LUBS 1225 Introduction to Accounting for

Managers

Textbook reading: Atrill and McLaney Chapter 1

Objectives
The objectives of this session are to:

• Have an overview of the module;

• Appreciate the purpose of, and distinguish between, financial and
management accountancy;
• Identify the types of organisations that produce financial information;
• Name the main users and their interests in accounting information; Identify
the characteristics of useful accounting information; and
• Discuss the accounting conventions underpinning financial reporting.

Study advice for this module

Accounting is a subject which takes some getting used to for most students. The
key is regular practice. Reading over your notes and the textbook is important but
will not be effective on its own as a study strategy.

Introduction to accountancy
If you ask anyone to define the word “accountancy”, you will usually obtain a
variety of answers, some of definitions more polite than others!

As the textbook states:

“Accounting is concerned with collecting, analysing and communicating

financial information. The ultimate aim is to help those using this
information to make more informed decisions”.

All this rather gives the impression of a multi-faceted job, the definition being
somewhat vague because an accountant can do so many different things. You may
find an accountant doing any one (or more) of the following jobs:

 Financial Accountant;
 Management Accountant;
 Cost Accountant;
 Auditor;
 Tax Consultant;
 Insolvency Practitioner;
 Receiver;
 Forensic Accountant;
 and many more.

The jobs referred above are specialised and require considerable practical
experience and further, very specific training in addition to basic accountancy
knowledge. There are a number of professional chartered accountancy bodies in
the UK including ICAEW (Institute of Chartered Accountants in England and Wales),
ACCA (Association of Chartered Certified Accountants) and CIMA (Chartered
Institute of Management Accountants).

We are not trying to make accountants out of you but, as Management students, it
is likely that you are preparing for a career in the world of business and it is
important that you speak the language of accountants and understand basic
financial information and tools that may be useful in your role as a manager.

Accounting can help users both inside and outside an organisation make decisions
such as:

 whether to invest in the organisation

 whether to lend money to the organisation
 whether to sell goods to the organisation
 whether to develop a new product; and
 whether to increase the operating capacity of the organisation

Every manager in every role in every business will use accounting information.

For example:

Chief executive / managing director – which area of the business should we seek to
expand?

Sales director/manager – if we try to export to country X what’s the minimum price

we should charge?

HR director/manager – what are the costs and benefits of introducing an employee

welfare scheme?

Marketing director/manager – is it worth spending £Xm on a new TV advertising

campaign?

Production director/factory manager – how much extra will it cost if we put on

another shift?

To suggest an accountant’s answer to the last question:

“It all depends on the variable and fixed costs – are they truly variable or fixed or
will they behave in some other way if we put on another shift? We need to
consider the contribution on the additional production – and we may need extra
working capital”

Does any of the previous paragraph make sense – hopefully it will after studying
this module!

Of course you may argue to the contrary – “I want to work for a charity in a poor
country helping people – I don’t want to bother with accounting”. I’m afraid you
will still have to account for your costs and work to a budget – so a basic
knowledge of accounting will be invaluable!
Financial accounting v Management accounting
Accounting is generally seen to have two main strands:

Financial accounting

 Provides information to users outside the organisation; the main documents are
the financial statements containing the Income Statement (or profit & loss
account), Statement of Financial Position (or Balance Sheet) and Statement of
Cash Flows;
 The information produced is often subject to regulation such as Company Law
and/or Accounting Standards;
 The information is provided about the past (historical) being produced after the
accounting year end;
 Information produced concerns items that can be measured in monetary terms;
 Involves bookkeeping which is the collection and organisation of data (this is
often digitalised now using accounting software);
 Preparation of financial statements from bookkeeping records;
 Analysis of the financial statements.

Management accounting

 Provides information to internal users (management) of the organisation and is

mainly concerned with the future;
 This information helps an organisation’s decision-making process;
 Management accounting helps control an organisation’s resources;
 Information used will be acquired from many sources including past
performance, future estimates, non-financial information etc. (this may include
information similar that prepared for financial accounting but it will be prepared
on a more timely basis, such as monthly financial statements and key ratios for
performance tracking);
 The information will often be more detailed than financial accounting.

Types of organisations
Business entities
The most common types of business are as follows:

Sole proprietor (or sole trader) - a person in business alone, operating, for
example, a shop. The capital is raised individually using personal savings, loans
from friends, banks, etc. The business is not a separate legal entity and, if the
business has financial difficulties, creditors can pursue the personal assets (as well
as the business assets) of the sole proprietor to obtain their money.

Companies – these have an existence separate from their owners. They are their
own separate legal entity.
There are two main types:

Public limited companies (plc) - whose shares may be listed and traded on a
Stock Exchange, possibly overseas as well as in their native country.

Private limited companies (Ltd) - whose shares cannot legally be traded in the
same way as a public company; these shares are usually held by members of a
family or a larger company (which may or may not itself be a public company).
The word limited here means that the liability of the shareholders ( is limited to
the amount which they have agreed to pay for their shares. If the company
becomes insolvent and cannot pay its creditors (payables), it means that those
creditors cannot pursue any individual shareholder’s personal assets to obtain
their money. We will consider companies more in Week 4.

The financial accounting part of this module will primarily look at the accounts of
sole traders and companies. Whatever its size an entity keeps accounting records
in much the same way, but what the world at large can see of the accounts
depends on a combination of the type of entity being considered and the
regulations which affect it. The basic difference between entities often seems to
lie in the ways in which they raise capital.

Other entities not covered by this module are partnerships, joint ventures and not
for profit organisations such as associations, clubs, trusts and charities.

Points to consider

There are often advantages to be gained from doing business in one form rather
than another, so this is something which needs to be considered in detail before a
business has even started, and often requires the benefit of professional advice.
The benefits that arise from the legal form of the entity are more obvious in some
instances than in others. For example, the protection granted by limited liability is
evident, and, indeed, is much the same anywhere in the world, but the details of
the tax benefits conferred by one business form rather than any other, cannot
usually be determined without a profound knowledge of the country of operation’s
tax system. It may transpire that it is better sense, because of the prevailing tax
laws, to do business in China, say, as a partnership or joint venture, rather than as
a company. One cannot decide this without a great deal of investigation and
usually seeking specialist advice from accountants and lawyers.
Accounting Information
Accounting information systems
According to the textbook an accounting information system is made up of the
following four features:

 Identifying and capturing relevant information – e.g. recording bills paid;

 Recording in a systematic manner the information collected – double entry
bookkeeping (not considered in this module);
 Analysing and interpreting the information collected – use of ratio analysis;
 Reporting the information in a manner that suits the needs of the user –
financial statements; management accounts; dashboards.

The final two features are the prime concerns of this module.

Main users of accounting information

The main users of accounting information together with suggested reasons for
their interest are shown in the table below:

User Relationship to Interest in accounting

organisation information includes
Investors /owners Invested capital in Profit earned
organisation Dividend receivable
Security of investment
Investment analysts None Advice to be given to
their clients about
purchase or sale of an
organisation’s shares;
look at the possible risks
and returns
Managers Appointed by investors to Daily information and
run the organisation comparison with
previously produced
information. E.g. Should
the organisation’s
direction be changed?
Lenders Loaned funds to an Whether interest will be
organisation paid on due date and the
security of the loan
Suppliers Supply goods to Whether credit should be
organisation extended to organisation;
will the organisation be
able to pay their debts on
time?
Customers Purchase goods or Will the organisation be
services from able to supply them with
organisation goods for foreseeable
future?
Competitors Compete against Assess an organisation’s
organisation strengths and
weaknesses
Public Effect of organisation on Will organisation provide
 User Relationship to Interest in accounting
organisation information includes
public and local local employment? Is
communities e.g. there any correlation
environmentalists between profits and
pollution?
Government & their Regulation and payment Has the organisation paid
agencies of tax correct amount of
taxation on due date; has
the organisation
complied with relevant
regulation etc.?
Employees Present and future Financial viability of
employees of the organisation – whether to
organisation commence or continue
employment with
organisation

As the above groups have a stake in the organisation they are often termed as
‘stakeholders’. On occasions there may be conflicts of interest between users. For
example investors are generally concerned about an organisation’s profits and
share price whereas an employee could be concerned about their own salary and
bonus.

Characteristics of accounting information

As identified above, accountants provide information to various users and to be of

use this information must possess certain characteristics:

 Relevance for purpose, such as making decisions like “Should I invest?” or

“Should I lend money?”
 Faithful representation – accounting information should reflect the
economic substance of what has happened and sometimes this will be
different to the legal form (known as ‘substance over form’); information
should also be complete and reliable - free from material error or bias
(different to accurate – often contains estimates)
 Comparability - over time / between businesses – differences and similarities
can be seen and evaluated
 Verifiability – independent experts would agree the accounting information is
faithfully portrayed and as factual as possible, based on objective evidence
 Understandability – understandable by those with a reasonable knowledge
of business activities and accounting (that is our aim for you!)
 Timeliness – available at the appropriate time when decisions are being
made
 Material - when determining materiality it is important to consider whether
including the information separately would influence a user’s decision(s) and
whether the benefit from having the information is greater than the cost of
obtaining it
Figure 1.2 in the textbook shows how these and other characteristics are related.

Accounting conventions
As well as requiring certain characteristics, the preparation of accounting
information is underpinned by a number of accounting conventions or rules. We
will just cover some of the key ones and will see these in practice over the course
of the module.

Business entity convention– “this convention holds that, for accounting

purposes, the business and it owners(s) are treated quite separate and distinct.”

For sole traders there is no legal distinction between business and personal assets,
in that if the business fails, creditors can also seek to recover their debts by
seizing the owner’s assets. However, for accounting purposes, the business should
be treated as a separate entity, with only financial information relating to the
business being reported..

Prudence – “this convention holds that financial statements should err on the
side of caution”.

This means that revenue and profits should not be anticipated, but recognised only
when realised in the form of cash or of other assets which can be assessed with
reasonable certainty (e.g. a credit agreement with a debtor). Provision is made for
all known liabilities (expenses and losses), whether the amount is known with
certainty or is a best estimate in the light of the information available. For
example, if it is realised that a customer is unlikely to be able to pay an amount
owed, it is deemed prudent to exclude, or write off, the debt as a known loss.

Going concern – “this convention assumes that the business will continue
operations for the foreseeable future, unless there is reason to believe otherwise.”

For example, if there were any doubts about the future of the business non-current
assets may be valued at resale (second hand) value or inventory at some sort of
“liquidation” price.

Matching – “this convention holds that, in measuring income, expenses should be

matched to revenues that they helped generate, in the same accounting period as
those revenues were realised.”

This means that revenues and costs are recognised (accrued) as they are earned
or incurred, not as money is received or paid. As a result, profit is the excess of
revenue over expenses, not the excess of cash receipts over cash payments and
profit for a period will not normally be the same as cash generated during that
period. . This convention underpins what is known as ‘accrual accounting’, the
basis on which the Income Statement and Statement of Financial Position are
prepared.

We will see this in practice when we look at Adjustments in Week 3.