Accounting and Finance: An Introduction

Front Cover
Half Title Page
Title Page
Copyright Page
Brief contents
Contents
Preface
How to use this book
Publisher's acknowledgements
1 Introduction to accounting and finance
	Introduction
	Learning outcomes
	What are accounting and finance?
	Who are the users of accounting information?
	The conflicting interests of users
	How useful is accounting information?
		Evidence on the usefulness of accounting
	Providing a service
	Further qualities
	Weighing up the costs and benefits
	Accounting as an information system
	Management accounting and financial accounting
	Scope of this book
	The changing face of accounting
	Why do I need to know anything about accounting and finance?
	Accounting for business
	What is the purpose of a business?
	What kinds of business ownership exist?
		Sole proprietorship
		Partnership
		Limited company
	How are businesses organised?
	How are businesses managed?
	The quest for wealth creation
	Meeting the needs of other stakeholders
	Balancing risk and return
	Reasons to be ethical
	Not-for-profit organisations
	Summary
	Key terms
	References
	Further reading
	Critical review questions
Part 1 Financial accounting
	2 Measuring and reporting financial position
		Introduction
		Learning outcomes
		The major financial statements – an overview
		The statement of financial position
			Assets
			Claims
		The effect of trading transactions
		Classifying assets
			Current assets
			Non-current assets
		Classifying claims
			Current liabilities
			Non-current liabilities
		Statement layouts
		Capturing a moment in time
		The role of accounting conventions
			Business entity convention
			Historic cost convention
			Prudence convention
			Going concern convention
			Dual aspect convention
		Money measurement
			Goodwill and brands
			Human resources
			Monetary stability
		Valuing assets
			Non-current assets
			Non-current assets with finite lives
			Non-current assets with indefinite useful lives
			Fair values
			The impairment of non-current assets
			Inventories
		Meeting user needs
		Self-assessment question 2.1
		Summary
		Key terms
		Reference
		Further reading
		Critical review questions
		Exercises
	3 Measuring and reporting financial performance
		Introduction
		Learning outcomes
		The income statement
		Different roles
		Income statement layout
			Gross profit
			Operating profit
			Profit for the period
		Further issues
			Cost of sales
			Classifying expenses
		Recognising revenue
			Revenue recognition and cash receipts
			Recognising revenue over time
		Recognising expenses
			When the expense for the period is more than the cash paid during the period
			When the amount paid during the period is more than the full expense for the period
			Profit, cash and accruals accounting
		Depreciation
			Calculating the depreciation expense
			Depreciation method
			Impairment and depreciation
			Depreciation and asset replacement
			Depreciation and judgement
		Costing inventories
			Inventories – some further issues
		Trade receivables problems
			Doubtful debts
		Uses and usefulness of the income statement
		Self-assessment question 3.1
		Summary
		Key terms
		Further reading
		Critical review questions
		Exercises
	4 Accounting for limited companies (1)
		Introduction
		Learning outcomes
		The main features of limited companies
			Legal nature
			Perpetual life
			Limited liability
			Legal safeguards
			Public and private companies
			Taxation
			The role of the Stock Exchange
		Managing a company
		Financing limited companies
			Equity (the owners’ claim)
			The basic division
			Share capital
			Reserves
			Bonus shares
			Share capital jargon
		Borrowings
		Raising share capital
		Withdrawing equity
		The main financial statements
			The income statement
			The statement of financial position
		Dividends
		Accounting for groups of companies
		Self-assessment question 4.1
		Summary
		Key terms
		Further reading
		Critical review questions
		Exercises
	5 Accounting for limited companies (2)
		Introduction
		Learning outcomes
		The directors’ duty to account
		The need for accounting rules
		Sources of accounting rules
			The growing authority of the IASB
			Adopting IFRSs
		The need for a conceptual framework
			The IASB framework
			Criticisms of the framework
		The auditors’ role
		The framework of annual financial reports
		Presenting the financial statements
			Fair representation
			Statement of financial position
			Statement of comprehensive income
			Statement of changes in equity
			Statement of cash flows
			Notes
			General points
		Segmental financial reports
			Segmental reporting rules
			Segmental disclosure
			Segmental reporting problems
		Management commentary
		Directors’ report
			Criticisms of the directors’ report
		Strategic report
		Corporate governance
			Strengthening the framework of rules
		Creative accounting
			Creative accounting methods
			Checking for creative accounting
			Creative accounting and economic growth
		Self-assessment question 5.1
		Summary
		Key terms
		References
		Further reading
		Critical review questions
		Exercises
	6 Measuring and reporting cash flows
		Introduction
		Learning outcomes
		Why is cash so important?
		The statement of cash flows and its relation to the other major financial statements
		The main features of the statement of cash flows
		A definition of cash and cash equivalents
		The layout of the statement of cash flows
			Cash flows from operating activities
			Cash flows from investing activities
			Cash flows from financing activities
			Net increase or decrease in cash and cash equivalents
		The normal direction of cash flows
		Preparing the statement of cash flows
			Deducing net cash flows from operating activities
			Assessing performance using cash flows from operating activities
			Deducing the other areas of the statement of cash flows
		Reconciliation of liabilities from financing activities
		What does the statement of cash flows tell us?
		Problems with IAS 7
		Self-assessment question 6.1
		Summary
		Key terms
		Reference
		Further reading
		Critical review questions
		Exercises
	7 Analysing and interpreting financial statements
		Introduction
		Learning outcomes
		Financial ratios
		Financial ratio classifications
		The need for comparison
			Past periods
			Similar businesses
			Planned performance
		Calculating the ratios
		A brief overview
		Profitability
			Return on ordinary shareholders’ funds
			Return on capital employed
			Operating profit margin
			Gross profit margin
		Efficiency
			Average inventories turnover period
			Average settlement period for trade receivables
			Average settlement period for trade payables
			Sales revenue to capital employed
			Sales revenue per employee
		Relationship between profitability and efficiency
		Liquidity
			Current ratio
			Acid test ratio
			Cash generated from operations to maturing obligations ratio
		Financial gearing
			Gearing ratio
			Interest cover ratio
		Investment ratios
			Dividend payout ratio
			Dividend yield ratio
			Earnings per share
			Cash generated from operations per share
			Price/earnings ratio
		Financial ratios and the problem of overtrading
		Trend analysis
		Using ratios to predict financial failure
			Using single ratios
			Using combinations of ratios
			Z-score models
		Limitations of ratio analysis
			Quality of financial statements
			Inflation
			The restricted view given by ratios
			The basis for comparison
			Statement of financial position ratios
		Self-assessment question 7.1
		Summary
		Key terms
		References
		Further reading
		Critical review questions
		Exercises
Part 2 Management accounting
	8 Making management decisions
		Introduction
		Learning outcomes
		Cost–benefit analysis
		What is meant by ‘cost’?
		Relevant costs: opportunity and outlay costs
		Irrelevant costs: sunk costs and committed costs
		Sunk cost fallacy
		Determining the relevant cost of labour and materials
			Labour
			Materials
			Non-measurable costs and benefits
		Risk
			Sensitivity analysis
		Self-assessment question 8.1
		Summary
		Key terms
		Further reading
		Critical review questions
		Exercises
	9 Cost–volume–profit analysis
		Introduction
		Learning outcomes
		Cost behaviour
		Fixed cost
		Variable cost
		Semi-fixed (semi-variable) cost
			Analysing semi-fixed (semi-variable) costs
		Finding the break-even point
		Contribution
			Contribution margin ratio
		Margin of safety
		Achieving a target profit
		Operating gearing and its effect on profit
		Profit–volume charts
		The economist’s view of the break-even chart
		The problem of breaking even
		Weaknesses of break-even analysis
		Using contribution to make decisions: marginal analysis
			Pricing/assessing opportunities to enter contracts
			The most efficient use of scarce resources
			Make-or-buy decisions
			Closing or continuation decisions
		Self-assessment question 9.1
		Summary
		Key terms
		Further reading
		Critical review questions
		Exercises
	10 Full costing
		Introduction
		Learning outcomes
		What is full costing?
		Why do managers want to know the full cost?
		Single-product businesses
			Process-costing problems
		Multi-product businesses
			Direct and indirect cost
			Job costing
			Full costing and cost behaviour
			The problem of indirect cost
		Overheads as service renderers
			Job costing: a worked example
			Selecting a basis for charging overheads
			Segmenting the overheads
			Dealing with overheads on a cost centre basis
			Batch costing
			Non-manufacturing overheads
			Full (absorption) costing and estimation errors
		Full cost (cost-plus) pricing
			Price makers and price takers
			Use of cost-plus information by price takers
			Full (absorption) costing and relevant costs
		Full (absorption) costing versus variable costing
			Which method is better?
		Self-assessment question 10.1
		Summary
		Key terms
		Reference
		Further reading
		Critical review questions
		Exercises
	11 Costing and performance evaluation in a competitive environment
		Introduction
		Learning outcomes
		Cost determination in the changed business environment
			Costing and pricing: the traditional way
			Costing and pricing: the new environment
		Cost management systems
			The problem of overheads
			Taking a closer look
		Activity-based costing
			Assigning overheads
			Benefits of ABC
			ABC and the traditional approach compared
			ABC and service industries
			Benefits and costs of ABC
			ABC in practice
		Managing costs over the product life cycle
			Total life-cycle costing
			Target costing
			Kaizen costing
		Other approaches to managing costs in a modern environment
			Value chain analysis
			Benchmarking
			Total quality management
			Managing quality costs
			An alternative view
		Non-financial measures of performance
			The balanced scorecard
			Scorecard problems
		Measuring shareholder value
			The quest for shareholder value
			How can shareholder value be created?
			The need for new measures
			Economic value added (EVA®)
		Self-assessment question 11.1
		Summary
		Key terms
		References
		Further reading
		Critical review questions
		Exercises
	12 Budgeting
		Introduction
		Learning outcomes
		How budgets link with strategic plans and objectives
		Exercising control
		Time horizon of plans and budgets
		Budgets and forecasts
		Periodic and continual budgets
		Limiting factors
		How budgets link to one another
		How budgets help managers
		The budget-setting process
		Using budgets in practice
		Incremental and zero-base budgeting
		Preparing budgets
			The cash budget
			Preparing other budgets
		Activity-based budgeting
		Non-financial measures in budgeting
		Budgets and management behaviour
		Who needs budgets?
		Beyond conventional budgeting
		Long live budgets!
		Self-assessment question 12.1
		Summary
		Key terms
		References
		Further reading
		Critical review questions
		Exercises
	13 Accounting for control
		Introduction
		Learning outcomes
		Budgeting for control
		Types of control
		Variances from budget
			Flexing the budget
			Sales volume variance
			Sales price variance
			Materials variances
			Labour variances
			Fixed overhead variance
		Reconciling the budgeted profit with the actual profit
		Reasons for adverse variances
		Variance analysis in service industries
		Non-operating-profit variances
		Investigating variances
			Variance analysis in practice
		Compensating variances
		Standard quantities and costs
		Setting standards
			Who sets the standards?
			How is information gathered?
			What kind of standards should be used?
			The learning-curve effect
		Other uses for standard costing
		Some problems
		The new business environment
		Making budgetary control effective
		Behavioural issues
			The impact of management style
			Failing to meet the budget
			Budgets and innovation
		Self-assessment question 13.1
		Summary
		Key terms
		Reference
		Further reading
		Critical review questions
		Exercises
Part 3 Financial management
	14 Making capital investment decisions
		Introduction
		Learning outcomes
		The nature of investment decisions
		Investment appraisal methods
		Accounting rate of return (ARR)
			ARR and ROCE
			Problems with ARR
		Payback period (PP)
			Problems with PP
		Net present value (NPV)
			Why does time matter?
			Interest lost
			Risk
			Inflation
			What should managers do?
			Dealing with the time value of money
			Calculating the net present value
			Using present value tables
			The discount rate and the cost of capital
		Why NPV is better
			NPV and economic value
		Internal rate of return (IRR)
			Problems with IRR
		Some practical points
		Investment appraisal in practice
			Survey evidence
		Investment appraisal and strategic planning
		Risk and investment
		Managing investment projects
			Stage 1: Determine investment funds available
			Stage 2: Identify profitable project opportunities
			Stage 3: Evaluate the proposed project
			Stage 4: Approve the project
			Stage 5: Monitor and control the project
		Self-assessment question 14.1
		Summary
		Key terms
		References
		Further reading
		Critical review questions
		Exercises
	15 Financing a business
		Introduction
		Learning outcomes
		The main objective of financing policy
		Sources of finance
		Internal sources of finance
		Internal sources of long-term finance
			Retained earnings
			Dividend policy
		Internal sources of short-term finance
			Tighter credit control
			Reducing inventories levels
			Delaying payment to trade payables
			Some further points
		External sources of finance
		External sources of long-term finance
			Ordinary shares
			Preference shares
			Borrowing
			Forms of borrowing
			Finance leases
			Sale-and-leaseback arrangements
			Hire purchase
			Securitisation
		External sources of short-term finance
			Bank overdrafts
			Debt factoring
			Invoice discounting
		Long-term versus short-term borrowing
		Gearing and the financing decision
			Financial gearing: the traditional approach
			A challenge to the traditional approach
		Raising long-term finance
		Share issues
			Rights issues
			Offers for sale and public issues
			Setting a share price
			Private placings
			Bonus issues
		The role of the Stock Exchange
			Advantages of a listing
			Disadvantages of a listing
			Going private
		The Alternative Investment Market
		Providing long-term finance for the small business
			Is finance a particular problem for small businesses?
			Equity finance
			Venture capital
			Business angels
			Crowdfunding
			Non-equity finance
			Evidence on small business financing
		Islamic finance
		Self-assessment question 15.1
		Summary
		Key terms
		References
		Further reading
		Critical review questions
		Exercises
	16 Managing working capital
		Introduction
		Learning outcomes
		What is working capital?
		Managing working capital
		The scale of working capital
		Managing inventories
			Budgeting future demand
			Financial ratios
			Recording and reordering systems
			Levels of control
			Inventories management models
		Managing trade receivables
			Which customers should receive credit and how much should they be offered?
			Length of credit period
			Cash discounts
			Debt factoring and invoice discounting
			Credit insurance
			Collection policies
		Managing cash
			Why hold cash?
			How much cash should be held?
			Controlling the cash balance
			Cash budgets and managing cash
			Operating cash cycle
			Cash transmission
			Bank overdrafts
		Managing trade payables
			Taking advantage of cash discounts
			Controlling trade payables
			Managing working capital
		Self-assessment question 16.1
		Summary
		Key terms
		Further reading
		Critical review questions
		Exercises
Part 4 Supplementary information
	Appendix A Recording financial transactions
		Introduction
		Learning outcomes
		The basics of double-entry bookkeeping
		Recording trading transactions
		Balancing accounts and the trial balance
		Preparing the financial statements (final accounts)
		The ledger and its division
		Summary
		Key terms
		Further reading
		Exercises
	Appendix B Glossary of key terms
	Appendix C Solutions to self-assessment questions
	Appendix D Solutions to critical review questions
	Appendix E Solutions to selected exercises
	Appendix F Present value table
Index
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