Accounting can be defined as the process of identifying, measuring and communicating economic information about an entity to a variety of users for the purpose of decision making.

The process of accounting: identifying- transactions that effect the entity’s financial position are taken into consideration. They must be able to reliably measured and recorded; measuring- this stage includes analysis, recording and classifying of business transactions; communicating- accounting information is used for a range of decisions by external and internal users.

Bookkeeping- the recording and summarising of financial transactions and the preparation of basic reports book keeping represents the first two stages of the accounting process: identifying and measuring.

Financial accounting- preparation and presentation of financial information for users to enable them to make economic decisions regarding the entity. Provides information for external parties to make economic decisions regarding the entity and can be used by management for internal decision making.

Management accounting- field of accounting that provides economic information for use by management in internal planning and decision making.

Differences between financial accounting and management accounting

Financial Accounting Management accounting 1. Regulations Bound by GAAP. GAAP are

represented by accounting standards (including those issued by both the AASB and IASB), the Corporations Act, and relevant rules of accounting association and other organisations such as the ASX.

Much less formal and without any prescribed rules. The reports are constructed to be of use to the managers.

2. Timeliness Information is often outdated by the time the statements are distributed to the users. The financial statements present a historical picture of the past operations of the entity.

Management reports can be both a historical record and a projection, e.g., a budget.

3. Level of Detail Most financial statements are of quantitative nature. The statements represent the entity as a whole, consolidating income and expenses from different segments of the business.

Much more detailed and can be tailored to suit the needs of management. Of both a quantitative and qualitative nature.

4. Main users Prepared to suit a variety of users including management, suppliers, consumers, employers, banks, taxation authorities, interested groups, investors and prospective investors.

Main users are the managers in the entity, hence the term management accounting.

Regulation ASIC (Australian securities and investments commission) acts as the company

watchdog, and enforces company and financial laws such as the Corporations Act 2001- national scheme of legislation, administered by ASIC, dealing with the regulation of companies and the securities and futures industries in Australia. Government body which regulates company borrowings, and investments advisers and dealers.

The ASX (Australian securities exchange- Australian market place for trading equities, government bonds and other fixed-interest securities) regulates companies through the market rules (rules governing the operations and behaviour of participating entities of the ASX and affiliates) and listing rules (rules governing the procedures and behaviour of all ASX listed companies).

APRA (Australian Prudential Regulation Authority) is responsible for ensuring that financial institutes honour their commitments to their stakeholders.

The ACCC (Australian competition and consumer commission) administers the Competition and Consumer Act 2010, which coves for anti-competitive behaviour and unfair market practices, mergers and acquisitions of companies, and product safety and liability.

Qualitative Characteristics

Relevance: The characteristic of relevance implies that the information should have predictive and confirmatory value for users in making and evaluating economic decisions. This characteristic also includes materiality- Information is material if omitting it or misstating it could influence decision making.

Faithful Representation- This characteristic implies that the financial information faithfully represents the phenomena it purports to represent. This depiction implies that the financial information will be complete, neutral and free from error.

Enhancing qualitative characteristics

Comparability- This characteristic implies that users of financial statements must be able to compare aspects of an entity at one time over time, and between entities at one time and over time. Therefore the measurement and display of transactions and events should be carried out in a consistent manner throughout an entity, or fully explained if they are measured or displayed differently.

Verifiability- This characteristic provides assurance that the information faithfully represents what it suggests that is representing.

Timeliness- This characteristic means that the accounting information is available to all stakeholders in time for decision making purposes.

Understandability- This characteristic implies that preparers should present information in the most understandable manner to users, without sacrificing relevance or reliability.

Limitations of accounting information: time lag (often up to a delay of up to 3 months from the end of the financial year until the information is published), historical information, subjectivity of informationCosts of providing accounting information: information costs, release of competitive information.

Accounting Judgments and Policy Choices have economic Consequences for contracting parties. – If there is a conflict of interest between principal and agent there is Incentive to “manipulate” the accounting numbers. – Hence we have financial accounting standards (regulations), and auditors (to assure the financial statements are “True & Fair”).

Why consolidate think back to advantage of a company: separate legal entity, thus setting up each part of a business as a separate company can help limit losses across the whole company, i.e. if one Woolworths store goes bankrupt, losses are limited to the one store, the rest of the company is not directly responsible.

Cash actual money and what’s in your normal every day accounts

Cash equivalents held for the purpose of meeting short-term cash commitments rather than for investment or other purposes. For an investment to qualify as a cash equivalent it must be readily convertible to a known amount of cash and be subject to an insignificant risk of changes in value.

Trade receivables: - is it probable we will receive everything owed? If we show 100% of trade receivables is it a faithful representation?

Inventory: What is the future benefit? - can we still sell stock at the recent selling price? (Does stock need to be revalued at lower of cost or NRV- obsolescence, lowering demand, damage). What inventory cost flow assumption is a faithful representation of what inventory was sold? – FIFO, weighted average, should have been specific identification- too time consuming and costly- relevance vs faithful representation.

Non-current assets: valuation: historical cost less accumulated depreciation: cost is reliable (faithfully represented) however the older the asset the less relevant this is for decision making. Fair value (market value- in absence of market can estimate this through either current(replacement) cost or present value of future cash flows(value in use)) – more relevant to decision making being current however it is an estimate and thus less reliable as true value can only be established through selling it. Depreciation applies for both methods and the estimations of useful life, residual value and method of depreciation however relevant, compromises reliability.

Different companies-> same asset different valuation methods can’t simply compare values.

Duality -> describes how every business transaction has at least two effects on the accounting equation.

Goodwill cannot be revalued and must be tested for impairment at least annually. Identifiable intangibles can only be revalued an active and liquid market exists.

Explain the nature and purpose of the balance sheet: The balance sheet lists the entity’s assets, the external claims on the assets (the liabilities) and the internal claim on the assets (the equity). The balance sheet reports the entity’s financial position at a point in time. The financial position of the entity refers to the entity’s economic resources (assets), economic obligations (liabilities), financial solvency and financial structure.

Discuss the limitations of the balance sheet: When analysing the financial numbers in the balance sheet, it is necessary to consider issues associated with the preparation of the statement that potentially limit the inferences made. The balance sheet is a historical snapshot of the entity’s economic resources and obligations at a point in time only, and this may not be representative of its resources and obligations throughout the reporting period. Further, the balance sheet does not represent the value of the entity. That is due to the existence of assets and liabilities that are not reported on the balance sheet, and the measurement systems used to recognise assets and liabilities. Finally, the definition and recognition of items on the balance sheet involve management choices, estimations and judgements.

Discuss the measurement of various assets and liabilities on the balance sheet.

Numerous measurement systems can be used to measure elements on the balance sheet. Items are initially recorded at their historical cost. At the time of acquisition, this reflects the items’ fair values. Subsequent to acquisition, receivables are recorded at their expected cash equivalent and inventory is measured at the lower of cost and net realisable value. Property, plant and equipment can either remain at their cost price or be revalued regularly to fair value. Regardless, the carrying amount of an asset must not exceed it recoverable amount. If it does the asset is impaired and must be written down. There are some asset classes (such as agricultural assets and derivative financial instruments) where accounting rules specify that the assets must be recognised at their fair value. Non-current assets with limited lives must be depreciated. Goodwill cannot be revalued and identifiable intangible assets can be only revalued if an active and liquid market exists. Goodwill and intangible assets must be tested for impairment at least annually. The value assigned to such assets on the balance sheet is their cost or revalue amount, less the accumulated depreciation charges, les any

impairment charges. It is important for a user to identify the basis for measuring assets and liabilities on the balance sheet.

Contingent liability- conditions existing at balance date where uncertainty

exists as to: outcome, valuation. Future benefit is beyond entity’s control. Can be either and asset or liability.

Provisions- liability class involving more uncertainty regarding the monetary value to be assigned to the future sacrifice of economic benefits. E.g. Employee benefits, warranty, lease provisions- returning stores to original condition at the end of the lease.

Derivative financial liability- financial liability whose value depends on the value of underlying security, reference rate or index.

Financial liability- Liability that is a contractual obligation to deliver cash or another financial asset to another entity or a contractual obligation to exchange financial assets or financial liabilities with another entity under conditions that are potentially unfavourable to the entity.

Present value (value in use) - used to value and asset. Future profit from using the equipment in today’s dollar value.

-Same annual profit- use the PV of a series (annuity) table. Different, for residual value- use present value of $1 table.

Multiple projects: Beware highest NPV is not always the best: length of time (quicker is often better as can reinvest), available budget ( the best way may not be affordable), reliability of cash flows, cash flows beyond the calculated period, non-financial reasons.

Advantages of NPV method are that it takes into account:

-all of the expected cash flows

-the timing of expected cash flows (with cash flows received sooner being more beneficial to the entity)

-cash flows only, so it is not subject to changing accounting rules and standards as profit figures are.

In addition, the decision rule is explicit, in that positive NPVs will increase entity value if the data are correct.

The disadvantages of the NPV method are that:

-the method relies on the use of appropriate discount factor for the circumstances

-the actual return in terms of percentage of the investment outlay is not revealed

-ranking of projects in terms of highest NPV’s may not lead to optimum outcomes when capital is rationed.

Apply the liability definition and recognition criteria:

Liabilities: A legal obligation is a liability; however, a non-legal obligation may also be a liability. To be recognised on the balance sheet, the outflow and resources embodying economic benefits must be probable and capable of being measured reliably. An entity can always disclose information about a liability that fails the definition or recognition criteria in the notes to the accounts.

Discuss and calculate the net present values (NPV) and apply the decision rule:

Discounted cash-flow techniques overcome the problem of the time value of money by specifically recognising that $1 received sometime in the future is worth less than $1 received now. The NPV measure compares the sum of present values (PVs) of all of the expected cash inflows form the project with the PVs of the expected cash outflows. The NPV is the net outcome. Positive NPV’s indicate that projects are acceptable. Negative NPV’s indicate that projects will not increase wealth.

Explain the relationship between the income statement, the balance sheet, the statement of comprehensive income and the statement of changes in equity.

The income statement reports for profit or loss generated in the reporting period that belongs to the owners of the business. It is added to the retained earnings from previous periods to determine the pool of retained earnings available for distribution to owners. Retained earnings is included in the equity section of the balance sheet as at the end of the period. The statement of comprehensive income details the profit or loss for the period (i.e. the income statement) as well as items of income and expense that are not recognised in profit or loss as required as permitted by accounting standards. These items of income and expense bypass the income statement and are recorded directly in the equity section of the balance sheet. (These include: non-current asset revaluations directly taken to a revaluation surplus, net exchange differences associated with translating foreign currency denominated accounts of a subsidiary into the reporting currency of the group, adjustments to equity allowed pursuant to the operation of a new accounting standard). The statement of changes in equity explains the change in equity from the start to the end of the reporting period. The statement shows the changes in equity arising from transactions with owners in their capacity as owners (such as equity contributions, dividends paid and shares purchased) separately from non-owner changes in equity (e.g. profit). The statements are also related, given

that recognising income and expenses involves simultaneously recognising (or reducing) assets or liabilities.

Discuss the definition, recognition and classification of income:

Income is defined as increases in economic benefits- in the form of inflows or enhancement of assets or decreases of liabilities of the entity- that result in increases in equity during the reporting period. Contributions by owners are not recognised as income. Income comprises revenue and gains.

Discuss the definition, recognition and classification of expenses:

Expenses are decreases in economic benefits- in the form of outflows of assets or increases of liabilities- that result in decreases in equity during the reporting period. Distributions to the owners are not expenses. Expenses can be classifies to their nature or function.

Differentiate between cash and accrual accounting:

An accrual system of accounting focuses on when a transaction takes place (e.g. sale) and not when the payment for that transaction occurs. In contrast, cash accounting is concerned with the receipts and payments and not the timing of the underlying transaction. Relevance Vs Faithful Representation, reporting period, going concern

To recognise income in the income statement, the increase in economic benefits related to an increase in asset or decrease in in a liability must have arisen and be capable of being measured reliably. To recognise an expense in the income statement, the decrease in economic benefits related to decrease in an asset or an increase in a liability must have arisen and be capable of being reliably measured.

Income and expenses are generated from various activities. Income comprises revenue (income arising in the ordinary course of an entity’s activities) and gains. Sources of income include the provision of goods and services (sales), investing or lending, selling assets, and receiving contributions such as government grants. Items of expense include the cost of providing goods and services (cost of sales), wages and salaries, depreciation and amortisation, and selling, administrative, investing and financing expenses.

Outline the effect of accounting policy choices, estimates and judgements on the financial statements.

Even when preparing financial statements in compliance with approved accounting standards, preparers are provided with choices and are required to use estimations and judgements. Therefore, users of financial statements need to appreciate that accounting flexibility and discretion exist, consider the incentives that may affect the choices, estimations and judgements being made, and be aware of the impact of the choices, estimations and judgements on the financial information reported.

Statement of Cash flows

- The purpose of the statement is to show the cash flows of an entity over a set period, in order to enable users of the financial statements to evaluate the entity’s ability to generate positive cash flows in the future, pay dividends and finance growth.

- A statement of cash flows is needed as it summarises the cash and types of cash flows coming into and flowing out of the entity.

- Relationship to other financial statements: The income statement shows the result of an entity’s performance for a particular period of time, and the balance sheet shows the entity’s financial position at a particular point in time. The statement of cash flows shows the cash flows relating to the entity’s performance and helps to identify the changes in the balance sheet items.

- Define cash: The definition of cash includes cash and cash equivalents. Cash includes cash on hand and demand deposits and cash equivalents are highly liquid investments and short-term borrowings.

- Direct method: Method of preparing a statement of cash flows that discloses major classes of gross cash receipts and gross cash payments.

- Indirect method: Method of preparing a statement of cash flows that adjusts profit or loss for the effects of transactions of a non-cash nature and deferrals or accruals of operating revenue and expenses. (The indirect method is the reconciliation or the profit/loss with the cash flows from operating activities).

- Usefulness: The statement of cash flows is useful in assessing an entity’s ability to generate cash and to meet future obligations. The heightened awareness of the management of earnings in the income statement has elevated the performance of reviewing the statement of cash flows in conjunction with the income statement. Limitations- since it only shows cash position, it is not possible to arrive at actual profit or loss of the company by just looking at the statement alone, in isolation this is of no use and it requires other financial statements like balance sheet, profit and loss etc.., and therefore limiting its use.

- The interpretation of the statement of cash flows requires a general evaluation, as well as the use of trend and ratio analysis. Cash flow warning signals can also indicate a cash flow problem. Cash-based ratios include the cash adequacy ratio, the cash flow ratio, the debt coverage ratio, the cash flow to sales ratio, and free cash flow. Despite the complexity of transactions, the basic purpose of a statement of cash flows is to report what cash came in and how it was spent.

Classify costs into direct and indirect costs for individual cost objects.

A direct cost is traceable to a particular cost object. The tracing is made possible by the implementation of a tracking system to link the cost to the cost object. An indirect cost (costs that are not economically feasible (cost/benefit test- assesses the costs and benefits of tracing costs to cost objects) to trace to the cost object) is used for the benefit of multiple costs, and the cost is linked to the individual cost objects by the identification of an appropriate cost driver- measure of the activity, related to cost pool (collection of similar costs), that is used to allocate costs.

Discuss the allocation process of indirect costs:

An indirect cost (also referred to as overhead) is used for the benefit of multiple cost objects. Therefore, an allocation of costs is necessary to enable the cost to be assigned to the many cost objects that make use of the resource. By allocating indirect costs, an entity is able to determine the full cost (direct costs plus allocated indirect costs) of the cost object.

Calculate the full cost of a cost object:

Full cost is equal to direct costs plus indirect costs. The accuracy of the cost is strengthened by the choice of cost driver for indirect cost allocation. Cost drivers can be based on either volume or activity. Volume drivers assign indirect costs based on the same measure of the volume of output; for example, units of output, direct labour hours or machine hours. In contrast, activity drivers recognise that factors other than volume will cause indirect costs to be consumed; for example, number of invoices processed, number of orders processed, or time taken to set up machines.

Calculate and inventoriable product cost:

An inventoriable product cost (costs of converting raw material into finished products) is calculated by manufacturing entities to satisfy the requirements of having and inventory value in financial reports, in line with the International Financial Reporting Standards (IFRSs). An inventoriable product cost includes only manufacturing costs (e.g. direct labour, direct material, manufacturing overhead). All non-manufacturing (e.g. selling expenses, administrative expenses, advertising, corporate salaries, office rent) costs are expensed in the current accounting period.

Define a cost object and explain how cost information is used:

A cost object is anything for which a separate measurement of cost is required. Examples are customers and individual business units. Cost information is used for a variety of purposes to assist in day-to-day management and strategic management- in determining inventory values, analysing product profitability, identifying relevant costs for outsourcing decisions and so on.

Discuss pricing issues for products and services:

An entity has the option of applying either a cost-based or market-based pricing strategy for its products or services. A cost-based price will add a mark-up to the calculated cost of the product or service. A market-based price will be set at the higher possible price that a customer will pay and this will be dependent on the degree of product differentiation and competition.

Uses of management information:

Pricing: based on understanding of: competitor pricing, costs, estimated sales volume and required return.

Cost decisions-finding opportunities for cost reduction, alternative ways of manufacturing product/ creating service, outsourcing decisions, evaluation of alternatives in all management decisions.

Building budgets: making forecasts, assessing ‘what if…’ alternatives

Measuring divisional performance: assessing whether the business strategy is working, providing feedback to mangers

Define fixed, variable and mixed costs:

Fixed costs are commonly identified as those that remain the same in total (with a given range of activity and timeframes), irrespective of the level of activity. Variable costs are commonly identified as those that change in total as the level of activity changes. Mixed costs are those that appear to possess fixed and variable characteristics.

Outline the concepts of margin of safety and operating leverage.

The margin of safety is commonly regarded as the excess of revenue (or unit of sales) above the break-even point. It provides an indication of how much revenue (sales in units) can decrease before reaching the break-even point. Operating leverage refers to the mix between fixed and variable costs in the cost structure of an entity. A knowledge of operating leverage helps in understanding the impact of changes in revenue on profit. Those entities with a higher proportion of fixed costs than variable costs

within their cost structure are often classified as having a high operating leverage. Such entities are commonly thought to be more risky, as fluctuations in sales will produce higher fluctuations in profit for entities with a high operating leverage than they would for entities with lower operating leverage.

Relevant range: The traditional definition of fixed and variable costs relates to the concept of the relevant range. The relevant range is the range of activity over which the cost behaviour is assumed to be valid. If the activity level goes outside the relevant range, then the expected behaviour of costs may change- for example, fixed costs can no longer be assumed to be fixed as the entity may be able to renegotiate contracts or change the level of resources to support operating activities.

Apply the contribution margin ratio to break even calculations:

The contribution margin ration can be used to perform break even calculations by focussing on the ratio of the contribution margin to sales. This can be particularly useful when seeking the total break-even sales dollars, rather than the per unit number.

Contribution margin per unit= (selling price per unit) – (variable cost per unit);

Contribution margin= (total revenue) – (total revenue costs)

Contribution margin ratio = (contribution margin per unit)/selling price per unit = x %

Or Contribution margin ratio = (total contribution margin)/total sales = x %

Prepare a cost-volume-profit (CVP) analysis for single-product and multi-product entities:

CVP analysis commonly requires the use of the contribution margin concept to calculate the break-even number of units. Data are needed on fixed and variable costs in order to execute the calculation. When calculating break-even for multi-product or service entities, we need to calculate the weighted average contribution margin before calculating the break-even units.

Outline the key assumptions underlying CVP analysis:

The key assumptions underlying CVP analysis include the assumption that the behaviour of costs can be neatly classified as fixed or variable- which may not be the case, as some costs do not behave as expected; cost behaviour is generally assumed to be ‘linear’; fixed costs are believed to remain ‘fixed’ over the time period and/or given range of activity (often referred to as the relevant range); unit price and cost data are assumed to remain constant over the time period and relevant range; and, for multi-product entities, the sales mix between the products is assumed to be constant.

Outline the uses of break-even data:

Break-even data can be used in a number of ways, including identifying the number of products or services required to be sold to meet break-even or profit targets; planning products and allocating resources by focussing on those products that contribute more to profitability, determining the impact on profit of changes in the mixed of fix and variable costs; and pricing products.

Explain what a budget is and describe the key steps in the budgeting process:

The key steps in the budgeting process are consideration of past performance, an assessment of the expected trading and operating conditions, preparation of the initial budget estimates, adjustments to estimates based on communication with and feedback from managers, preparation of the budgeted financial statements and any sub-budgets, monitoring of actual performance against the budget over the budget period, and, where necessary, adjusting the budget during the budget period.

Discuss the issues associated with the behavioural aspects of budgeting:

The behavioural aspects of budgets relate to the human involvement in decision making. They include: the style of budgeting process used, such as authoritarian or participative; attempts by senior management to set targets that are too difficult to achieve; and attempts by unit managers to set targets that are too low.

Master budget: coordinates all the financial projections in the organisation

A master budget is a set of interrelated budgets for a future period. It provides a framework for viewing the relevant budgets of the entity. While the nature of the budgets prepared will vary according to the nature of the entity and its operating environment, the master budget is commonly classified into operating budgets and financial budgets. The operating budgets usually include the sales budget and operating expenses budget, while the financial budgets commonly include the broader budgeted income statement, the budgeted balance sheet, the cash budget and the capital budget. The plans developed for a master budget are summarised in a set of budgeted financial statements. To enable the budget to be used as a control too to monitor the entity’s achievement of its plans, the classification of items included in the master budget needs to mirror the entity’s chart of accounts. The chart of accounts is the detailed listing/ index that guides how transactions will be classified and recorded in the financial reporting system. It is important that the budget is developed in line with this classification structure, otherwise those within the entity will be unable to identify any budget variances by comparing actuals against budget.

Explain the link between strategic planning and budgeting

Strategic planning focusses on a longer time horizon (perhaps three to five years), and relates to the direction of the entity. It is carried out by senior management, and generates strategic plans for the entity that further influence shorter term aspects of the planning process. Budgeting focusses on a shorter time horizon (commonly 12 months), and results in the production of budgets that set the financial framework for the year ahead.

Explain the importance of measuring the performance of entities and the aspects of entities that are measured:

Measuring the performance of entities helps to ascertain the achievement of the entity’s objectives. The performance measurement system also helps to communicate the organisation’s goals and focus the efforts of employees. The performance of individuals, teams, divisions and the whole of the organisation can be measured.

Appraise and apply the balanced scorecard framework:

The balanced scorecard provides a framework to measure performance from four perspectives: financial, customer, internal operation, and innovation and improvement. The framework encourages the use of a wide range of measures including financial, non-financial, short-term, long-term and qualitative measures. Environmental and social performance can also be incorporated into the balanced scorecard framework.

Outline common organisational structures, responsibility centres and reasons for divisional performance evaluation and generate divisional performance reports:

Common organisational structures include functional, geographical ad enterprise-based groups. Responsibility centres include cost centres, revenue centres, profit centres and investment centres. The preparation of divisional performance reports is designed to help evaluate the division’s performance, to provide a guide for the pricing of products and services, and to evaluate the level of investment of each division.

Control is exercised by measuring and monitoring performance- by measuring “how well” a business unit manager is doing with their job or adding a firm value, we can make sure they are doing the job are asked with.

Discuss the components of GRI reporting framework

The GRI reporting framework contains principles and standard disclosures required, technical protocols and information relevant to different sectors. The standard sustainability report should contain the strategy and profile of the entity, the management approach and the entity’s economic, social and environmental performance indicators.

Examine the three dimensions of the triple bottom line:

The three dimensions of the triple bottom line are economic, social and environmental.

Explain the concept of corporate governance:

Corporate governance refers to the direction, control and management of the entity. The board of the directors is given the authority through the company constitution and the Corporations Act 2001 to act on behalf of shareholders.

Outline corporate governance guidelines and practices:

Corporate governance guidelines help to foster improved corporate governance practices. An example is put forward by the ASX Corporate Governance Council. The guidelines foster awareness of director’s responsibilities, and help communicate society’s expectations to the business community. Such guidelines generally include items such as board structure, financial reporting, ethics, stakeholders, remuneration and disclosure.

Describe sustainability and outline its key drivers and principles:

Business sustainability considers the use of the world’s resources in a way that does not compromise the ability of future generations to meet their needs. Key drivers include the competition for resources, climate change, economic globalisation and connectivity and communication. Principles include ethics, governance, transparency, business relationships, financial return, community involvement/ economic development, value of products and services, employment practices and protection of the environment. By necessity, decision making in business incorporates certain level of ethical contemplation. Business decision makers influence the use of the world’s resources and can affect the lives of many people. Ethics is central to the study of humankind, and so should be explored in a business context.