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Study Organiser
Topic
(weeks)
1
(1)
Nature and role of accounting Accounting information user groups Accounting as an information system Accounting as a service function Characteristics of accounting information Decision-making, planning and control Overview of the planning and control process Business objectives Financial and management accounting The main financial reports and relationships
2
(2,3)
Nature of sole proprietorships Nature of partnerships Nature of companies Corporate governance and the role of directors Types of companies Analyse the capital of companies Role of the alternative regulatory bodies
3
(3,4,5)
Purpose of the balance sheet Assets definition, recognition, measurement and classification Liabilities in terms of definition, recognition, measurement and classification Nature and classification of owners equity Basic accounting equation Balance sheet formats Factors that influence in a balance sheet Simple balance sheet Analyse balance sheets of reporting entities Limitations of the balance
Discussion questions Additional exercises Review questions Critical thinking Paraphrasing Summarizing Listening & note taking
4
(6,7)
Measuring and reporting financial performance Income statement (profit and loss) Income statement and the balance sheet Profit and loss equation Income statement format Income definition, recognition, classification and measurement Relation definition, recognition, classification and measurement Accrual and cash-based transaction recognition Expense recognition for noncurrent tangible assets Expense recognition for inventory Expense recognition for accounts receivable Income statement
Discussion questions Additional exercises Review questions Summarizing Listening & note taking Critical thinking and analysis skills
5
(9,10)
Importance of cash Define cash and cash equivalents Accrual and cash-based transaction recognition Three external financial reports Cash flow statement Non-cash transactions Recognise the alternative Cash flow statement Reconciliation of net profit Useful of cash flow statement
Discussion questions Additional exercises Review questions Summarizing Critical thinking and analysis skills Report writing Vocabulary activity
6
(11,12)
Define ratio Financial performance and financial position Terms profitability, efficiency, liquidity, gearing and investment Comparison for ratio analysis Ratio formulae Analyse and interpret ratios Limitations of ratios Index or percentage analysis
7
(13)
Working capital Working capital cycle The importance of inventory Controlling asset Controlling and managing holding cash Creditor management
These notes have been adapted from power point slides from Atrill, McLaney, Harvey & Jenner, Accounting: An Introduction, 4th edition, Pearson Education Australia
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8
(14)
Budgeting
Cost behaviour Fixed costs and variable costs Break-even point Concept of contribution Concept of a margin of safety Weaknesses of break-even analysis
9
(15,16)
Define a budget Relation between budgets, corporate objectives and longterm plans Main components of the budgetsetting process Interlinking of the various budgets Main uses of budgeting Construct budgets from relevant data Use a budget Implication of controlling budgets traditionally
(8)
_
(12)
Test 2 (Class 2)
Print version of study organiser Introductory Accounting - study organiser (39.561 Kb)
Topic Notes
Semester 2, 2009
Course Title: Introductory Accounting
Part A: Course Overview
Course Title: Introductory Accounting Credit Points: 12
Course CodeCampus
ACCT2189
Career
School
Course Coordinator: Sonia Magdziarz Course Coordinator Phone: +61 3 9925 5737 Course Coordinator Email:sonia.magdziarz @rmit.edu.au
Course Description Introductory Accounting introduces you to the role of accounting information in business and is taught with the assumption that you have not previously studied accounting concepts and techniques. Introductory Accounting is a compulsory core unit in the Bachelor of Business (Accountancy) degree and is required for membership of CPA Australia and the ICAA for all Faculty of Business students seeking this form of professional recognition.
Objectives/Learning Outcomes/Capability Development Successful completion of Introductory Accounting means that you should be able to identify and understand the most significant critical factors that influence the success or failure of a business. In addition, the course provides an opportunity for you to develop generic capabilities. These include the
These notes have been adapted from power point slides from Atrill, McLaney, Harvey & Jenner, Accounting: An Introduction, 4th edition, Pearson Education Australia Page 4 of 73
ability to: - Analyse, reason logically and conceptualise issues - Identify, understand and interpret basic concepts.
Overview of Learning Activities As an introductory course, learning activities are based on the assumption that set tutorial work will be completed by you prior to attending tutorials. This ensures that valuable discussion, extension of concepts and issues requiring clarification can be attended to in the tutorial.
Overview of Learning Resources You will be advised of the prescribed text for this course and other reading materials upon enrolment. Extra material may be provided or recommended by the teaching team of this course. This material may be supplied in hard copy, and/or via the RMIT internet site called the Learning Hub.
Overview of Assessment Assessment in Introductory Accounting may take the form of an assignment, and/or an in-semester test, and/or an end-of-semester examination.The in-semester assessment is designed to test your comprehension and understanding of the course material. The end-of-semester exam will again test the students ability to identify and understand basic accounting concepts and further, their ability to analyse and interpret basic accounting information. To pass this course you must:
These notes have been adapted from power point slides from Atrill, McLaney, Harvey & Jenner, Accounting: An Introduction, 4th edition, Pearson Education Australia
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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
Figure 1.2 Accounting as a Service Function 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) Characteristics of accounting information
Figure 1.3
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Decision-Making, Planning and Control 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) The nature of control in the decision-making process: Control is the process of making planned events actually occur terms Accounting is useful in control to compare planned outcomes with actual outcomes in commonly specified
Managers can take steps to get the business back on track if variances are highlighted between planned and actual outcomes Overview of the planning and control process:
Consider options
Perform and collect information on actual performance Respond to divergences between plans and actuals, and exercise control Revise plans and budgets if necessary
Figure 1.4
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Business Objectives Some alternative business objectives: 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) 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.) Achieving sustainable development (Achieving economic growth while minimising or eliminating environmental impact and meeting societys 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 ) 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
Financial Accounting Focus Nature of reports Level of detail Restrictions Reporting interval Time horizon Range of information Mainly external General purpose Broad overview
Accounting standards and other regulationsNo restrictions Mainly semi-annual or annual Mainly historical Whenever required Both past and future
Quantifiable in money terms; focus onCan contain non-financial information; less objective and verifiable data focus on objectivity and verifiability
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An Overview of the Main Financial Reports There are four main financial reports: The Statement of Cash Flows (shows the sources and uses of cash for a period) The Income Statement (traditionally known as Profit and Loss; measures and reports how much profit has been generated in a period) The Statement of Financial Position (otherwise known as the Balance Sheet; shows overall net financial position) The Statement of Changes in Owners Equity (shows all changes in owners interest in net assets from transactions during the period)
A Simple Example: Paul starts an office stationery retail business with $100 On the first day, he uses the $100 to purchase office stationery (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? Opening balance $100 - $100 stock purchase + $110 sales = $110 What is the closing cash balance at the end of day 1? Closing cash balance for day 1 is $110 How much did wealth increase as a result of the first days 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 office stationery SOLD is measured against the sales to find profit, not the total cost of the office supplies purchased. 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 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) Summary: Cash Opening balance $100 purchase inventory $100 + sales $110 = Closing cash balance of $100 Wealth (of the owner) Owner invested $100 + Profit $35 = Owners wealth of $135 Wealth (of the total business) Consists of Cash $110 + Inventory $25 = $135
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Some important concepts arise from this example: assets (inventory, cash) revenue expenses profit (matching revenue with expenses) wealth of the owner/owners investment in the business transactions taking place in a business purchase of the wrapping paper sale of the wrapping paper cash being different to profit recognising the relationship between the business and the owner (what happens when the owner undertakes a personal transaction? Is this transaction recorded in the accounting information system?)
Income statement
Period 1 Time
Period 2
Figure 1.6
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Sole Proprietorships
The nature of sole proprietorships: No separate legal entity (as distinct from a separate accounting entity) Limited life (restricted to the period the owner continues to operate the business in) Unlimited liability (the owner is fully responsible for the debts and obligations of the business) Minimum reporting regulations (minimal compared with other entity structures) Limited access to funds (restricted to the personal resources of a single owner) Low establishment costs (comparatively much lower compared to other entity structures) Some advantages of sole proprietorships include: Simple and inexpensive to establish and operate Minimal financial reporting regulations Ownership and management are normally combined Financial rewards flow directly to the owner Timely decision-making is possible
Partnerships
The nature of partnerships: A partnership may be described as the relationship that exists between two or more persons carrying on a business with a view to profit. The relationship may be established by a formal partnership agreement or an informal arrangement
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between the parties, or it may be inferred by the actions of two or more individuals. The partnership maintains individual records of each partners transactions according to: Resource contributions (capital) Resource withdrawals (drawings) Share of undistributed profits (either current or retained earnings)
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The characteristics of partnerships: No separate legal entity Limited life Unlimited liability Mutual agency (each partner is responsible for the actions of the other partners) Co-ownership of assets (the partnership assets are owned by the partners in aggregate, not individually) Co-ownership of profits (equally or in agreed proportions) Limited membership (a restriction on the number of partners allowed. Normally twenty is the limit. Some exemptions exist e.g. accounting practices) Increased regulation (most states have Partnership Acts for direction of activities and rights and responsibilities of partners) Partnership Agreements: Important to have a detailed and formal agreement so that most potential problems can be avoided Issues not covered by the partnership agreement will be governed by law Some examples of default legal rules that an agreement may cover include: No entitlement of partners to a salary or wage Partners not entitled to interest on capital contributed Equal shares of profits and losses
Companies
The nature of companies: There are a number of company types, the most common being the company limited by shares, or limited company A limited company may be defined as: An artificial legal person who has an identity separate from that of those who own and manage it. Ownership interest is broken down into shares hence the term shareholders to describe the owners, who have invested in the business. Characteristics of companies: Separate legal entity (a limited company has the legal capacity of a person and is separate from those who own the entity i.e. can sue and be sued, buy, borrow, lend and employ in its own right as a legal person) Unlimited (perpetual) life (the life of the company is indefinite and not related to the life of the owners) Limited liability (the entity is responsible for its own debts and obligations because it is a legal person. Shareholders obligations cease upon full payment of the agreed price of their shares.) Company ownership of assets (assets owned by the company in its own right as a legal person) Company profits belong to the shareholders (profits are either distributed or retained for the benefit of shareholders) Extensive membership (some forms of companies may be limited, but public companies e.g. Westpac, Telstra often exceed 250,000 initial shareholders) Separation of ownership and management (usually a separate specialist management team exists outside the ownership interest, although increasingly managers are also shareholders)
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Extensive regulation (much stricter requirements due to limited liability benefit granted to owners. Corporations Act, ASIC, ASX, accounting standards all govern reporting to shareholders and markets) Advantages of companies: Separation of ownership and management Perpetual existence Separate legal entity Owners have limited liability Greater access to ownership funding Potentially greater access to debt funding Potential taxation advantages Potential increases in share values when listed on the ASX (Australian Stock Exchange) Disadvantages of companies: Extensive regulation Higher establishment costs Subject to more public scrutiny Owners not able to watch everything Pressure for short-term performance Loss or dilution of original ownership control Income tax is paid on every dollar of profit earned (no tax-free threshold)
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Share Capital
Shares are the basic units of ownership of the business All companies issue ordinary shares which are the main risk-bearing shares of the company. Ordinary shareholders returns come from distributions of profit (dividends) or from increases in the value of the shares Normally, retaining profits will increase the value of ordinary shares Dividends - transfers of assets made by a company to its shareholders Partly-paid shares - shares on which the full issue price has not been paid, but the balance is to be paid in a series of installments or calls Fully paid shares - shares on which the shareholders have paid the full issue price Preference shares - shares which have a fixed rate of dividend that must be paid before any ordinary share dividends can be paid. These have higher priority in the event of the company going in to liquidation Companies may issue shares of various classes with equally various conditions, but ordinary and preference shares are the most common Within each class, all shares must be treated equally Voting rights are normally only ascribed to holders of ordinary shares. One ordinary share normally equals one vote New shares can be issued at any time and they are priced at, or close to, market price. This is to ensure no disadvantage to existing shareholders since all have the same rights
Reserves
Reserves - profits and gains made by the company that have not been distributed to Shareholders. The most common type of reserve is retained profits - profits earned by the company that are held back for use within the company Other reserves may be created in certain circumstances - a reserve is created (asset revaluation reserve) when assets are re-valued at greater than their book value
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Bonus Shares
Bonus shares - reserves which are converted into shares and given free to shareholders - A bonus issue of shares simply takes one form of shareholders equity (reserves) and transforms it into another form (share capital) - Bonus share issues have no impact on the net assets (total assets less total liabilities) of a company Rights Issues To generate additional share capital for expansion, a company may make a rights issue - These are issues of shares for cash, offered first to current shareholders (who may sell the right to others) in proportion to their existing holdings Such shares are normally offered at a price below the prevailing market price to encourage takeup of the offer - Rights issues differ from bonus issues in that rights issues result in an asset (cash) being transferred from shareholders to the company
accounting standards Financial reports must include the balance sheet, the income statement, the cash flow statement, the statement of changes in owners equity and related notes, also the directors declaration and directors report Compliance with Corporations Act disclosure requirements Publish the auditors report (if applicable)
Prepare a simple statement of financial position/balance sheet Analyse statements of financial position/balance sheets of reporting entities State the potential limitations of the statement of financial position/balance sheet in portraying an entitys financial position. Note: the term Statement of Financial Position and Balance Sheet refer to the same report. The names will be used interchangeably in this course.
Assets
Definition: An asset, according to the AASB Framework is a resource controlled by the entity as a result of past events, and from which economic benefits are expected to flow to the entity The main identifying characteristics of an asset are: Expected future economic benefit The business has exclusive right to control the benefit The benefit must arise from some past transaction or event The asset must be capable of reliable measurement in monetary terms Note that these conditions limit the kind of items that may be referred to as assets in financial reports Some examples of items that appear as assets in a business balance sheet include: Freehold premises Machinery and equipment Fixtures and fittings Patents and trademarks Debtors Investments Assets may be either tangible (items with a physical substance) or intangible (no physical substance e.g. patents)
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Liabilities
Definition: A liability according to the AASB Framework is a present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits In addition to meeting the definition on the previous slide, there is a twofold recognition criterion: Probability of occurrence (in the case of liabilities, it is more likely than not that a future sacrifice of economic benefits will occur) Reliability of measurement (in the case of liabilities the amount of the claim can be determined with acceptable precision or accuracy) Some examples of items that appear as liabilities in a business balance sheet include: Creditors Staff entitlements Loans and other credit facilities Warranty provisions and other social or moral obligations Provision for employee bonuses
Owners equity
Assets (cash at bank) by $40,000 Assets (motor vehicle) by $40,000 Overall, there is no change to the accounting equation as the total value of assets remains the same. One asset has simply been exchanged for another. Trading operations (i.e. the sale of goods or services) introduces additional transactions that impact on the balance sheet. To take into account the effect of trading, the balance sheet equation previously described is extended as follows to take into account the impact of income and expenses and changes in owners equity. Recall that this is the basic accounting equation:
then added to owners equity (capital). In summary, three of these accounting elements (assets, liabilities and owners equity) are shown in the Balance Sheet (Statement of Financial Position) while the remaining two accounting elements (income and expenses) are shown in the Income Statement.
AASB 101 Presentation of Financial Statements requires a current asset to be classified according to the following criteria: a) The asset is expected to be realised in, or is intended for sale or consumption in, the entitys normal operating cycle; b) The asset is held primarily for the purpose of being traded; c) The asset is expected to be realised within twelve months after the reporting date; or d) The asset is cash or a cash equivalent unless it is restricted from being exchanged or used to settle a liability for at least twelve months after the reporting date Non-Current assets: Held for the purpose of generating wealth, rather than for resale May be seen as the tools of the business Normally held on a continuing basis for a minimum period of one year Includes goodwill purchased - see page 90
AASB 101 Presentation of Financial Statements requires assets to be classified as non-current if they do not satisfy any of the criteria for being classified as current (previous slide)
d) The entity does not have an unconditional right to defer settlement of the liability for at least twelve months after the reporting date AASB 101 Presentation of Financial Statements also requires that liabilities be classified according to their nature. This classification can be on: Current / Non-Current basis, or The order of liquidity (payment)
The alternative liquidity classification may be used for liabilities if it provides more relevant and reliable information
AASB Framework defines equity as the residual interest in the assets of the entity after deducting all its liabilities. Classification of owners equity: Owners equity is normally classified as follows for a sole trader/sole proprietorship: 1) Capital 2) Drawings Owners equity is normally classified as follows for a partnership: 1) Capital account for each partner 2) Current account for each partner (optional) Owners equity is normally classified in three separate categories for a company: 1) Owners equity contributed (share capital) - represents profits left in the business by the owners 2) Reserves 3) Retained profit It is common to combine categories 2 and 3 into other reserves and then have them listed as sub-categories of other reserves such as (a) retained profits and (b) other reserves. Note: Reserves represent ownership interests in the assets, not the assets themselves. Reserves are not separate deposits of cash available for other purposes.
Curren t Assets
NonCurrent Assets
Curren t Liabiliti es
NonCurrent Liabilitie s
Owner s Equity
Figure 3.2 The Horizontal layout and entity approach The equation for the horizontal form of balance sheet layout Example: page 93 of textbook for Brie Manufacturing (reproduced in lecture notes)
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$ Current assets Cash at bank Trade debtors Inventory Non current assets Motor vehicle Plant and machinery Freehold premises Total assets 12,000 18,000 23,000
Brie Manufacturing Balance Sheet as at 31 December 2008 $ Current liabilities Trade creditors 53,000 Non current liabilities Loan Owners equity Opening balance Add profit 94,000 147,000 Less drawings Ending balance Total liabilities and owners equity
$ 37,000 50,000
87,000 19,000 30,000 45,000 50,000 14,000 64,000 4,000 60,000 147,000
Source: Accounting-An Introduction, 4th edition, Atrill, McLaney, Harvey & Jenner, Pearson Education Australia 2009
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NonCurrent Assets
Curren t Liabiliti es
NonCurrent Liabilitie s
= Capital
Figure 3.3 The Vertical layout and proprietary approach The equation for the vertical form of balance sheet layout Example: page 94 of textbook for Brie Manufacturing (reproduced in lecture notes) Brie Manufacturing Balance Sheet as at 31 December 2008 $ Current assets Cash at bank 12,000 Trade debtors 18,000 Inventory 23,000 Non current assets Motor vehicle Plant and machinery Freehold premises Total assets minus Current liabilities Trade creditors Non current liabilities Loan Total liabilities Net assets equals Owners equity Opening balance Add profit Less drawings Ending balance 50,000 14,000 64,000 4,000 60,000 37,000 50,000 87,000 60,000 19,000 30,000 45,000 94,000 147,000
53,000
Source: Accounting-An Introduction, 4th edition, Atrill, McLaney, Harvey & Jenner, Pearson Education Australia 2009
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Business Entity Convention: Holds that for accounting purposes, the business and its owner(s) are treated as separate and distinct Money Measurement Convention: Holds that accounting should only deal with those items which are capable of being expressed in monetary terms Historic Cost Convention: Holds that assets should be recorded at their historic (acquisition) cost Going Concern (Continuity) Convention: Holds that the business will continue operations for the foreseeable future i.e. no intention or need to liquidate the business Dual Aspect Convention: Holds that each transaction has two aspects and that each aspect must be recorded in the financial statements Conservatism / Prudence Convention: Holds that financial reports should err on the side of caution vis--vis, anticipating losses but only recognising realised profits Other conventions include: Stable monetary unit convention, Objectivity / reliability convention, Accounting period convention, Realisation convention and Matching convention. Further details are on pp 101 - 103
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Accounting Standards:
The history and significance of accounting standard setting in Australia is covered in detail in chapter 2 Regarding the balance sheet, there are numerous standards that directly affect recording and reporting assets, liabilities and owners equity The implications of the applicable Australian Accounting Standards will continue to be considered
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Remember: this is an extension of the basic accounting equation of A = OE + L As a result of the relationship between the income statement and two consecutive balance sheets, profit and loss can be calculated for a period based on the stock approach The stock approach computes profit and loss by adjusting the change in net assets for the period by other changes in owners equity in the period The equation for the stock approach is:
Profit (or Loss) = (Aend - Abeg) - (Lend - Lbeg) - New contributions + Owners distributions +/- Other changes in owners equity The stock approach can be used to check the accuracy of the transaction approach where income less expenses is used to calculate profit. It can also be used where there are incomplete records and may be used by insurance assessors or the Australian Taxation Office.
NOTE: you will not be required to calculate profit using the stock approach. You will need to be aware of the theoretical aspects of the stock approach.
Simple reports:
For smaller organisations, may be just a listing of income and expenses in alphabetical or financial magnitude order Example: page 145 of textbook for Newlands Soccer Club and reproduced in lecture notes.
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Classified reports:
Relate to larger organisations and often called the classified financial report. Income and expenses are not simply listed, but grouped into categories Income would normally be broken down into sales, and other revenues
Expenses are often broken down into four categories: 1. Cost of sales 2. Selling and distribution 3. Administration and general 4. Financial Example: page 147 of textbook for Hi-Price Stores
Hi-Price Stores
Income Statement for the year ended 31 October 2008 $ Sales Less Cost of sales Gross profit Other revenue Interest from investments Rent from properties Less Expenses Selling and distribution Advertising Commissions Delivery Display Salary and wages Administration and general Salary and wages Rates Heat and light Telephone and postage Insurance Repairs and maintenance Motor vehicle running expenses Depreciation plant and equipment Depreciation motor vehicles Depreciation buildings Financial Interest Bad debts Total expenses Net profit $ 432,000 254,000 178,000 7,000 185,000
2,000 5,000
5,000 4,000 3,000 2,000 37,000 41,000 2,000 3,000 2,000 1,000 5,000 4,000 1,000 2,000 3,000 3,000 7,000
51,000
Regulatory reports:
Required to be produced by companies and other entities in accordance with statutory standards AASB 101 Presentation of Financial Statements requires that the income statement should classify expenses according to their nature or function Refer to page 149 for a list of AASB 101 requirements For external reporting, the reporting cycle is normally one year
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For internal functions, it is common for profit figures to be prepared on a monthly basis Example: page 150/151 of textbook
Revenue earned for the period is greater than the cash received for the revenue (accrued revenue)
For example, a business earns rental income from renting out part of their premises but there is an amount of rental income that relates to the current financial period but has not been received. Hence, the revenue has been earned but has not been received so it should be recognised as revenue in the current financial period. In this case, the revenue account is increased and a temporary asset is created for the amount that is owed to the business and appears in the balance sheet as effectively it is an asset at the date of the balance sheet
The amount received for the revenue is greater than the revenue earned for the period (prepaid / unearned revenue)
For example, a business earns rental income from renting out part of their premises and the tenant has paid the rent in advance of which part of this amount relates to the next financial period. In this case, the revenue account is decreased and a temporary liability is created for the unused amount and appears in the balance sheet as effectively it is an amount that has been received but not earned at the date of the balance sheet
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In the next period, the prepayment will cease to be an liability and become revenue in the income statement in the period it relates to
It is common for adjustments to be made to accounting information prior to it being published in the financial reports. These adjustments are known as balance day adjustments. The adjustments are required to ensure that expenses incurred are reflected in the Income Statement for the period rather than expenses paid when using the cash basis for revenue recognition. The need for such adjustments arises where: An expense incurred for the period is greater than the cash paid for the expense The amount paid for an expense is greater than the expense incurred for the period
An expense incurred for the period is greater than the cash paid for the expense (accrued expense)
For example, the wages account may show the total wage expense however the next pay period occurs in the new financial year. However, we are unaware that a portion of the wages to be paid next financial year have actually been used up in the current financial year and therefore should appear as wages expense in the current year. In this case, the wages account is increased and a temporary liability is created for the unpaid amount and appears in the balance sheet as effectively it is an unpaid expense at the date of the balance sheet
The amount paid for an expense is greater than the expense incurred for the period (prepaid expense)
For example, some expenses may be paid in advance (such as insurance, advertising) but not all of the amount paid may have been used up/consumed by the end of the financial year. In this case, the expense account is decreased and a temporary asset is created for the unused amount and appears in the balance sheet as effectively it is an amount that has been paid but not used up at the date of the balance sheet In the next period, the prepayment will cease to be an asset and become an expense in the income statement in the period it relates to
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Profit measurement
We will now look at three common assets and how they impact on expense recognition: Non-current tangible assets (depreciation expense) Inventory (cost of goods sold) Accounts receivable (bad and doubtful debts)
P = (1 n
R ) x 100% C
where P = the depreciation percentage, n = the useful life (in years), R = the residual value, and C = the cost of the asset
NOTE: you will not need to use the accelerated depreciation formula to calculate the depreciation percentage in the exam. If you are asked to use the accelerated depreciation method, the depreciation percentage (P) will be provided to you.
Units of production based depreciation: Depreciation based on productive capacity of the asset and its use over time
Depreciation:
Depreciation methods should be selected to be appropriate to the particular assets and to their use in the business. Accounting standard AASB 116 - Property, Plant and Equipment reinforces this view Depreciation does not provide funds for asset replacement, it is used to calculate net profit Depreciation is an example of an accounting process that requires a lot of judgement
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What is the basis for transferring the inventory cost to cost of sales/cost of goods sold?
Where inventory movements are difficult to trace, assumptions can be made about the physical flow of inventory through the business. These assumptions are: First in First out (FIFO) - the earlier inventory held is the first to be sold Last in First out (LIFO) - the latest inventory held is the first to be sold (not permitted in Australia) Average Cost - a weighted average cost is determined, to derive cost of sales and cost of remaining inventory held
AASB 102 Inventories requires valuing inventory on the basis of the lower of cost and net realisable value on an item-byitem basis. Inventory valuation and depreciation are good examples of where the consistency convention should be applied. Consistency convention: holds that when a particular method of accounting is selected to deal with a transaction, this method should be applied consistently over time
Note: from a practical perspective, you are only expected to undertake practical examples regarding use of the FIFO and average cost assumptions as part of the inventory section just covered.
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Interpreting the Income Statement How the final net profit figure was derived can be found by: analysing sales levels - against history and planned sales for the current/future periods examining the nature and amount of expenses incurred comparison against history and future indicator of efficiency of business operations investigating gross profit levels in relation to sales in similar businesses helpful in assessing profitability and margins analysing net profit levels, for example against previous periods and also in relation to sales
Balance sheet and profit and loss reports show movements in wealth and the net increase or decrease in wealth for the period concerned The cash flow statement is required to be produced because the above two reports do not concentrate sufficiently on liquidity (cash flow) The accrual nature of the above two reports are thought to obscure the question of how and where a company is generating the cash it needs to continue operating Cash and Cash Equivalents Cash represents cash on hand and demand deposits Cash equivalents represent short-term, highly liquid investments that can readily be converted to a fixed amount of cash Examples include: - Cash at Bank - Bank Overdraft - Short-term Money Market Deposits - Bank Bills
Cash vs Accrual Transaction Recognition Cash-based - Revenue is recognised when cash is received and expenses are recognised when cash is paid Accrual-based - Revenue is recognised when it is earned and expenses are recognised when they are incurred Accrual-based accounting removes the distortion of the entitys performance from the cash-based system and reflects the economic reality of what has been earned Differences between the Three External Financial Reports Balance Sheet static report made at a given point in time and based on balances in assets, liabilities and owners equity, normally based on accrual transactions Income Statement (Profit & Loss) measures the financial performance over a period of time - normally one year, related to revenues earned less expenses incurred Cash flow statement identifies all cash receipts and cash payments for the period. All account types are included and is based on cash, not accrual transactions
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Income statement
Figure 5.1 - The relationship between the balance sheet, the income statement and the cash flow statement
The Cash Flow Statement The cash flow statement is basically an analysis of the business cash movements over the period concerned All payments of a particular type are added together to give just one figure, which appears in the statement The net total of the statement is the net increase or decrease in cash of the business over the period
The three components of the cash flow statement are: Operating activities - represents net inflows from operations. Only cash received and paid, not expenses earned and revenue incurred, are featured (that is, cash flows associated with the operating activities of the business) Investing activities - concerned with cash payments to acquire additional non-current assets, and cash receipts from the disposal/sale of such assets e.g. plant and machinery, shares etc (that is, cash flows from changes in Non Current Assets and Investments) Financing activities - deals with financing the business excluding short-term credit e.g. debt and equity sources, share issues, repayment of debt etc (that is, cash flows from changes in Non Current Liabilities and Equity)
Items which may appear under more than one section of the cash flow statement: Interest Paid, Interest Received and Dividends Received Interest paid may be shown under Operating Activities (because it is used to help determine profit or loss) or under Financing Activities (because it is a cost of obtaining financial resources). Interest received and dividends received can be shown under operating activities (because they help determine profit or loss) or under investing activities (because they are returns on investment).
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Net increase or decrease in cash and cash equivalents over the period
Non-cash Transactions
Non-cash transactions are transactions that do not directly involve cash Most relate to the operating activity section of the cash flow statement and are linked to the difference between cashbased and accrual-based transactions Examples - depreciation, revaluations, doubtful debts, accruals (receivables, inventory, prepayments, payables, gains or losses on disposal of non-current assets) etc Some relate to the investing and financing activity section e.g. direct exchanges such as shares for assets, non-current assets for reduction in debt, bonus issues from reserves etc
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Preparation of the Cash Flow Statement - an Overview Can be produced in two ways: 1. Independently viewing the cash receipts and cash payments for the period and allocating transactions to the different activities and categories 2. Reconstructing the income statement by tracking the changes in the balance sheet for the period and eliminating accrual transactions so that only cash transactions remain, forming the basis for preparing the cash flow statement. The information can be reconstructed in the following ways: Schedule approach using additions and subtractions Ledger reconstructions Worksheets You will only be expected to use the first approach to prepare a Cash Flow Statement. You will not be expected to use method 2 to prepare a cash flow statement. Preparation of the Cash Flow Statement - a Simple Example Refer to Example 5.1 on page 231 for detailed information on how reconstructions are used to prepare a cash flow statement. You will not be expected to use these reconstructions in this course. However you may be interested in these calculations as a matter of interest. Cash flow statement for the year ended 30 June 2009 $m Cash flows from operating activities Cash receipts from customers Cash payments to suppliers and employees Interest paid Income taxes paid Net cash provided by operating activities Cash flows from investing activities Purchase of property, plant and equipment Net cash used in investing activities Cash flows from financing activities Proceeds from issue of share capital Proceeds from long-term borrowings Dividends paid Net cash provided by financing activities Net decrease in cash and cash equivalents held Cash and cash equivalents at the beginning of the financial year Cash and cash equivalents at the end of the financial year Reconciling Cash from Operations with Operating Profit Purpose of reconciliation is to reconcile the net operating profit or loss after tax with the cash flows from operating activities The starting point is the operating profit after tax We then effectively add back the depreciation charged in arriving at that profit and adjust this total by movements in non-cash current asset and current liability accounts to arrive at cash flow from operations 95 (80) (3) (4) 8 (20) (20) 15 5 (15) 5 (7) 12 5 $m
Refer Example 5.1 on page 231 for data. Reconciliation would be as follows: Operating profit after tax $m 10
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Depreciation Increase in inventory Increase in accounts receivable Increase in accounts payable Increase in tax payable Net cash flow provided by operating activities
5 (8) (5) 5 1 8
You will not be expected to prepare this reconciliation but you will need to be aware of it. What Does the Cash Flow Statement Tell Us? The cash flow statement tells us how the business has generated cash during the period and where that cash has gone Tracks the sources and uses of cash over time, which is indicative of trends and useful for predicting future opportunities and patterns of cash flow Provides an insight to working capital management Is a good indictor of debt management practices Identifies non-operational cash flows
Required activities For this topic, you are expected to have completed, as a minimum, Discussion Questions 5.5, 5.6, 5.8, 5.9, 5.15, 5.18. Application Exercises 5.1 These questions are on pages 256 to 258 of the text book Accounting, an introduction 4th Edition by Atrill, McLaney, Harvey and Jenner. The answers to these questions are available on the Learning Hub.
The key aspects of financial performance / position evaluated by the use of ratios are: Profitability Efficiency Liquidity Gearing Investment
Financial Ratio Classification Profitability - Measure of success in wealth creation Efficiency - Effectiveness of utilisation of resources Liquidity - The ability to meet short-term obligations Gearing - Measure of degree of risk to do with the amount of leverage used to finance the business Investment - Measure of the returns and performance of shares held by a business The alternative bases of comparison for ratio analysis Bases (benchmarks) that may be used as a basis of comparison for ratio analysis include: Intertemporal - Based on past performance Budget - Based on planned performance Intra-industry - Based on comparison of performance with other firms in the same industry A calculated ratio on its own does not say much about a business - it is only when it is compared with some form of benchmark that the information can be interpreted and evaluated The Key Steps in Financial Ratio Analysis Step 1: Identify which key indicators and relationships require examination Identify who needs the information and why they need it Step 2: Choose the most relevant set of ratios that will accomplish the desired purposes Calculate and record the results using the selected ratios Step 3: Interpret and evaluate the results
Common ratios that we will consider now follow that illustrate the name of the ratio, a description of the ratio, the ratio formula and the terms in which the ratio is often expressed, for example, %, times, etc. Note that we will not be focusing on the Investment Ratios in any great detail.
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Return on (ROA):
total
assets
ROA = Net profit before interest and taxation x 100 Average total assets
Normally expressed as a percentage x 100 Normally expressed as a percentage Normally expressed as a percentage
Net profit margin = Net profit before interest and taxation Sales
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Calculates how long, on average credit customers take to pay amounts owed
Calculates how long, on average the business takes to pay its creditors Examines how effectively the assets of the business are being employed in generating sales revenue
Average asset turnover period = Average total assets employed x 365 Sales
The Relationship Between Profitability and Efficiency The overall return on funds employed in the business will be determined both by the profitability of sales, and by efficiency in the use of assets
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Acid test (also known as the quick or liquid) ratio: Cash flows from operations ratio:
Represents a more stringent test of liquidity than the current ratio Compares the operating cash flows with the current liabilities of the business
Acid test ratio = Current assets (excluding inventory & prepayments) Current liabilities
Expressed in terms of the number of times the liquid current assets will cover the current liabilities Expressed in terms of the number of times the operating cash flows will cover the current liabilities
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Description Measures the contribution of long-term lenders to the long-term capital structure of the business Measures the amount of profit available to cover interest expense of the business
Formula Gearing ratio = Long term liabilities x 100 Share capital + Reserves + Long-term liabilities Expressed in terms of a percentage
Interest cover ratio = Profit before interest and taxation Interest expense
x 100
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Trend Analysis Trends may be identified by plotting key ratios on a graph, giving a visual representation of changes happening over time Intra-company trends may be compared against industry trends Key financial ratios are often published in companies annual reports as a way to help users to identify important trends
Ratios and Prediction Models Ratios are often used to help predict the future however the choice of ratios and interpretation of results depend on the judgment of the analyst Researchers have developed ratio-based models which claim to predict future financial distress as well as vulnerability to takeover The future is likely to see further ratio-based prediction models developed to predict other aspects of financial performance
Limitations of Ratio Analysis The quality of the underlying financial statements determines the usefulness of the ratios derived from them Ratios only offer a restricted view of relative performance and position - not the full picture No two businesses are identical and the greater their differences, the greater the limitations of ratio analysis as a basis for comparison Any ratios based upon balance sheet figures will not be representative of the whole period because the balance sheet is a snapshot of a moment in time Index or Percentage Analysis Index or Percentage analysis simply allows monetary figures to be replaced with an index or a percentage as an alternative to ratio analysis There are three alternative index or percentage methods: 1. The common size reports (also known as vertical analysis) 2. Trend percentage 3. Percentage change (also known as horizontal analysis)
Illustrate the working capital cycle Demonstrate the importance of inventory and the techniques available to manage this asset efficiently Discuss the provision of credit to customers and use various management tools to monitor and control this asset Explain the reasons for holding cash, and the basis of management and control Summarise the key aspects of creditor management
Cash sales Finished Goods Trade Receivabl es Raw Material s Inventor ies
Work in Progress
Trade Creditor s
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The management of working capital is an essential part of the short-term planning process There are costs incurred by holding too much and too little of each element Costs include opportunity cost of using these elements elsewhere Needs are likely to change over time Change may be externally driven or result from changes to the internal environment
Forecasts of future demand: Accurate forecasts are key Can use statistical approaches or judgment of staff / managers Financial ratios:
Recording and re-ordering systems: Efficiency is key, should be monitored regularly Decision authority should be confined to a few senior staff Lead-times and likely demand should be determined Buffer levels to deal with uncertainty should be determined
Levels of control: ABC system - a method of applying selective levels of control to different categories of inventory High levels of control and recording would apply to high-value, low-volume A items Lower levels of recording would apply to lesser-value, higher-volume B items Lowest levels of control and recording would apply to low-value, high-volume Category C items
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Stock / inventory management models: Economic order quantity (EOQ): Recognises that total cost includes holding and ordering costs Calculates the optimum size of the order, taking these two components into account Decreasing inventory held means an increase in order costs as the number of orders rises in the period EOQ seeks to identify the size of the order that will minimise the total costs
Figure 13.4 - Inventories holding and order costs The EOQ model:
EOQ =
2DC H
where: D is the annual demand for the item of stock C is the cost of placing an order H is the cost of holding one unit of stock for one year Some limiting assumptions apply to the model: That demand for the product can be predicted with accuracy Demand is even over the period with no fluctuations
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Materials requirements planning (MRP) systems: Begins with forecasting sales demand Technology schedules delivery of bought-in parts to coincide with production requirements By ordering those items of inventory necessary for production, inventory holding costs may be reduced Recognises that ordering decisions cannot be made independent of production decisions Newer systems also take account of other resources such as labour and machine capacity
Just-in-time (JIT) stock / inventory management: Aims to have materials delivered to production just in time for their required use Limits holding time and investment in raw materials Suppliers are informed of production requirements in advance Some disadvantages: May mean inventory is more expensive Risk of non-supply
Which customers should receive credit? The five Cs of credit: 1. Capital - must appear to be financially sound (liquidity risk) before credit is offered 2. Capacity - must seem able to pay amounts owing (examine payment record / history) 3. Collateral - can the customer offer satisfactory security if required 4. Conditions - how the industry and general economic environment the customer operates in affects their ability to pay amounts owing
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5. Character - a subjective assessment made by the business of factors such as honesty, integrity etc. Length of credit period: The length of credit offered varies and may be influenced by factors such as: The typical credit terms operating in the industry The degree of competition in the industry The bargaining power of particular customers The risk of non-payment The capacity of the business to offer credit The marketing strategy of the business An alternative approach is to view the credit decision as a capital investment decision, using the NPV investment appraisal method Cash discounts (early settlement): The cost must be weighed against the benefits Danger that customers will be slow to pay and still take the discount offered The benefit represents a reduction in the cost of financing debtors and bad debts Collection policies: Steps to ensure amounts owing are paid promptly may include: Develop customer relationships Publicise credit terms Issue invoices promptly Monitor outstanding debts Produce a schedule of aged debtors (refer example below) Answer queries quickly Deal with slow payers Identify the monthly pattern of receipts from credit sales Example of Schedule of Aged Debtors Ageing schedule of debtors at 31 December Days outstanding 1-30 days 31-60 days 61-90 days $ $ $ 20,000 10,000 24,000 12,000 13,000 14,000 32,000 47,000 14,000
Source: Accounting An Introduction 4th edition, Atrill et al, Pearson Education Australia, page 656.
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Why hold cash? Most businesses hold cash but the amount held varies considerably There are three reasons for holding cash: Transactionary Precautionary Speculative How much cash should be held? No set formula - different businesses will have different views Amount held can be reduced if funds can be raised quickly or assets held that can be converted to cash such as shares or bonds Controlling the cash balance Use of upper and lower control limits: Assumes business can access cash as needed The model proposes the use of two upper and two lower limits If an outer limit is exceeded, managers must decide if the balance is likely to return over the next few days to within the inner limits, if not, cash must be bought or sold to restore the cash balance to within limits Model relies heavily on management judgement to determine where the control limits are set and what time limits for breaches are acceptable
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Figure 13.5 - Controlling the cash balance Cash flow statements and management of cash: It is useful for a business to a prepare cash flow statements and / or a cash budget Comparison of budgeted cash flows to cash flow statements will identify variances for action Expected cash surpluses and deficits can have a course of action decided upon by management prior to them occurring Operating cash cycle: Definition: The time period between the outlay of cash to purchase supplies and the ultimate receipt of cash from the sale of goods To effectively manage cash, there must be awareness of the operating cash cycle Management seeks to shorten the time and reduce cash required in the cycle Cash transmission: Benefit is received immediately when payment is made in cash Cheques normally incur a delay of up to ten working days to clear through the banking system Opportunity cost of this delay can be significant
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Alternatives to minimise delays can include: - Insist on payment in cash (not always practical) - Utilise direct debit facilities and card payments Are simply a type of bank loan Can be useful for managing cash flow requirements
Bank overdrafts:
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+
Average settlement period for debtors (days)
= Average trade debtors x 365 Credit sales
Explain the importance of a detailed understanding of cost behaviour Distinguish between fixed costs and variable costs Use knowledge of this distinction to deduce the break-even point for some activity Explain why knowledge of the break-even point is useful Explain and apply the concept of contribution Explain the concept of a margin of safety Identify the weaknesses of break-even analysis Explain and apply the idea of relevant costing Make decisions using knowledge of the relationship between fixed and variable costs.
Fixed (those that stay the same when the volume of activity changes) Variable (those that vary in accordance with the volume of activity)
Both types of costs are often associated with an activity, hence the importance to the decisionmaking process of understanding the quantity and impact of both.
Fixed Costs
As the volume of activity increases, the fixed costs stay
Figure 7.1
Fixed costs: likely to change as a result of inflation or general price increases but not as a result of change in volume of activity are almost always time-based i.e. they vary with the length of time concerned do not stay unchanged irrespective of level of output. They often must increase to allow higher output levels
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Figure 7.2
Variable Costs
Figure 7.3 The graph above suggests that costs are linear, i.e. normally the same per unit of production irrespective of the number of units produced. In some cases the line is not straight as higher volumes of activity may introduce economies of scale, thus changing the variable costs line as production increases
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The slope of this line gives the variable cost per unit of activity
Break-even analysis
We have established that with fixed costs, increase in activity does not have any bearing on total cost. We also know that variable costs will increase on a per unit basis as activity increases. Break-even point occurs where total revenues equal total costs.
Break-even point can be calculated as follows: Fixed Costs (Sales Revenue per Unit Variable Cost per Unit)
Figure 7.6 Example 7.1 (refer page 358) Fixed Costs = $1,500
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Variable Costs = $6 + $18 = $24 Sales revenue per unit sold = $30 = 150 ($30-$24) 250 units per month
Contribution
Contribution per unit - Sales revenue per unit less variable costs per unit (bottom part of the break-even formula) Marginal cost - The addition to total cost which will be incurred by producing one more unit of output Break-even point can be calculated as:
Profit-Volume Charts
Obtained by plotting profit or loss against volume of activity The slope of the graph is equal to the contribution per unit As level of activity increases, the amount of the loss gradually decreases until the break-even point is reached Beyond the break-even point, profits increase as activity increases
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Profit ($)
Break-even point
Volume of activity
Fixed cost
0
Figure 7.8
Note: you will not be expected to draw a profit-volume chart in the exam
Margin of Safety and Operating Gearing
Margin of safety is the difference between output activity and the break-even activity level. Operating gearing is the relationship between contribution and fixed costs. An activity with relatively high fixed costs compared with its variable costs is said to have high operating gearing
Making the most efficient use of scarce resources Deciding whether to make or buy Deciding whether to close or continue a section
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It is common for businesses to account separately for each department or section in order to assess the relative effectiveness of each one Example 7.7 (page 378) Looking solely at trading results it would seem that the general clothes department is running at a loss to the overall business Further analysis shows that the department makes a positive contribution If the general clothes department is closed, Goodsports Ltd would be worse off to the value of the contribution made
Required activities
These questions are on pages 381 to 388 of the text book Accounting, an introduction 4th Edition by Atrill, McLaney, Harvey and Jenner. The answers to these questions are available on the Learning Hub.
Topic 9 - Budgeting
Learning Objectives Define a budget Explain how budgets, corporate objectives and long-term plans are related Set out the main components of the budget-setting process Explain the interlinking of the various budgets in the business Identify the main uses of budgeting Construct budgets from relevant data Use a budget to provide a means of exercising control over the business Identify the limitations and the behavioural implications of the traditional approach to control through budgets and standards
Relevant parts of Chapter 9 are: Pages 437 449 Pages 453 457 Pages 464 471
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Note that we will be focusing on the Cash Budget. In terms of exercising control over the business, we will look theoretically at flexible budgets, variances and standards but you will not be expected to prepare a flexible budget or calculate the variances mentioned in your textbook. This is done in further detail in ACCT1060 Management Accounting and Business.
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Consider options
Figure 9.1
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In a business, there is not one budget, but several - each relating to a specific aspect of the business Ideally, there should be a separate budget for each person in a managerial position
Cash budget
Sales budget
Overheads budget
Production budget
This may seem a little confusing so looking at a Master Budget for a Manufacturer (next diagram) might help to make more sense of this interrelationship between the budgets.
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Production Budget
Direct materials usage and purchases budgets Direct labour budget Manufacturing overhead budget
Capital budget
Adapted from Jackling, Raar, Williams & Wines, 2007, Accounting a Framework for Decision Making, McGraw-Hill p.718
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1.
Establish who will take responsibility for the budget-setting
6.
Review and co-ordinate the budgets
7.
Prepare the master budgets
process
2.
Communicate budget guidelines to relevant managers
5.
Prepare draft budgets for all other areas
8.
Review and co-ordinate the budgets
3.
Identify the key or limiting factor
4.
Prepare the budget for the area of the limiting factor
9.
Monitor performance relative to the budgets
Budget committee - a group of managers formed to supervise and take responsibility for the budgetsetting process Budget officer - an individual, often an accountant, appointed to carry out or take responsibility for having carried out the tasks of the budget committee Top-down - an approach to budgeting where senior management originates the budget targets Bottom-up - most of the budget input comes from lower level staff such as sales representatives
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Budgets
Using Budgets for Control Control is usually seen as making events conform to a plan Budgets represent the plan and therefore provide the basis for exercising control over the business The planning and control process usually follows a sequence which is illustrated on the following slide
Identify objectives
Consider options
(This is figure 9.4 in your textbook it just looks a little different but contains the same steps).
selling price is $100 for every unit of output. (Atrill et al., p. 464). They are developed from experience and require frequent reviews and possibly revisions and they need to be as realistic as possible. A flexible budget can be prepared (i.e. Can flex the budget) o Revise the budget to reflect actual volume of output using the same standards as when the original budget was prepared o Then the flexed budget is compared with actual figures to determine variances between items in the budget Specific variances can be calculated and analysed to assist in decision making. These variances include: o Sales volume variance o Sales price variance o Materials variance o Labour variances o Fixed overhead variances Variances can be adverse (unfavourable) or favourable and significant or insignificant o Small variances (favourable or unfavourable) are not unexpected o Significant adverse variances should be investigated but organization needs to decide what significant means to them o Significant favourable variances should also be investigated as they may indicate that target is too low o Insignificant favourable or unfavourable variances should be monitored o Policy needed to determine which variances to investigate as there is a cost/benefit issue with investigating minor variances o Variances do not solve an issue; investigation of variances can only highlight issues o Adverse variances may occur because standards used to construct the budget are not realistic but it should not be assumed that this is the cause investigation is required to determine the cause of adverse variances.
Time consuming and costly to put together Budgets are rarely strategically focused Budgets are out of touch with the needs of modern business
Budgets dealing with Increases in technology may lead to more centralisation at the cost of greater involvement
Budgets may make people feel under-valued A system of accountability may create a counterproductive atmosphere of blame and mistrust When managers are in a position to influence budget figures, the danger of bias exists
Review
Any budgetary control system set up must ensure that: The environment the business operates in is fully understood; The business develops an appropriate culture; The role of the budget in terms of its fit with the strategic plan is clearly understood; A culture of value-adding is developed
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