What is accounting? Flashcards
Week 1
Suggest the role of accounting in the future.
- foundation of business
- understanding performance
- plan and support decisions
What is accounting and its purpose?
- accounting is concerned with collecting, analysing and communicating financial information.
- analysing financial transactions
- making informed decisions
- assess performance in company/ sectors/ individuals
5 reasons for accounting
- record money in and out
- support decision making
- record financial state
- control the company
- plan future activities
- basis for taxation
- reduce uncertainty about decisions
Accounting; relevance
- accounting information should make a difference
- help to predict future events
- help to confirm past events
Materiality
The quality of being relevant or significant
Accounting; faithful representation
- accounting information should portray what it is supposed to portray
- accounting information must contain both fundamental qualities if it is to be useful. There is little point in producing information that is relevant, but which lacks faithful representation, or producing information that is irrelevant, even if it is faithfully represented
Comparability
comparing performance over time or comparing aspects of performance
Qualities that influence usefulness
(fig 1.3)
QUALITIES
fundamental qualities
- relevance
- predictive value
- conformatory value
- meteraility threshold
- faithful representation
- completeness
- neutrality
- freedom of error
enhancing
- comparability
- timeliness
varifiaility
- understandability
Verifiability
information provided faithfully portrays what it is supposed to
Timeliness
less relevant and therefore useful further from data collection
Understandability
clear and concise
Cost v benefit
accounting information should only be produced if the costs of providing it are less than the benefits, or value, to be derived from its use.
Limitations of accounting
- requires a more holistic approach
- reflects the past
- non quantifiable
- may be based on unreliable information
Relationship between costs and value of accounting information
(fig 1.2)
accounting information should only be produced if the costs of providing it are less than the benefits, or value, to be derived from its use. (fig 1.2)
- value may decline due to relevance,
costs may increase due to additional information
timeliness
Who uses accounting?
Business wide - all stakeholders, different stakeholders may have conflicting interests
Different types of businesses.
Different types of businesses.
Accounting information system
- identifying and capturing relevant information (in this case financial information);
- recording, in a systematic way, the information collected;
- analysing and interpreting the information collected; and
- reporting the information in a manner that suits the needs of users.
Real world application - unreliable accounting
(RW 1.1)
Systems error!
Some of Metrobank’s largest customers left the bank after the discovery of a historic accounting error in the first quarter. Chief executive Craig Donaldson said ‘adverse sentiment’ had led to the departure of a ‘small number of large commercial and partnership customers’, contributing to a 4 per cent quarter-on-quarter reduction in deposits.
Metro Bank in January revealed that it had mis-categorised a large number of commercial loans, meaning that it did not have as much capital against them as it should. The discovery prompted a sharp drop in its stock – it is down 54 per cent since the start of the year – and forced the lender to cut its long-term growth plans.
Management accounting
(fig 1.5)
which seeks to meet the accounting needs of managers
- to aid planning, control and decision making
- financial and non financial
- past and future
- specific purpose reports
- considerable detail
- not subject to regulation
Financial accounting
(fig 1.5)
which seeks to meet the accounting needs of managers
- financial performance and position in a period
- general purpose and useful to a number of stakeholders
- broad view for a business period
- subject to regulations, financial statements
- mainly past
Reporting interval
- financial accounting reports may be produced on an annual, half-yearly and quarterly basis
- management accounting reports will be produced as frequently as needed by managers.
- special-purpose reports can also be prepared when the occasion demands: for example, where an evaluation is required of a proposed investment in new equipment.
Time orientation
- financial accounting reports reflect the performance and position of the business for the past period - backward looking.
- management accounting reports often provide information concerning future performance as well as past performance.
- businesses may release projected information to other users in an attempt to raise capital or to fight off unwanted takeover bids.
Range and quality of information
- financial accounting reports focus more on information that can be quantified in monetary terms
- management accounting also produces such reports, but is also more likely to produce reports that contain quantitative, non-financial, information, such as physical volume of inventories, number of sales orders received, number of new products launched, physical output per employee
- financial accounting places greater emphasis on the use of objective, verifiable evidence when preparing reports.
- management accounting reports may use information that is less objective and verifiable, but nevertheless provide managers with the information they need.
Changing competition;
- increasing sophistication of customers;
- availability of rapid and sophisticated forms of information and communication
- development of a global economy where national frontiers become less important;
- rapid changes in technology;
- deregulation of domestic markets (for example, the privatisation of electricity, water and gas);
- increasing pressure from owners (shareholders) for competitive economic returns; and
- greater volatility of financial markets.
Greater harmonisation of accounting
- financial accounts reports will not vary internationally
- significant cost savings as data reports can be used internationally
Financial performance of a rival business
- ‘benchmark’ against which to compare performance (for example, product costs);
- guide to whether and, if so, how rival businesses are likely to respond to new initiatives by the business (for example, offering longer credit periods to customers);
- basis for creating new strategies that exploit the weaknesses of rival businesses (for example, price discounting); and
- guide to likely future actions by rival businesses (for example, takeovers, price increases, exiting the market and so on).
Financial management
- more informed decisions
- how funds are raised and invested
Real world application - poor investment
(RW 1.2)
Some investments are purchased impulsively, disposed of with difficulty. Miner Anglo American wants to be rid its unwanted assets to cut debt and save its skin. In just two years, its market value has fallen by two-thirds. Its target this year is to sell $3 to $4 billion of assets and cut into its net debt position of over $10bn.
To this end, on Monday the miner announced the sale of its 70 per cent stake in an Australian coal mine, Foxleigh, to an Australian investment firm. Bought in December 2007 for $620 million, Foxleigh has been written down to zero on Anglo’s books. It was among a number of bad acquisitions for Anglo, including its ill-fated $5 billion purchase of iron ore miner, Minas Rio, a few months before Foxleigh.
Any price received for Foxleigh looks positive next to a base of zero. Still, this disposal and the proceeds of other sales — another coal mine and some building materials assets— will not make much of a dent in its money-raising target.
Investment project appraisal
Investment in new long-term projects can have a profound effect on the future prospects of a business as they often involve large amounts and may bind the business to onerous commitments. By providing managers with appraisals of the profitability and riskiness of investment project proposals, they can make more informed decisions about whether to accept or reject them. These appraisals can also help in prioritising investment projects that have already been accepted.
Managing and controlling resources
Once investment projects are accepted and put into practice, they must be properly managed and controlled. In carrying out this task, managers may rely on various financial tools relating to resource management and performance monitoring. This may help to ensure that actual performance corresponds to earlier planned performance.
Financing decisions
Investment projects and other business activities have to be financed. The various sources of finance available need to be identified and evaluated: each will have its own characteristics and costs. When evaluating different sources, the overall financial structure of the business must be taken into account. An appropriate balance must be struck between long- and short-term sources of finance and between the contribution of shareholders (owners) and that of lenders. Not all of the finance required may come from external sources: some may be internally generated. An important source of internally generated finance is profits, and the extent to which these are reinvested within the business, rather than distributed to the owners, requires careful consideration.
Capital market operations
New finance may be raised through the capital markets, which include stock markets and banks. Managers will often seek advice and guidance on how finance can be raised through these markets, how securities (shares and loan capital) are priced, and how the markets are likely to react to proposed investment and financing plans.
Real world application - the customer focused approach
(RW 1.3)
Apple is often considered the highest profile brand in terms of putting the consumer first and always being ahead of the curve. The consumer experience is at the heart of everything– the purchasing experience, the product’s use, the aftercare…Every touch-point in the organisation has a consumer philosophy running through it because at Apple, everything about that end user matters. It matters so much that many products are launched to consumers who don’t even know they need them yet. But they will soon and shortly afterwards they will wonder how they ever coped without them.
Income statement
records income and expenses of a business overtime
income - expenses = profit/ loss
Statement of financial position (SOFP)
records assets/ liabilities and capital at a point in time
Going concern
continue in operations for foreseeable future
Prudence
cautious mindset, profits recorded once realised, losses anticipated in full
Consistency
consistent treatment in accounts, any change stated and effect quantified, inconsistency reduces utility of data
