PowerPoint to accompany

Introduction to
accounting and
finance

Chapter 1
 Nature and Role of Accounting

Learning Objective: Define accounting

• Accounting is concerned with the collection, analysis

and communication of economic information.

• Accounting information is useful to those who need

to make decisions and plans about businesses, and
for those who control those businesses.

Atrill, McLaney, Harvey, Jenner: Accounting 4e © 2008 Pearson Education Australia

 Nature and Role of Accounting
Learning Objective: Discuss the role of accounting information

Accounting information is a tool for decision-making,

planning and control of business

• Stewardship
The more traditional role of providing accountability reports of
transactions for a given period

• Decision usefulness
Is about assisting users with making informed choices about
issues e.g. resource allocation
Atrill, McLaney, Harvey, Jenner: Accounting 4e © 2008 Pearson Education Australia
 The Flow of Accounting
Information

1. People make decisions.

2. Business transactions occur.

3. Businesses prepare reports to show

the results of their operations.

Atrill, McLaney, Harvey, Jenner: Accounting 4e © 2008 Pearson Education Australia

Accounting information user
groups

Figure 1.1

Atrill, McLaney, Harvey, Jenner: Accounting 4e © 2008 Pearson Education Australia

 Accounting as an information
system
Learning Objective: Explain the different procedures
involved in the accounting information system

• Identify and capture relevant economic information

• Record the information collected in a systematic
manner
• Analyse and interpret the information collected
• Report the information in a manner suitable to the
needs of users

Atrill, McLaney, Harvey, Jenner: Accounting 4e © 2008 Pearson Education Australia

Accounting as an information
system cont’d

Figure 1.2

Atrill, McLaney, Harvey, Jenner: Accounting 4e © 2008 Pearson Education Australia

 Accounting as a service function
Learning Objective: State the key characteristics of
accounting information

• Relevance (ability to be used to influence decisions)

• Reliability (free from material error or bias)
• Comparability (consistency of measurement and
presentation of items)
• Understandability (clarity and readability of
presentation)
• Cost of information (is the benefit worth the cost)

Atrill, McLaney, Harvey, Jenner: Accounting 4e © 2008 Pearson Education Australia

Characteristics of accounting
information
Timeliness

Figure 1.3

Atrill, McLaney, Harvey, Jenner: Accounting 4e © 2008 Pearson Education Australia

 Accounting in crisis
Learning Objective: Discuss the recent crisis in accounting

• Enron and HIH are cases of recent notoriety

• HIH collapse caused losses of up to $5.3 billion

• Resultant scrutiny led to accusations of dubious

accounting practices

• Credibility of financial reports has been undermined

• Tighter controls on quality of financial information have

been introduced

Atrill, McLaney, Harvey, Jenner: Accounting 4e © 2008 Pearson Education Australia

 Decision-making, planning and
control
• Planning is essential for business success
• Prudent decision-making is closely linked to
effective planning
• Planning covers both long-term and short-term
scenarios
• Over time, plans are normally adapted to changing
circumstances

Atrill, McLaney, Harvey, Jenner: Accounting 4e © 2008 Pearson Education Australia

 Decision-making, planning and
control cont’d
Learning Objective: Relate the steps in the planning process

Planning is usually broken down into three stages:

1. Setting the objectives or mission of the business

(Detailing what the business is basically trying to achieve)

2. Setting long-term plans

(Describing how the business will set out to achieve its long-
term objectives)

3. Setting detailed short-term plans or budgets

(Typically financial plans for one year ahead)
Atrill, McLaney, Harvey, Jenner: Accounting 4e © 2008 Pearson Education Australia
 Decision-making, planning and
control cont’d
Learning Objective: Discuss the nature of control in the
decision-making process

• Control is the process of making planned events

actually occur

• Accounting is useful in control to compare planned

outcomes with actual outcomes in commonly
specified terms

• Managers can take steps to get the business back

on track if variances are highlighted between
planned and actual outcomes
Atrill, McLaney, Harvey, Jenner: Accounting 4e © 2008 Pearson Education Australia
Overview of the planning and control
process
Step 1 Identify business objectives

Step 2 Consider options

Prepare a long-term plan based on the

Step 3 most appropriate option(s)

Step 4 Prepare short-term plans (budgets)

Step 5 Perform and collect information on actual performance

Respond to divergences between plans and actuals,

Step 6
and exercise control

Step 7 Revise plans and budgets if necessary Figure 1.4

Atrill, McLaney, Harvey, Jenner: Accounting 4e © 2008 Pearson Education Australia

 Business Objectives
Learning Objective: Explain the different procedures involved
in the accounting information system.

The popular suggested business objectives include:

• Maximisation of sales revenue (this does not consider
the need to cover business costs)
• Maximisation of profit (this takes in to account sales
revenues as well as expenses, but is limited as it does not
include other factors such as risk.
• Maximisation of return on capital employed (accounts
for level of profit as well as the level of investment)

Atrill, McLaney, Harvey, Jenner: Accounting 4e © 2008 Pearson Education Australia

Maximisation of profit

Atrill, McLaney, Harvey, Jenner: Accounting 4e © 2008 Pearson Education Australia

Business Objectives cont’d

• Survival (This is the aim of most businesses, however it is

rarely a primary objective)
• Long-term stability (Like survival, most businesses aim for it,
but it is rarely a primary objective)
• Growth (Encompasses survival and long-term stability and
aims to strike a balance between short and long-term
benefits, however it is probably not a specific enough target)
• Satisficing (Attempting to grant a satisfactory return to all
stakeholders - not just the owners. Difficult to define as a
practical benchmark for business decisions.)

Atrill, McLaney, Harvey, Jenner: Accounting 4e © 2008 Pearson Education Australia

Business Growth

Atrill, McLaney, Harvey, Jenner: Accounting 4e © 2008 Pearson Education Australia

 Business Objectives cont’d
• Achieving sustainable development (Achieving economic
growth while minimising or eliminating environmental impact
and meeting society’s expectations of good corporate
citizenship.)
• Enhancement / maximisation of business wealth
• Means the business takes decisions intended to make it
worth more.
• Encompasses all the valuable features of the previous
suggested objectives.
• Likely to be the main financial objective for many
businesses )

Atrill, McLaney, Harvey, Jenner: Accounting 4e © 2008 Pearson Education Australia

 Financial and Management
Accounting
Learning Objective: Compare and contrast financial and
management accounting

• Management accounting is concerned with

providing managers with information required for
day-to-day running of the business

• Financial accounting is concerned with providing

the other users with useful information

Atrill, McLaney, Harvey, Jenner: Accounting 4e © 2008 Pearson Education Australia

Financial and Management
Accounting cont’d
Financial Accounting Management Accounting
Focus Mainly external Internal only
Nature of reports General purpose Specific purpose
Level of detail Broad overview Quite detailed
Restrictions Accounting standards and No restrictions
other regulations
Reporting interval Mainly annual, sometimes Whenever required –
semi-annual or quarterly weekly, monthly
Time horizon Mainly historical Both past and future
Range of information Quantifiable in money Can contain non-financial
terms; focus on objective information; less focus on
and verifiable data objectivity and verifiability

Atrill, McLaney, Harvey, Jenner: Accounting 4e © 2008 Pearson Education Australia

 The Main Financial Reports - an
overview
Learning Objective: Provide an overview of the main financial reports
There are four main financial reports:
• The Cash Flow Statement (shows the sources and uses of
cash for a period i.e. cash movements – cash in & cash out)
• The Income Statement - statement of financial performance
(traditionally known as Profit and Loss; measures and reports
how much profit has been generated in a period )
• The Statement of Changes in Owner’s Equity (shows all
changes in owner’s interest in net assets from transactions
during the period)
• The Balance Sheet - statement of financial position (shows
overall net financial position at the end of a particular period)

Atrill, McLaney, Harvey, Jenner: Accounting 4e © 2008 Pearson Education Australia

 A Simple Example

• Paul starts a wrapping paper sales business with $100

• On the first day, he uses the $100 to purchase wrapping paper
(“inventory”)
• On the same day he sells 75% of that inventory for $110 in total
What cash movements took place in the first day of trading?
• Closing cash balance for the day is $110 (opening balance
$100 - $100 stock purchase + $110 sales = $110)

Atrill, McLaney, Harvey, Jenner: Accounting 4e © 2008 Pearson Education Australia

A Simple Example cont’d
How much did wealth increase as a result of the first
day’s trading?

• The increase or decrease in wealth is measured

as the difference between sales made and the
cost of goods sold
• sales were $110 less cost of goods sold $75 =
profit of $35

Note that only the cost of the paper sold is measured against
the sales to find profit, not the total cost of the wrapping paper
purchased.

Atrill, McLaney, Harvey, Jenner: Accounting 4e © 2008 Pearson Education Australia

A Simple Example cont’d
What is the financial position at the end of the first day?
At the end of the first day, a balance sheet is drawn up,
showing the resources held by the business:

• Cash (closing balance) = $110

• Inventory (stock available for resale) = $25
• Total business wealth at end of day = $135

Note that the profit of $35 has led to an increase in wealth of

$35
Note also that the increase in cash of $10 is not the same as
the increase in wealth because wealth does not exist only in
the form of cash (see inventory)

Atrill, McLaney, Harvey, Jenner: Accounting 4e © 2008 Pearson Education Australia

Financial Report Relationships
Balance sheet at the Balance sheet at the Balance sheet at the
beginning of Period 1 end of Period 1 end of Period 2

Income statement Income statement

Cash flow statement Cash flow statement

Statement of changes Statement of changes

in owner’s equity in owner’s equity

Period 1 Period 2 Time

Note: Balance sheet measures stock of wealth at a particular moment in time (static) Figure 1.6
Other three statements measure flows of wealth over time
Atrill, McLaney, Harvey, Jenner: Accounting 4e © 2008 Pearson Education Australia