ACCOUNTING
Financial and Organisational
Decision Making
Chapter 2
Accounting reports: their nature and
uses
Slides written and designed by
Tony Van Eekelen
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Learning Objectives
In this chapter you will be introduced to
– financial accounting and management
accounting
– the elements of financial statements and the
criteria for their recognition
– the structure, contents and uses of the major
financial statements
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Learning Objectives
– financial ratio analysis
– the historical cost basis of
accounting
– the nature and use of
estimation and judgment
in accounting
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Two major forms of accounting
F igur e 2 .1 F or ms of account ing
A ccount ing
F inancial account ing M anagement A ccount ing
Gener al pur pos e S pecial pur pos e
fi nancial r epor t s fi nancial r epor t s
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Financial Accounting
Oriented towards users of financial reports
who are external to an organisation
Users
– investors, employees, lenders, suppliers,
customers, governments, community groups
and others
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General Purpose financial reports
Prepared for outsiders
Users/uses undefined
Aggregate information
Generally presented after the event
Established format according to reporting
requirements
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Special Purpose financial reports
Prepared for outsiders who are able to
command financial information
Defined users
Detailed information
Generally presented after the event
Established format as prescribed
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Management Accounting
Prepared internally for insiders
– management (including directors)
Specific purpose
– organising, planning, control and performance
evaluation
Detailed information
Critical time constraint
Flexible format
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Organisational Decision Making
Internal vs. External reporting
Two major differences
– External users may be many and varied
• variety of needs
• highly standardised, summarised reports
• satisfy multiplicity of users
• internal can be specific
– Legal obligations on external reporting
• Company requirements, objective, evidence
• Internal - subjective, “what if”
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Organisational Decision Making
Major Financial Statements
Three questions
– How well has the entity performed?
– What is the financial position of the entity?
– What is the ability of the entity to generate cash
to pay its debts?
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Profit and Loss Statement
Profit and loss statement (operating
statement) reports as profit (or loss) the
difference between the revenue earned and
the expenses incurred during a given period.
Revenue
– CCA - sales of goods, accountants - fees
– Cash or/and credit (amount paid at a later date)
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Organisational Decision Making
Profit and Loss Statement
Expenses
– incurred in earning revenue
– types: cost of goods sold, rent, electricity,
salary, interest, …
– cash or/and credit
Net Profit = Revenue - Expenses
– increases the net assets of the entity
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Profit and Loss Statement
Operating Items
– arise from the entity’s ordinary operations
Extraordinary
– not related to the ordinary operations of the entity and
which are non-recurring
– eg sale of part of the entity
Abnormal
– operating items which are disclosed due to their size
and effect
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Balance Sheet
Balance sheet (statement of financial
position) reports the resources of value
controlled by the entity and claims of
owners and non-owners to those resources
at a given date.
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Balance Sheet components
Assets
– resources which provide benefits to the
entity either by use or by sale
– current assets
• converted to cash or consumed within the next
financial year
• eg cash, inventory, prepayments, receivables
– non-current assets
• intended to be held for continuing use rather than
exchange
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Balance Sheet components
Liabilities are financial claims on the entity
by non-owners
– Current liabilities
• liabilities which must be discharged within 12
months
– eg creditors, bank overdraft, provision for taxation
– Non- Current liabilities
• all other liabilities maturing beyond the next 12
months
– eg debentures, mortgages, long-term loans
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Organisational Decision Making
Balance Sheet components
Equity represents the excess of assets over
liabilities
– based upon valuation of liabilities and assets
– may include paid-up capital, retained profits,
reserves
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Cash flow statement
Reports the effects of all transactions
involving a flow of cash into or out of the
entity
These transactions are classified into
– operational - profit/loss activities
– financial - sources of finance
– investment - asset transactions
Reconciliation of operating activities
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Recognition criteria
When should an item be included within the
financial statements?
Eg revenue recognition
– at point of sale?
– delivery?
– invoicing of customer?
– receipt of payment?
Based upon probability and measurement
tests
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Recognition criteria
Probability
– “probable” > than 50% chance
Measurement
– able to assign a value to an item reliably
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Valuation in accounting
Different valuation techniques
– historical cost- value at original cost
• most common due to reliability
• may not be relevant
– current replacement cost
– net realisable value
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Organisational Decision Making
Estimation and judgement in accounting
Accountants are required to make a large number
of accounting policy choices and estimations in
arriving at the figures in the reports
Accrual accounting does not help the situation
Policy development - generally accepted
accounting principles
Standard setters - reduce the level of diversity
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