|Module 1| Introduction to accounting Learning objectives: • • • • • • • 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 • • • • • • • 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. • • • 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 - 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: • • • • • • • 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? • • • • 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 • 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] • 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 • 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 • • • • • • • 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 • • • • 3.1 Planning a new business • • • 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 • • • • • 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 = π + vX § π = 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 π΅ππππ ππ£ππ πππππ‘ = Unit sales volume πΉππ₯ππ πππ π‘π πππππ πππππ πππ π’πππ‘ − π£πππππππ πππ π‘π πππ π’πππ‘ ππππ‘ π ππππ π£πππ’ππ = πππ‘ππ πππ₯ππ πππ π‘π πΆπππ‘ππππ’π‘πππ ππππππ πππ π’πππ‘ |Module 4| Developing a business plan – Budgeting Showing CVP relationships Learning objectives: • • • • 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 • • 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 • 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] • • • 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 • 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? • 3.4 Using CVP Analysis Uses of the CVP analysis Estimating profit at given sales volume • • • Finding the breakeven point • Finding the unit sales volume to achieve a target profit • 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? • • 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 • • • 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 • • 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 • 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 • • 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 “ 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 • • • 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 • Learning objectives: • • • • • • • • 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 • Source document • Monetary Unit concept • • 6.1 Financial accounting information and decision making • • • 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 • Transactions • Historical Cost Concept • 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 • 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 • 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 • • Assets = Liabilities + Owner’s equity Assets • • Liabilities • Owner’s equity • • • 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 • A company’s Balance Sheet has contributed capital (share capital) and retained earnings 6.4 The Double-Entry System and dual effect of transactions • • • 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 • 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 π ππ‘π’ππ ππ π‘ππ‘ππ ππ π ππ‘π = πππ‘ ππππππ + πππ‘ππππ π‘ ππ₯ππππ π π΄π£πππππ π‘ππ‘ππ ππ π ππ‘π - 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 • • • 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 • • • • • 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: • • • • • • 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 • • • • 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) • • • • • • • 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 • • • • • • • • 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 πΆππ β πππ‘π’ππ ππ ππ€πππ / π πππ’ππ‘π¦ πππ‘ πππ β ππππ€ ππππ£ππππ ππ¦ ππππππ‘πππ πππ‘ππ£ππ‘πππ = π΄π£πππππ ππ€πππ / π πππ’ππ‘π¦ ** For negative amounts, use a bracket around report amount • 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 • 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 ππππππ‘πππ πππ β ππππ€ ππππππ πππ‘ πππ β ππππ€ ππππ£ππππ ππ¦ ππππππ‘πππ πππ‘ππ£ππ‘πππ = πππ‘ π ππππ • 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 πΆππ β πππ‘π’ππ ππ π‘ππ‘ππ ππ π ππ‘π = πππ‘ πππ β ππππ£ππππ ππππ ππππππ‘πππ πππ‘ππ£ππ‘πππ πΌππ‘ππππ π‘ ππππ + π΄π£πππππ π‘ππ‘ππ ππ π ππ‘ • • • • 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 • 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 • 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 - 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 - 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 - 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 - 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 • 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 • 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? • Issues about climate change risks o How should those risks be built into a company’s financial statement? Learning objectives: • • • • • • 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 • • Many alternate names e.g. environmental report, corporate social report, social impact report triple bottom line report etc. Triple bottom line reporting • 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 - 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 • 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 • 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. •