Use LEFT and RIGHT arrow keys to navigate between flashcards;
Use UP and DOWN arrow keys to flip the card;
H to show hint;
A reads text to speech;
127 Cards in this Set
- Front
- Back
|
identifying, measuring, communication, decision making |
- Identifying: transactions that must be able to be reliably measured and recorded - Measuring: Analysis, recording and classifying transactions - Communicating: via income statements, balance sheets and statements of cash flows - Decision making: Used for a range of decisions by internal and external users |
|
|
Business transactions |
- external exchange of something of value between two or more entities - affects assets, liabilities and equity - must be able to be reliably measured and recorded |
|
|
Accounting info and its role in decision making |
external users include: Investors, suppliers and banks, employees, government authories |
|
|
Financial and management accoutning |
- financial accounting is the preparation and presentation of financial statements to allow a range of users to make economic decisions about the entity - "general purpose financial statements" - financial statements consit of - income statement - balance sheet - statmenet of changes in equity - statement of cash flows |
|
|
continued financial and mangement accoutning |
- Management accoutning provides economic information for internal users - core activities include - formulating plans and budgets - providing information to be used in monitoring and control within the entity - management accoutning provides economic information for internal users that is then relfected in financial accoutning statements for external users |
|
|
financial and management accoutning continued |
F/A - Bound by more regulations, historical picture of past operations, quantitative in nature, concerns the whole entity - main users are external M/A - less formal and without prescribed rules, can be both historical and a projection, both quantitative and qualititve, more detailed - used mainly by internal managers in the entity |
|
|
Sources of regulation and ASX |
- all disclosing entities must apply australian accounting standards to their financial reports - enforced by ASIC asx - main aus market place for trading equities, government bonds and other fixed interest securities - helps ensure that companies are providing adequate disclosures to various stakeholders |
|
|
Standard setting framework - role of professional bodies |
the AASB is responsible for issuing aus versions of internatial accoutning standards - CPA Australia, the institute of chartered accountants in AUS - institute of public accountants |
|
|
conceptual framework |
- the IASB's conceptual framework applies to entities that are required to prepare general purpose statements - the objective of financial reporting - qualitative characterisitcs of financial reports - definition and recognition criteria of the elements of financial statements |
|
|
the objective of financial reporting |
- 1.Objective offinancial reports: “to provide financial information … useful to existing andpotential investors, lenders and other creditors in making decisions aboutproviding resources to the entity” - 2.Qualitativecharacteristics of financial statements: ,Relevance ,FaithfulRepresentation,Comparability ,Verifiability,Timeliness, Understandability - 3. 3.Definition and recognition of elements offinancial statement: Assets: futureeconomic benefits, Liabilities: futureoutflows of economic benefits, Equity: netassets = assets lessliabilities , Income: increasesin equity (excl. contributions from owners), Expenses: decreasesin equity (excl. distributions toowners) |
|
|
limitations of acct information |
•Time lag in the distribution of information to users, therefore affecting its accuracy •Historical information based on past data and is often out dated
•Subjectivity of information refers to choice involved in inclusion ofitems to be reported,choice of accountingpolicies to adopt,need for estimates |
|
|
costs of providing acct information |
•Information costs; Costsinvolved in gathering, summarising and producing info contained in financialreport •Release of competitive information: Infoin financial report may contain proprietary information that could be used bycompetitors to strengthen their market position |
|
|
Basic forms of business structure |
- sole trader, partnership, company, trust - differ in terms of owner liabilit, equity structure, funding opps, decision making and taxation - all businesses are separate accounting entities but may not be seperate legal entities |
|
|
sole trader |
- business is not a separate legal entity - individual owner is fully liable for all debts - owner pays personal income tax on business profits - general registration requirments involve applying for an ABN - examples, hairdressers, plumbers ect Advantages - quick, inexpensive to establish - not subject to company regulation - owner has total autonomy over business decisions - owner claims all the profits of the business Disadvantages - unlimited liability - limited by skill, time, investmenet - restrictive structure - business can cease to exist |
|
|
partnerships |
- association between two or more persons - enables sharing of ideas, skills, resources - easy and cheap to establish - not a separate legal entity - no separate taxation payable by does lodge income tax return partnership agreement - name of i, contributions, profit and loss sharing ratios, entry and exit information Advantages - relatively easy and simple to set up - informal business structure- not bound by accounting standards - ability to share capital, skills, talents, knowledge and worload between two or more people Disadvatages - unlimited liability - limited life - mutual agency |
|
|
Companies |
- owners of companies are shareholders -independant legal entity - shareholders have limited liability - company has unlimmited life Advantages - limited liability - taxation rate lower than top personal tax rate - business expansio networks made easier due to legal structure - can raise addition equity Disadvantages - more time consuming and costly to set up - must comply with complex company rules and legal requirments - taxed from first dollar of proift - limited liability may cause problems - separation of ownership and control |
|
|
Comparison of business reports |
- a business entity funds are not available for personal use - if they are used to pay personal expenses must be recorded as a decrease in cash and a decrease in owners EQ |
|
|
Business transactions |
•Business transactions are occurrences thataffect the assets, liabilities and equity items in an entity •A business transactionis recorded when it can be reliably measured in monetary terms •Under the accounting entity concept, every entity mustkeep records of its business transactions separate from any personaltransactions of the owners |
|
|
personal transctions and business events |
•Personal transactions are transactions of the owners, partners or shareholdersthat are unrelated to the operation ofthe business •Business events are occurrences that will probably affect the entity in someway, but are notrecorded as businesstransactions until an exchange of goods occurs between the entity and anoutside entity |
|
|
business transactions and the acct equation |
- business transactions affect the elements of the acct equation assets= liabilties + equity - transactions are recorded in a way that keeps this equation balanced - the balanc e is relfected in the balnce sheet which is recorded as Assets - liabilities = EQ |
|
|
Accounting equation |
ASSETS = L =EQ - expresses the relationship between A of an entity and how those assets are financed - assets are recouses controlled by an entity - they can be financed intwo ways - by external fund providers (L) - by owner's funds (EQ) -liabilties and EQ represent the claims against the entity's assets |
|
|
The concept of duality |
- every business trans has a dual effect - business trans are analysed by examing - the dual effect of each business trans - the impact on the acct equation example - a firm borrows money from a bank to purchase a truck A = L+ E |
|
|
Capitial contribution and asset purchase |
owner contributed 50,000 in cash to start a business - this shows as increase in cash (A) and increase in capital (EQ) asset purchase - firm purchase new laptop for 3,500 and pays by cash - this will show as a decrease in cash (A) and an increase in office equip (A) by the same amount - income produces an increase in EQ - expenses result in decreases in EQ therefore - profit (loss) is added to (subtracted from) opening EQ on the balance sheet |
|
|
durther analysis of business transactions |
income earned - firm sends invoice for 3,000 or services provided - this will show as an icnrease in debtors or accounts recieveable (A) and an increase in fees (income) by the same ammount - note income increase EQ while expenses decrease EQ |
|
|
capturing accounting info journal and ledger accounts |
•Analysing eachtransaction by using the accounting equation is not appropriate for a largenumber of transactions •Instead, we can usethe journal or ledger to effectively and efficiently capture accountinginformation |
|
|
Nature and purpose of the balance sheet |
•The balance sheet is afinancial statement that details the entity’s assets, liabilities and equity asat a particular point in time — the end of the reporting period •Thebalance sheet shows: -whatthe entity owns or controls asat a particular date = the assets -theexternal claims on the entity’s assets (what it owes) = the liabilities -the internalclaim on the entity’s assets = the owner’s equity reflects . the assets in which the entity has invested and how the entity has financed the assets |
|
|
format and presentation of the balance sheet |
•twomain formats: -T-format •Assetson left hand side and liabilities on right hand side •Oftenused for smaller entities -Narrativeformat •Assets,liabilities and equity presented down the page •Comparative information allows users to see how firm’sfinancial position has changed between the previous and current periods |
|
|
definition and recognition of assets |
•An asset isformally defined in the Conceptual Framework (para. 49(a)) as ‘a resource controlled bythe entity as a result of past events and from which future economic benefits areexpected to flow to the entity’. |
|
|
recongition of asset |
•Recognitionmeans recording items in the financial statements with a monetary valueassigned to them -Satisfyingthe definition criteria is only part of the process in recording an item on thebalance sheet – recognition criteria must also be satisfied •Tobe recognised asan asset onthe balance sheet, the future economic benefits expected to flow from the assetmust: -be probable,and becapable of beingmeasured reliably - probable - it is more likely that the future economic benefits will flow from the asset to the business controlling it - reliably measured - the value of the asset can be measured reliably - may require use of estimates |
|
|
criteria to be satisfied to recognise an asset |
Theessential characteristics for an asset are:1.theresource must be controlled bythe entity2.theresource must be as a result of a past event 3.future economic benefits are expected to flow to the entity fromthe resource. - Furthermore,to be recognised as an asset on the balance sheet, the future economic benefitsmust be probable andcapable of being measuredreliably. |
|
|
definition and recognition of liabilities |
•A liability isformally defined in the Framework (para. 49(b)) as ‘a present obligation ofthe entity arising from past events, the settlement of which is expectedto result in an outflowfrom the entity of resources embodying economic benefits’. |
|
|
present obligation |
- a commitment to another entity ro provide resources to that entity - can be formal or informal - entity may not be known |
|
|
liability recognition |
•Tobe recognised asa liability on the balance sheet, the outflow of resources embodying economicbenefits must: -be probable and -becapable of being measuredreliably•Contingent liabilities arise from a past event that may be confirmed only by uncertain future events not controllable bythe entity -Contingent liabilities are NOT shown on the balance sheet (may be mentioned in the Notes) |
|
|
criteria to be satisfied to recognise a liability |
Theessential characteristics for a liability are:1.a present obligation toanother entity 2.thepresent obligation arises as a result of past events 3.an outflow of resources embodyingeconomic benefits is expected to flow from the entity as a result of settlingthe present obligation. - Furthermore,to be recognised as a liability on the balance sheet, the outflow of resourcesembodying future benefits must be probable and capable of being measured reliably. |
|
|
definition and nature of EQ |
•Equity isdefined in the Conceptual Framework as ‘the residual interest in theassets of the entity, deducting all its liabilities’. •Equityrepresents the claim of owner/s on the firm’s assets •Equitycomprises of various items including: -Capitalcontribution by owners -Profitsretained in the entity |
|
|
current and non-current assets and liabilities |
•Distinction between current and non-current classification isbased on timing •If the economic benefits (of asset) or outflow of resources(for liability) are expected to be realised in the next reporting period, theasset or liability is categorised as current •If economic benefits (of asset) or outflow of resources (forliability) are expected beyond next the reporting period, the classification isnon-current - on the balance sheet an entity will usually show total amounts for current assets, non current assets, current liabilites, non current liabilities |
|
|
classification of assets |
- cash and cash equivs - trade recieveables - inventories - non current assets held for sale - investments accounted for using eq method - financial assets - deferred tax assets - property, plant and equipment - agricultural assets - intagiable assets - goodwill |
|
|
liabilties classification |
- trade and other payables - borrowings - tax liabilities - provisions - financial liabilties - secured debts |
|
|
classification of EQ |
- depending on the entity structure the terminology and EQ classifications appearing on the balance sheet will vary between entities - sole traders will have a capital account with profit/loss and drawings contributing directly to this account - companies will have - paid up share capital, contributed capital - retained earnings - reserves - minority interests |
|
|
measurement of assets and liabilties |
- the dollar value assigned to assets and liabilties is called their carrying amount or book value - alternative measurement systems include: historical cost, current cost, market value, present value how do we know which measure to use? - no universally accepted answer - all assets initially recognised at their cost price - but financial info must be relevant and reliable |
|
|
measuring receivables |
- carrying amount of receivables is the expected cash to be received - thus the amount owing must be reduced by the amount expected to be uncollectable - on the balance sheet, receiveables should be shown at their net amount - net amount = gross value, less alowance for doubtful debts |
|
|
measuring non current assets |
•Allassets with limited useful lives must be depreciated •Landis not depreciated – why not?•Depreciation is the allocation of the depreciableamount of the asset over the useful life of the asset •Onthe balance sheet, depreciable assets are carried at their cost (or fair value)less accumulated depreciation – this is known as the asset’s “carrying amount” or “book value” |
|
|
measuring inventory |
- the valuation rule for inventory is that it mus tbe shown on the balance sheet at the lower of cost price or net realisable value - NRV: expected selling price -less the expected costs associated with getting the inventory to a saleable state, less the costs of marketing, selling and distribution |
|
|
measuring goodwill |
•“Internallydeveloped” goodwill cannot berecognised on an entity’s balance sheet •Only“purchased” goodwill canbe recognised as the excess of the consideration paid for a business over the fair value ofthe net assets acquired -canonly be recognised when a business is acquired as a going concern •Goodwillcannot berevalued upwards -mustbe tested for impairment at least annually -anyimpairment (loss of value) must be recognised as an expense •Goodwillis classified as an unidentifiable intangible asset |
|
|
purpose and importance of measuring financial performance |
- income statement reflects the accounting return for an entity over a specified time period - profit = income - expenses - but not all value changes result in income or expenses that are recognised in the income statement - income encompasses both - revenue: arising in the ordinary course of activities - gains: gains on disposal of non current assets - only realised gains are included in the income statement |
|
|
the reporting period |
- financial statements assume that an entity is an ongoing coerns but the life of the entity is divided into arbitrary reporting periods - for external reports its yearly |
|
|
accrual accounting vs cash accoutning |
•Accounting standards require financialstatements to be prepared on the basis of accrual accounting •Accrual accounting is asystem in which transactions and events are recorded in the periods they occur,rather than in the periods the entity receives or pays the related cash •A cash accounting system would determine profit or loss as thedifference between the cash received in relation to income items and the cashpaid for expenses |
|
|
accrual accoutning |
•Under accrual accounting, the followingmay occur: -Income is recognised without receipt ofcash (accrued income) -Cash is received but income is notrecognised (unearned income) -Expense is recognised without paymentof cash (accrued expense)Expenseis paid but not recognised as an expense (prepaid expense) |
|
|
accrued income |
•Income has been earned inthe current accounting period but has not yet been received in cash •Examples include accrued interestrevenue (interest earned on a term deposit) or accrued rent revenue (tenant is‘behind’ in the rent) •Must be recorded as both income (e.g. interest income, rent income) and an asset(e.g. interestreceivable, rent receivable) •When the cash is received next period,do not record as income – simply record thereceipt of cash and reduce/eliminate the receivable |
|
|
deferred income (unearned) |
•Cash has been received inthe current accounting period, but the income has not yet been earned is •Examples include purchases paid for inadvance of delivery, magazine subscriptions, etc.•At the time cash is received, income isnot recorded – instead, a liability isrecognised (‘unearned income’ or ‘revenues received in advance’) Atthe end of the period, must determine how much of the ‘unearned’ income has nowbeen earned (goods delivered or services provided)and record this amount as income, while reducing the liability by the sameamount |
|
|
accrued expenses |
•Expenses have been incurred inthe current accounting period (resources consumed) but cash has not yet been paid •Examples include accrued wages, accruedelectricity, etc. •Must be recorded as both an expense (e.g. wages exp, electricity exp) and a liability (e.g.wagespayable, electricity payable) •When the cash is paidnextperiod, do not record as anexpense –simply record the decrease in cash and reduce/eliminate the liability |
|
|
prepaid deferred expenses |
•Expenses have been paid inthe current accounting period but resources not yetconsumed •At the time cash is paid, theexpense is not recorded – instead, an asset is recognised (e.g.‘prepaid rent’, ‘prepaid insurance’, etc.) •At the end of the periodmustdetermine how much of the prepaid expense has expired or beenconsumed, and record this amount as an expense whilereducing the pre-payment (asset) by the same amount |
|
|
depreciation |
•Depreciation (amortisation) is the systematic allocation of thecost of a tangible (intangible)asset to expense over the asset’s useful life •The associated asset can be considereda ‘prepaid expense’ •Depreciation does NOT represent theloss in the asset’s value during the reporting period •It does NOT involve cash flows •Accumulated depreciation representsthe total depreciation that has been charged to income statements inrelation to an asset |
|
|
straight line depreciation |
example - equip is purchased for 47,000 with an estimated useful life of 5 years and expected residual value of 12,000 annual depreciation expense = cost of asset minus expected residual value/ assets expected useful life 47,000 - 12,000/ 5 years = 7,000 |
|
|
acct policy choices, estimates and judgements |
- GAAP often permit choices when transactions are being recorded and require estimations be preparers - reported profit or loss figure is affected by an entity's: accounting policy choices and estimations example - equip is purchases for 47,000 with an estimated life of 5 years and expected residual value of 12,000 reducing balance depreciation rate = 24% - depreciation expenses = book value x depreciation rate - depreciation expense = 47,000 x 24% = 11,280- next year, depn expense = 47,000 - 11,280 x 24% = 8,573 |
|
|
acct policy cont. |
examples of acct policy choices - method of depreciation - method of inventory costing - method of valuing property plant and equip - capitalising or expensing development expenditure examples of acct estimates - useful life of depreciable asset - impairment of assets - employee benefits - residual value used in depreciation calculations |
|
|
quality of earnings |
•Since the preparers of financial statementshave choices with respect to accounting policies and estimations, it isnecessary to consider the quality ofthe reported profit or loss figure (i.e. the ‘quality of earnings’) •Reported profits are an importantnumberbecausethey are used in contractualarrangementsand to value entities •Managers’ choices may portray economicreality or be driven by self-interest |
|
|
measuring financial performance |
- to measure the profit or loss on an entity it is necessary to identify and measure all income and expense items attributable to the reporting period - this requires an understanding of what attributes a transaction requires in order to be classified as an item or income or expense |
|
|
income |
definition: recall that income comprises both revenue and gains with revenue arising the ordinary course of an entity's activities - gains also represent increases in economic benefits but the may or may not arise in ordinary activities - income must be inflows or enhancements of economic benefits that increase assets or reduce liabilities and result in an increase in EQ excluding contributions from EQ owners Recognition - an item that meets the definition of income must also satisfy recog criteria - to be recognised as income the increase in future economic benefits must have arisen and be able to be measured reliably Classification - by income generating activies - by income types |
|
|
expenses |
defintion -Decreases in economicbenefits duringthe accounting period in the form of outflows or depletions of assets or incurrences ofliabilities that result in decreases in equity, other than those relating todistributions to equity participants - Qualification:Distribution to owners is NOT an expense despite it resulting in a decrease inequity Recognition -Recognising an expense involvesdetermining •if a decrease in economic benefits has arisen and •if the decrease in economic benefits iscapable of reliable measurement cost of sales expense - main expense incurred by a retail entity in order to sell goods and generate income, the entity must purchase goods for resale cost of sales = inventory and beginning of period + purchases - inventory and end of period - the acquisition of certain assets is not an expense of the period because there is no reduction in EQ associated with the transaction Classification - smaller entities: list all their expenses indivually in the income statement - larger entities: aggregate their expenses into certain classes for reporting purposes - reporting entities: required to classify their expenses by nature or function |
|
|
presenting the income statement |
- differs on whether it is prepared for internal or external reporting purposes and whether the preparing entity is a reporting entity prescribed format - revenue, finance costs, share of profit or loss of associates and joint ventures if equity accounted, tax expense, profit or loss - must also segregate profit or loss from continuing and discontinued operations format for non- reporting entities - no prescribed reporting format - purpose does not change - profit objective is not relevant for all entities |
|
|
financial performanc emeasures |
profit measures include the following - gross profit - profit before and after tax - earnings before interest and tax - net profit after interest and tex - profit before and after material items - profit including and excluding discontinued operations |
|
|
statement of comprehensive income |
- reporting entities can elect to present all items in a single statement of comrehensive income or in two statements - an income statement showing the income and expenses associated with the determination of profit for the reporting period - a statement beginning with profit or loss and displaying components of other comrephensive income |
|
|
statement of changes in EQ |
- Required by all reporting entites - details changes in EQ from the beginning to the end of the reporting period - it shows - profit for the period as per the income statement - income and expenses recognised directly in EQ - transactions with EQ holders as EQ holders ( i.e shares repurchased, dividends paid) |
|
|
link between financial statements |
•Profit (loss) for reporting period is added to retainedearnings at start of period •The entity can make distributions from retained earnings andtransfers to/from retained earnings •The balance of retained earnings at the end of the period isincluded as an equity item in the balance sheet |
|
|
statement of cash flows |
- reports information regarding cash inflows, cash outflows for a period of time - the accrual system focuses on when a transaction takes place - in contrast the statement of cash flows is concerned with cash receipts and payments not the timing of the underlying transaction |
|
|
difference between cash and accrual acct profit |
cash acct system - cash sales - cash collected from accts recievable - cash recieved in advcance of sale - expenses paid in cash - payments to accounts payable - expenses paid in advance accrual acct system - cash sales - credit sales - expenses paid in cash - expenses incurred not yet paid |
|
|
cont. |
- cash flow statement: receipts from sales, payments for inventory, payments for rent, wages, result is 'net operation cash flow' -income statement: sales income, cost of sales, rent expenses, wage expenses, depreciation expenses, result is 'net profit' |
|
|
why is accrual acct better than cash acct? |
-Accrualaccounting recognises income when it has been ‘earned’ -Accrualaccounting system recognises all resources consumed in earning that income -Accrualaccounting system permits the recognition of ‘assets’ (resources available forfuture consumption) -Accrualaccounting gives a more realistic interpretation of an entity’s overallfinancial performance |
|
|
why is cash flow statement needed? |
Toprovide information about: •cashreceipts •cashpayments •netchange in cash resulting from operating, investing and financing activities -Toensure that an entity has enough cash on hand to meet its financial commitmentsin a timely fashion – avoid insolvency |
|
|
relationship of cash flows to other financial statements |
- income statement and balance sheet only show part of business activities - cash flow gives additional info to assist decision makers in assessing an entities ability to: - generate cash flows, meet financial commitments, fund changes in scope and nature of activities, obtain external finance Classified into three main sections - operating activities (income statement revenue and expenses, current assets and liabilities in the balance sheet) - Investing activities (non current assets) - financing activities (non current liabilities and equity in the balance sheet) |
|
|
definition of cash |
Cash: •Notesand coins held •Depositcall accounts at financial institutions Cashequivalents: •Shortterm, highly liquid investments, easily converted to known amounts of cash withlittle risk of a change in value •Investmentswith maturity ≤ 3 months •Bankoverdrafts |
|
|
format statement of cash flows |
-Operating activities -Activitiesrelatingto provision of goods andservices andother activities that are neither investing nor financing activities -Activitiesreported in the income statement are adjusted from accrual to cash basis -Cash from operating activities shows ability to:•generate cash •meet short term obligations •continue as a going concern •expand Investing activities -Consistof those activities that relate to theacquisition and/or disposal of: •non-current assets (including property, plant andequipment, and other productive assets), and •investments (such as securities) not falling within the definition ofcash - Theseitems allow users to analyse future directions of the entity by studying majorasset acquisitions and disposals Financing activities Consistof: •Activitiesthat change the size and/or composition of the financial structure ofthe entity (including equity), and •Borrowingsnot falling within definition of cash -Usuallyassociated with changes in non-current liabilities and equity |
|
|
reconsiling cash from operations with operating profit |
- profit must be reconciled to net cash provided/used by operations - reconciliation must be disclosed in financial statements as a note the accounts - allows users to see the changes in operating accounts brought about by the use of accrual vs cash basis of acct usefullness - for investment comm - recognition that management of earnings can lead to some acct manipulations in the income statment - for lending comm - used to assess orgs management and whether it has or can generate sufficient cash |
|
|
the statement of cash flow can provide warnings signals such as.... |
- cash received less than cash paid - net operating cash outflow - cash from operations less than after tax profit - proceeds from share capital, investments and borrowings used to compensate for negative operating cash - loss of cash on a continual basis |
|
|
managing net working captial |
working capital: funds invested in current assets - assets the entity expects to covert cash within the next 12 months eg. cash, debtors net working capital: current assets minus current liabilities ie. creditors - effective management of net working capital involves - maintaining liquidity - the need to earn the required rate of return on assets for investors - the cost and risk of short term funding |
|
|
deciding the appropriate level of net working capitial |
•To achieve an appropriate level of net working capital manyfirms use the hedging principle•This means matching the maturity of the source of fundingwith its use or cash flows •To make the hedging principle more useful, it is useful tothink in terms of different 3 different sources of funding - principles for using the various sources of financing are - permanent assets should be financed with permamnet and spontaneous sources of funding - temporary assets should be financed with temporary sources of funding |
|
|
managing cash |
- entities manage cash in relation to the following issues - the need to have sufficient cash - the timing of cash flows - the cost of cash - the cost of not having enough cash need for sufficient cash - managers face a trade off between risk and return when contemplating how much cash to hold - cash may be minimised by holding as little cash as possible, but risk is increased |
|
|
timing of cash flows |
•The timing of most cash flows is normally variable, the onlyexceptions probably being the payment by the entity of wages and taxes •Entities can plan the timing of the purchase and sale ofassets, and the requirements for capital injections, to suit their needs •Similarly, in contracting for loans or placing funds in theshort-term money market, an entity can negotiate timing that best suits its ownneeds |
|
|
cost of cash |
two types of cost associated with holding cash - opp cost of holding currency or cash deposits, rather than short term securities - cost of ensuring physical security of currency - electronic alternatives -have reduced the amounts of currency handled by entities - has increased costs everywhere else cost of not having enough cash - may result in loss of business, insolvency |
|
|
inventory management techniques |
1- maintaining a minimum level of stock - either explicit or implicit level 2- arrange inventory turnover period (ITP) - manager can decide on a number of days of inventory to be held as optimum for the firm Inventory turnover = average inventory x 365 days = x days/ cost of sales 3. 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 |
|
|
sources of short term finance |
- accrued wages and taxes - trade credit - bank overdrafts - commercial bills and promissory notes - factoring or debtor/invoice, trade finance - stock/inventory loans or floor-plan finance - trade credit particularly important because it arises through normal business activities sources of long term finance - through financial institutions: acting as intermediaries, directly by the debt market EQ finance obtained through - ordinary shares, preference shares other forms of EQ financing: rights issues, options |
|
|
Business sustainabiliy key drivers |
- competition for resources - climate change - economic globalisation - connectivity and communication Principles - ethics - governance - transparency - business relationships - financial return - community involvement/ economic development - value of products and services - employment practices - protection of the environment |
|
|
theories of business sustainability and corporate social resposibility |
- corporate social responsibility refers to the responsibility an entity has to all stake holders, including society in general and the physical environment in which it operates - its profitable to do so, reduces interference from government and desire to do the right thing a corporation has many stakeholders - individuals or groups who have an interest in the affairs - they represent all parties that can influence - stakeholder include shareholders, employees, creditors ect |
|
|
theories |
stakeholder theory: holds that the purpose of the entity is to work for the good of all stakeholder groups not just to maximise shareholder wealth stewardship theory: directors act in interest of a group of stakeholders not just shareholder value - contributes to the rise of independant non executive directors |
|
|
reporting and disclosure |
- in addition to required financial reporting, organisations are voluntarily reporting on their sustainability practise - reporting frame work - sustainability reporting guidelines, technical protocol, sector supplements Standard disclosures include.... - strategy and profile ( overview of risks and opps facing the org) - management approach (How to manage sustainability topics associated with risks and opps) - performance indicators ( economic, environmental, social |
|
|
cont. |
•Whilemany entities aim for profit maximisation, the importance of sustainablebusiness practices means that decisions may be made that are not necessarilyprofit maximising, but are beneficial for the environment or the community. •Entitiesoften articulate their governance, environmental and social policies, andreport on their environmental and social performance in addition to theirfinancial performance. This is referred to as triple bottom line reporting. |
|
|
triple bottom line reporting and corporate governance |
- reporting on the pillars of sustainability - economic performance - environmental performance - social performance •Corporategovernance refersto the direction, control and management of an entity. This includes the rules,procedures and structure upon which the organisation seeks to meet itsobjectives. •Corporate governance responsibilities generallyrest with board of directors. |
|
|
legal duties |
directors owe the following legal duties to their company - act in good faith - care and dilligence - avoid use of improper information - avoid personal conflicts |
|
|
ethics |
•Thekey to governance for sustainability may be determined by the extent of ethicalconsciousness. •MoralityvsPrudence -Prudence •Acting in one’s self-interest -Morality •Actingas one ought to by taking into account the interests of other people ethical theories •Teleological theories areconcerned with consequences of decisions •If actions result in good consequences, behaviour is said tobe ethical •Two issues: -What is a desirable consequence? -Upon whose judgement is the consequence examined? |
|
|
teleological theories |
•Mostnotable teleological theory is ethical utilitarianism -Allindividuals maximising their utility (happiness) will lead to society’s utilitybeing maximised also - Greatesthappiness principle: common good (maximisation of human happiness) is mostimportant vWhogets the most utility? Individualor Society? -John Stuart Mill(1806-1873) proposed that behaviour should be based on what provides thegreatest good to the greatest number -Ifall businesses focus on profitability, maximum production will be achieved fromsociety’s limited resources -Providesjustificationfor profit maximisation |
|
|
deontological theories |
•Deontological theories areconcerned with duties•Kant (1724-1804) proposed that an action ismorally right if it is motivated by a good will that stems from a sense of duty -Do unto others as you would have them dounto you -The end does not always justify the means•Kant’s philosophy grounded in the notions of dutyor obligation, human dignity and respect for the individual •So a business motivated by profits, despite doing respectfulthings, is acting in a prudent rather than a moral way •Sense of duty and respect can lead to partiality -When does partiality become immoral?•Impartiality (and regulation) are seen as essentialcomponents of a moral system – arm’s-length transactions •Business issues to consider: -Insider trading -External audit |
|
|
ethical behaviour and professional code of ethics |
•Manycompanies and professional bodies have developed their own codesof ethics •CPAAustralia and ICAA have joint code of ethics for professional accountants •Fivefundamental principles -Integrity (honest, sincere), Objectivity (no bias or conflict of interest), Professional competence and due care, Confidentiality, Professional behaviour (uphold the reputation of yourprofession) key ethical issues facing entities today - carbon emissions, ethical investments, whistle blowing, insider trading, bribery, fraud |
|
|
users and decison making |
users of financial reports can be catergorised as - resource prodivers, recipients of goods and services, parties performing an overview, internal management |
|
|
need for financial analysis |
- involves expressing reported numbers in relative terms rather than relying on absolutes - can highlight strengths and weaknesses of a firm - users are in a better position to see the entity's future financial health - try to understand past results to predict future performance |
|
|
analytical methods |
- compare figures with - equiv figures from prior year - other figures in financial statements - benchmarks methods include - horizontal - trend - vertical - ratio analysis |
|
|
horizontal anlysis |
- compares reported numbers in different reporting periods to highlight magnitude and significance of changes - dollar change is calculated by: acct number in current period minus acct number prior period - % change: acct number in current period minus acct number prior period x 100 divided by acct number prior period |
|
|
trend analysis |
•Triesto predict the future direction of various items on the basis of the directionof the items in the past •Tocalculate a trend, it is necessary to have at least three years of data •Trendanalysis of a particular item involves expressing the item in subsequent years,relative to a selected base year (which is usually given a value of 100) Example - set 2008 as base year and assign it index value of 100 divide 2009 rev by 2008 rev and x 100 divide 2010 rev by 2008 rev and x 100 divide each subsquent years rev by 2008 rev and x 100 |
|
|
Vertical analysis |
•Involves comparing the items in a financial statement to ananchor item in the same financial statement: - Revenue and expense items are expressed as a percentage ofsales or revenue -A, L and Equity items are expressed as a percentage of totalassets •Demonstrates the internal structure of financial statements •Particularly useful for inter-company comparisons anddifferent size comparisons (“common size financial statements”) |
|
|
ratio analysis |
•An expression of one item in the financial statements as afraction of another item in the financial statements – one item is dividedby another to create the ratio •The ratiocomparison can be between two different statements -But income statement and statement of cash flows involve flowitems whilebalance sheet reports stock items – need to use averages for stock items •Ratios provide clues or symptoms of underlying conditions -Point to areas requiring further investigation •Ratioanalysis is a 3-step process1.Calculatea meaningful ratio by dividing $ amt of an item by $ amount of another item 2.Comparethe ratio with a benchmark3.Interpretthe ratio and seek to explain why it differs -fromprevious years -fromcomparative entities or -fromindustry averages vRatiosin various categories help users in their decision making: profitabilityratios, efficiencyratios, liquidityratios, capitalstructure ratios, marketperformance ratios (relevant to companies listed on an organised stockexchange) |
|
|
benchmarks |
-Ratiosare of limited usefulness unless compared to relevant benchmarks -Comparisonsmay be made of: •theentity’s ratios over time (identify trends)•theentity’s ratios with those of other entities in same industry (intra-industryanalysis) •theentity’s ratios with industry averages •theentity’s ratios with those of entities operating in different industries (inter-industryanalysis) •theentity’s ratios with arbitrary standards |
|
|
profitability analysis |
- Return on EQ (ROE) - roe measures the rate of return achieved by the company's management on the capital invested - roe will be greater than roa when a firm is earning a return on borrowed funds that is greater than cost of those funds -upward trend is good for entity - but a sustained high roe attracts new competitors to industry which erodes roe Example: profit available to woners x 100 = x %/ average owner's EQ |
|
|
CONT. |
ROA - compares firms profits to assets that are available to generate profits - relfects the results of entitys ability EBIT/ average assets x 100 = x % - EBIT is used to eliminate impact of how assets are financed and to exclude effects of taxation policy |
|
|
profit margin ratios |
- ratios that relate profit to sales revenue generated by the entity include the gross profit margin and the profit margin - gross profit margin reflects the proportion of sales dollars the end up as gross proifit Example: gross profit/sales revenue x 100 = x% net profit after tax/sales rev x 100 =x% |
|
|
asset turnover ratio |
- shows an entity's overall efficiency in generating income per dollar of investments in assets - value will depend on the efficiency with which it manages its current and non current investments Example: sales rev/ average total assets = x times Day inventory ratio - indicates the average period of time it takes to sell inventory Example: av inventory/ cost of sales x 365 = x days Day debtors ratio - indicates average period of time it takes to collect money from its trade related accounts receivable Example: Average accounts receivable/ sales rev x 365 |
|
|
Aseet efficiency analysis cont |
-Itis common to calculate the number of times per annum that inventory and tradedebtors are ‘turned over’, rather than the number of days it takes for this tooccur: times turnover inv: cost of sales/ av inventory = times turnover debtors: sales rev/average accounts recieveable = -Daysinventory and days debtors turnovers can be considered together to reflect theentity’s activity cycle (alsoreferred to as the operatingcycle) -The cash cyclerepresents the period of time that elapses between an entity paying for theinventory, selling the inventory, and receiving cash for the inventory =>deduct days creditors from activity cycle |
|
|
liquidity analysis |
•Thesurvival of the entity depends on its ability to pay its debts when they falldue (its liquidity) ••Anentity must have sufficient working capital to satisfy its short-term requirementsand obligations •Butexcess working capital is undesirable because the funds could be invested inother assets that would generate higher returns •Current ratio (or working capital ratio) indicates $ of current assets per$ of current liabilities -Measures a firm’s liquidity = the ability of the firm to meetits short-term obligations) -An arbitraryratio of 1.5:1 is considered a minimum Example: current assets/current libs = •Quick asset ratio (or acidtest ratio) measures $ ofcurrent assets available (excluding inventory and prepayments) to service each $ of current liabilities -A more stringent measure of liquidity than the current ratio -Inventory and prepayments excluded because these are theleast liquid current assets -An arbitrary benchmark ratio for the minimum quick assetratio is around $0.80 of current assets for every $1 of current liabilities Example: current assets - invent/current libs = |
|
|
capital structure anaylsis |
- is the proportion of debt financing relative to EQ financing (gearing or leverage) - reflects the entity's financing decision - investments in assets are funded externally by liabilities or internally by owner's EQ as shown in the accounting equation |
|
|
financial gearing (leverage) |
Financial Gearing: The existence of fixed payment- bearing securities (e.g. loans) in the capital structure of acompany -Thelevel of gearing (or the extent to which a business is financed by outside parties) is an important factor inassessing financial risk -Debt carries contractual obligations that must be metregardless of how well the business is performing – inability to meet theseobligations can result in bankruptcy -Gearingmay be used both to adequately finance the business, and to increase thereturns to owners –provided that the returnsgenerated from the borrowed funds exceed the interest cost of borrowing Capital structure (gearing) ratios - only 1 of the 3 capital structure ratios needs to be calculated . debt to EQ ration: total liabilities/total eq x 100 . debt ration: total liabilities/total assets x 100 . eq ratio: total eq/total assets x 100 - an effect of gearing is that the returns to eq become more sensitive to changes in profits - when highly geared, an increase or decrease in profits will lead to a proportionately greater change in returns to eq |
|
|
Interest servicing ratios |
- the financial risk of the entity can also be assessed through the interest coverage ratio i.e.: EBIT/ net finance costs = x times (value above 3 is usually good) Debt coverage ratio - debt needs to be serviced from cash flow, to relate the entity's cash generating capacity to it's long term debt - this ratio links cash flows with long term debt i.e.: non current libs/net cash flows op acts = |
|
|
market performance analysis |
- net tangible asset backing per share - provides an indication of the value of assets, per ord share on issue - intangible assets such as goodwill are excluded from calculation due to their lack of well known. NTAB per share: ord shareholders EQ- int assets/no. of ord shares on year end issue = - dividend payout ratio - the proportion of current year's profits that are distributed to shareholders as dividends - profits not distributed are retained by the entity for reinvestment. price earnings ratio - a market value indicator that reflects the number of years of earnings that investors are prepared to pay to acquire a share at it's current market price -highlights the market's assessments of the future performance of a firm |
|
|
ratio interrealtionships |
•In presenting profitability, asset efficiency, liquidity,capital structure and market performance ratios, we attempt to link ratios todescribe the financial health of the firm •Ratioanalysis is valuable because it helps to interpret and explain why ratios maybe different from those of: previous years, competitors, industry averagesentities in unrelated industries performing a ratio analysis - across time ( a ratio from two years) - The DES method (describe, explain, suggest) Limitations of ratio analysis - quality of underlying financial statements - most analysis is for forecasting future performance but historical relationships may not continue - any ratios based on balance sheets will not be representative of the whole period - no two businesses are identical - lack of disclosure |
|
|
budgeting and strategic planning |
- longer term planning 3-5 years -carried out by senior management - commonly relates to broader issues such as business takeovers - budgeting focuses on the short term - they operationalise strategic plans and allow operational areas to understand how they contribute to the entity |
|
|
budgets |
Part of the formal planning process relates to an entity’soperational plans, including short term goals and targets: -Performance management: •involvessetting targets in other than just financial terms, e.g. improving customerservice, corporate governance, management techniques, and human resource management •a budget is the quantitative expression of anentity’s plans Budgeting can assist in decision-making by: puttinginto operation longer-term plans, settingtargets for managers, identifyingresource constraints in budget period, identifyingperiods of expected cash shortages and excess cash holdings, assistingwith short-term planning decisions, such as capacity utilisation, providingprofit forecasts and other financial data to the capital markets, forecastingdata such as sales or fees, which commonly set the level of activity for thebudget period, helpingdetermine required inventory levels and purchasing requirements for rawmaterials, planninglabour and other inputs, determiningthe ability of the entity to meet financing commitments"A budget is just |
|
|
types of budgets |
•Sales(or fees) budget •Operating(expenses) budget •Production and inventory budgets •Purchases budget •Budgeted income statement •Cash budget •Budgeted balance sheet •Capital budgets •Manufacturing overhead budget •Programbudget |
|
|
master budget and budgeting process |
•A masterbudget is a set ofinterrelated budgets for a future period which provides a framework for viewingrelevant budgets of an entity •Becausebudgets are based on forecasts about the future, complete accuracy isimpossible and variances will inevitably arise -Bothfavourable and unfavourable variances must beanalysed to understand their causes -Correctiveaction may be taken, or the budget revised The budgeting process 1. Consideration of past performance 2. Assessment of expected trading and operating conditions 3. Preparation of initial budget estimates 4. Adjustment to estimates based on communication with, andfeedback from, managers 5. Preparation of budgeted reports and sub-budgets 6. Monitoring of actual performance against the budget overthe budget period 7. Making any necessary adjustments to the budget during thebudget period stages of prep for master budget - developing sales budget - developing production budget - developing materials budget - developing labour budget - developing operating expenses budget |
|
|
the cash budget |
The cash budget is a statement of expectedfuture cash receipts and payments •Itassists decision making by: -documentingtiming of all cash receipts and payments -helpingto identify periods of expected cash shortages and surpluses -identifyingsuitable times for purchase of non-current assets -assistingwith planning and use of borrowed funds -providinga framework for ‘what if’ analysis •Foran entity that provides goods or services on credit, one of the main tasks inthe preparation of a cash budget is calculating the cash receipts from thecredit sales or fees generated •Thisis commonly shown in a schedule of receipts from debtors/accounts receivable |
|
|
budgets: planning and control |
•Thepreparation of the cash budget is an important part of the planningprocess•Itcan then be used for monitoring cash performance, also known as the controlprocess •Acash budget prepared on a month-by-month basis is much more useful for thispurpose than one prepared on a quarterly or yearly basis •Aseach month passes, actual cash numbers can be compared to the budget numbers,with the difference between the two known asa variance |
|
|
improving cash flow |
•Cash inflow may be increased by: -improvingthe collections of cash from debtors -seekingways to improve sales or fees -reducingunnecessary stock levels -arrangingexternal finance -providingan extra capital contribution from the owners, or considering a change inownership structure -sellingexcess non-current assets •Cash outflow may be reduced by: -cuttingexpenses by identifying areas of waste, duplication or inefficiency -makinguse of creditors’ terms -keepinginventory levels to only what is required, as excess inventory ties up cash andoften adds to storage and handling costs -deferringcapital expenditures |
|
|
CVP analysis |
-CVPanalysis is concerned with the change in profits in response to changes in sales volumes, costs andprices •Helpsanswer the following questions:- -Howmany units need to be sold, or services performed, to break even (that is, earnzero profit)? -Whatis the impact on profit of a change in the mix between fixed and variablecosts? -Howmany units need to be sold, or services performed, to achieve a particularlevel of profit? -Whatis the impact on profit of a 15 per cent increase in costs? A 10% decrease insales volume? Etc. -CVPanalysis is an important part of the managerial planning process -Beginswith a consideration of cost behaviour•Examiningcost behaviour enables us to consider: -theway in which costs change, and -themain factors that influence those changes •Costscan be classified as fixed, variable or mixed -Thenature of fixed and variable costs relates to whether such costs are likely toalter in total with changes in activity |
|
|
fixed, variable and mixed costs |
•Fixed costs are thosecosts that remain the same in total (within a given range of activity andtimeframe) irrespective of the level of activity e.g. leasecosts; depreciation charges •When we consider levels of activity in terms of units ofoutput: -total fixed costs remain thesame, but -fixed costs per unit willdecrease as the number of units produced increases •Variable costs change in totalas thelevel of activity changese.g. costof bricks to build a house; aviation fuel for Qantas •Variablecosts can be considered on either a total or unit basis: -total variable costs increaseas the number of units produced increases, but -variable costs per unit willremain the same •Therelevant range is the range ofactivity over which the cost behaviour is assumed to be valid•Ifthe activity level goes outside the relevant range, then the expected behaviourof costs changes, e.g. fixed costs can no longer be assumed to be fixed |
|
|
break-even analysis |
-Break-even analysis relates to the calculation of the necessary levels ofactivity required in order to break even in a given period •Break-evenoccurs when total revenue and total costs are equal, resulting in zero profit -i.e.when: revenue = FC + VC •Break-evenanalysis involves thecontribution margin concept •Contributionmargin is calculated bydeducting total variable costs from total revenue•Contributionmargin per unit canbe calculated by deducting variable cost per unit from revenue per unit |
|
|
using breakeven data |
•Identifyingthe number of products or services required to be sold to meet break-even orprofit targets •Planningproducts and allocating resources by focusing on those products that contributemore to profitability •Determiningthe impact on profit of changes in the mix of fixed and variable costs •Pricingproducts |
|
|
CVP assumptions |
•Thebehaviour of costs can be classified as fixed or variable •Costbehaviour is linear •Fixedcosts remain ‘fixed’ over the time period and/or a given range of activity(often referred to as the relevant range) •Unitprice and cost data remain constant over the time period and relevant range •Formulti-product entities, the sales mix between the products is constant Margin of safety - provides an indication of how much revenue can decrease before reaching the break even point - provides a measure of how much risk is involved in the activity |
|
|
operating leverage |
-Operatingleverage is the mix between FCand VC in the cost structure of an entity •Itprovides an understanding of the impact of changes in revenue on profit •Greater proportion of FC in a firm: -more highlyleveraged - more risky -because fluctuations in sales - higher fluctuations inprofit example: •Modcleanuses casual labour to demonstrate their product -Variablecost $1 per unit •Humanresource manager proposes to hire a part-time permanent employee -fixedcost $10,000 •Ifthis proposal goes ahead -Variablecosts drop by $1.00 per unit -Fixedcosts increase by $10,000 - Determinelevel of sales at which profit would be the same... - fixed costs/ variable costs - 10,000/1 = 10,000 units - indifferent because profit is the same •Contributionmargin under permanent employee $25 – 14 = $11 •ContributionMargin under casual employee $25 – 15 = $10 •Thereforeif sales fall below 10,000 units they should use casual labour because profitreduces at a slower rate •andif sales rise above 10,000 units they should use permanent labour becauseprofit increases at a faster rate |
|
|
contribution margin per limiting factor |
- the contribution margin per unit of limited resource •Bysumming the required hours, we find that the firm needs a total of 370,000hours •BUTonly 250,000 hours are available for production •Firmwants to know which product it should promote •Thismeans we need to determine the most profitable product •Todo this need to find CMper hour becausetime is the limiting factor |
|
|
make or buy (outsourcing) |
•Tomake sure decisions are based on the right information, the following must beidentified where relevant: -Relevantcosts and relevant income -Incrementalcosts and incremental income -Opportunitycost -Avoidablecosts and unavoidable costs •A make or buy(outsourcing) decision requiresan entity to choose whether: -Tomake or provide a product or service, or -Tooutsource the production of that product or service Special order decision - a special order is a one off request from a customer that is different from the orders usually received by the entity - will incremental rev exceed incremental costs - incremental costs = additional VC but may also be incremental FC - must consider whether the entity is operating at full capacity or has idle capacity - insufficient idle capacity => opportunity cost |
