price
=x׿
Earnings per ratio
Limitations of ratio analysis
- Ratio Analysis is only one financial analysis tool
- Comprehensive and effective financial analysis considers information beyond financial
reported numbers
- Non-financial consideration, such as environmental performance, are also taken into
consideration by users when assessing an entity’s performance
Topic 9: Asset investment & financing Decisions
Risk and Decision Making
Risk: in finance is defined as measurable variation in outcomes
Uncertainty: on the hand is the unmeasurable variation of outcomes
The process of Decision Making
1.
2.
3.
4.
5.
6.
Identify all current available investment alternatives
Select a decision – support tool and set the decision rule
Collect the data necessary to make the decision
Analyse the data
Interpret the results in relation to the decision rule
Make the decision
Investment decision tools
-
Accounting rate of return
Payback period
Net present value
Internal rate of return
Practice Issues Making Investment Decision
1.
2.
3.
-
Collecting data
Cost and revenue may not be easy to determine
Taxation Effects
Company tax rate is 30%
Finance
Same investments look good on paper but may have trouble attracting finance from banks or
venture capitalist
4. Human resources
- Will there be employees or consultants available with required skills
5. Goodwill and future opportunity
6. Social responsibility and care of the natural environment
Note: Net working capital: current assets minus current liabilities
Managing Net Working Capital
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Effective Management of net working capital involves
1. Maintaining liquidity
2. The need to earn the required rate of return
3. The cost and risk of short term funding (current liabilities)
Permanent assets: must be financed with permanent and spontaneous source of funding
Temporary assets: must be financed with temporary source of funding
Managing Cash
-
Entities manage cash in relation to the following issues:
The need to have sufficient cash to meet financial obligations
The timing of cash flows
The cost of cash
The cost of not having enough cash
Topic 10: Budgeting
Strategic planning: concerns long term planning (typically 3-5 years)
Budgeting is a process that focuses on the short term
Budgets operationalize strategic plans and allow operational areas to understand how their area
contributes to the entity’s strategic objectives
Budgets
Performance management involve setting targets in other than just financial terms. E.g
improving customer service and corporate governance
- A budget is the quantities expression of an entities plan
Budgeting can assist in decision-making
- Setting targets for managers
- Identifying resources constraints in budget period
- Identify periods of expected cash shortages and excess holdings
- Determine the ability of the entity to meet financial commitments
-
The budgeting process
1.
2.
3.
4.
5.
6.
7.
Consideration of past performance
Assessment of expected trading and operating conditions
Preparation of initial budget estimates
Adjustment to estimates based on communication with, and feedback from mangers
Preparation of budgeted reports and sub-budgets
Monitoring of actual performance against the budget over the budget period
Making any necessary adjustments to the budget during the budgeting period
Master Budget
-
A master budget is a set of interrelated budgets for a future period which provides a framework
for viewing relevant budgets of an entity
To enable the budget to be used s a control tool to monitor the entity’s achievement of its plans,
classification of items included in the master budget need to mirror the chart of accounts
Because budgets are based on forecast about the future, complete accuracy is impossible and
variances will occur
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Cash Budgets
Note: Budgets form part of management accounting because it is not bound by regulatory
requirements.
- A cash budget is a statement of expected future cash receipts and payments
- Best prepared on a month by month basis to enable closer monitoring of cash position
It assist in decision making by:
- Documenting timing of all cash receipts and payments
- Helping to identify periods of expected cash shortages and surpluses
- Identify suitable times for purchase of non-current assets
Budgets: Planning and control
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The preparation of the cash budget is an important part of the planning process
It can be used for monitoring cash performance, also known as the control process
Improving cash flow
Cash inflow may be increase by:
- Improving the collections of cash from debtors
- Seeking ways to improve sales to fees
- Reducing unnecessary stock levels
Cash outflow may be reduced by:
- Cutting expenses by identifying areas of waste, duplication or inefficiency
- Making use of creditors terms
- Keeping inventory levels to only what is required
Behavioural Aspects of Budgeting
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The behavioural aspects of budgeting relate to human involvement in decision-making
Topic 11 – Cost Volume Profit Analysis
Introduction to the concept of CVP
- CVP analysis is concerned with the change in profits in response to changes in sales volumes,
costs and prices
Help answer the following questions:
- How many units need to be sold, or services performed, to break even (earn zero profit)
- What is the impact on profit of a change in the mix between fixed and variable costs
- How many units need to be sold, or services performed to achieve a particular level of profit
Cost Behaviour
Costs behaviour enables:
- The way in which costs change, and
- The main factors that influence those changes
Costs can be classified as fixed, variable or mixed
- The nature of fixed and variable costs, relate to whether such costs are likely to alter in total
with changes in activity
Fixed, Variable and mixed costs
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Fixed costs are those costs which remain the same in total (with a given range of activity and
timeframe) irrespective of the level of activity. E.g. lease costs, depreciation charges
When we consider levels of activity in terms of units of output
- Total fixed costs – remain the same, but
- Fixed costs per unit – will decrease as the number of units produced increased
Variable costs: change in total as the level of activity changes. e.g. costs of bricks to build a house, or
aviation fuel for Qantas
Mixed costs: occur when some costs have both fixed and variable components
Break-even analysis
Break even analysis – relates to the calculation of the necessary levels of activity required in order to
break even in a given period
Break even occurs when total revenue and total costs are equal, resulting in zero profit
Break even analysis involves the contribution margin concept
- Contribution margin per unit can be calculated by deducting variable costs per unit
Contribution margin Ratio
CM per unit
total CM
×100=x 1∨
× 100=x 1
SP per unit
Total sales
Unit Break even Data
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Identify the number of products or services required to be sold to break even or reach profit
analysis
Planning products and allocating resources by focusing on those products that contribute more
to profitability
Pricing products
Operating Leverage
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Refers to the mix between fixed and variable costs
Can help understand the impact of changes in sales profit
Entities with a higher proportion of fixed costs to variables costs are classified as having a
higher operating leverage
Entities with a higher operating leverage are more risky because more sales are needed to
cover the fixed costs
Topic 12: Accounting and business sustainability
Sustainable business
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Ensuring business is continuously profitable
The ability of the entity to continue or maintain business as a going concern i.e. to be able to
continues operating into the future
The developed world is highly industrialised we produce goods using raw materials whose byproducts & consumption impact on natural resources
Sustainable development is development that meets the needs of the present without
compromising the ability of future generations to meet their own needs.
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Business Sustainability: Key drivers
Competition for resources
- Growing population – leading to increasing demands on natural resources, causing some to
become finite because they cannot be replenished quickly enough
- Depletion of resources is also impacting on ecosystems and our environment
Climate Change
- Industrialisation & fossil fuel based economy has led to global warning and climate change
- More extreme weather conditions, cycles of drought and flood which is impacting on primary
producers
- Implementing climate policy to minimise carbon emissions & create solutions to global
warming
Economic Globalisation
- Business operate national and expanding to operate at a global level
- Disparities exist between countries in relation to their enforced environment and social
standards
Connectivity and Communication
- Advances in digital communication and technology enable people to track a company’s
sustainability and disseminate their perspectives on its using social media
Business Sustainability: Principles
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The need for sustainability has led to the development of guidelines and principles to help
shape the business to help shape the business sustainability movement
Ethics
Governance
Transparency
Business relationships
Financial return
Community involvement/economic development
Value of products and services
Employment practices
Protection of the environment
Business Sustainability Theories:
Corporate social responsibility (CSR): refers to the responsibility an entity has to all stakeholders,
including society in general and the physical environment in which it operates.
Shareholder value
Corporations Act and company constitution give powers to company board of directors to act on
behalf of the owner, shareholders.
Separation of ownership and control has led to agency theory, which describes the relationship where
managers act on behalf of shareholders.
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Stakeholder theory:
Holds that the purpose of the entity is to work for the good of all stakeholder groups, not just to
maximise shareholder wealth
Stewardship theory:
Directors act in the interest of group of stakeholders and not just shareholder wealth
Contributes to the rise of independent non-executive directors servicing on companies boards.
Legitimacy theory
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Entities must operate within the bound and norms of society
Deemed the social contract represents explicit and implicit about how the organisation should
conduct its operations.
Business Sustainability: Reporting and Disclosure
One approach to sustainability reporting is the GRI reporting framework, which is comprised of:
- Sustainability Reporting Guidelines
- Technical Protocol
- Sector Supplements
Standard disclosures include:
- Strategy and profile – overview of risks and opportunities
- Management approach – management of sustainability
- Performance indicators – economic, environment and social
Triple Bottom Line Reporting
3 pillars of sustainability known as “Triple Bottom Line” people
Role of Accountants in Sustainability
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Use of skills to aggregate data to generate information for decision making for environmental &
sustainability decisions for reporting purposes
Performing costs analysis for competing investments
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Audit & assurance services used to develop internal control procedures to ensure the
collections and integrity of information gathers is safeguarded
Ethical Behaviour and Codes of Ethics
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The professional accounting bodies in Australia have a joint code of ethics that is mandatory for
all members and disciplinary action can take place for non-compliance
It communicates a minimum standard that members must fulfil
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