|Module 1| Introduction to accounting
Learning objectives:
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Familiarise yourself with canvas, your weekly earning schedule,
assessment and tutorials
Why is it necessary to understand business before trying to learn
about accounting?
What factors are causing the business environment to change?
What are three characteristics that someone might require to
become a successful businessperson in a complex business
environment?
What is a private enterprise, and what forms does it take?
What are the three most common forms of business
organisations and their basic characteristics?
What types of regulations do businesses face?
Three forms of business organisations
1. Sole proprietor or trader – owned by one person who is the sole
investor of the capital
2. Partnership – owned by two or more investors who each invest
capital into the business
3. Company or corporation – a separate legal entity independent of
its owners and run by a board of
1.1. Business, businesspeople and accounting
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People inside a business use accounting information:
o Help determine and manage costs
o Set selling prices
o Control the operations of the business
People outside the business use accounting information to help
make investments and credit decisions about the business
There are many factors which affect the complexity of the business
environment
More information generated than ever before
Globalisation has provided more opportunity to create a more
diverse and larger marketplace
Creates challenges when operating in other countries and selling
goods in other countries
Business environment rapidly changing therefore skills of
accountants and managers also need to evolve
The regulatory environment
• Laws and regulations manage the complex business environment
• These can cover:
o Consumer protection
o Environmental protection
o Employee safety
o Employment practices
o Taxes
• When a business conduct business internationally it also must
abide by laws and regulations of the other countries in which it
operates
Regulations
Pros
Cons
1.2 Types of businesses and regulations
What is private enterprise?
• Individuals own businesses that produce and sells goods and
services for a profit
• Three categories:
1) Services: performs activities/services that benefits individuals or
customers
- E.g. accounting, law and medicine
2) Merchandising: purchases goods for resale to their customers
- E.g. Woolworths, Coles, JBHiFi etc.
3) Manufacturing: makes products and sell these products to
customers
- E.g. Dell, Ford, Caltex etc.
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All businesses require capital to begin, operate and then to grow
Capital is the funds that a business uses to operate or expand its
operations
Entrepreneur is an individual willing to risk the uncertainty of
starting a business in exchange for earning a profit
Entrepreneur can raise capital by:
1) Investing their own money into the business or finding other
investors
2) Borrowing money from a bank or other lending sources
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Safety of the business in time of crisis
Safety for employed people
Safety for the quality of products
Consumer safety and consumer rights
Safety for the state, that provides and control the
market and revenue
Fair competition
Obstacles to start a business
High costs
Bureaucracy
Slow innovation
Less competition
|Module 2| Introduction to accounting
• There are 3 major financial statements
(1) Income statement
(2) Balance sheet
(3) Cash flow statement
Learning objectives:
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What information does the accounting system provide to support
management activities?
How does the accounting support external decision making?
What roles do ethics and sustainability play in the business
environment?
What skills do accountants of the 21st century require?
How can people learn to think critically?
How can the critical thinking help people make better business
decisions?
What are the logical stages in problem solving and decision
making?
1. Income statement
- Summarises the results of a business’ operating
activities for a specific time period
- Shows revenues, expenses, net income/loss
2. Balance sheet (statement of financial position)
- Shows the financial position of a business on a given
day
3. Statement of changes in owner’s equity
- Provides info about amount in owner’s equity
section
- Includes: beginning equity, net income, owner’s
contributions/withdrawals, ending equity
2.1 Accounting, accounting systems and Reporting
What is accounting and why is it used? What is an accountant?
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Accounting is the process of recording transactions relating to a
business
Accountants:
o Ensure the accuracy of financial documents & their
compliance with relevant laws and regulations
o Prepare financial reports and tax returns (ensure taxes are
paid correctly and on time)
o Evaluate financial operations to recommend best practices,
identify issues and propose solutions to assist organisations
in running efficiently
o Offer guidance on revenue enhancement & profit
maximisation
o Conduct forecasting and risk analysis assessments
The process includes identify, summarising, analysing and reporting
business transactions à information is then used to prepare
financial statements
Stakeholders use accounting information to make business
decisions and assess the ability of the business to carry out its
responsibility
• Helps managers plan, operate and evaluate
business activities
4. Cash flow statement
- Summarises cash receipts, cash payments, and net
change in cash for a specific time period
- Includes: cash flows from operating activities
- Cash flow from investing activities
- Cash flow from financial activities
GAAP – Generally Accepted Accounting Principles
• The Australian Accounting Standards Board (AASB) sets the
standards for Australian companies and govt. bodies
2.2 Ethics in business and accounting
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If financial statements do not convey a realistic picture about the
business – decisions made by internal and external users may be
disastrous
Professional organisation’s code of ethics
• In Aus. most professional bodies adopt the code of ethics for
professional accountants developed by Accounting Professional
and Ethical Standards Board (APESB)
• Code requires members to:
o Comply with fundamental principles of ethics
o Apply conceptual frameworks to identify, evaluate and
address threats to compliance with the fundamental
principles
• Applying to conceptual framework requires exercising professional
judgement and flexibility to changes
[Look at pros and cons of having a code of ethics]
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Management
accounting
Financial
accounting
• Planning establishes a business’ goals and the
means of achieving these goals
• Operating is the management process that enables
a business to conduct business plan (decisions are
made daily)
• Evaluating measures a business’ actual operations
and progress against benchmarks and provides
feedback on decisions made
• Budgeting is the process of quantifying manager’s
plans and shows impact of these plans on business’
operating activities
• Cost analysis is the process of determining and
evaluating the costs of specific products/activities
of a business
• Organised for use of people outside the business –
external users
• Follows the Generally Accepted Accounting
Principles (GAAP)
• Financial statements summarise and communicate
financial information to external users
A sustainable business ensures that all processes, products and
activities address current environmental concerns whilst still
achieving a profit
Skills that accounting requires
1. Judgement
2. Knowledge
3. Critical analysis and
problem solving
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4. Communication
5. Teamwork
6. Self-management
Critical thinking skills – process that evaluates ideas generates by
creative thinking
|Module 3| Developing a business plan – Cost Volume
Profit Analysis
Learning objectives
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Understand why business make plans
Recall the elements of a business plan and their importance to a
business
Comprehend how accounting information contributes to the
planning process
Recall and comprehend what a decision maker must be able to
predict so they can estimate profits at a given sales volume
Understand how a decision maker can predict the sales volume
necessary for estimates revenues to cover estimated costs
Understand how a decision makers predict the sales volume
necessary to achieve a target profit
Comprehend and understand why decision makers use
accounting information to evaluate alternative plans
3.2 Cost Volume Profit (CVP) Planning
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3.1 Planning a new business
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Planning is an ongoing and evolving process for a successful
business – plans should be evolving and flexible and reviews
regularly by management
There are 2 types of business plans:
(1) One-page plan – building ideas
(2) More formal plan – you need this when you need funding
The content includes:
o Who the target market is
o Why they need your product or service
o How you’ll reach them
o Who you’re competing with
o How much you expect to make
Business plan
An evolving report describing a business’ goals and current plans for
achieving those goals, including;
(1) Description of the business
o Type of company & product
o How company is organised
o Potential customers
o Objectives (location/where it conducts business, important
people in the business)
(2) Marketing plan
o How the business will make sales
o How the business will influence and respond to market
conditions
o Evidence of the demand for the business’ products or
services
o Any market research that has been conducted
(3) Operating plan
o Relationships between the business and its suppliers
o Relationships between the business and its customers
o How the business will develop, service, protect and support
its products or services
(4) Environmental management plan
o Environmental impact of the business
o Social impact of the business
o Environmental indicators cover performance related to
inputs and outputs
(5) Financial plan
o Capital requirement
o Sources of capital
o Projected financial performance
o Main purposes of business plan:
§ To organise the business and its operations
§ Served as a benchmark/standard to measure actual
performance
§ Assist in obtaining funding
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Management accounting’s main purpose is to assist internal users
in making informed business decision
Management accountants can:
o Take leadership roles in design implementation strategies,
policies, plans and structures
o Enablers of values by informing & guiding managerial
operation decision making
o Implementation of strategy for sustainable value creation
o Planning/monitor and improve supporting practices
o Ensure protection of value-creation strategies against
strategic, operation and financial
o Ensure compliance with regulations
CVP provides a more detailed way a manager can assess and
predict the course of business for the company
CVP makes several assumptions to be relevant to it is only an
approximate calculation
o It is aimed at determining the output that adds value to a
business
o It analyses and calculates benchmarks which can be used in
decision making
e.g. fixed-costs, break-even points and target profits that
determines sales volume and revenue estimates
Making price decisions and price structures is simpler when using
CVP
CVP analysis shows how profit will be affected by alternative sale
volumes, selling price and costs
It helps managers in estimating profit at given unit sales volumes,
finding break-even point and finding unit sales volumes (activity
level) to achieve targeted profit
Sometimes called “break-even analysis”
CVP analysis uses revenues and costs to calculate profit
Fixed costs
Variable costs
Total costs
Profit
calculation
• Constant in total for a specific time period
• Not affected by difference in volume during that
same period
• Depicted by the horizontal straight line on a graph
• Constant per unit of volume
• Change in a time period in direct proportion to a
change in volume
• Depicted by a sloping line on a graph
• The sum of the fixed cost and the total cost at any
given volume
TC = 𝑓 + vX
§ 𝑓 = fixed costs
§ v = variable costs per unit sold
§ X = sales volume
Net income (profit) = Revenues – Expenses
• Useful in estimating net income based on projected
revenues and income
• Internal users can decide how much should be sold
for desired/targeted profit
Profit = (selling price per unit)(unit sales volume) – (variable
costs per unit)(unit sales volume) – total fixed costs
Contribution
margin
• The measures indicate how a particular product
contributes to overall profit of the company
Contribution margin = revenue – variable costs
Contribution margin per unit = selling price per unit – variable
cost per unit
Break-even
point
• If contribution margins > fixed total costs, there is
profit
• If contribution margin < fixed total costs, there is
loss
• Sales less variable costs equal contribution margin
• Total cost = Total Revenue
𝐵𝑟𝑒𝑎𝑘 𝑒𝑣𝑒𝑛 𝑝𝑜𝑖𝑛𝑡 =
Unit sales
volume
𝐹𝑖𝑥𝑒𝑑 𝑐𝑜𝑠𝑡𝑠
𝑆𝑎𝑙𝑒𝑠 𝑝𝑟𝑖𝑐𝑒 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡 − 𝑣𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝑐𝑜𝑠𝑡𝑠 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡
𝑈𝑛𝑖𝑡 𝑠𝑎𝑙𝑒𝑠 𝑣𝑜𝑙𝑢𝑚𝑒 =
𝑇𝑜𝑡𝑎𝑙 𝑓𝑖𝑥𝑒𝑑 𝑐𝑜𝑠𝑡𝑠
𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 𝑚𝑎𝑟𝑔𝑖𝑛 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡
|Module 4| Developing a business plan – Budgeting
Showing CVP relationships
Learning objectives:
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Why should we budget?
Understanding the operating cycles of a business
The budget as a framework for planning
How to use the master budget to evaluate business performance
4.1 Why budget? Steps in budgeting
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3.3 Understanding CVP terms and calculations
Break-even point
• Is the unit sales volume at which a business earns zero profit
• Business wants to be ABOVE their break-even point
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It helps managers with planning decisions e.g. setting budgets,
determining effects of changes in fixed and variable costs &
deciding on pricing strategy
[Look at video of worked example]
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A budget:
(1) Shows management’s operating plans for the coming periods
(2) Formalises management’s plan in quantitative terms
(3) Forces all levels of management to think ahead, anticipate
results and take actions to remedy possible poor results
(4) May motivate individuals to strive to achieve stated goals
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A budget includes both financial (projection of revenue & expenses)
and non-financial information (how many employees you have)
Budgeting normally starts with sales budget
o How many employees do we need?
o What will be their salaries?
o When do we expect to receive the cash from sales?
o What are our selling expenses?
o What is our production budget?
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3.4 Using CVP Analysis
Uses of the CVP analysis
Estimating profit at
given sales volume
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Finding the breakeven point
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Finding the unit sales
volume to achieve a
target profit
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Budgeting allows you to create a spending plan for your money
Budgeting keeps you out of debt by projecting your future
expenses and ensuring you have enough income/savings
A budget is a report that gives a financial description of one part of
a business’ planned activity
It helps to:
o Add discipline/order to the planning process
o Recognise and avoid potential operating problems
o Quantifying plans
o Create benchmarks for evaluating a business’ performance
Can be used to estimate profit at any
given sales volume
Decisions makers can estimate profit
based on sales volume
Managers can then set volume targets
based on desired profit target
Help decisions makers estimate how
many units need to be sold to breakeven each month
Decision makers can predict the sales
volume needed to estimate revenues to
cover estimated costs
3.5 Planning
What happens if a business doesn’t plan?
• They will fail
• CVP analysis can help the owners of companies foresee any issues
before their business get into financial trouble
E.g. They could have confirmed the selling needed to
breakeven and at what volume
Business issues and values
Entrepreneurs need to consider the following questions
• What will be the impact on the environment?
• What health effects might employees suffer later?
• What might be the health impact on the business’ neighbours?
• Legally, can we even consider not cleaning up toxic wastes?
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A cash budget is critical for business because it shows cash receipts
& payments and enables planning for cash outflows
A master budget is the integrated set of budgets starting with the
sales budget and ending with the budgeted financial statements
o Manager will investigate the difference between budgeted
and actual results, and look for the answers to these
variations
o A budget it flexible and it is based on estimates, so it is
normal to see slight variations
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Some argue that budgeting takes a lot of time, and that time could
be used for something more valuable
Budgets can cause individuals in organisations to fight for scarce
resources and so these resources aren’t allocated in the best way
Most of the non-financial information included in a budget is
related to nonoperational data
Steps in the budgeting process
1. Establish who will take responsibility for the budget-setting process
2. Communicate budget guidelines to relevant managers
3. Identify the key or limiting factor
4. Prepare the budget for the area of the limiting factor
5. Prepare draft budgets for all other areas
6. Review and coordinate the budgets
7. Communicate the budgets to all interested parties
8. Monitor performance relative to the budgets
Who is responsible for the budgeting process?
Budget committee A group of managers formed to supervise and take
responsibility for the budget-setting process
Budget officer
An individual (accountant) appointed to carry out
tasks of the budget committee
Top-down
An approach to budgeting where the senior
management of each budget area originates the
budget-target and discuss it with lower levels of
management
Bottom-up
Where budgets are driven by the views of junior
staff such as sales representatives
industry trends (3) economic forecasts are
gathered
Retail business’ • Shows purchases (in units) required each month to
purchases budget
make the expected sales and to keep inventory at
desired levels
• Contains the amount of inventory that a company
must purchase during each budget period
• Shows the costs of purchases and expected timing
and amount of the cash payments for these
purchases
Retail business’
selling expenses
budget
• Shows expenses & related cash payment
Retail business’
general and
administrative
expenses budget
• Shows related cash payments associated with
Retail business
Service business
4.3 Budget as a framework for planning
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A set interrelated reports showing (1) goals to be met (2) activities
to be performed in its operating cycle (3) resources to be used (4)
expected financial results
It can include:
o Sales & purchases budget
o Selling expenses budget
o General and administrative expenses budget
o Cash budget (projected statement)
o Projected income statement
Project balance
sheet
Sales budget
• Summarises a business’ expected financial
position @ the end of a budget period
• Summarises projected assets, liabilities and
owner’s equity
• All product sales/services contracts affect all the
other operating activities of a business
• Basic calculation in the sales classifies the number
of unit sales expected in one row → list the
average expected unit price in the next row →
total sales appearing in 3rd row
Service business’
sales budget
Retail business’
sales budget
“As above”
• Shows the number of units of inventory expected
to sell each month
• Shows related monthly sales revenue
• Shows which months the business expects to
collect cash from sales
• To estimate no. units of inventory sold each
month, information of (1) post sales data (2)
advertising
• Budget developed by reviewing past selling
expenses and adjusting
expected activities other than selling
• Preparing this involves:
o Reviewing past expenses
o Identifying them as fixed/variable expenses
o Adjusting them for current plans
4.4 Cash management and the cash budget
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Cash management involves keeping an eye on business’ cash
balance to ensure:
o There is enough cash on hand to pay for planned operations
during planned period
o There is cash buffer on hand
o There isn’t too much cash on hand
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Cash budget reflects the business more than any other ones
Some main features:
1. Budget period broken down into sub-periods (months)
2. Columnar form (month/column)
3. Cash receipts & payments are identified under headings &
total for each month shown
4. Surplus/deficit of cash identifies for each month
5. Running balance of cash identified
4.2 Operating cycles
• This is the average time it takes the business to:
o Use cash to buy goods for sale (inventory)
o Sell goods to customers
o Collect cash from its customer
• The average time it takes the business to:
o Use cash to acquire more supplies and
services
o Sell the services to customers
o Collect cash from its customers
• E.g. PwC, accountants etc.
associated with planned selling activities
• E.g. salespeople’s & commissions, shop rent &
Example of cash budget
Let's assume Byron Surfboards manufactures surfboards, and it
estimates $300,000 in sales for the months of June, July, and August. At
a retail price of $60 per surfboard, the company estimates sales of 5,000
surfboards each month. Byron Surfboards forecasts that 80% of the cash
from these sales will be collected in the month following the sale and
the other 20% will be collected two months after the sale. The beginning
cash balance for July is forecast to be $20,000, and the cash budget
assumes 80% of the June sales will be collected in July, which equals
$240,000 (80% of $300,000). Byron's Surfboards also projects $100,000
in cash inflows from sales made earlier in the year.
On the expense side, Byron Surfboards must also calculate the
production costs required to produce the boards and meet customer
demand. The company expects 1,000 boards to be in the beginning
inventory, which means a minimum of 4,000 boards must be produced
in July. If the production cost is $50 per board, Byron Surfboards spends
$200,000 ($50 x 4,000) in the month of July on the cost of goods sold,
which is the manufacturing cost. The company also expects to pay
$60,000 in costs not directly related to production, such as insurance.
Byron Surfboards computes the cash inflows by adding the receivables
collected during July to the beginning balance, which is $360,000
($20,000 July beginning balance + $240,000 in June sales collected in July
+ $100,000 in cash inflows from earlier sales). The company then
subtracts the cash needed to pay for production and other expenses.
That total is $260,000 ($200,000 in cost of goods sold + $60,000 in other
costs). Vyron Surfboards July ending cash balance is $100,000, or
$360,000 in cash inflows minus $260,000 in cash outflows.
Retail business’
cash budget
(projected cash
flow statement)
• Shows expected cash receipts and payments and
Service business’
cash budget
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Projected income
statement
• Summarises expected revenues and expenses for
how they affect the business’ cash balance
• Helps anticipate cash shortages/excess
the budget period
• Data for projected income derived from the
sales/purchase/expenses budget
• A snapshot of your forecasted sales, cost of sales
& expenses
• Projected income should be for the next 12-month
period from end of the latest business year end
and compared to previous results
4.5 Using the master budget in evaluating the business’
performance
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The master budget can help to determine where plans went wrong
and where to take corrective action
A cost report can be used to analyse difference between a business’
budgeted/actual results
Non-financial measures in budgeting can be incorporated into the
budgeting process and reported alongside financial targets
o Used as a basis for targets
|Module 6| Introduction to accounting concepts and
applications
6.2 Basic concepts and terms
Entity concept
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Learning objectives:
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Comprehend why users need information about a business’
operations
Understand the basic concepts and terms used in accounting
Understand and apply the accounting equation
Understand accounting for transactions
Recall and apply accounting principles and concepts related to
income
Have a working knowledge of how to record daily transactions in
a worksheet
Understand the end of period adjustments
Reflect on the relationship between income and the balance
sheet
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Source document
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Monetary Unit concept
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6.1 Financial accounting information and decision making
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The accounting process provides financial data for a broad range of
individuals including external and internal users
Internal users use the financial data for decision making
(managerial accounting)
o Assessing how management protects and manages the
company’s resources
o Shaping decisions about when to borrow or invest company
resources
o Shaping decisions about expansion or downsizing
External users are more concerned with financial accounting
information of a business which records all financial business
transactions in a General Purpose Financial Report (GPFR)
There are 6 groups of external users
Owners &
- Has the company earned satisfactory
prospective owners
income on its total investment?
- Should an investment be made in this
company?
- Should the present investment be
decreased, increased or retained at the
same level?
- Can the company install costly pollution
control equipment and still be profitable?
Employees & their
- Does the company have the ability to pay
unions
increased wages?
- Is the company financially able to provide
long-term employment for its workforce?
Governmental units
- Is the company, such as a local public
utility, charging a fair rate for its services
Creditors & lenders
- Should a loan be granted to the company?
- Will the company be able to pay its debts
as they become due?
Customers
- Does the company offer useful products at
fair prices?
- Will the company survive long enough to
honour its product warranties?
General public
- Is the company providing useful products
and gainful employment for citizens
without causing serious environmental
problems?
Some of the ways external users employ accounting information include
the following:
• Shareholders have the right to know how a company is managing
its investments
• Federal and State Government require tax returns and other
documents often prepared by accountants
• Banks or lending institutions may use accounting to guide decisions
such as whether to lend or how much to lend a business
• Investors will also use accounting information to guide investment
decisions
• General-purpose financial statements provide information on a
company’s financial position, cash inflows and outflows and the
results of operations
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Transactions
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Historical Cost Concept
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This concept states that an entity is
considered to be separate from its
owners and from any other business
Each business is an entity has its own
accounting system and records
These are records used as evidence that a
transaction has occurred, including:
o Sales receipt, invoice/bill from a
supplier
o Printout from an EFT machine,
payroll timesheet
o Log of km driven in business’
delivery truck
o Invoice/bill sent to a customer
This concept states that the source
document for transactions show the value
of the exchange in terms of money
The monetary unit used depends on the
national currency of the country in which
the business operates
An exchange in property or service with
another entity
Each transaction a business engages in
must be recorded, based on information
from source documents
This concept states that business records
its transactions based on the amount
exchanged at the time the transaction
occurred
6.3 The accounting equation
The process used to prepare financial information of a business:
1. Identify and measure the transactions
2. Record the transactions
3. Report the transactions
4. Analyse and interpret the transactions
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The Accounting Equation is used to record all the transactions of a
business – after analysing and recording each transaction the
accounting equation must remain in balance
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Two key components of the balance sheet:
1. Assets – represent the resources controlled by the company
2. Liabilities – the company’s obligations
3. Owner’s equity
The accounting equation is a representation of how these three
components are associated with each other
Both liabilities and owner’s equity represent how the assets of a
company are financed
o Financed through debt it is a liability
o Financed through issuing equity/shares it will show
shareholder’s equity
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Assets = Liabilities + Owner’s equity
Assets
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Liabilities
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Owner’s equity
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A present economic resource controlled by
the entity as a result of past events and has
the potential to product economic benefits
Can either be tangible or intangible e.g.
copyrights, trademarks, patents etc
A present obligation of the entity to transfer
an economic resource as a result of past
events – company has no practical ability to
avoid
The claim of the owner(s) against the business
The residual interest in the assets of the entity
after deducting all its liabilities
On Balance Sheet of Sole Proprietorship the
balance sheet lists the total ending equity in a
single Capital account – records capital
invested by the owner plus earnings from
operations and less any withdrawal of capital
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A company’s Balance Sheet has contributed
capital (share capital) and retained earnings
6.4 The Double-Entry System and dual effect of transactions
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The balance sheet is based on the double-entry accounting system
where the total assets of a company are equal to the total liabilities
as shareholder’s equity
Because there are always two or more accounts affected by every
transaction carried out by a company, the accounting system is
referred to as double-entry accounting
The accounting equation ensures that all entries in the books are
vetted, and a verifiable relationship exists between each
liability/expense and its corresponding source OR between each
item of income/asset and its source
Worksheet – summary of all transactions
Examples: [LOOK AT WORKED EXAMPLE VIDEO]
6.6 Expanding the accounting equation
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To modify the accounting system for a sole proprietor, the owner’s
equity part of the equation can be split into 2 parts
o Owner’s capital account lets the owner record transactions
of investment/withdrawal of capital of capital from the
business
o Net income records → revenue & expenses
Revenue less expenses = gross profit
- When making a cash sale the profit is added onto the ‘Cash’ section
under the Assets column
- Any expenses towards acquiring the products need to be
subtracted from the inventory
-
§ E.g. “gift packs originally cost $600” → -600 from inventory
When making a sale you also need to account for any profit/loss
from that sale
§ Record ‘Sales Revenue’ and ‘Expenses’ (cost of the goods
sold) – When expenses are recorded make sure that the
figure is recorded with a (+) sign
•
The purpose of the worksheet is to keep track of all the changes to
each account name and total them at the end
o Businesses can use this to create an Income Statement and
a Balance Sheet
-
To adjust transactions previously made or pick up any transactions
that were forgotten about
<Supplies being consumed>
- When supplies were bought, (+1900) recorded into Assets account
so when so when completely used up need to adjust this amount to
become (-1900)
§ When you use up an asset you need to Expense* the asset
* An expense decreases the overall equity of a business – therefore the
Accounting Equation is in balance
-
When you show the Expenses as a positive amount but that’s
because we are taking up the Expense
§ Impact to net income is that it’s shown as a (-) figure
<Prepaid Rent>
- Scrumptious Donut used up 2 months’ worth of rent – so now need
to decrease the prepaid assets of prepaid rent
§ Once an asset is consumed, you need to record
corresponding “Rent Expense”
-
When making a credit sale – the profit made is recorded under
“Accounts Receivable”(selling on credit terms means the cash
hasn’t been collected) in the Assets column
Revenue and Expenses are actual account names found on Income
Statement
The balancing figure is the actual profit/loss that’s earned for the period
<Depreciation on Equipment>
§ Depreciation is a non-current asset (a contra asset,
like a negative asset)
- Show the depreciation account directly under the asset that it
relates to
§ Under the equipment account under non-current asset
- Record account of “Accumulated Depreciation” of $30 under
Asset’s account
§ On actual Balance Sheet the amount would be
shown as a less amount or in brackets: (30)
§ Corresponding “Depreciation Expenses”
Moving over the adjusting entries into adjusted worksheet
|Module 7| Internal control – Managing and reporting
working capital
Learning objectives:
•
•
•
•
Understand the concept of ‘working capital’
Understand the importance of managing the asset of cash (cash
receipts and payments)
Learn how to control accounts receivable
Identify control procedures for inventory
7.1 Introduction to managing and reporting working capital
6.7 Extending accounting concepts and terms
TERMS
Accounting period
Matching principle
Going concern
Accrual accounting
Depreciation
DEFINITION
This is the timespan for which a business reports
its revenues and its expenses
To determine its net income for an accounting
period, a business computes and deducts the
total expenses from the total revenues earned
during this period
This is an assumption that an entity is able to
continue as a viable entity for the foreseeable
future
Recording revenues and related expense
transactions in the same accounting period that
goods or services are provided, regardless of
when cash is received or paid
This is the systematic periodic transfer of the cost
of fixed asset to an expense account during its
expected useful life
Net income and its effect on the balance sheet
• The revenues and expenses of a business are recorded on the
Income Statement (Profit or Loss statement) and the difference
between Revenue and Expenses is known as “Profit or Net Income”
•
•
Revenues and gains cause owner’s equity to increase
Expenses and losses cause owner’s equity to decrease
Working capital
• It is said that once organisations have appropriate management
over their working capital, they would also have adequate internal
control systems that will enhance the financial performance of the
business
7.2 What is working capital and why is its management
important?
Working capital is a business’ current assets minus its current liabilities. It
is important for businesses to manage their working capital to ensure they
have an appropriate amount on hand
• It represents the net resources managers have to work with in the
business’ day-to-day operations
•
Too little working capital:
o Risk not having enough liquidity
•
Too much working capital:
o Risk not putting resources to their best use
Important working capital items include:
1. Cash
2. Accounts receivable
3. Inventory
4. Accounts payable
Internal control structure:
§ Important for a business’ success
A set of policies and procedures that directs how employees should
perform a business’ activities
→ this ensures that the reporting on the balance sheet is correct and helps
managers evaluate the business adequately
3 main accounting issues for a business’ failure are:
1. A lack of management systems, such as financial controls
2. A lack of financial planning and review
3. An inadequate level of financial resources
7.3 Management and control of cash
•
A business’ cash includes:
o Cash (money on hand)
o Deposits
o Others, such as cheques
Controls over cash receipts
• A business internal control procedures to ensure that it records the
amounts of all cash receipts in the accounting system
1. Proper use of a cash register
2. Confirming the identity of customers paying by cheque (accepted
and rarely used these days)
3. Matching the total amounts collected against the total of the cash
register/POS (point of sales) system at the end of each employee’s
shift
Separation of duties
For example, the person collecting the cash should not be the same person
that is recording or depositing the cash
All details and endorsement should be recorded, such as the details of cash
received, when it was received and from who
7.4 Bank reconciliation
Bank reconciliation is the schedule used to analyse the difference between
the ending cash balance in a business’ accounting records and the ending
cash balance reported by the bank of the business’ bank statement
• If the balance reconciles then all the cash payments and deposits
are accounted for
• If it does not reconcile, then this could be an indication to
management that funds have been misappropriated
Causes of differences in the cash balance may include:
1. Deposits in transit
2. Outstanding or pending payments
3. Direct deposits
4. Direct charges
5. Errors
Format and preparation of a bank reconciliation
8. Journalise and post entries for the amounts that need to be adjusted
in the books of the business
7.5 Internal control over accounts receivable and accounts
payable
For a business, internal controls over accounts
receivable focus on procedures that help
maximise profit and include:
Accounts receivable
1. Set up the format for the bank reconciliation and fill in any information
you already know
e.g. ending balance from the bank statement and ending balance
from the cash account
Accounts payable
2. Look for any deposits in transits
What amounts are in the books of the business but are not on the
bank statement
For any deposits in transit, add these amounts to the ending
balance on the bank statement
Inventory
3. Identity any outstanding payments, transfers or cheques
What payments have been made in the books of the business but
do not appear on the bank statement yet? These amounts need to
be deducted from the bank balance
Determining that a customer is likely to
pay
- Monitoring the accounts receivable
balances of its customers; and
- Monitoring its total accounts receivable
balance
Accounts payable are the amounts a business
owes its suppliers to credit purchases of
inventory and supplies.
Controls over accounts payable should focus on:
- Establishing control over who can obligate
the business
- Establishing controls over payments; and
- Monitoring the total amount of accounts
payable
Inventory is merchandise being held resale.
Internal controls may include the following:
-
4. Identify any deposits that were made directly to the bank account but
were not recorded in the business’ cash account
E.g. interest earned
Deposits need to be added back to the business’ cash account
-
5. Identify any charges made directly by the bank but not included as
decreases in the cash records of a business
e.g. bank charges
These need to be deducted from the cash balance of a business
Controlling the ordering and acceptance
of inventory deliveries
Establishing physical controls over
inventory while the inventory is being
held for sale; and
Periodically taking a physical count of its
inventory to ensure accurate inventory
records
Determining the cost of ending inventory
The specific identification method allocates costs
to cost of goods sold and to ending inventory
It assigns to each unit sold and to each unit
ending inventory the cost to the business of
purchasing that particular unit.
6. Look for any errors
Usually any errors found are made by the business
The cash balance of the business needs to be adjusted for these
errors
7. Finalise the reconciliation
Add up both sections and calculate the closing adjusted cash and
bank balances
-
The amount of the ending inventory is usually
verified by a physical count
What have I learnt?
•
•
•
•
•
The importance of managing working capital
An understanding of cash
Simple cash controls
How to prepare a bank reconciliation
Simple internal controls over accounts receivable, accounts
payable and inventory
|Module 8|Introduction to the income statement
Elements of financial
statements
Element
Learning objectives:
•
•
•
•
•
Explain the purpose of an income statement
The importance of measuring financial performance
Understanding Revenue
Understanding Expenses
Evaluating the performance of a business
Economic resources
Liability
8.1 The importance of an income statement
•
Claim
The revenue and expense transactions form the basis of a
business’s income statement, which shows external users the
profit/income for the accounting period
Why is the income statement important?
• It gives us a summary of the business’ revenues and expenses
• A business earns income by either selling inventory or providing a
service
o Revenues are amounts earned by the business
o Expenses are the costs of providing the goods or services
Equity
Income
Changes in economic
resources and claims,
reflecting financial
performance
Net income = Revenues – Expenses
•
The income statement is important because it offers the most
recent picture of the business’s revenues and expenses and overall
profitability
How is the income statement used?
Asset
Other changes in
economic resources
and claims
Definition of description
A present economic resource
controlled by the entity as a result
of past events.
An economic resource is a right that
has the potential to produce
economic benefits.
A present obligation of the entity to
transfer and economic resource as
a result of past events
The residual interest in assets of the
entity after deducting all its
liabilities
Increases in assets, or decrease in
liabilities that result in increases in
equity, other than those relating to
contributions from holders or
equity claims
Decreases in assets, or increase in
liabilities that result in decrease in
Expenses equity, other than those relating to
distributions to holder of equity
claims
Contributions from holders of
equity claims and distribution of
them
Exchanges of assets or liabilities
that do not result in increases or
decreases in equity
Measuring financial performance
Net income (or loss) is the difference between the increases in owner’s
equity (capital) known as income, and the decreases in owner’s equity,
known as expenses
•
•
•
•
•
•
The information published helps both external and internal users to
evaluate how well the manager of the business have “managed”
during the period
For internal users the income statement can be used to compare
actual results with expected results
o Income statement shows the result of the CVP analysis and
budgeting decisions made by managers and by comparing
the results to the projections made they can determine
where their CVP analysis was accurate
Budgeting decisions can be analysed, and variance can be corrected
For external users (e.g. investors and banks) the income statement
is used to compare a business’ actual operating performance with
other businesses
o Investors can decide if they want to remove their
investment and banks can use financial information for
future lending decisions
o Suppliers can use information to make decisions on whether
they should continue to provide credit to a business
8.2 Measuring financial performance
•
•
Recall that every equation must remain in balance after every
transaction is posted
We analyse each transaction in terms of its impact on the
accounting equation i.e. whether it caused an increase or decrease
to the assets, liabilities or equity accounts
Income is made up of revenue (from operating activities) and other
gains (usually from non-operating activities)
Expenses are the outflow of assets (or increase in liabilities)
incurred as a result of generating revenues
•
A classified income statement for a retail business has two parts:
1. Operating income section
2. Other items section
•
Operating income has 3 mains sections:
1. Revenues
2. Cost of goods sold (COGS)
3. Operating expenses
Revenues and expenses
• Revenue can be recorded upon point of sale
• Commissions, interest, gains on sale of assets can also be recorded
as revenue
•
•
Most expenses result from the production or delivery of goods
and/or services during the accounting period
o Costs of goods sold is one of the largest expenses
Most other expenses will fall under operating, financial, selling and
general administrative expenses
How various sales policies affect Income Statement reporting:
1. Discount policies: a quantity (or trade) discount which is a
reduction in the sales price of a good/service. A sale discount (cash
discount) which is a percentage reduction of the invoice price if the
customer pays the invoice within a specified period
2. Sales return policies: a sales return occurs when a customer returns
previously purchased merchandise
3. Sales allowance policies: a sales allowance occurs when a customer
agrees to keep the merchandise, and the business refunds a
portion of the original sales price
•
At the end of an accounting period the balance of a business’ Sales
Revenue account includes the initial sales revenue, less sales
returns and allowances and discounts
o This balance is called net sales and is recorded on the
income statement – it is the net sales figure that is used in
many of the profitability ratio calculations
Expenses
Cost of Goods Sold (COGS)
Operating expenses
•
•
•
Selling expenses
•
General and administrative
expenses
•
Financial expenses
•
•
Expense of a retail business
consisting of the cost of the goods
that it sells during the accounting
period
Expenses (other than COGS) that a
business incurs in its day-to-day
operations
E.g., the cost of employing staff
and the cost of building rent
Related to the sales activities of a
business e.g. advertising expenses,
delivery/transport costs
General and administrative
expenses – related to the general
management of a business e.g.
office salaries expense, insurance
expense, office supplied expense
Related to financing of the
business and its operations and to
debt collecting e.g., bank charges,
discounts allowed, interest
expense
4. The depreciation method
Once the depreciated amount has been estimated it must be allocated
over the useful life of the asset
Straight method of depreciation
• Allocated the amount to be depreciated equally over each year
of the useful life of the asset
Accelerated depreciation
• Applies a fixed percentage rate of depreciation to the writtendown value of an asset each year
• Higher annual depreciation is charged in earlier years
Unit of production-based depreciation
• Depreciation based on productive capacity of the asset and its
use over time
[Selective the depreciation method]
• Methods should be appropriate to the assets and to their use in
the business
• Depreciation is a non-cash adjustment that is used to calculate
net profit
o An example of an accounting process that requires
judgement
Preparing an income statement
It is common for some operating expenses to fit under more than
one category – expenses can be allocated based on estimating the
split between the categories
o One way the Income statement can be used for evaluation
is through ratio analysis
Explaining the concept of depreciation
• Depreciation is an allocation of the cost of an asset over its useful
life – it measures the portion of the cost (less residual value) of a
fixed asset that has been consumed during an accounting period
• Depreciation refers to long-term limited life tangible assets
o Amortisation is the equivalent concept for intangible assets
• At the end of each period the depreciation is calculated and
recorded on the Income Statement and the corresponding
accumulated depreciation amount is recorded on the Balance Sheet
• Accumulated depreciation is a contra account à it sits under noncurrent asset in brackets
Income Statement Extract
Balance Sheet Extract
Expenses
Depreciation Expense: 1,000
Non-current Asset
Property, plant and equipment: 10,000
Less: accumulated depreciation: (1,000)
Carrying amount: (9,000)
Factors to consider when calculating depreciation
1. The cost (value) of the asset
All costs incurred by the business to bring the asset to its required
location and make it ready and available for use
E.g. delivery, installation, legal title, alterations, improvements
2. The useful life of the asset
The economic life of the asset determines the expected useful life of the
asset for the purpose of calculating depreciation
The economic life of an asset ends when the cost of operating or holding
the asset exceed the benefit derived ***
Economic life may be shorter than physical life
3. The estimated residual value of the asset
The likely amount to be received on disposal of the asset
8.3 Using the income statement for evaluation
Investors: use the income statement to help judge their return on
investment
Creditors: use the income statement to help make loan decisions
Manager: use the income statement for internal decisions making such as
planning, operating and evaluation decisions
• They will evaluate a business’ risk, operating capability and financial
flexibility
Business potential and ability:
- Risk: the uncertainty about the future earnings potential of a
business
- Operating capability: a business’ ability to continue a given level of
operations in the future
- Financial flexibility: a business’ ability to adapt to change in the
future
Using ratio analysis as a means of evaluation
• Ratio analysis is where an item on the business’ financial
statements is divided by another related item
• Ratios are used to compare a business’ performance with previous
periods and with other business’
o Main ones: Profit Margin and Gross Profit percentage
Profit Margin = Net Income/Net Sales
8.4 Linking profit to owner’s equity and closing accounts
Statement of changes in equity
• External users use this information to evaluate the changes in
the claims of the business’ assets and changes that can have an
impact on a business’ risk, operating capability and financial
flexibility
•
•
If the profit margin is higher than that of other businesses or other
previous years calculations, then this is an indication that the
business is doing well in controlling its expenses
If expenses are controlled, then profit will be maximised and the
return to investors should be favourable
Gross Profit Percentage or Margin = Gross Profit/Net Sales
Real world example – JB Hi Fi and Qantas
Governance statement
• Talk about how they disclose information to the stock exchange to
the shareholders
• How they identify certain risks in the company and how they
manage interest in the company (e.g. impact of business operations
on broader society)
• Remuneration
o Details how much directors and key executives are paid and
the basis of their remuneration
• Operative and financial review
o Displays numerical and descriptive data
o E.g. during the year there was an accounting standard
adopted and there was a significant change in financial
information
•
The annual report is the responsibility of the directors to ensure
that the information is accurate, fairly represents the economic
activities of the entity
< Overview and description of most important areas of income
statement >
Q. Is the company profitable? Does its revenue exceed its expenses?
• For JB Hi Fi, look at the bottom of the ‘statement of profit or
loss’ and loss at ‘profit for the year attributable to owners of
the company’
•
•
•
To look at how good a company’s revenue is for a year you can
compare it against what revenue is earned in prior years and
calculate a % increase/decrease
Cost of sales: cost of purchasing products for resale
Cross profit is important because it has to cover all the
operational activities
o To calculate how good that profit is, you should
!"#$$ &"#'()
calculate a Gross Profit Margin " *+,+-.+ #
o There are 2 major expenses:
(1) Sales and marketing expenses
(2) Occupancy expenses (e.g. leasing)
Compare these values against revenue to see
how well the company is controlling these
costs
o To get a better idea of the results – compare that
number against the performance of another company in
the same industry [compared to Industry Growth] to
see if the company is underperforming
Total equity split into sections:
(1) Contributed equity
§ Value of the shareholder’s interest in the firm share capital
(2) Reserve accounts
§ Accounts that are impacted by accounting entries
(3) Retained earnings
!!! Look at share capital and understand how the values have been moved
around!!!
Acquisition of share by employees share trust is when the
company buys back shares from employees
Closing temporary accounts
• These are used for one accounting period to record the effects
of a business’ transactions on its net income
• At the end of a financial period these accounts are closed off
through the transfer of the overall net income/loss to the
equity section of the balance sheet
• In the next financial year, the Income Statement accounts begin
at zero unlike the Balance Sheet accounts which carry forward
from one period to the next
[For this course you just need to understand the theory that entries close
at the end of the financial period]
Exam information: Income statement
Ensure that you answer explains why the income statement is important
to both managers and external users, particularly in decision making
- How managers should identify the reasons why actual revenues
and expenses are worse than expected amount
|Module 9| Balance Sheet
How to account for depreciation in a balance sheet?
•
Learning objectives:
•
•
•
•
9.1 Purpose and importance of a balance sheet
•
•
A financial statement that reports the types and monetary
amounts of a business’ assets, liabilities and owner’s equity at a
specific date
Provides a snapshot of the business’ financial position
9.2 The accounting equation and the balance sheet
•
•
•
•
Understanding the purpose of a balance sheet and its link to
the income statement
How the accounting equation links to the balance sheet
Using the balance sheet for evaluation purposes
Limitations of the financial statements
Current assets:
o Cash
o Receivables
o Inventory
o Prepaid items
Non-current assets:
o Property
o Equipment
•
•
•
•
•
•
•
§
Liquidity is a measure of how quickly a business can convert its
assets into cash to pay its bills
o External users assess how well a business manages its
liquidity by studying its working capital
o The current ratio and the quick (acid-test) ratio are two
common indicators of a business’ liquidity
o A business will also prepare a cash budget to ensure it has
adequate liquidity
-
Shows the relationship between a current asset and current
liabilities
It tells investors and analysts how a company can maximise the
current assets on its balance sheet to satisfy current debt and other
payables
§ Current ratio that is in line with the industry standard or
slightly higher is considered acceptable
§ A current ratio that is lower than the industry average may
indicate a higher risk of distress or default
§ A company with a very high current ratio compared to its
peer group may indicate that management may not be
using assets efficiently
Accumulated depreciation is calculated at the end of each
period for each depreciated asset
Accumulated depreciation is recorded on the balance sheet and
the matching depreciated expenses is recorded on the income
statement
Land is non-depreciable, non-current asset
Shareholder’s equity
• Contributed capital
o AKA. Share capital
•
-
Non-current liabilities
o Long-term notes payable
§ [an agreement a company enters with another
party, includes a formal written promise to pay
predetermined amounts on specific dates etc]
o Loans payable
o Bonds payable
§ [Liability account that contains the amount owed
to bond holders by the issuer]
Owner’s equity
• For a sole proprietorship, the balance sheet lists the total
ending owner’s equity in a single capital account
• This account affected by owner’s withdrawals or additional
investment
Retained earnings
o Profits left in the business less any dividends distributed
to owners/shareholders
Balance sheet items help evaluate the liquidity, financial flexibility,
profitability and the operating capability of a business
You can achieve this through financial statement analysis (i.e. ratio
analysis)
Financial statement analysis provides a quick snapshot of a
business’ health and wealth and pinpoints a starting point for
further analysis or investigation
Evaluating liquidity
Use the term carrying amount as depreciation is an allocation
concept, not a valuation concept
Liabilities
• Current liabilities
o Accounts and salaries payable
o Unearned revenues
o Short-term notes
o Provisions
§ [liabilities for uncertain timings/amounts e.g.
long-service leave]
Accumulated depreciation is a “contra-asset” that sits directly
under the non-current asset it relates to
o Accumulated depreciation is shown in brackets
9.3 Using the balance sheet for evaluation
Carrying amount = Original cost – Accumulated depreciation
•
Depreciation is the allocation of the cost of an asset over its
useful life
When recording depreciation there are two accounts affected:
1. Depreciation expense account under the expense
header on the income statement
2. Accumulated depreciation found under non-current
assets on the balance sheet
-
The quick ratio is an indicator of a company’s short term liquidity
position and measures a company’s ability to meet its short-term
obligations with its most liquid assets
§ Measures company’s ability to pay current liabilities without
needing to sell its inventory or obtain additional financing
§ This ratio is considered a more conservative measure than
the current ratio which includes all current assets
§ The higher the ratio result, the better a company’s liquidity
and health, the lower the ratio, the more likely the company
will struggle with paying debts
Evaluating financial flexibility
-
Fast fashion businesses e.g. H&M and Zara have high inventory
turnover, limit runs and replace depleted inventory quickly]
§ High inventory turnover assists in monitoring stock levels
and ensuring that companies are not left with obsolete
stocks that they would have to sell at a discount
-
Measures how efficiently a business is in collecting cash from
customers
§ A high receivable turnover ratio may that a company’s
collection of accounts receivable is efficient & company has
high ratio of customers that pay their debt quickly
§ Low receivables ratio could be result of insufficient
collection, inadequate credit policies OR customers who are
not financially viable or credit worthy
Financial flexibility is the ability of a business to adapt to change
• Managers, owners and creditors are interested in a business’ ability
to take advantage of major, long-term business opportunities
• To asses long-term financial flexibility, financial statement users
calculate a business’ debt ratio
-
Measures the extent of a company’s leverage
§ A debt ratio greater than 1.0 (100%) means a company has
more debt than assets and vice versa
§ Debt ratio can vary across industries depending on how
capital-intensive the industry is
Evaluating profitability
Decision makers user profitability ratios to evaluate how well a business
has met its profit objective in relation to the resources invested
𝑅𝑒𝑡𝑢𝑟𝑛 𝑜𝑛 𝑡𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠 =
𝑁𝑒𝑡 𝑖𝑛𝑐𝑜𝑚𝑒 + 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑒𝑥𝑝𝑒𝑛𝑠𝑒
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑡𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠
-
Indicates whether a business is using its assets effectively
§ Indicator of how effectively a company is using its assets to
generate earnings
§ EBIT is used instead of net profit to keep the metric focused
on operating earnings without the influence of tax or
financing differences when compared to similar companies
-
Shows the business’ return to the owner
§ ROE is considered as a measure of a corporation’s
profitability and how efficient the organisation is in
generating profits
§ Standard of acceptability will depend on industry average
Limitations of the balance sheet and income statement
• The income statement and the balance sheet do not provide much
information about a business’ cash management because they are
based on accrual accounting
•
Evaluating operating capability
•
Operating capability refers to a business’ ability to sustain a given level of
operations
• Information about a business’ operating capability helps in
evaluating how well it is maintaining its operating level and in
predicting future changes in its operating activities
-
Calculating inventory turnover can help business make better
decision on pricing, manufacturing, marketing and purchasing new
inventory
Slow turnover indicates weak sales and excess inventory – speed of
which business sells inventory is a measure of its performance
The longer an item is held the higher its holding-cost will be à
fewer reason consumers have to return to the shop for new items
Statement of cash flow is needed as an additional financial
statement to provide a clearer picture of a business’ performance
Some guidelines and principles used to prepare financial
statements also hinder the usefulness of financial information
provided in these statements
o Includes cost to prepare the statements, the exclusion of
inflation adjustments, the absence of some intangible assets
and the fact that they cover only a specific period of time
9.4 Real world example
Evaluation using a balance sheet
Remember:
Assets = liabilities + owner’s equity
When looking at balance sheet
1. Looking for major categories of assets
2. Major categories of liabilities
3. Look at what’s in residual assets, net assets that is in shareholder
equity accounts
Assets
Current à used up in next 12 months
• Cash/cash equivalent
o Too much cash on hand = excess cash and you don’t get a
great return on cash holdings
• Trade and receivables à money customers owe
• Inventories
o For companies that purchase products for resale, we expect
to see a large amount in inventory
o To analyse – see that company is not holding onto its
inventory for very long
• Prepayments
Non-current à used up in 12< months
(Long-term assets) aka productive capacity
• Plant and equipment (fixed assets)
o Could be machinery & buildings
• Intangible assets
o Could be intellectual property
o Could be Goodwill*
• Right of use
o Related to leases, when you lease a property, you don’t own
in it but you have the right of use
§ Change in accounting standard means that you now need to
record underlying property as an asset even if you don’t
own it
o Leases of stores, properties and warehouses
* Goodwill is an accounting entry but it represents the difference between
the purchase of a business and the net assets that has been acquired in. the
expected benefits of acquiring another business
Liabilities
Current liabilities à Due in the next 12 months
Make assessments around whether company has adequate resources to
meet those payments
• Trade and other payable
o Key liability for retail company because it’s purchasing
goods for resale
• Deferred revenue
o Refers to money that has been received from customers
usually in relation to gift-cards that cannot be booked as
revenue until used
• Provision
o Mainly employee costs
• Lease liabilities
Non-current liabilities
Make some assessments to how large these are in relation to the business
to ensure the business is minimising risk over long term
• Borrowings
o Money borrowed from banks (not payable in next 12
months)
• Lease liabilities
Equity
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Contributed equity
o Amounts that shareholders have contributed in the past
Reserves
Retained earnings
o The profit that has been made by the company less any
dividends paid over that time
9.5 Review
What have I learnt?
In this module, we have identified
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Why a business should prepare a balance sheet
The accounts that appear on a balance sheet
How to prepare a simple classified balance sheet
How to use the balance sheet for evaluation purposes; and
Limitations of a balance sheet
|Module 10| The cash flow statement
Learning objectives:
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Importance of the cash flow statement
Identify transactions that generate cash flows
Understand the operating, investing and financing activities
Prepare a simple cash flow statement using the direct method
Explain how the cash flow statement can be used in decision
making, and;
Calculate and interpret simple cash flow ratios
Sections of cash flow statement
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10.1 The importance of the cash flow statement
Businesses have to pay close attention to their cash
- Where have they received their cash from? (inflows)
- Where have they spent their cash? (outflows)
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Understanding that effective management over a business’ cash
account is crucial for its continued operations and success
Financial statements are based on accrual accounting, which takes
into account non-cash items
o Financial statements consider non-cash items to reflect the
financial help of a company more accurately
However, accrual account may hide or shadow the actual cash
health of a business so for a more precise image of the cash a
company is generating, a statement of cash flow is prepared
Statement of cash flow provides clarity to the users of financial
reports and to management on the actual cash inflows and
outflows of a business
It provides answers to questions that the balance sheet and income
statement cannot: E.g.
o Did the entity’s operations produce sufficient cash to meet
dividend payments?
o Did the entity issue shares or increase liabilities during the
year and what happened to the proceeds?
It shows a business’ changes of cash during an accounting period by
showing its inflows and outflows from its operating, investing and
financing activities during the period
It does NOT show cash that is yet to be paid or received
o These amounts are removed from the accrual calculations
that appear in the other financial statements
Understanding the cash account and cash flows
Every transaction that affected the cash account is shown as either a
decrease or increase to that account
Beginning cash balance + cash inflows – cash outflows = ending cash
balance
Inflows/receipts of cash result in an increase to the cash account of a
business:
• Decrease in assets other than cash i.e. when cash is received in
exchange for another asset
• Increase in liabilities i.e. where a business receives cash in exchange
for a liability for example a business borrows $10,000 from a bank.
The liability of a loan payable increases by $10,000 and the cash
account also increases by $10,000
• Increase in owner’s equity – i.e. cash investment by an owner
Outflows or payments of cash result in a decrease to the cash account of a
business. They include:
• Increase in assets other than cash i.e. when a company pays cash to
purchase an asset
• Decrease in liabilities i.e. when a company pays off their loans
• Decreases in owner’s equity i.e. owner withdrawals
Operating activities
Cash flow associated with business’s day-to-day activities or
principal revenue-generating activities
Net inflows from operations – only cash received and paid
Expenses & revenue on accrual basis are not included
Activities reflects how much cash is generated from a company’s
products or services and include:
o Primary activities – buying inventory/materials
o Selling and delivering goods
o Interest payments
o Income tax payments
o Payments made to suppliers for goods and services used
in production
Refer to 9.10 “Calculations for all operating cash flows” summary of how
to calculate cash inflow and outflow for operating activities using simple
formula method
o Salary & wage payments to employees
Salaries expense account à salaries recorded as owed to employee
- When Salaries Payable increases, an expense is recorded but no
cash paid
- When payable decreases, cash is paid but no expense recorded
- Payment can be calculated by adding payments for the period
o Rent payment
o Providing services
o Administrative activities
Cash collected from customers
= Sales revenue + decrease in Accounts Receivable
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Investing activities
Can include any sources and uses of cash from a company’s
investments
Purchase/sale of an asset, loans made to vendors/received from
customers/payments related to merger or acquisition
Examples can include:
o Lending money
o Collecting loans
o Acquisition and disposal of long-term assets
o Investing in other companies
o Buying and selling property and equipment
Financing activities
Often includes cash from investors/banks and the use of cash
paid to shareholders
Dividends, payments for stock repurchases and the repayment of
loans are included
“Cash in” when capital is raised
“Cash out” when dividends are paid
Financing activities include:
o Movements in equity and non-current liabilities
o Obtaining capital from the owner
o Providing the owner with a return on their investment
o Obtaining capital for creditors
o Repaying amounts borrowed
Organisation and presentation of the cash flow statement
• A cash flow statement shows how much cash is generated and used
in a given period
10.2 Preparing the cash flow statement
THINGS TO INCLUDE IN THE HEADER
• Name of business
• Type of statement/report being prepared (e.g. Cash Flow)
• Detail the period
Cash Flow statement is financial statement that summarises the amount of
cash & cash equivalent entering and leaving a company
§ Cash flows from operating activities
§ Cash flows from investing activities
§ Cash flows from financing activities
OPERATING ACTIVITIES
• Inflows à payments from customers
• Outflows à payments for utilities, wages, supplies, rent/office
space
Net cash PROVIDED = cash inflow – cash outflow
INVESTING ACTIVITIES
• Outflow à purchase of office equipment
= net cash USED in investing activities
𝐶𝑎𝑠ℎ 𝑟𝑒𝑡𝑢𝑟𝑛 𝑜𝑛 𝑜𝑤𝑛𝑒𝑟 / 𝑠 𝑒𝑞𝑢𝑖𝑡𝑦
𝑁𝑒𝑡 𝑐𝑎𝑠ℎ 𝑓𝑙𝑜𝑤 𝑝𝑟𝑜𝑣𝑖𝑑𝑒𝑑 𝑏𝑦 𝑜𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑎𝑐𝑡𝑖𝑣𝑖𝑡𝑖𝑒𝑠
=
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑜𝑤𝑛𝑒𝑟 / 𝑠𝑒𝑞𝑢𝑖𝑡𝑦
** For negative amounts, use a bracket around report amount
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FINANCING ACTIVITIES
• Inflow à proceeds from a bank loan
o When a business goes to the bank and borrows money, they
receive that cash which increases their cash up bank
• Outflow à drawing
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Net increase in cash: Total cash provided/used by each of the activities
summed together
Cash at end of year = Net increase + Cash at beginning of year
** The ending cash balance of a cash flow statement will always equal the
cash amount shown on th[/e company’s balance sheet
10.3 Analysing the Cash Flow Statement
External users can use the cash flow statement to understand how a
business obtained and used it cash in certain activities
- They can use cash flow statements to evaluate a business’ need for
additional cash to fund operation or expand
- Can evaluate the business’ ability to make interest payments and
pay off debt
- The statement can be used to compare similar companies as a
benchmark
Relationship between the cash flow statement and the cash budget
• A cash budget is a company’s estimation of cash inflows and
outflows over a certain period (weekly, monthly etc.)
• Cash flow statement does a post-mortem analysis of actual inflow
of cash and outflows of cash for a given period
Relationship between the cash flow statement and the income statement
• They both report on a business’ activities during an accounting
period
• Difference is that income statement reports on accrual accounting
whereas cash flow only reports cash activities
Cash Flow ratios
𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑐𝑎𝑠ℎ 𝑓𝑙𝑜𝑤 𝑚𝑎𝑟𝑔𝑖𝑛
𝑁𝑒𝑡 𝑐𝑎𝑠ℎ 𝑓𝑙𝑜𝑤 𝑝𝑟𝑜𝑣𝑖𝑑𝑒𝑑 𝑏𝑦 𝑜𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑎𝑐𝑡𝑖𝑣𝑖𝑡𝑖𝑒𝑠
=
𝑁𝑒𝑡 𝑠𝑎𝑙𝑒𝑠
•
This measures cash from operating activities as a % of sales
revenue
o Measures profitability and efficiency and earning ability
o How efficiently company converts sales $ to cash
o Higher the ratio, more cash is available from sales
o There is no “perfect” ratio as every company is different
Relationship between the cash flow statement and the balance sheet
• Balance sheet shows the assets and liabilities that result, in part,
from the activities on the cash flow statement
𝐶𝑎𝑠ℎ 𝑟𝑒𝑡𝑢𝑟𝑛 𝑜𝑛 𝑡𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠
= 𝑁𝑒𝑡 𝑐𝑎𝑠ℎ 𝑝𝑟𝑜𝑣𝑖𝑑𝑒𝑑 𝑓𝑟𝑜𝑚 𝑜𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑎𝑐𝑡𝑖𝑣𝑖𝑡𝑖𝑒𝑠
𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑝𝑎𝑖𝑑
+
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑡𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡
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This calculation is used by management it to prepare budgets and
predict future performance
Investors use this calculation to estimate company’s earnings
Cash flow to assets ratio is much like the return on total assets ratio
which measure how efficiently a business uses it assets to create a
return or income
Cash flow to total assets ratio shows investors how efficiently
business is at using assets to collect cash from sales & customers
Measures how much net cash from operating activities a business
generates for each dollar of owner’s capital
Both ratios help managers and external users assess if a business is
generating enough cash from operating activities
|Module 11| Short term Planning decisions
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11.1 Relevant costs and revenues
Introduction to decision making
Businesses are constantly changing and evolving based on the
environment in which they operate
• Managers need to analyse the relevant revenues and costs to assist
in decision-making
• Cost management and analysis should be viewed as a continuous
process so that it is more likely to deliver sustainable improvements
to the business
• Managers need to have a good understanding of the business value
chain and understand what products create value to make positive
business decisions
• To know which activities/products generate value, managers must
be informed of the costs incurred throughout the value chain
o Can use the information from the value chain in a
systematic way to manage costs and preserve resources and
maximise revenue
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Managers need information about costs to control product costs,
assist in planning, value inventories, and set selling prices to
determine profitability
o Do we continue to sell the product?
o Do we continue to provide a particular service?
o Can we reduce cost by user cheaper materials?
What types of costs and revenues are relevant to decision-making?
• Relevant costs are future costs that are relevant to a particular
option
o These costs will change depending on alternatives
o Some costs can be avoided altogether
• Relevant revenues are future revenues that are relevant to a
particular option – also varies
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Historical costs and sunk costs should be omitted from the analysis
as no costs incurred before making the decision are relevant to the
current decisions that need to be made
§ E.g. If a business has purchased a glazing machine for its
donut production, they have already recorded the purchase
of that machine at it historical cost on the balance sheet in
the year of the purchase. Cost not used to predict any future.
Costs of producing new flavours of glazed donuts this year
or in future years.
Other costs and revenue concepts for short-term decision
Incremental costs: Costs increases resulting from a higher volume of
activity or from the performance of additional activity
• always relevant when the higher volume of activity or additional
activity is not necessary for all the alternatives
Avoidable costs: costs that business must incur to perform an activity at a
given level but can be avoided if the business reduces or discontinues the
activity
• business can decide to reduce cost at any time after evaluating its
contribution to financial performance of a business
Opportunity costs: profits that a business forgoes by following a particular
course of action.
• Performing activities for one of the alternatives may disrupt a
business’ other profitability activities or reduce its opportunities to
engage in other profitable activities
Example of determining relevant costs and revenues
• Management sometimes needs to make decisions about activities
that are spontaneous and were not included in the
budgeting/planning processes
• E.g. Decisions that will not affect other opportunities
o Introduction of a new product
• Decisions where there are resource constraints
• Mutually exclusive decisions
o Where the acceptance of one opportunity means that
another must be rejected
These types of decisions look at quantitative financial data but also
managers must look at qualitative financial data
o These include impact of decision on
§ Customers
§ Employees
§ Competitors
§ Legal constraints
§ Suppliers
11.2 Calculation short term decisions
Deciding whether to drop a product
Management may decide to drop a product for several reasons:
• Changing technology and competition
• No longer profitable
• Customer’s interest decreased
• It is becoming obsolete
• It has poor safety record
• New information indicates product might harm the environment
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Management accounting information highlights the profitability of
an individual product which help managers decide whether to
continue the sales of a product or drop it
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Key to evaluating the profit effects is to determine the avoidable
costs and revenues it would not earn if it discontinued
Even if product is profitable management may still drop it for
reasons such as: it harms the environment
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Deciding whether to make or buy a part
Manager must decide to make a component part or purchase externally.
This decision involves analysis of the relevant costs for each alternative.
Reasons to make parts can include:
• Obtaining a short-term cost advantage
• Quality and supplier reliability
These decisions could impact relationships with established suppliers
Deciding whether to sell a product or process it further
Considerations can include:
1. The difference in business profits between two alternatives
2. The impact of the alternative on consumer behaviour
3. The impact on the environment
4. Availability of skilled employee
5. Ability to continue to employ staff who do not have the needed skill
This type of analysis involves subtracting relevant costs (incremental costs
and opportunity costs) from the relevant revenues under each alternative
11.3 Non-financial issues in Decision making
When thinking about taking a one-off or special order:
- Impact on workers if the order requires non-standard adjustments
e.g. learning curve of performing non-routine task
- Impact on current customers E.g. if order is sold at a reduced price
- Customers can expect you to drop prices in the future
In the case of dropping products:
- Loss of customers to competitors because they cannot get the full
range of products from your business anymore
- Drop in morale because of lay-off workers, people fear for their
jobs and productivity drops
- Need to consider alternate uses for now unused machinery or
space
In terms of make and buy decisions:
- If we stop making the products are there alternate uses for the
equipment or machinery
- Morale of workers who are laid off due to business now buying
components
- Reliability, quantity, and reputation of the supplier
Sell or process further:
• Skill level of employee to do the work in processing the product
• If machine process further, will there be loss of jobs?
|Module 12| Trends and Issues in Accounting
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In the changing environment, companies will have to undertake
very complex transactions and will have to refer to legislations like
the accounting standards and Corporation’s Act
o So that companies can faithfully represent that information
to financial statement users
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How to account for intangible assets cost
o E.g. costs for research and development for new technology
o Should they be treated as an asset or expense?
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Issues about climate change risks
o How should those risks be built into a company’s financial
statement?
Learning objectives:
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Understand the concept of sustainability reporting
Understand the concept of triple bottom line reporting
What is the global reporting initiative?
Understand the role of auditors and auditing
What is corporate governance and why is it important?
The role of ethics in accounting
12.1 Accounting for the future
Sustainability reporting
Traditionally, the major objective of businesses has been the maximisation
of profit and reporting of the FY
However, in recent years, there is a strong shift in impact that business
decisions are having on the world’s resources which means that
sustainability development is now crucial.
Sustainability reports are largely voluntary, and many organisations
provide information as part of their financial reporting
12.1 Ethics, Corporate Governance and Audits
Ethics in Accounting
Many believe that if companies adopt a code of ethics, create departments
to monitor this code and provide employees with training, then many of
the ethical breaches that occur in businesses can be avoided
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Many alternate names e.g. environmental report, corporate social report,
social impact report triple bottom line report etc.
Triple bottom line reporting
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A triple bottom line report includes a business’s economic, environmental,
and social information in one report and has three components:
Components
Environmental
Social
Economic
Disclosures about the environment and the
organisations activities in this area:
• Issues with water, air, natural resources,
and human health
• Amount of energy used
• Type of energy used
• Raw material used
• Greenhouse gas emissions
• Land use and management of ecosystems
Disclosures and social issues such as:
• Diversity of employees
• Treatment of minority
• Work conditions
• Ratio of wages to cost of living expenses
• Non-discrimination
• Community involvement initiatives
Contains more quantitative data
- Not a general-purpose financial report
- Financial data provided in the economic
disclosure would contain financial
information such as a business’s ability to
meet the superannuation entitlements of
its employees
Global reporting initiative
The Global Reporting Initiative (GRI) serves as a generally accepted
framework for reporting an organisation’s economic, environmental, and
social performance.
- Been established to encourage businesses to take accountability for
their actions
- GRI framework is continually updated and works with a global
multi-stakeholder network from over 60 countries
Financial accounting and reporting – intangibles and climate change
Financial accountants compile important detailed information about the
company’s transactions that presents a story/summary that financial
statement uses like shareholders and lenders to make informed decisions
about the business.
Professional behaviour is governed by rules and members of
controlling bodies are expected to follow the guidelines
In Australia, most major professional accounting bodies have
adopted the code of Ethics for Professional Accountants which has
been. Developed by the Accounting Professional and Ethical
Standards Board (APESB)
o Rules created to guide accountants when facing dilemma
Members of professional accounting bodies in Australia are
required to comply with a code of ethics and expected to act with:
o Integrity
o Objectivity
o Professional competence
o Due care
o Maintain client confidentiality
o Act in a professional manner
Corporate governance
What is corporate governance?
“Corporate governance is the framework of rules, regulations, and
practices by which a company operates. The primary focus is to ensure
compliance with the law, accountability, fairness, and transparency in a
company’s relationship with all major stakeholders”
Who is involved in corporate governance?
Shareholders
- Provide start-up capital
- Charged with approving major financial
transactions and decisions
Board of directors
- Develops strategy and policies of a business
- Ensure that these strategies are
implemented
Senior Leadership
- Responsible for day-to-day operation of the
company
Why is corporate governance important?
• Corporate governance intended to protect the rights of
shareholders, enhance business disclosure, and increase
transparency to business operations
• It enables the Board of director5s to function effectively and
comply to legislations and legal requirements
•
In Australia, ASX develops and issues recommendations on
corporate governance practice for businesses:
1. Delineation in the roles and responsibilities of board
and management
2. Skills, commitment, knowledge, and diversity of the
board
3. A culture of acting lawfully, ethically, and responsibly
4. Integrity of corporate reporting
5. Providing timely and balanced information
6. Respecting the rights of shareholders
7. Recognise and manage risk
Accounting and corporate governance
Role of accountants and accounting in corporate governance includes:
• Providing disclosure of the financial status, performance, and
ownership to the public
• Planning growth and operational strategies e.g. when to invest
o This can lead to positive impact for stakeholders
• By preparing financial statements and disclosing useful information,
accounting can ensure that management and the Board of
Directors are held accountable for the decisions they make
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Corporate governance is not only about ensuring financial
disclosure responsibility but also a social undertaking
There are a few ways which companies can ensure corporate
governance:
§ Ensuring that Board of Directors is structured appropriately
so that members that appropriate skills and the
commitment to perform their duties
§ Directors must be independent meaning they are not
impacted by conflicts of interests or association of anyone in
the company – meaning that the decisions are made in the
best interest of the company
The role of audits and auditors
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The role of an auditor is to give a professional and independent
view of a business’ financial statements
o This ensures for greater accountability to users and provide
an assurance to them that all funds have been reported
correctly
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Auditing is a systematic process:
o Planning the audit
o Understanding the audit client and the industry they
operate in
o Making judgements about business risks that may impact a
client’s financial
•
Auditors need to understand and test internal controls of the
company that they want to place reliance on
They also test control environment, management, corporate
governance, risk assessment process etc.
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