Accounting and Finance: An Introduction

Cover......Page 1
Title page......Page 4
Copyright......Page 5
Brief contents......Page 6
Contents......Page 8
Preface......Page 22
How to use this book......Page 24
Acknowledgements......Page 26
 Learning outcomes......Page 30
 Who are the users of accounting information?......Page 31
 The conflicting interests of users......Page 33
 How useful is accounting information?......Page 34
  Evidence on the usefulness of accounting......Page 35
 Providing a service......Page 36
 Further qualities......Page 37
 Weighing up the costs and benefits......Page 38
 Accounting as an information system......Page 40
 Management accounting and financial accounting......Page 42
 Scope of this book......Page 44
 The changing face of accounting......Page 45
 Why do I need to know anything about accounting and finance?......Page 46
 What is the purpose of a business?......Page 47
  Sole proprietorship......Page 48
  Partnership......Page 49
  Limited company......Page 50
 How are businesses organised?......Page 51
 How are businesses managed?......Page 54
 Meeting the needs of other stakeholders......Page 56
 Balancing risk and return......Page 58
 Reasons to be ethical......Page 60
 Not-for-profit organisations......Page 61
 Summary......Page 62
 Further reading......Page 64
 Review questions......Page 65
Part 1 Financial accounting......Page 66
  Learning outcomes......Page 68
  The major financial statements - an overview......Page 69
   Assets......Page 73
   Claims......Page 76
  The effect of trading transactions......Page 79
  Classifying assets......Page 81
   Non-current assets......Page 82
   Non-current liabilities......Page 84
  Statement layouts......Page 85
   Business entity convention......Page 87
   Historic cost convention......Page 88
   Going concern convention......Page 89
   Dual aspect convention......Page 90
   Goodwill and brands......Page 91
   Human resources......Page 92
  Valuing assets......Page 93
   Non-current assets with indefinite useful lives......Page 94
   Fair values......Page 95
   The impairment of non-current assets......Page 96
   Inventories......Page 98
  Meeting user needs......Page 99
  Summary......Page 100
  Further reading......Page 102
  Exercises......Page 103
  Learning outcomes......Page 106
  The income statement......Page 107
  Different roles......Page 108
  Income statement layout......Page 109
   Profit for the period......Page 110
   Cost of sales......Page 111
   Classifying expenses......Page 112
  Recognising revenue......Page 114
   Long-term contracts......Page 115
  Recognising expenses......Page 117
   When the expense for the period is more than the cash paid during the period......Page 118
   When the amount paid during the period is more than the full expense for the period......Page 120
   Profit, cash and accruals accounting......Page 122
   Calculating the depreciation expense......Page 123
   Depreciation method......Page 125
   Impairment and depreciation......Page 129
   Depreciation and judgement......Page 130
  Costing inventories......Page 132
   Inventories - some further issues......Page 136
  Trade receivables problems......Page 137
   Doubtful debts......Page 139
  Uses and usefulness of the income statement......Page 141
  Self-assessment question 3.1......Page 142
  Summary......Page 143
  Key terms......Page 144
  Further reading......Page 145
  Exercises......Page 146
  Learning outcomes......Page 150
   Perpetual life......Page 151
   Limited liability......Page 153
   Public and private companies......Page 154
   Taxation......Page 156
  Managing a company......Page 157
   The basic division......Page 158
   Share capital......Page 159
   Reserves......Page 161
   Bonus shares......Page 163
   Share capital jargon......Page 165
  Borrowings......Page 166
  Raising share capital......Page 167
  Withdrawing equity......Page 168
  The main financial statements......Page 171
   The income statement......Page 172
  Dividends......Page 174
  Accounting for groups of companies......Page 175
  Self-assessment question 4.1......Page 179
  Summary......Page 180
  Further reading......Page 182
  Exercises......Page 183
  Learning outcomes......Page 188
  The framework of annual financial reports......Page 189
  The need for accounting rules......Page 190
   The growing authority of the IASB......Page 193
   Adopting IFRSs......Page 194
   Fair representation......Page 196
   Statement of financial position......Page 197
   Statement of comprehensive income......Page 198
   Statement of changes in equity......Page 200
   Statement of cash flows......Page 201
  The need for a conceptual framework......Page 202
   The IASB framework......Page 203
  The auditors\' role......Page 204
  Segmental financial reports......Page 205
   Segmental reporting rules......Page 206
   Segmental disclosure......Page 207
   Segmental reporting problems......Page 208
  Corporate governance......Page 209
   Strengthening the framework of rules......Page 210
   The UK Corporate Governance Code......Page 211
  Directors\' report......Page 213
  Strategic report......Page 214
  Creative accounting......Page 216
   Creative accounting methods......Page 217
   Checking for creative accounting......Page 222
   Creative accounting and economic growth......Page 223
  Summary......Page 224
  References......Page 226
  Further reading......Page 227
  Exercises......Page 228
  Learning outcomes......Page 230
  The statement of cash flows......Page 231
  Why is cash so important?......Page 232
  A definition of cash and cash equivalents......Page 234
  The relationship between the main financial statements......Page 235
   Cash flows from operating activities......Page 236
   Cash flows from financing activities......Page 237
  The normal direction of cash flows......Page 238
   Deducing net cash flows from operating activities......Page 240
   Deducing the other areas of the statement of cash flows......Page 245
  What does the statement of cash flows tell us?......Page 248
  Self-assessment question 6.1......Page 251
  Summary......Page 253
  Further reading......Page 254
  Exercises......Page 255
  Learning outcomes......Page 262
  Financial ratio classifications......Page 263
   Past periods......Page 265
  Calculating the ratios......Page 266
  A brief overview......Page 269
   Return on ordinary shareholders\' funds (ROSF)......Page 270
   Return on capital employed (ROCE)......Page 271
   Operating profit margin......Page 273
   Gross profit margin......Page 274
   Average inventories turnover period......Page 276
   Average settlement period for trade receivables......Page 277
   Average settlement period for trade payables......Page 278
   Sales revenue per employee......Page 280
  Relationship between profitability and efficiency......Page 282
  Liquidity......Page 283
   Acid test ratio......Page 284
   Cash generated from operations to maturing obligations ratio......Page 285
  Financial gearing......Page 286
   Gearing ratio......Page 289
   Interest cover ratio......Page 290
   Dividend payout ratio......Page 291
   Dividend yield ratio......Page 292
   Earnings per share......Page 293
   Price/earnings (P/E) ratio......Page 295
  Financial ratios and the problem of overtrading......Page 299
  Using ratios to predict financial failure......Page 301
   Using single ratios......Page 302
   Using combinations of ratios......Page 303
   Z-score models......Page 305
   Quality of financial statements......Page 307
   The restricted view given by ratios......Page 308
   Statement of financial position ratios......Page 309
  Self-assessment question 7.1......Page 310
  Summary......Page 311
  Key terms......Page 312
  Further reading......Page 313
  Exercises......Page 314
Part 2 Management accounting......Page 322
  Learning outcomes......Page 324
  Cost-benefit analysis......Page 325
  What is meant by \'cost\'?......Page 326
  Relevant costs: opportunity and outlay costs......Page 328
  Sunk costs and committed costs......Page 333
  Non-measurable costs and benefits......Page 335
  Risk......Page 336
   Sensitivity analysis......Page 337
  Self-assessment question 8.1......Page 340
  Summary......Page 341
  Further reading......Page 342
  Exercises......Page 343
  Learning outcomes......Page 348
  Fixed cost......Page 349
  Variable cost......Page 351
  Semi-fixed (semi-variable) cost......Page 352
   Analysing semi-fixed (semi-variable) costs......Page 353
  Finding the break-even point......Page 354
   Contribution margin ratio......Page 361
  Margin of safety......Page 362
  Achieving a target profit......Page 364
  Operating gearing......Page 365
   Operating gearing and its effect on profit......Page 366
  Profit-volume charts......Page 367
  The economist\'s view of the break-even chart......Page 368
  Weaknesses of break-even analysis......Page 370
  Using contribution to make decisions: marginal analysis......Page 373
   Pricing/assessing opportunities to enter contracts......Page 374
   The most efficient use of scarce resources......Page 376
   Make-or-buy decisions......Page 378
   Closing or continuation decisions......Page 380
  Self-assessment question 9.1......Page 382
  Summary......Page 383
  Further reading......Page 384
  Exercises......Page 385
  Learning outcomes......Page 390
  Why do managers want to know the full cost?......Page 391
  Single-product businesses......Page 393
  Multi-product businesses......Page 394
   Direct and indirect cost......Page 395
   Job costing......Page 396
   Full (absorption) costing and the behaviour of cost......Page 397
   Job costing: a worked example......Page 399
   Selecting a basis for charging overheads......Page 403
   Dealing with overheads on a cost centre basis......Page 406
   Batch costing......Page 416
   Non-manufacturing overheads......Page 417
   Full (absorption) costing and estimation errors......Page 418
  Using full (absorption) cost information......Page 420
   Price makers and price takers......Page 422
   Use of cost-plus information by price takers......Page 423
  Full (absorption) costing versus variable costing......Page 425
   Which method is better?......Page 427
  Self-assessment question 10.1......Page 429
  Summary......Page 430
  Key terms......Page 431
  Further reading......Page 432
  Exercises......Page 433
  Learning outcomes......Page 437
   Costing and pricing: the traditional way......Page 438
  Cost management systems......Page 439
   Taking a closer look......Page 440
  Activity-based costing......Page 441
   Attributing overheads......Page 442
   ABC and service industries......Page 443
   Criticisms of ABC......Page 448
   Total life-cycle costing......Page 450
   Total quality management......Page 453
   Costing quality procedures......Page 455
   Target costing......Page 456
   Kaizen costing......Page 457
   Value chain analysis......Page 458
   Benchmarking......Page 460
  Non-financial measures of performance......Page 462
   The balanced scorecard......Page 463
  Measuring shareholder value......Page 469
   How can shareholder value be created?......Page 470
   The need for new measures......Page 471
   Economic value added (EVA®)......Page 472
  Self-assessment question 11.1......Page 477
  Summary......Page 479
  Further reading......Page 480
  Exercises......Page 481
  Learning outcomes......Page 486
  How budgets link with strategic plans and objectives......Page 487
  Time horizon of plans and budgets......Page 489
  How budgets help managers......Page 490
  Budgets and forecasts......Page 492
  Periodic and continual budgets......Page 493
  How budgets link to one another......Page 494
  The budget-setting process......Page 497
  Using budgets in practice......Page 500
  Incremental and zero-base budgeting......Page 502
   The cash budget......Page 505
   Preparing other budgets......Page 509
  Activity-based budgeting......Page 512
  Who needs budgets?......Page 514
  Beyond conventional budgeting......Page 516
  Long live budgets!......Page 518
  Self-assessment question 12.1......Page 521
  Summary......Page 522
  Further reading......Page 523
  Exercises......Page 524
  Learning outcomes......Page 530
  Budgeting for control......Page 531
  Types of control......Page 532
  Variances from budget......Page 534
   Flexing the budget......Page 535
   Sales volume variance......Page 536
   Sales price variance......Page 538
   Materials variances......Page 540
   Labour variances......Page 541
   Fixed overhead variance......Page 542
  Reasons for adverse variances......Page 547
  Investigating variances......Page 549
  Compensating variances......Page 552
  Standard quantities and costs......Page 553
   How is information gathered?......Page 554
   The learning-curve effect......Page 555
  Keeping standards relevant......Page 556
  Making budgetary control effective......Page 557
  Some problems . . .......Page 558
  The new business environment......Page 559
  Behavioural issues......Page 561
   The impact of management style......Page 562
   Failing to meet the budget......Page 564
   Budgets and innovation......Page 565
  Summary......Page 566
  Further reading......Page 568
  Exercises......Page 569
Part 3 Financial management......Page 574
  Learning outcomes......Page 576
  The nature of investment decisions......Page 577
  Investment appraisal methods......Page 578
  Accounting rate of return (ARR)......Page 580
   ARR and ROCE......Page 581
   Problems with ARR......Page 582
  Payback period (PP)......Page 584
   Problems with PP......Page 586
  Net present value (NPV)......Page 588
   Risk......Page 589
   Inflation......Page 590
   What will logical investors do?......Page 591
   Using present value tables......Page 594
   The discount rate and the cost of capital......Page 595
  Why NPV is better......Page 596
  Internal rate of return (IRR)......Page 597
   Problems with IRR......Page 601
  Some practical points......Page 602
  Investment appraisal in practice......Page 606
  Risk and investment......Page 609
  Managing investment projects......Page 610
   Stage 1: Determine investment funds available......Page 611
   Stage 3: Evaluate the proposed project......Page 612
   Stage 5: Monitor and control the project......Page 613
  Self-assessment question 14.1......Page 615
  Summary......Page 616
  Further reading......Page 618
  Exercises......Page 619
  Learning outcomes......Page 625
  Internal sources of finance......Page 626
   Retained earnings......Page 627
   Dividend policy......Page 628
   Delaying payment to trade payables......Page 629
   Some further points......Page 630
  External sources of long-term finance......Page 631
   Preference shares......Page 632
   Borrowing......Page 633
   Forms of borrowing......Page 637
   Finance leases......Page 641
   Sale-and-leaseback arrangements......Page 644
   Hire purchase......Page 645
   Securitisation......Page 646
   Debt factoring......Page 648
   Invoice discounting......Page 650
  Long-term versus short-term borrowing......Page 652
  Gearing and the financing decision......Page 653
  Share issues......Page 657
   Rights issues......Page 658
   Setting a share price......Page 661
   Bonus issues......Page 662
   Advantages of a listing......Page 663
   Disadvantages of a listing......Page 665
  The Alternative Investment Market......Page 667
   Venture capital......Page 668
   Government assistance......Page 670
  Self-assessment question 15.1......Page 671
  Summary......Page 673
  References......Page 675
  Further reading......Page 676
  Exercises......Page 677
  Learning outcomes......Page 682
  What is working capital?......Page 683
  The scale of working capital......Page 684
  Managing inventories......Page 687
   Recording and reordering systems......Page 690
   Levels of control......Page 692
   Inventories management models......Page 694
  Managing trade receivables......Page 698
   Which customers should receive credit and how much should they be offered?......Page 699
   Length of credit period......Page 701
   Cash discounts......Page 704
   Collection policies......Page 705
   Why hold cash?......Page 709
   How much cash should be held?......Page 710
   Controlling the cash balance......Page 711
   The operating cash cycle......Page 712
   Cash transmission......Page 717
   Bank overdrafts......Page 718
  Managing trade payables......Page 719
   Taking advantage of cash discounts......Page 721
   Controlling trade payables......Page 722
  Self-assessment question 16.1......Page 724
  Summary......Page 725
  Key terms......Page 727
  Further reading......Page 728
  Exercises......Page 729
Part 4 Supplementary information......Page 736
  Learning outcomes......Page 738
  The basics of double-entry bookkeeping......Page 739
  Recording trading transactions......Page 741
  Balancing accounts and the trial balance......Page 744
  Preparing the financial statements (final accounts)......Page 748
  The ledger and its division......Page 751
  Summary......Page 752
  Further reading......Page 753
  Exercises......Page 754
 Appendix B Glossary of key terms......Page 757
 Appendix C Solutions to self-assessment questions......Page 774
 Appendix D Solutions to review questions......Page 795
 Appendix E Solutions to selected exercises......Page 810
 Appendix F Present value table......Page 859
Index......Page 862