Chapter 1: Accounting in Action Flashcards
What highighted the importance of fatihful representation of fnancial reports?
HIH Insurance Limited and One.Tell. Then later on the GFC as well as the collapse of Westpoint and Centro.
What has been the regulatory response as a result of corporate collapses increasing?
A number of proposals to improve business practices and accouting overssights have been put forward (from government, professional associations, regulators and the investment community).
What is a example of the governments regulations introduced to combat major business failure (attempt to correct market inefficiencies)?
Corporate Law Economic Reform Program (Audit Reform and Corporate Disclosure) Act 2004 (Cwlth).
It initiatied major financial reporting and audit reform and came into use on 01/July/2004.
What has corporate law recognised for some time?
That financial reports do not provide all the information that investors need in order to make informed decisions.
What does S299 of the Corporations Act. set out?
It sets out the required content of directors’ reports, and for listed entities, it requires that the directors’ report must contain information that shareholders would reasonably require to make an informed assessment of the entity’s financial position, and importantly, their business strategies and prospects for future financial years.
What is an OFR?
This is an Operating and Financial Review.
This is a key part of annual reporting by listed entities. An OFR provides an overview that enables shareholders to understand the entity’s business performance and the factors underlying its results and financial position.
What is accounting?
Accounting is an information system that identifies, records and communicates the economic events of an entity to interested users.
Explain the following factor of accounting: identifying.
Identifying economic events involves selecting the economic activities relevant to a particular entity.
The sale of running shoes and sporting attire by Nike, the providing of services by Jim’s Group, the payment of wages by Ford Motor Company, and the collection of ticket sales and the payment of expenses by major sporting clubs are examples of economic events.
Explain the following factor of accounting: recording.
Once identified, economic events are recorded to provide a history of the entity’s financial activities.
Recording consists of keeping a systematic, chronological diary of events, measured in dollars and cents. In recording, economic events are also classified and summarised.
Explain the following factor of accounting: communicating.
The identifying and recording activities are of little use unless the information is communicated to interested users.
Financial information is communicated through accounting reports, the most common of which are called financial statements. To make the reported financial information meaningful, accountants report the recorded data in a standardised way. Information resulting from similar transactions is accumulated and totalled.
For example, a company’s sales transactions are accumulated over a certain period of time and reported as one amount in its financial statements. Such data are said to be reported in the aggregate.
What happens when the recorded data is presented in the aggregate?
By presenting the recorded data in the aggregate, the accounting process simplifies a multitude of transactions and makes a series of activities understandable and meaningful.
What is a vital element in communicating economic events?
A vital element in communicating economic events is the accountant’s ability to analyse and interpret the reported information.
Analysis involves the use of ratios, percentages, graphs and charts to highlight significant financial trends and relationships. Interpretation involves explaining the uses, meaning and limitations of reported data.
Financial statements will be referred to in a number of chapters of this book.
The role of accounting (language of business).
Accounting is often referred to as the ‘language of business’. The purpose of accounting is to assist people, whether internal or external to an entity, to make decisions about the allocation of scarce resources.
Why is the information provided through accounting important?
This information is important so that the users of such information can make informed decisions.
The role of accounting (communication).
Accounting is a means of communication, as it provides information that assists users to understand where the entity has been by looking at its past performance, to understand where it is now by looking at its current financial position, and to provide insight into what its likely future prospects are.
The role of accounting (measuring business activity).
Accounting is a means of measuring business activity and processing this information into reports to communicate results to decision makers. For the information to be useful, it must be relevant and faithfully represented (reliable).
The role of accounting (communication tool).
More specifically, accounting, as a communication tool, also enables internal users (i.e. management) to assess and analyse information to gain insight, especially if the entity is not performing as well as anticipated.
In these instances, through regular reporting, management can identify what may have gone wrong and what to do to get the entity back on track.
Many would say the information provided by an entity’s accounting system is the most important single source of information for financial decision makers.
The role of corporate governance in enhancing the the quality of financial reporting.
Financial failures and collapses, as identified in the scene setter at the beginning of this chapter, cost investors billions of dollars.
These failures impact employees and creditors of those entities, and undermine public confidence in accounting information and reports. As a result, corporate governance has become a focus of regulatory attention around the world.
What is corporate governance?
Corporate governance can be defined as the system in which entities are directed or controlled, managed and administered.
It influences how the objectives of a company are set and achieved, how risk is monitored and assessed, how performance of the entity is optimised and how management is held to account.
Much government regulation is designed to encourage good corporate governance. Governance is largely about the decision-making process of the entity, ensuring that the goals and hence the decisions made by management are aligned with those of shareholders (i.e. capital providers).
What happens if good corporate governance practices are followed?
If good corporate governance practices are followed, investors may be better protected from opportunistic behaviours of managers who may not act in the best interest of stakeholders.
Good corporate governance such as increased transparency through the disclosure of information and effective monitoring should enhance the perception, reputation and prosperity of the entity, as well as assisting management to maximise operational performance.
Why is corporate governance important?
There are various participants who have an interest in the entity and who determine and influence the direction and performance of the entity, namely, for a company, shareholders, management and the board of directors.
What is the agency theory?
Agency theory:
. Investors typically do not manage companies, particularly public companies: managers are entrusted with this decision-making authority on behalf of shareholders.
. The principal (shareholders) delegates its decision rights to the agent (management) to act in the principal’s best interest.
The separation of ownership and control, which implies a loss of effective control by shareholders. If the interests of those who manage the entity differ from those who own the entity, there is the potential for profits to be diverted away from the best interests of shareholders.
Agency theory and corporate governance.
Good corporate governance principles and practices such as effective monitoring and transparency through the disclosure of information means shareholders can monitor the performance of management and thus reduce the incidence of divergent behaviour.
What are the Australian Securities Exchange’s (ASX) Corporate Governance Principles and Recommendations in 2003?
It includes eight core principles that underlie good corporate governance.
While these recommendations are not mandatory and cannot, by themselves, prevent corporate failures or mistakes in decision making, they can provide a reference point for companies to optimise performance and accountability and minimise risks.
The 8 principles.
Page 7-8.
Three important changes to the 8 principles in 2014.
Page 8.
Financial reporting and corporate governance.
Page 8.
Who uses accounting data?
Because it communicates financial information, accounting, as stated earlier, is often called ‘the language of business’.
The information that a user of financial information needs depends on the kinds of decisions the user makes.
The differences in the decisions divide the users of financial information into two broad groups: internal users and external users.
Internal users.
Internal users of accounting information are managers who plan, organise and run a business. These include marketing managers, production supervisors, chief financial officers and other employees. In running a business, managers must answer many important questions.
To answer these and other questions, users need detailed information in a timely manner. For internal users, accounting provides internal reports. Examples are contribution margin statements and cash budgets.
External users.
There are several types of external users of accounting information:
. Investors (owners) use accounting information to make decisions to buy, hold or sell shares.
. Creditors such as suppliers and bankers use accounting information to evaluate the risks of granting credit or lending money.
The information needs and questions of other external users vary considerably:
. Tax authorities, such as the Australian Taxation Office, want to know whether the entity complies with the tax laws.
. Regulatory agencies, such as the Australian Securities and Investments Commission (ASIC) and the Securities and Exchange Commission (SEC) in the US, want to know whether the entity is operating within prescribed rules.
. Customers are interested in whether an entity will continue to honour product warranties and support its product lines.
. Employees and labour unions want to know whether the entity can pay increased wages and benefits.
. Economists use accounting information to forecast economic activity.
Distinguishing between bookkeeping and accounting.
Many individuals mistakenly consider bookkeeping and accounting to be the same. This confusion is understandable because the accounting process includes the bookkeeping function. However, accounting also includes much more.
Bookkeeping usually involves only the recording of economic events. It is therefore just one part of the accounting process. In total, accounting involves the entire process of identifying, recording and communicating economic events and involves considerable judgement.
How may accounting be further divided?
Accounting may be further divided into financial accounting and management accounting.
