Financial Statements and Business Decisions

i have a accounting test tomorrow,(11.58am on 9.17, Melbourne time)Thirty multiple-choice questions, a total of 60 minutes

I will provide you with similar practice questions and Lecture of the exam scopeAccounting for Decision
Making (ACCT90004 )
Lecture 1:
(i) Financial statements and business decisions;
(ii) Investing and financing decisions and the Statement of
Financial Position
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Objectives for Week 1
1. Define accounting, describe the accounting process and define the
diverse roles of accountants
2. Explain the characteristics of the main forms of business organisation
3. Understand the conceptual framework and the purpose of financial
reporting
4. Identify the users of financial reports and describe users’ information
needs
5. Identify the elements of each of the four main financial statements
6. Describe the financial reporting environment
7. Explain the accounting concepts, principles, qualitative characteristics
and constraints underlying financial statements
8. Calculate and interpret ratios for analysing an entity’s profitability,
liquidity and solvency
Introduction
Accounting is often referred to as the ‘language of
business’ as it is a means of common communication
where information flows from one party to others.
Accounting:
Primary Function:
‘The primary function of accounting is to provide reliable and
relevant financial information for decision making’.
Model of economic reality of business
The Accounting Process
• Accounting is the process of identifying, measuring,
recording and communicating the economic
transactions and events of a business operation.
• Transactions are economic activities relevant to a
particular business
e.g., – sale of item to customer
– purchase of office stationery from supplier
The Accounting process
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• Transactions are the basic inputs into the
accounting process
Identifying
Taking into
consideration all
transactions
which affect
business entity
Measuring
Quantifying in
monetary terms
Recording
Analysing,
recording,
classifying and
summarising
transactions
Communication
Preparing
accounting
reports,
analysing and
interpreting
Commonly referred to as
‘bookkeeping’
Objective of Financial Reporting
The objective of Financial Reporting is to provide financial
information about a reporting entity that is useful to
existing and potential equity investors, lenders and other
creditors (suppliers who provide a line of credit) in
MAKING DECISIONS about providing resources to the
entity. Those decisions involve decisions about
1. Buying and selling or holding equity and debt
instruments.
2. Providing or selling loans and or other forms of credit.
3. Exercising rights to vote on, or otherwise influence
management’s actions that affect the use of the
entity’s economic resources.
Australian Regulatory Framework
Australian Securities & Investment Commission (ASIC)
Corporate Watchdog – Independent federal Government
agency with widespread powers.
• sole responsibility for administering corporations
legislation throughout Australia.
– enforces and regulates all corporate activity (including
directors and companies, financial markets and financial
services).
• aims to ensure fair and transparent markets supported
by confident and informed investors
The Corporations Act (2001)
Australian Regulatory Framework
The Corporations Act (2001)
The Corporations Act (2001) requires compliance (following the
rules) with Australian Accounting Standards.
S. 292(1) requires the preparation of financial reports for all;
• Disclosing entities
With few exceptions, entities whose securities are listed on a securities exchange
are disclosing entities
• Public companies
A public company means any company other than a proprietary company.
• Large Proprietary companies
A proprietary company is a large proprietary company if it does not satisfy the
definition of a small proprietary company.
• Registered schemes (management investment schemes)
Managed investment scheme that is registered under 601EB of the Corporations
Act。
Australian Regulatory Framework
Australian Accounting Standard Board – AASB (Australian
Government)
• The AASB is responsible for setting the standards (laws) to be applied in for
financial statements:
• For profit
• Not for profit
• Public sector
Australian Securities Exchange (ASX)
ASX is at the heart of the globally attractive, deep and liquid Australian financial
markets, helping companies grow and investors build wealth. As an integrated
exchange, ASX offers listings, trading, technology, data and post-trade services for
a wide range of asset classes, including equities, fixed income, commodities and
energy.
Recognised as world-leading and innovative, we are a top ten listed global
securities exchange and the largest interest rate derivatives market in Asia. Issuers
and corporates from Australia and around the world engage
Forms of Business Organisation
• Business may organise through various forms, including:
– Sole Proprietorship
• Owned by one person. It is the simplest form of business structure and
has very few legal formalities.
• The owner of the business has no separate legal existence from the
business.
• e.g. restaurants, dentist, panel beaters
– Partnership
• Owned by more than one partner. A partnership is a relationship
between two or more entities carrying on a business in ‘common’ with
the view to making a profit.
• Partnerships have unlimited liability which means that all partners are
responsible for the debts of the partnership.
• e.g. accountants, solicitors, doctors
– Corporation
• Organised as a separate legal entity and owned by shareholders.
• Shareholders have limited liability which means that shareholders are
liable for the debts of the business only to the extent of amounts unpaid
on their shares
• Under the jurisdiction of ASIC and must abide by the Corporations Act
(2001), Australian Accounting Standard Board (AASB) and the Australian
Securities Exchange (ASX) if a publicly listed company.
• BHP, CSR, Westpac, RM Williams.
• Other Forms
– A trust is a relationship or association between 2 or more parties whereby one
party holds property in trust for the other
• Corporate trust is a popular business structure for small business.
– A cooperative is member-owned, controlled and used, and must consist of 5 or
more people
• e.g. Australian Forest Growers, Ballina Fishermen’s Co-operative Ltd
Forms of Business Organisation
Conceptual Framework – introduction
• A Conceptual framework set of concepts to be followed by
preparers of financial statements and standard setters
The Conceptual Framework for Financial Reporting (the
‘Conceptual Framework’) describes the objective of, and the
concepts for, general purpose financial reporting.
It is a practical tool that:
(a) assists the International Accounting Standards Board (IASB) to
develop Standards that are based on consistent concepts;
(b) assists preparers to develop consistent accounting policies
when no Standard applies to a particular transaction or event,
or when a Standard allows a choice of accounting policy; and
(c) assists others to understand and interpret the Standards.
General Purpose Financial Reports – introduction
• The objective of general purpose financial reporting
(1st element and foundation of the conceptual
framework)
– To provide financial information about the reporting entity
to the resource providers that is useful in making decisions
about providing resources to the entity.
The reporting entity
• This section is still under development by the
IASB – use Australian SAC 1
• It is important to determine as a reporting
entity must prepare external general purpose
financial reports that comply with accounting
standards
• Definition from SAC 1
– an entity in which it is reasonable to expect
the existence of users who depend on
general-purpose financial reports to enable
them to make economic decisions
The Reporting entity
Indicators
– if the entity is managed by individuals who are not owners
of the entity;
– if the entity is politically or economically important;
– if the entity is considered large in sales, assets,
borrowings, customers, and employees;
then the entity is more likely to be a reporting entity
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Primary users and uses of financial reports
Accounting Information System
External Decision Makers Internal Decision Makers
Lenders
Investors
Suppliers
Customers
Regulators
Managers
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Definition of Asset
An asset is a present economic resource
controlled by the entity as a result of past
events.
An economic resource is a right that has the potential to produce economic
benefits.
Rights established by contract, legislation or similar means such as – (i) rights
arising from a financial instrument; (ii) rights over physical objects, such as
property; (iii) rights to exchange economic resources; and rights to receive
goods and services.
Control links the economic resource to the entity. Assessing control helps to
identify what economic resources the entity should account for.
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The classified statement of financial position
Current assets
– Assets that are cash, held for the purpose of being traded,
or expected to be converted to cash or used in the business
within one year.
Examples: Cash on Hand, Accounts Receivable, Inventory,
Stock of Supplies, Prepayments.
Non-current assets
– Assets that are not expected to be sold or consumed within
one year.
– Examples: Building, Land, Motor Vehicles, Plant &
Equipment.
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Definition of Liability
A liability is a present obligation of the entity to transfer
an economic resource as a result of past events.
If one party has an obligation to transfer an economic resource (a liability), it
follows that another party (or parties) has a right to receive that economic
resource (an asset). The party (or parties) could be a specific person or
entity, a group of people or entities, or society at large.
Present obligation: An entity has a present obligation to transfer an economic
resource if both: (a) the entity has no practical ability to avoid the transfer;
and (b) the obligation has arisen from past events; in other words, the
entity has received the economic benefits, or conducted the activities, that
establish the extent of its obligation.
Past event: An entity has a present obligation as a result of a past event only if
it has already received the economic benefits, or conducted the activities,
that establish the extent of its obligation.
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The classified statement of financial position
Current liabilities
– Obligations that are to be paid within the coming year or
the entity’s operating cycle
– Examples: Accounts Payable, Bank Overdraft, Loan (less
that 12 months), Accrued expenses,
Non-current liabilities
– Obligations that are not classified as current.
– Examples: Mortgage, Loans (greater than 12 months)
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Definition of Equity
The residual interest in the assets of the entity after
deducting all its liabilities.
Equity claims are claims on the residual interest in the assets of the entity after
deducting all its liabilities. In other words, they are claims against the entity that do
not meet the definition of a liability.
Such claims may be established by contract, legislation or similar means, and include
(to the extent that they do not meet the definition of a liability): (a) shares of
various types; and (b) rights to receive an equity claim.
Different equity claims convey to their holders different rights to, for example, receive
some or all of the following: (a) dividends; (b) the repayment of contributed equity
on liquidation; or (c) other equity claims.
To provide useful information, it may be necessary to divide the total carrying
amount of equity if, for example, there are: (a) more than one class of equity claim;
or (b) restrictions on particular components of equity; for example, the rights of
particular equity claims may be affected by legal, regulatory or other restrictions on
the ability of the entity to distribute its economic resources to the holders of those
equity claims.
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CONCEPTS , PRINCIPLES and QUANTITATIVE CHARACTERISTICS
• Monetary Principle
– Items included in accounting records must be able
to be expressed in monetary terms (e.g. $)
• Accounting Entity Concept
– Every entity can be separately identified and
accounted for
– Owner’s transactions are separate from entity’s
transactions
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CONCEPTS AND PRINCIPLES
• Accounting Period Concept
– The life of a business entity can be divided into
artificial periods
– Useful reports covering those periods can be
prepared for the entity
• Going Concern Principle
– Business will remain in operation for the
foreseeable future.
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CONCEPTS AND PRINCIPLES
• Cost Principle
– All assets are initially recorded in the accounts at
their purchase price or cost
– To provide useful information, sometimes entities
need to deviate from cost principle (e.g.
revaluation of non-current assets)
• Full Disclosure Principle
– All circumstances and events that could make a
difference to decision-making process should be
disclosed in the financial statements
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QUALITATIVE CHARACTERISTICS
• Fundamental qualitative characteristics
– Relevance
– Faithful representation
• Enhancing qualitative characteristics
– Comparability
– Verifiability
– Timeliness
– Understandability
• Constraint- cost versus benefit
Conceptual Framework
• The role of accounting is to provide financial
information for decision making that is relevant &
faithful representation.
Information is considered relevant IF IT IS capable of making a difference in the
decisions made by users. Information that has predictive value and /or
confirmatory value is considered to be relevant.
Information is considered to have confirmatory value if it can be used to develop
expectations for the future.
• Relevant
Information is a faithful representation of the economic phenomena it purports to
represent if it is complete, neutral and free from material error.
It is important that information depicts the economic substance of the transactions,
events or circumstances.
• Faithful Representation
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QUALITATIVE CHARACTERISTICS
Enhancing qualitative characteristics:
• Comparability • Year to year, firm to firm, consistency of
preparation and application
• Verifiability • Achieved if different independent observers arrive
at the same conclusion.
• Timeliness • To be useful, must be available in a timely manner
• Understandability • Presentation is important • Assumed users
have reasonable knowledge
• Constraint- cost versus benefit
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ANALYSING FINANCIAL STATEMENTS
Ratio analysis
• Expresses relationship among items of financial
statement data
• Expresses mathematical relationship between two
different quantities
• Expressed in terms of percentages, rates or
proportions
Rationale for GENERAL PURPOSE FINANCIAL REPORTS
• General purpose financial reports are the published
financial statements of an entity prepared in
accordance with applicable accounting standards.
• External users have an interest in 3 main types of
activities
– financing
– investing and
– operating
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GENERAL PURPOSE FINANCIAL REPORTS
• Financing Activities
– Outside sources of funds
• Borrowing (debt funding) from banks or
investors by debt securities
– Unsecured notes
– Debentures
• Selling shares to investors
– Payments to shareholders are called dividends
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GENERAL PURPOSE FINANCIAL REPORTS
• Investing Activities
– Acquisition or sale of resources/assets needed to
operate the business
– Examples:
• Purchase or sale of property plant and equipment
• Purchase of investments
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GENERAL PURPOSE FINANCIAL REPORTS
• Operating Activities
– Results from operational activities undertaken to earn income:
• Revenue(1) (sale of goods, provision of services, return from
investments)
LESS
• Expenses(2) (cost of resources/assets consumed or services used)
(1) Revenue:
Under the Conceptual Frameworks revenue should be recognised when and only when:
(a) It is probable that any future economic benefits associated with the revenue will flow to the entity,
and
(b) The revenue can be measured with reliability
(2) Expenses:
Expenses are decreases in economic benefits during the accounting period in the form of outflows or
depletions of assets or incurrences of liabilities that result in decreases in equity, other than those
relating to distributions to equity participants.
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FINANCIAL STATEMENTS
• Income Statement:
Reports revenues less expenses for a particular period
of time.
• Purpose is to report success or failure of the entity’s
operations for a period of time.
• Managers are interested in the bottom line because they
allocate resources based on their beliefs about an entity’s
future performance.
• Statement of Changes in Equity
Reports total comprehensive income for the period
and other changes in equity
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Income statement
WONG PTY LTD
Income Statement
for the month ended 31 October 2018
Service revenues $10 600
Expenses
Salaries expense $3 200
Supplies expense 1 500
Rent expense 900
Insurance expense 50
Interest expense 50
Depreciation expense 40 5 740
Profit before tax 4 860
Tax expense 2 000
Profit after tax $ 2 860
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Statement of changes in equity
WONG PTY LTD
Calculation of Retained Earnings
For the month ended 31 October 2018
Profit $ 2 860
Retained earnings 1/10/18 0
Dividends (500)
Retained earnings 31/10/18 $ 2 360
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Statement of changes in equity
• Retained earnings refers to accumulated profit which
has not been distributed to shareholders
– the statement of changes in equity will show as one
of the items movement in retained earnings
between reporting periods
– Wong Ltd’s movement in retained earnings is
demonstrated so the link between the income
statement and statement of financial position can
be understood
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Statement of changes in equity
• Reports total comprehensive income for period
and other changes in equity such as adjustments
to retained earnings for
– Changes in accounting standards
– Changes in accounting policies (Note)
– Correction of errors
– Gains recognised directly in equity accounts
Note: Something to think about…….
In sport, change the rules it may change the final outcome of the event or game.
Change the accounting policy, profit and equity could be a different result.
Decision making impacts!
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FINANCIAL STATEMENTS
• Statement of Financial Position (Balance Sheet):
– Reports assets and claims to those assets at a
particular point in time
• Cash Flow Statement:
– Reports information regarding cash receipts and
cash payments for a particular period of time
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Statement of Financial Position: (Balance Sheet)
• Reports assets and claims to those assets at a specific
point in time; ‘as at’.
• Based on the basic accounting equation. The Balance
Sheet is simply the accounting equation in a
published report.
Total Assets = Total Equities
ASSETS = LIABILITIES + EQUITY
or
Net Assets = Net Equities
Assets – Liabilities = Equity
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Statement of financial position
WONG PTY LTD
Statement of Financial Position
as at 31 October 2018
Assets
Cash $15 200
Accounts receivable 200
Advertising supplies 1 000
Prepaid insurance 550
Office equipment 4 960
Total assets 21 910
Liabilities
Accounts payable $ 2 500
Interest payable 50
Revenue received in advance 800
Salaries payable 1 200
Bank loan 5 000
Total liabilities 9 550
Net Assets $12 360
Equity
Share capital 10 000
Retained earnings 31/10/18 2 360
Equity $12 360
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Cash Flow Statement
• Main purpose is to provide financial information
about cash receipts (cash inflow) and cash payments
(cash outflow) of an entity for a specific time period
• Users are interested in the statement of cash flows in
order to find out what is happening to entity’s most
important resource
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Cash Flow Statement
WONG PTY LTD
Statement of Cash Flows
for the month ended 31 October 2018
Cash flows from operating activities
Cash receipts from operating activities $11 200
Cash payments from operating activities (5 500)
Net cash provided by operating activities $ 5 700
Cash flows from investing activities
Purchased office equipment (5 000)
Net cash used by investing activities (5 000)
Cash flows from financing activities
Issue of shares 10 000
Proceeds from bank loan 5 000
Payment of dividend (500)
Net cash provided by financing activities 14 500
Net increase in cash 15 200
Cash at beginning of period —
Cash at end of period $15 200
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Interrelationships between the statements
• Statement of financial position depends on results of
the Income statement/Statement of comprehensive
income and the Statement of changes in equity
• Ending amount in the statement of cash flows is
reported in the statement of financial position
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ANALYSING FINANCIAL STATEMENTS
Ratio analysis
• Expresses relationship among items of financial
statement data.
• Expresses mathematical relationship between two
different quantities.
• Expressed in terms of percentages, rates or
proportions
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Profitability
Measures operating success of an entity for a given
time period
• Return on assets
– Indicates amount of net profit generated by each
dollar invested in assets
Profit .
Average Total Assets
($ in thousands) 2010 2009
Fantastic Holdings $18 527 = 11.8% $18 593 = 14.9%
($168 185 + $146 386)/2 ($146 386+ $103 960)/2
Nick Scali $11 255 = 30.7% $4 817 = 15.9%
($41 075 + $32 171)/2 ($32 171+ $28 326)/2
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Profitability
• Profit margin:
Measures percentage each sales dollar that results
in profit
Profit .
Net Sales
($ in thousands) 2010 2009
Fantastic Holdings $18 527 = 4.0% $18 593 = 5.0%
$419 084 $402 073
Nick Scali $11 255 = 12.0% $4 817 = 6.0%
$96 365 $77 507
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Liquidity
• Measures short-term ability of entity to pay its
maturing obligations and to meet unexpected needs
for cash
• Working Capital
Current Assets – Current Liabilities
Fantastic Holdings (year ending 30 June 2010)
Working Capital = $102 111 066 – $58 265 089
= $43 845 977
Good position to pay short-term debts as they fall due
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Liquidity
• Current Ratio:
Measures short term ability to meet current obligations
Current assets .
Current liabilities
($ in thousands) 2010 2009
Fantastic Holdings $102 111 = 1.75:1 $99 186 = 1.80:1
$58 265 $55 227
Nick Scali 1.70:1 1.82:1
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Liquidity
Using the statement of cash flows
• Current cash debt coverage
– Indicates the entity’s ability to generate sufficient cash to
meet short term needs
Net cash provided by operating activities
Average current liabilities
($ in thousands) 2010 2009
Fantastic Holdings $11 011 = 0.19 times $13 297 = 0.31 times
($58 265 + $55 227)/2 ($55 227+ $29 401)/2
Nick Scali 0.94 times 0.66 times
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Solvency
• Measures ability of an entity to survive over a long
period of time
• Debt to total assets ratio
– Measures percentage of assets financed by creditors rather
than shareholders
Total liabilities
Total assets
($ in thousands) 2010 2009
Fantastic Holdings $77 697 = 0.46 $68 851 = 0.46
$168 185 $146 386
Nick Scali 0.48 0.43
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Solvency
• Cash debt coverage
– Indicates entity’s ability to generate sufficient cash to
meet long term needs
Net cash provided by operating activities
Average total liabilities
($ in thousands) 2010 2009
Fantastic Holdings $11 011 = 0.15 times $13 297 = 0.24
times
($77 697+ $66 851)/2 ($66 851+ $42 225)/2
Nick Scali 0.93 times 0.66 times
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Notes to the financial reports
Notes provide supplemental information about the financial
condition of a company.
Three basic types of notes:
(i) Description of accounting rules applied.
(ii) Presentation of additional detail about an item on the financial
statements.
(iii) Provide additional information about an item not on the financial
statements.
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Reviewed BEFORE YOUR WORKSHOP
The following should be reviewed before your workshop:
Text: Financial Accounting – Reporting, Analysis & Decision Making 6th Edition
Carlon, McAlpine, Lee, Mitrione, Kirk & Wong
Key Terms: Pages 62 – 65
Summary: Pages 60 – 61; 1.1 – 1.9
Demonstration Problem:
Pages 66 – 68
Jeff Andringa – Footy Camp
Self-Study Questions:
Pages 68 – 71, Question 1.1 – 1.25
Brief Exercises:
Pages 71 – 73 BE 1.1 – BE 1.7
This Lecture
The main aspects of accounting that were covered this
week are set out below and include the:
• Review the information contained in the four principal financial statements
and the use of this information by various stakeholders;
• Understand key players that shape the environment in which financial
reports are prepared;
• Identify the factors to consider by companies when making the decision to
raise additional funds either through borrowing or through the issue of
shares;
• Determine the impacts of business transactions on the statement of financial
position using journal entries and ledger accounts.
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