Topic 1: Introduction to financial accounting

Accounting: process of identifying, measuring and communicating economic

information to allow informed decisions by the users of that information.
Management accounting: focuses on provision of info to users within the
enterprise.
Financial performance generating new resources from day-to-day operations
over a period of time
Financial position the enterprises set of financial resources and obligations at a
point in time
Financial statements the reports describing financial performance and position
The two main things financial accounting measures are f performance and f
position.
User
Bankers
Managers
ASIC
Sharehold
ers
Suppliers
ATO
Trade
unions

Type of information
Likelihood of company meeting its interest payment on time
Profitability of each division of company
Financial position and performance issuing shares to public for 1 st
time
Prospects for future dividend payments
Probability that company will be able to pay for its purchases on
time
Profitability of company based on taxation laws
Profitability of company since last contract with employees was
signed

3 main groups responsible for information in financial statements: managers,

bookkeepers and clerks and accountants.
The simplest method of accounting is to record cash when it is received or paid;
termed cash accounting. Alternatively, under an accrual accounting system,
revenues and expenses are recorded when they occur, not when the cash is
received or paid.
E.g. In June, a company makes cash sales of $10,000 and credit sales of $20,000
(all to be collected in July). It pays wages of $6000 and owes $1000 for June
expenses (to be paid in July).
1. What is profit using cash accounting? $10k - $6k = $4k
2. What is profit using accrual accounting? $10k + $20k - $6k - $1k = $23k
Using accrual accounting to prepare financial statements
Include all cash receipts and payments that have already happened
Include future cash receipts and payments

 Measure the value of incomplete transactions e.g. a likely amount of

accounts receivable that wont be collected treat the amount as an
expense of this year
Estimate figures when exact amounts unknown e.g. the amount of interest
due from the bank at year-end this amount is interest revenue
Make an assessment of awkward problems e.g. a customer suing you $1m
for a faulty product, you agree to pay $200k in settlement now but they
take the matter to court with the case to be held next year. You need to
determine if there is an expense this year.

Balance sheet: shows the financial position at a point in time

-

3 main components: assets, liabilities and shareholders equity (if org. is a

sole trader; proprietors equity OR partnership; partners equity).
Assets: future economic benefits that are controlled by an organization as
a result of past transaction or other past events.
The cash at bank account records deposits and withdrawals from
the bank
Accounts receivable is shown net, which indicates the amount that
management expects to collect from customers after allowances
have been made for unlikely collectable circumstances
Inventory generally represents the cost of stock on hand; unsold
products
Property, plant and equipment i.e. land, equipment, furniture
Assets = Liabilities + Shareholders equity
Liabilities: future sacrifices of economic benefits that an organization of
presently obliged to make to other organizations/individuals as a result of
past transactions or events.
I.e. accounts payable, wages payable, provision for employee
entitlements, or long term loans (loans that arent repayable within
a year.
Shareholders equity: excess of assets over liabilities.
1. Share capital the amount that owners have directly invested in the
company
2. Retained profits the total cumulative amounts of profits that the
company has retained in the business rather than distributed as
dividends

1. What would be a likely explanation for the increase in accounts receivable?

Most likely credit sales (increases acc. receivable) are relatively greater than
cash received from customers
2. What does the no change in share capital mean? Normally that there have
been no shares issued during the year.
- If the balances of total assets are $100 000 and shareholders equity is $40
000, what is the balance of total liabilities? 500 000 = 200 000 + 300 000
- Given the following balances assets $300 000; liabilities $200 000; share
capital $60 000 what is the balance of retained profits? 300 000 = 200 000 +
60 000 (40 000)
Income statement: measures financial performance over a defined period by
deducting expenses from revenues during the period to obtain profit for the
period
- The difference between sales revenue and COGS = gross profit
deducting operating expenses from gross profit = operating profit before
tax tax is then deducted to give operating profit after tax

The profit of
6000 000 can be
paid out in dividends to shareholders or retained
in the business
Companies provide a separate note to the accounts showing the change in
retained profit for the year. Opening retained profits for the year = 24M:

Statement of cash flows: shows the sources and uses of cash during the
period. Transactions are normally split into 3 categories:
1. operating activities: related to the provision of goods and services
2. investing activities: related to the acquisition and disposal of noncurrent
assets, including property, plant and equipment
3. financing activities: related to changing the size and composition of the
financial structure of the entity inc. equity and certain borrowings.
*Note that the figures are not the same as the income
statement because cash only.
The company received 17M from
customers; paid 7.7M to suppliers; paid
2.3M to employees; and paid 4.5M in
other operating costs.
There was only one investing item 2.3M
Relationships
between the financial
on a machine.
statements:
The company receive 4M from an issue
of shares; paid back a 3.6M bank loan
the net effect on cash was an increase
of 600 000. When added to the opening
balance of 1.4M, the closing balance is

The cash flow statement explains the change in cash in the balance sheet
from $1400 to $2000. Net profits (6000) is shown in the income
statement, this amount increases retained profits (24 000 27 000) due
to net profit for the year minus dividends.

Demands on the quality of financial accounting information:

[1] Relevance: Financial statements need to contain info that is useful to
those who are making decisions. + Timeliness: the need to provide the
relevant info in enough time for the decision to be made [2] Reliability:
should not be deliberately misleading, should be free from bias. [3]
Materiality: concerned with assessing whether the omission, misstatement
or non-disclosure of a piece of information would affect the decisions of
the accounting reports. [4] GAAP (generally accepted accounting
principles): standard against which an accounting method or number can
be judged. [5] Prudence: if there is uncertainty (i.e. value of unsold
inventory), assets, revenues and profit should not be overstated and
liabilities, expenses and losses should not be understated. [6] Disclosure:
disclosure beyond accounting figures i.e. notes or account descriptions to
make it clear which accounting methods have been followed and to
provide supplementary information on debts, law suits [7]
Understandability: reports should be prepared having regard to the
interests of users [8] Comparability: allows to compare performance with
other companies [9] Consistency: keeping the same accounting methods
over time.
The Framework (put out by the Aust. Accounting Standards Board AASB) says
that these 4 qualitative characteristics are the attributes that make info in
financial statements useful to users:
Understandability
Relevance
Materiality
Reliability
Faithful representation, substance over form (economic reality, not
legal/technical), neutrality (free from bias), prudence (estimates in
uncertain situations) and completeness (no omission of info).
Comparability
Financial statement assumptions:
1. Accounting entity assumption (e.g. private transactions of owners not
accounted) Activities of the entity are separate from those of its
members
2. Accounting period assumption Life of business is divided into discrete
time periods of equal length to determine financial performance and
position
3. Monetary assumption Money is the universally accepted medium of
exchange
4. Historical cost assumption transactions are initially recorded at their
original cost e.g. land purchased at 1995 at $50 000 and still owned will
be reported on the balance sheet at its historical cost (50 000) even
though market value may be $500 000.

5. Going concern assumption assumes continued operation of accounting

entity into foreseeable future. Theres no intention/need to liquidate. It
produces demand for financial information during life of entity.
Chapter 1: Practice problems

1. Asset cash at bank, inventory; liability accounts payable; revenue sales;

expense wages, COGS; equity share capital.
2.
Income statement
For the year ending 30 June 2012
$
Sales
210 000
Cost of goods sold (70 000)
Gross profit
140 000
Wages
(40 000)
Net profit
100 000
3.
Balance sheet
As at 30 June 2012
Assets
Liabilities and Shareholders Equity
$
$
Cash at bank
210 000
Accounts payable 30 000
Inventory
60 000
Wages
40 000
270 000
Cost of goods sold 70 000
wrong
Share capital
140 000
280 000

1. Total sales total expenses: 750k + 260k 580k 240k = 190k

2. COGS: 3000 x 5 = (15 000) x 2000 x 5 (10 000) (cost of goods SOLD!!!)
Sales revenue: 2000 x 8 = 16 000

A = L + OE // Assets Liabilities = OE
Assets (1.5m + 400k + 100k + 500k = 2.5m) - Liabilities (250k + 90k = 340k) =
2.16m
Preparation questions:

1. Produce information to improve decision-making in allocating scarce

resources.
2. Financial performance: generating new resources from day-to-day operations
over a period of time. Financial position: the org.s set of financial resources and
obligations at a point in time.
3. Managerial accounting is a branch of accounting that aims to help managers
and others inside the enterprise. Financial accounting has a more external focus,
and is often used by parties external to the enterprise i.e. shareholders,
investors, bankers, legislators and employers etc.
7. No. Theyre all different people with differing objectives, preferences and
capabilities.

[1] Profit for the period (revenue expenses) and financial position; a strong
balance sheet makes it easier for the CEO to carry out strategic initiatives e.g.
new training facilities
[2] Cash flow; as players depend on it. The higher the profit, the likelier to argue
for pay increases.
[3] Long term viability of the club from the balance sheet.
[4] How many people are attending the game likely to correlate with sales
revenue.

1. A

2. L

3. E x

7. SE

8. L

9. A

4. E

10. A 11. E

3) Provision = Liability

Case 1A Balance Sheet:

5. E

6. A
12. R

1. Trade and other receivables, trade and other payables, provisions,

depreciation, amortization, prepayments, accruals, unearned revenue and not 1.
2. Total assets at 26 June 2011 = 21,094.5 m
3. Total liabilities at 26 June 2011 = 13,248.7m
4. Shareholders equity at 26 June 2011 = 7,845.8 m
5. Accounting equation in dollar figures at 26 June 2011
A
=
L
+
OE
21,094.5m =
13,248.7m + 7,845.8 m
6. Net profit before tax = 3,014.9 m (from income statement)
7. Net profit after tax = 2,149 m (from income statement)
8. Largest cash inflow relating to operating activities = 58,886.6 m (from cash
flow statement)
Largest cash outflow relating to operating activities = 54,797 m (from cash flow
statement)
9. 2 reasons why the cash flow from operations is a different figure from
operating profit after tax:
- Operating profit after tax is calculated on an accrual basis.
- Cash flow from operations includes revenues and expenses relating to
prior/subsequent periods.
10. Total assets increased over the last year (balance sheet)
11. Inventory at 26 June 2011 = 3,736.5 m
12. Their most recent reporting year ends on 26 June 2011
13. A) 2 years B) 2 years C) 2 years
14. Yes, they are. There is an auditors declaration from Deloitte (p. 787)
Tutorial questions:

12. Accrual accounting includes impact of transactions on the financial

statements in the time periods where revenues and expenses occur rather than
when the cash is received or paid. Cash accounting only accounts for
revenues/expenses when cash is paid or received by the enterprise.
16. [A] The accounting entity is separate and distinguishable from its owners
personal financial affairs of the owners can be separated from the finances of the
business the performance of the business can be evaluated [B] The life of a
business needs to be divided into discrete periods to evaluate performance for
that period. [C] Accounting transactions need to be measured in a common
denominator i.e. the AUD for Australia. [D] Assets are initially recorded at cost [E]
Financial statements are prepared on the premise that the organisation will

continue operations in the foreseeable future. If this is not the case then its
necessary to report the liquidation values of an organisations assets. [F] All
transactions are recorded, but items that have a small dollar value are expensed
rather than included as an asset on the Balance sheet e.g. a box of pens that
costs $13 and has a useful life of 2 years would be treated as a stationery
expense rather than an asset.

Accrual profit = total sales total expenses, 640k + 490k 590k 380k = 160k

Bush Traders
Income statement for the year ended 30 June 2012
$
Sales
48 000
Cost of goods sold
(21 000)
Gross profit
27 000
Less operating expenses
- Wages
(8 000)
- Electricity
(4 000)
- Travel
(2 000)
- Advertising (1 000) 15 000
Net profit
12 000

1. Loan L; cash A; accounts payable L; accounts receivable A; equipment

A
2. A L = OE: A = 90k + 170k + 200K, L = 180k + 110k, SE = 460k 290k =
170k

Topic 2: Measuring and Evaluating Financial performance

Assets include the enterprises cash, accounts receivable, inventory, land,
building
Sources (L) include existing obligations that will have to be paid in the future i.e.
loans from the bank, wages payable, accounts payable, mortgages (OE)
includes amounts received from owners which normally dont have to be repaid,
plus any past accrual profits that havent been paid out to the owners.

E.g.

- The 495k of assets has been financed by 190k (103k + 87k) of liabilities
and 305k of owners investment.
Is the enterprise soundly financed? Its debt to equity ratio is 190k/305k
= 62.3% = 0.62:1 so Sound and Light is not much in debt proportionally.
Can the enterprise pay its bills on time? The company has 245k in current
assets that it should be able to turn into cash to pay the 103k of current
liabilities. It has 245k 103 k = 142k in working capital and its working
capital ratio aka current ratio is 245k/103k = 2.38. The number is
positive with more than twice current assets over current liabilities so they
appear fine.
Concerned about the companys ability to sell inventory to pay its bills
calculate the quick ratio (like the working capital ratio BUT cash, sell-able
short-term investments and accounts receivables). (50k + 75k/103k) =
1.21 the company could pay current L without having to sell inventory.
Should owners declare themselves a dividend? If so, how large should it
be? Legally, the board of directors are able to declare a dividend to
shareholders of 175k (retained earnings) but there isnt nearly enough
cash for that. A dividend of more than 25k would cause Sound and Light
some cash strain.

Assets are a mixture of resources the company needs to do business.

They need to have 3 characteristics:
Future economic benefits
Control by the entity relates to the capacity of an entity to benefit
from the asset in pursuing its objectives and to deny or regulate the
access of others
Occurrence of past transactions or other past events the
transaction or other event giving the entity control over the future
economic benefits must have occurred.
Assets are separated into CURRENT expect to be used/sold/collected
within the next year and NONCURRENT expected to have benefits for
more than a year into the future
Liabilities are present obligations of the entity arising from past events.
2 characteristics:

A present obligation exists - tis obligation involves settlement in the

future via the sacrifice of future economic benefits
It has adverse financial consequences for the entity

Liabilities include amounts owed to creditors, or amounts estimated to

be due later i.e. long service leave payments, future income taxes or
interest building up on a bank loan. Not all liabilities are expected to be
paid in cash; some are paid by providing goods or services i.e. a deposit
received from a customer for goods or services to be shipped later.

! An expectation to pay later is NOT a liability if the transaction bringing

the benefit has not happened e.g. agreement to borrow cash before the
cash has been received isnt a liability.
Liabilities are separated into CURRENT those that are due within the
next year and NONCURRENT due more than a year into the future
some are partly paid each year so the balance sheet would show BOTH
a current and a noncurrent portion for them.
Equity is the owners interest in the enterprise. It can be derived from
direct contributions the owners have made, or the accumulation of profits
that the owners have chosen not to withdraw.
Because OE = A L, the concept is often referred to as the book value
of the whole enterprise

Working capital = current assets/current liabilities = 3300/2100 = 1.57 so

it is not as strong currently as Sound and Light is. Liabilities of 2100 are
39.6% of total sources with a debt to equity ratio of 65.6% (2100/3200) so
the companys financing is similar to Sound and Lights though all of its
liabilities are current which is unusual. With $500 cash, it doesnt have
enough cash to pay all of its $2200 retained profits to shareholders as
dividends if it wanted to.

Prepaid expenses e.g. paying

for a 12 month insurance
premium on April 2012; at May
2013 we will have a
prepayment equal to 10/12ths
of the amount paid.
Prepayments = assets
because they represent future
economic
benefits
Land
isnt depreciated
but
buildings, equipment and
furniture and fittings are
shown in net
accumulated depreciation
has been deducted

Non-current assets that

have no physical
substance i.e.
copyrights, patents,
trademarks, brand
names and goodwill.

Working capital = current assets/current liabilities = 80 281/27 795

current ratio = 2.89:1 Chez is in a strong position; CA is almost 3 times
CL.

Total Assets = 1270 (640 + 210 + [890 470]

Total Liabilities = 610 (250 + 360)
Net Assets = 660 (1270 610)
Owners equity = 660 (stated)
Two types of tax can be

Current tax liabilities: an estimate amount of income tax to be paid

next financial yr
Deferred tax liabilities: which result because of some different rules
in calculating accounting profit and taxation profit (as per the
companys tax return). When current reported accounting profit is
more than the profit reported on the tax return, a liability is implied
for income tax is implied for later. Conversely, if accounting profit is
less than reported on the income tax return, an asset is credited
(deferred tax asset),

Maintaining the accounting equation (A = L + OE)

- The accounting equation is always kept in balance. If an asset goes
up, a liability or equity must go up too (or another asset must go
down).

1.
2.
3.
4.
5.

No effect: equipment increases but cash decreases

Increases by 30k (inventory)
Increases by 50k (cash)
No effect: cash increases but accounts receivable decreases (both are assets)
increases by 30k (cash)

The income statement: Net profit for the period = Revenues Expenses for the
period
-

Revenues are increases in the companys wealth arising from the provision
of services or the sale of goods to customers.
Expenses are decreases in the companys wealth that are incurred in order
to earn revenue. When the enterprise buys goods for sale, they begin on
the asset account inventory of unsold goods. When they are sold; cost is
transferred from the asset account expense account COGS

Profit as the difference between revenues and expenses, represents the

net inflow of wealth to the company during the period.
Expenses include all costs of earning revenue but do not include payments
to owners. Payments or promises of payment, or returns to owners are
considered to be distributions of net profit to owners undistributed
remainder is kept in the company as retained profits.

Revenue 200k + 300k; Expenses 30k + 6k +1.5k

Retained profits: is the sum of net past profits, measured since the company
began, minus dividends declared to owners since the beginning. Retained
profits for the end of preceding period are therefore increased by profits for the
period and reduced by any dividends.

Transactions with owners are taken out of retained profits they arent
an expense therefore not deducted in calculating profit for the period.

1. Revenue (1 141 900 + 4000 = 1 145 000)

*others accounting
figures are assets etc.
2. Expenses (700 000 + 218 000 + 2900 = 921 100)
3. 1 145 000 921 100 = 223 900
Profit is part of the change in retained profits for the period, therefore:

Bratwurst Ltd had this balance sheet at the end of 2011 (beginning of 2012);
assets 5000; liabilities 3000; equity 2000.
- The beginning equity figure was made up of shareholders invested capital of
500 + retained profit accumulated to the end of 2011 (1500; the sum of all net
profits the company ever had up to the end of 2011 minus all dividends ever
declared to owners)
- During 2012 they had revenues of 11 000 and expenses of 10 000 and declared
dividends to owners of 300.
- At the end of 2012, they had assets of 5900, liabilities of 3200 and equity of
2700 (500 + 2200).

2. Revenue expenses: 14 200 12 900 = 1300

Previous period retained profits + dividends dividends paid: 2200 + 1300 600
= 2900

Here ^ the right hand column refers to the parent company (Tabcorp) and the
left-hand columns are consolidated figures that refer to Tabcorp AND its
subsidiaries. Consolidation involves aggregating revenues and expenses of the
parent entity and subsidiaries after eliminating any transactions between these
entities.
- Expenses (inc. employment costs of 583.9m) are then deducted to get
operating profit before income tax. For Tabcorp it amounts up to 742.1m
(profit income before tax exp.)
- Income tax is levied on a company before it is legally separate from its
owners such tax is usually a percentage of profit before income tax.

Income tax expense of 220.4, is deducted to get operating profit after

income tax of 521.7m.
Note that govt. taxes and levies (1 13600 000) arent income tax. There
are separate taxes related to the gaming industry.
In 2008 theres mention of impairment where companies need to reduce
the value of some assets below cost

850k + 120k 70k = 900k

Capital markets, Managers and Performance Evaluation:
Page 70.