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Diploma

Study Guide

ACCT1008 Semester 2, 2014

ACCOUNTING FOR BUSINESS

Course Coordinator: Greg Touzeau

How to use the Study guide

Students differ in the ways in which they best assimilate information. This Study guide has been designed to meet the needs of most students. It was designed with the following sequence in mind.

Topic introduction

Each topic’s study starts with the topic introduction and you should read this to provide a basic understanding of the general direction and content of the topic.

Study objectives

After checking the topic introduction you should read the learning objectives for the particular topic. The objectives are placed in this prominent position so you can get an immediate picture of where you are heading for the topic, even if the terms may not be familiar to you. The objectives, therefore, reflect the content of the topic that will then be broken down into a series of knowledge, skill and attitudinal goals. Assessment tasks are designed around testing your achievement of these objectives. Once you have completed a topic, you should return to the objectives as a checklist of what you have covered.

Required reading

This reading is essential. It forms the core of your learning material. The Study guide expands, clarifies and provides examples of certain issues where I feel it is required. However, to reduce unnecessary repetition in the Study guide, the main content of each topic comes from this essential reading that reflects various authors' perceptions of the topic. I recommend that each topic you go through the required reading once (at least scan through it) before lectures. In this way the lecture will answer as many questions for you as it will raise. This will also assist you to better realise what you need to get out of lectures so as to more easily achieve the study objectives and prepare for the tutorials.

Where no page numbers are indicated, the entire chapter should be read. In cases where page numbers are given you need only read these pages.

Topic 8 has an extra reading of 7 pages that is available on the course web site under the topic 8 heading.

Additional reading

For some topics additional reading has been set to clarify and extend your understanding of the topic. This additional reading provides a different perspective from the required reading if you feel you would benefit from such clarification. For the purposes of assessment, only the issues that arise from the required reading are immediately relevant. However, in your preparation for assignments, it would make sense to consult the additional reading to ensure that you maximise your performance in an open book assessment medium.

Web site

A significant amount of information that is not available in print is on the course web site. Details about how to access it are explained earlier in this booklet. You should get in the habit of visiting the site regularly. The Study guide will direct you to the web site from time to time, but don't wait to be prompted.

Suggested study activities

These are suggested activities for each topic to ensure you have a thorough understanding. You may devise your own study timetable for each topic or follow these suggestions.

Tutorial questions

Each topic, tutorial questions have been set which best reflect the objectives of the topic. Students are expected to prepare answers for all tutorial questions so that they can be shared in the tutorial class.

Tutorials only work when students in them contribute (i.e. do work in advance and bring it and their thoughts to the tutorial). For the purposes of a tutorial, a wrong answer contributed is often more valuable than a correct answer since it provides a starting point for ironing out difficulties (chances are you are not the only one who hasn’t quite understood, and even if you are, it’s your tutorial as much as it is anyone else’s - so use it!). No answer contributed is a nothing. The tutorial is not the place to “get” answers (as per reading a solutions book), it is a place for negotiating and discovering answers from a group of people with the assistance of the tutor as facilitator. Students who don’t approach tutorials correctly are depriving themselves and others of a valuable educational experience. Students are also improving the chances of failing the course rather than passing it!

Supplementary questions

After going through the preceding process, you may require further exercises to hone your skills and improve your understanding. Supplementary, optional questions have been included to fulfil this purpose. If you are having difficulty completing a tutorial question you will usually find a similar supplementary question. If this is the case, work through the supplementary question and then attempt the tutorial question again.

TOPIC 1 Introduction to accounting

Topic 1

Introduction to accounting

Topic introduction

As the topics unfold in this course you will find that in many ways accounting involves the application of specific assumptions and techniques to a variety of situations. As important as these assumptions and procedures are, they make no sense if the social context of their use is not understood. If you have previously studied accounting at secondary school, TAFE or a similar institution and level, the prevalence of 'Why?' in this course in addition to the 'How?' that may have guided your previous study will take a little getting used to. However, the 'Why?' is central to the nature of any course at tertiary level—even accounting!

For those who have not done any accounting study before, you will not be tainted by the bad habits of previous experience.

Before the first number is written on paper (or keyed into the computer), purveyors and users of accounting information need to contemplate why they are doing so. Posing questions such as 'Why account at all?', 'Why use certain methods in accounting?', 'Who is this being done for?', 'What regulation surrounds accounting and why does it exist?' will lead to a better understanding of the discipline and explain the assumptions, techniques and resultant information that you will be introduced to as the course unfolds.

Study objectives

At the end of this topic, you should:

· understand why all business students need a basic understanding of accounting;

· be able to define accounting and its role;

· be able to outline the accountability and decision-making rationales for accounting;

· know and be able to apply the decision-making process;

· understand the nature of information and the needs and types of its various users;

· be aware of the regulatory framework that impacts upon accounting information;

· have an understanding of ethics and accounting.

Graduate Qualities

The Graduate Qualities (generic skills) developed by studying this topic include:

· body of knowledge

· work autonomously and collaboratively

· ethical action and social responsibility

· international perspective

Required reading

Resource: text reading

Hoggett, John, Medlin, John, Edwards, Lew, Tilling, Matthew & Hogg, Evelyn (2012). Chapter 1 'Decision making and the role of accounting' and Chapter 17 `Regulation and the conceptual framework'. In Accounting. 8th edition. Brisbane: John Wiley and Sons, pages 2-13 and 20 - 21, page 65 (if you are interested) and pages 701-709.

Possible study activities – Topic 1
	Recommended time
Read Course information and study guide booklets and note important contents and dates and familiarise yourself with its layout	1.0 hour
Visit the web site and familiarise yourself with its contents.	0.5 hour
Required reading for topic 1	2.0 hours
Attend lecture	2.0 hours
Attend Tutorial (no preparation required)	3.0 hour
Review lecture notes	0.5 hour
Prepare the topic 1 tutorial answers to be covered during tutorials in week 2 (make a copy of your submission question solution ready for review at the start of the week 2 tutorial)	2.0 hours
	10.0 hours

Tutorial questions (Can be found on the course website under the relevant week)

At the end of each chapter in the text the questions are in the order:

· Discussion Questions

· Exercises

· Problems

Supplementary materials – to be considered as additional resources. To be completed on a discretionary basis.

Extra materials provided by the text book publisher are available on the course web site under the link for Text Book Student Resources.

WileyPLUS Topic 1 www.wileyplus.com

Lecture Outline Topic 1

Introduction to Accounting

_____________________________________________________________________

1. Introduction to the course, aims, emphases, materials and assessment requirements.

Why study accounting?

Refer to the “Welcome” on page 3.

Accounting is often called the “language of business”.

If you want to be part of the “business” conversation, you need to learn some accounting.

This course aims to give you some basic financial literacy skills to complement your language literacy and number skills that are essential to success in business.

2. What is accounting?

2.1 “Accounting has been defined as the process of identifying, measuring, recording and communicating economic information to permit informed judgements and economic decisions by the users of the information.” (H,M,E,T & H 2012, p. 7)

3. The decision making process

3.1 Decision making is the process of choosing from among alternative courses of action in order to achieve an objective (Rivett & Jones 1990).

Resource allocation problem

· Economic wants are unlimited

· Resources are relatively scarce

· Resources = land, labour & capital

· Need to make choices or decisions as to which wants will be satisfied with the resources that are available

Figure 1.1 Hoggett, Medlin, Edwards, Tilling & Hogg. 8th edition, p. 5 (modified).

Steps in the decision-making process

Establish goals

Gather available information on alternatives

Determine consequences of alternatives

Choose a course of action

Implement &

review (feedback)

3.2 Decision making case study

Rivett & Jones Case 1.2 (adapted)

Adam is an amateur photographer and has $60,000 available for investment. He is considering two options, investing in long term bank deposit at 6% interest per year or purchasing a small photographic business for $60,000. His aim is to maximise his financial return. Purchasing the business will involve him leaving his present job which will give him a salary of $40,000 for the foreseeable future, should he stay. He has worked closely with an accountant and calculated that if the business does poorly it will return him $30,000pa, but should it be successful, it is expected to make him $70,000pa. There is an 80% likelihood that it will be successful and a 20% likelihood that it won't.

Establish Goals

Objective: To maximise financial return

Constraints: Has $60,000 to invest

Will need to leave his job if he buys the photographic business

Gather available information on alternatives &

Determine consequences of alternatives

Solution Technique:

To evaluate the expected future returns of each alternative.

Prediction: For long term bank deposit alternative:

Total future return = Salary + Interest on bonds

= $ .

For business alternative:

Total future return = Expected returns x probability of return

= $ .

Choose a course of action

Choice: In light of the objective as defined, the business alternative is chosen assuming no other qualitative factors take precedence.

Implementation & Review:

SYMBOL 183 \f "Symbol" \s 10 \h Together with his accountant, Adam should monitor the progress of his business venture to ensure that it is performing as it should, if not, he will need to implement some kind of corrective action.

SYMBOL 183 \f "Symbol" \s 10 \h Should the venture not go as planned, Adam should check the decision making process to ensure that it was carried out correctly.

SYMBOL 183 \f "Symbol" \s 10 \h However the investment performs, Adam will have learned a lot of information from this decision and its subsequent implications. This will assist him in developing an information base for future decisions of a similar nature.

4. Types of users of accounting information

4.1 Internal uses include management, marketing, production, finance, human resources, research and development, information systems and general managers who receive accounting information in the form of special-purpose financial reports. These use accounting information to make decisions about the allocation of resources within the entity.

4.2 External users include creditors, investors, customers, unions and government agencies who receive accounting information in the form of general-purpose financial reports. These use accounting information about an entity to make decisions about the allocation of their own resources such as granting credit, investing, purchasing goods and services and complying with tax laws and other regulatory requirements.

5. Accountability v. Decision usefulness rationale of accounting

SYMBOL 183 \f "Symbol" \s 10 \h Following the tsunami in the Indian Ocean on 26 December 2004 millions of dollars were donated to non-government organisations (NGOs) to provide relief to the victims. Some questions were raised about how much of each dollar donated would be used to directly benefit the victims and how much would be used to run the NGOs. Accounting information is used to show that the donated funds are used appropriately, i.e. to meet the accountability function of the entities.

5.1 Accountability can be defined as:

..an obligatory relationship created via transactions in which one party is expected to give an account of its actions to other parties.

(Williams, 1987 p.170)

5.2 Accountability as the initial driving force behind financial reporting.

Accountability rationale for accounting suggest that the primary purpose of accounting is to provide information which helps to discharge accountability.

5.3 Decision usefulness rationale for accounting is evident in the definition in 3.1 above.

The notion of an accountability purpose is added to by Statement of Accounting Concepts 2 (SAC2):

In a broader sense, because of the influence reporting entities exert on members of the community at both the microeconomic and macroeconomic levels, they are accountable to the public at large (SAC2, paragraph 14).

However, through SAC2, the profession seems to interpret the concept of accountability very narrowly:

...the objective of general purpose financial reporting is to provide information to users that is useful for making and evaluating decisions about the allocation of scarce resources. When general purpose financial reports meet this objective they will also be the means by which managements and governing bodies discharge their accountability to the users of the reports (paragraphs 26 and 27).

How might the minimum requirements of SAC2 in regard to the assumed degree of accountability of managers and governing bodies to investors and the community affect the reporting or otherwise of:

SYMBOL 183 \f "Symbol" \s 10 \h The use of "sweat shop" conditions for labour to keep costs down?

SYMBOL 183 \f "Symbol" \s 10 \h The degradation of the environment in the quest to earn higher profits?

It is has been said that the effect of statements such as SAC2 is to limit accountability in reporting to stakeholders to the very narrow area of financial utility. This editorial exclusion of other criteria in adjudging accountability (e.g. ethical conduct, social impact of operations, etc.) in turn, imparts an implicit ethical values base to financial accounting along the lines of more financial utility = good, less financial utility = bad.

Is this fair criticism? In any case, what might this say about the appropriate use of conventional accounting information in decision making?

6. The accounting regulatory framework

Financial Reporting Council (FRC) – est. 2000 by the Treasurer to provide strategic direction for the AASB. From 1 January 2005 required AASB to adopt IASB standards for Australia.

Australian Accounting Standards Board (AASB) – adapt the IASB standards for Australia including for government and not-for-profit sectors that are not covered by the IASB standards.

Australian Securities and Investment Commission (ASIC) – administers company law and ensures companies comply with the requirements to provide the information in their financial reports as per the AASB accounting standards.

Australian Stock Exchange (ASX) – provides some of the resources for the AASB toward the international harmonisation of accounting standards. Also has a number or disclosure requirements and other regulations for companies listed on the exchange.

International Accounting Standards Board (IASB) – develop international accounting standards that are adapted in Australia by the AASB. Financial statements prepared in Australia are in line with those prepared by entities in other countries that have also adopted IASB standards. IASB gives greater comparability across countries and better understanding internationally leading to more efficient flow of capital around the world.

Keith Reilly, ICAA, 2005 (adapted)

7. Ethics and Accounting

Hoggett, Medlin, Edwards, Tilling & Hogg (2012), pp. 20-21 introduced a discussion of ethics and accounting.

CPA Australia and the ICAA have rules of professional conduct for members.

Failure to abide by these rules can result in penalties or expulsion.

TOPIC 2 Organisations and the accounting process

Topic 2

Organisations and the accounting process

Topic introduction

Having looked at the nature of accounting and the roles it plays, we now look at the different types of organisations that are accounted for. In this topic we also introduce the three major financial statements available to external users—the Balance Sheet, Income Statement and the Statement of Changes in Equity.

The activities that produce these statements are collectively termed the accounting process. We examine this process and begin analysing financial events that affect the organisation. This analysis involves identifying the effect of events on the accounting equation and applying certain assumptions that have been established in accounting.

Study objectives

At the end of this topic you should:

· be aware of the different types and forms of organisations that may be accounted for;

· understand the financial accounting process in general terms;

· be able to define the three major financial statements, their objectives and elements;

· be aware of, and be able to explain and apply, the following underlying concepts—entity, historic cost, going concern, period, reliability and realisation; and

· be able to analyse events in terms of their effect on the accounting equation and prepare simple financial reports.

Graduate Qualities

The Graduate Qualities (generic skills) developed by studying this topic includes:

· body of knowledge

· lifelong learning

· effective problem solving

· work autonomously and collaboratively

Required reading

Resource: text reading

Hoggett, J, Medlin, J, Edwards, L, Tilling, M, & Hogg, E. (2012). Chapter 2 'Financial statements for decision making' and Chapter 3 'Recording transactions'. In Accounting. 8th edition. Brisbane: John Wiley and Sons, pages 30-45, 66-74.

Possible study activities – Topic 2
	Recommended time

Visit the web site and familiarise yourself with its contents.	0.5 hour
Required reading for topic 2	2.0 hours
Attend lecture	2.0 hours
Attend Tutorial (topic 1 questions)	3.0 hour
Review lecture notes	0.5 hour
Prepare the topic 2 tutorial answers to be covered during tutorials in week 3	2.0 hours
	10.0 hours

Tutorial questions (Can be found on the course website under the relevant week)

At the end of each chapter in the text the questions are in the order:

· Discussion Questions

· Exercises

· Problems

Supplementary questions

Extra materials provided by the text book publisher are available on the course web site under the link for Text Book Student Resources.

WileyPLUS Topic 2 www.wileyplus.com

Lecture Outline Topic 2

Organisations and the Accounting Process

_______________________________________________________________

1. Introduction

2. Types of Organisations

· by purpose

- commercial / “for profit”

- non commercial / “non profit”

· by form

- sole trader

- partnership

- company

3. Introduction to the Financial Accounting Process

(Adapted from Figures 1.1 and 1.2 from Hoggett, Medlin, Edwards, Tilling & Hogg)

4. The Major Financial Reports

4.1 The Balance Sheet (Statement of Financial Position)

A report listing the assets, liabilities and equity of a business at a specific date.

Assets: An asset is a resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity.

1. ……………………………………………………………………..

2. ……………………………………………………………………..

3. ……………………………………………………………………..

Liabilities: A liability is a present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits.

1. ……………………………………………………………………….

2. ……………………………………………………………………

3. …………………………………………………………………….

Equity: Equity is the residual interest in the assets of the entity after deducting all its liabilities.

4.2 The Income Statement

A financial report listing income, expenses and profit or loss of a business for a certain time period.

Income: Income is increases in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases of liabilities that result in increases in equity, other than those relating to contributions from equity participants.

1. …………………………………………………………………………

2. …………………………………………………………………………

3. ………………………………………………………………………….

Expenses: Expenses are decreases in economic benefits during the accounting period in the form of outflows or depletions of assets or incurrences of liabilities that result in decreases in equity, other than those relating to distributions to equity participants.

1. ………………………………………………………………………….

2. ………………………………………………………………………….

3. …………………………………………………………………………..

Profit: The change in the equity in an entity during a period from all events other than direct contributions of capital, or withdrawals of capital by owners. (Rivett & Jones)

Loss: The excess of expenses over incomes.

4.3 Statement of Changes in Equity

A link between the balance sheet and the income statement that explains the changes that took place in equity during the period.

5. The Financial Accounting Process

Overview - Figure at point 3 above.

5.1 Identification

· select those transactions/ economic events which have consequences for the entity, i.e. will affect one of the elements within the financial statements

5.2 Measurement

· measure the quantitative effect of the event

- measurement attribute, e.g. financial attribute

- measurement unit, e.g. $A

5.3 Recording

· classify consequences of the event in terms of the affect on specific items

- for all events at least TWO items are affected

5.4 Communication

6. The Accounting Identity (or Accounting Equation).

· Assets = Liabilities + Equity

(A) = (L) + (Eq)

· Eq = CC - D + I – Ex

· Profit = I – Ex = ( Eq

Capital Contributions: amounts contributed by the owners to the entity. These increase equity.

Drawings (Capital Withdrawals): The withdrawal of assets from the business by its owners. Capital withdrawals decrease equity.

7. Some Underlying Assumptions of Accounting

7.1 Accounting Entity Assumption

The assumption that a business entity is separate and distinct from its owners and ,from other business entities.

7.2 Period Assumption

The assumption that the life of a business entity can be divided into arbitrary equal time intervals for reporting periods.

•5 pairs of shoes on hand

•cost $60 per pair, historic cost = $300

•current replacement cost $70 per pair, total replacement cost of $350

•Current market selling price $90 per pair, total market selling price of $450

7.3 Historic Cost Assumption

Historical cost Assets are recorded at the amount of cash or cash equivalents paid or the fair value of the consideration given to acquire them at the time of their acquisition. Liabilities are recorded at the amount of proceeds received in exchange for the obligation, or in some circumstances (for example, income taxes), at the amounts of cash or cash equivalents expected to be paid to satisfy the liability in the normal course of business. (FPPFS 100 (a))

The measurement basis most commonly adopted by entities in preparing their financial report is historical cost. This is usually combined with other measurement bases. (FPPFS 101)

· Balance Sheet (SFP) items do not (usually) reflect amounts expected to be received

· there are exceptions, e.g. non-current assets can be revalued

· some debate – current cost often claimed to be more relevant

7.4 Going Concern Assumption

The assumption that, in the absence of evidence to the contrary, a business will continue in the future and use its assets in operations rather than sell them.

7.5 Relevance

The information can influence the economic decisions made by users.

7.6 Reliability

The assumption that accounting data should be based on objectively established and factual data. The information presented represents faithfully, without bias or undue error, the underlying transactions and events being reported in the financial statements.

8. Transaction Analysis

8.1 Example 1 : Weekly Whisper

Expenses are recognised in the income statement when a decrease in future economic benefits related to a decrease in an asset or an increase of a liability has arisen that can be measured reliably. This means, in effect, that recognition of expenses occurs simultaneously with the recognition of an increase in liabilities or a decrease in assets (for example, the accrual of employee entitlements or the depreciation of equipment). (FPPFS 94)

Income is recognised in the income statement when an increase in future economic benefits related to an increase in an asset or a decrease of a liability has arisen that can be measured reliably. This means, in effect, that recognition of income occurs simultaneously with the recognition of increases in assets or decreases in liabilities (for example, the net increase in assets arising on a sale of goods or services or the decrease in liabilities arising from the waiver of a debt payable). (FPPFS 92)

Three Questions:

· which items (( 2)

· how much?

· Increase or decrease the item?

Example 1

(Martin, C., An Introduction to Accounting, McGraw Hill, Sydney, Question 3. 1)

The following events concern a small business, The Weekly Whisper, set up to provide a pictorial newspaper for Adelaide readers.

Event:

1. The proprietor, Ms J.A. List, contributed $18,000 cash as capital to start the business.

2. Bought office equipment costing $5,000 on credit from E.Z. Chair; paid a deposit of $1,000 on the furniture.

3. Paid for a delivery van, $10,000.

4. Paid week's wages to reporter/photographer, $400.

5. Sold first week's newspaper to various shops for cash, $250.

6. Sold first week's newspaper to “Corner Stall” for $600 on credit.

7. Withdrew $100 for personal use.

8. Corner Stall paid $200 of the amount owing.

(a) Analyse each event as it affects the basic accounting equation of the business.

(b) Summarise the effects in a Balance Sheet, Income Statement and Statement of Changes in Equity.

The Weekly Whisper

Event Analysis Table

Event # Assets = Liabilities + Equity

Cash * Other Assets Increases Decreases

Contributed Income Expenses Withdrawals

Capital of Capital

(drawings)

__________________________________________________________________________________________________________________________

* Cash is no different from any other asset. It has been separated out in this example to highlight that not all sales and expenses will affect the cash account. This shows that Profit cannot be measured using just cash transactions.

Balance Sheet after event 3.

The Weekly Whisper

Balance Sheet

at end of event 3

Assets	$	Liabilities	$
Cash	7,000	E.Z. Chair	4,000
Equipment	5,000
Motor Vehicle	10,000	Equity
		J A List	18,000
	$22,000		$22,000

Income Statement for period ended with event 6

The Weekly Whisper

Income Statement

for period ended with event 6

	$
Sales Income	850
Less Expenses
Wages	400
Profit	$450

Balance Sheet after event 6

The Weekly Whisper

Balance Sheet

as at end of event 6

Assets	$	Liabilities	$
Cash	6,850	E.Z. Chair	4,000
A/C’s Receivable	600
Equipment	5,000	Equity
Motor Vehicle	10,000	J A List	18,450
	$22,450		$22,450

Balance Sheet after event 8.

The Weekly Whisper

Balance Sheet

as at end of event 8

Assets	$	Liabilities	$
Cash	6,950	E.Z. Chair	4,000
A/C’s Receivable	400
Equipment	5,000	Equity
Motor Vehicle	10,000	J A List	18,350
	$22,350		$22,350

Statement of Changes in Equity for period ended with event 8

The Weekly Whisper

Statement of Changes in Equity

for the period ended with event 8

	$
J A List Capital - Beginning	0
Capital Contributed	18,000
Profit for the period	450
	18,450
Less: Drawings	100
J A List Capital – after event 8	$18,350

8.2 Link between the Balance Sheet and the Income Statement

INCOME STATEMENT

for the period

Ex = PROFIT

BALANCE SHEET

(as of beginning

of year)

= Eq

BALANCE SHEET

(as at end of year)

= Eq

STATEMENT

OF CHANGES IN EQUITY

for the period

+ Profit

Drawings =

Period of time, e.g. 1 year

TOPIC 3 Recording accounting data

Topic 3

Recording accounting data

Topic introduction

Within businesses it is usually accepted that there is an accounting cycle at the end of which accountants prepare financial statements.

For any new business, the cycle will begin with the setting up of a recording system for the transactions of the firm. A traditional method is to set up a series of ledger accounts for this purpose. Once the ledger account recording structure is in place, data reflecting all transactions affecting the business are systematically entered up to the end of the period being accounted for. At this point, the accountant will extract balances from all of the accounts. Using a trial balance he/she ensures that the ledger is in balance and then assembles these balances into financial statements.

The three statements we consider here were introduced to you in the last topic, the Income Statement which provides a trading result over the accounting period and the Balance Sheet which gives the financial position of the business at the end of the period and the Statement of Changes in Equity, which provides the link between the previous two statements.

During this topic we look at the process of recording these transactions in the journal, transferring the data from the journal to the ledger and then using the information recorded to prepare financial reports.

Although it is true that much transactional recording is done using computer-based systems, the emphasis here is on a manual technique. This is not for some misplaced and out of touch academic view of how transactions are recorded in the 'real world', but rather it is based upon the view of the role of this topic in this course. If through studying this topic you gain some skills, or become more proficient in bookkeeping that is good; however, the finer points of bookkeeping (both manual and computerised) are emphasised much more in the course Financial Accounting 1.

The role of this topic in this course is three-fold:

· First it introduces students to the need to keep financial records in a systematic manner so as to be able to produce financial statements.

· Secondly, so you will become proficient in the conventions of double entry that underlies so much of accounting procedure.

· Thirdly, so that you (especially those of you with little business experience) will better understand what the items contained within financial statements actually represent after processing transactions which arise from day-to-day business activities and tracing their effect through to the financial statements.

Study objectives

At the end of this topic you should:

· know the steps in the accounting cycle;

· be able to apply the rules of debit and credit;

· be able to record transactions in the journal and post from the journal to the ledger;

· know how to foot ledger accounts;

· understand the purpose and limitations of the trial balance;

· be able to prepare a trial balance from ledger balances; and

· from the trial balance be able to prepare a simple Income Statement, Balance Sheet (SFP)and Statement of Changes in Equity.

Graduate Qualities

The Graduate Qualities (generic skills) developed by studying this topic include:

· body of knowledge

· lifelong learning

· effective problem solving

· work autonomously and collaboratively

Required reading

Resource: text reading

Hoggett, J, Medlin, J, Edwards, L, Tilling, M, & Hogg, E. (2012). Chapter 3 'Recording transactions' and Chapter 4 'Adjusting the accounts and preparing financial statements'. In Accounting. 8th edition. Brisbane: John Wiley and Sons, pages 68-101 and 142-144.

Notes on the readings

Hoggett, Medlin, Edwards, Tilling & Hogg (2012, pages 68-69 and 79) discuss and illustrate the accounting cycle that occurs each accounting period. Note that the last sentence of the section on page 79 makes clear that the entire process is not illustrated on the diagram. (The full process is illustrated on page 178.) For this course we will ignore steps 8, 9, 12 and 13 as they are taken up in Financial Accounting 1. This topic you will carry out steps 1-4 and 11 in your tutorial questions (step 5 is next topic). For this topic, work through Hoggett, Medlin, Edwards, Tilling & Hogg (2012, chapter 3, pages 68-101).

The purpose of the directed reading in chapter 4 of Hoggett, Medlin, Edwards, Tilling & Hogg (2012) is to illustrate the transferral of data from the trial balance to the financial reports. The further classification of items into sub-groups on a statement (for example, current and non-current assets) which is part of the Balance Sheet (Statement of Financial Position) in Hoggett, Medlin, Edwards, Tilling & Tilling (2012, page 146 - 147) is addressed in topic 4.

Chapter 3 of Hoggett, Medlin, Edwards, Tilling & Hogg (2012) is basically organised according to the flow diagram on page 79 however, note that after the discussion on source documents the authors apparently skip the step of journalising to talk about ledger accounts. In fact they are not 'skipping' the journal. It is imperative that you understand something about ledger accounts before being confronted by a journal because the format and role of a journal is inextricably linked to the accounts which it precedes. Read the section on accounts very carefully.

Possible study activities – Topic 3
	Recommended time

Visit the web site and familiarise yourself with its contents.	0.5 hour
Required reading for topic 3	2.0 hours
Attend lecture	2.0 hours
Attend Tutorial (topic 2 questions)	3.0 hour
Review lecture notes	0.5 hour
Prepare the topic 3 tutorial answers to be covered during tutorials in week 4	2.0 hours
	10.0 hours

Tutorial questions (Can be found on the course website under the relevant week)

At the end of each chapter in the text the questions are in the order:

· Discussion Questions

· Exercises

· Problems

Supplementary questions

Extra materials provided by the text book publisher are available on the course web site under the link for Text Book Student Resources.

WileyPLUS Topic 3 www.wileyplus.com

Lecture Outline Topic 3

Recording Accounting Data

_____________________________________________________________________

1. Introduction

2. The Accounting Cycle and its use in an entity.

Refer Figure 5.1, Hoggett, Medlin, Edwards, Tilling & Hogg p. 178

3. Chart of Accounts

- a listing of the complete account titles and their related numbers

The Ledger Account

Three basic parts:

· Title

· Place for recording increases

· Place for recording decreases

*Account Title*

*Date*	*Explanation*	*Amount*	*Date*	*Explanation*	*Amount*


	*Debit (Dr) side*			*Credit (Cr) side*

The basic rules of double entry accounting are that:

1. All assets are debit in nature

(ie if an asset exists, the account will contain an amount on the debit side. When more assets are acquired, they are entered on the debit side).

2. Credits are the opposite entry to debits

The implications of this are:

a) Decreases in an account are recorded by making an entry opposite to its nature

b) The accounts for other items in the accounting equation (ie liabilities & equity) have a credit nature.

If an asset account such as “Cash at Bank” is debit in nature and is increased by putting the amount of the increase on the left hand side of the account, the debit side, how would you show a decrease in an asset account? Would you show a negative amount on the debit side (left) or a positive amount on the credit side (right)?

· Remember: Assets = Liabilities + Equity

· Another rule is: Total Debits = Total Credits

· Remember Assets have a Debit balance

· Therefore Liabilities and Equity must have a _ _ _ _ _ _ balance if the first two rules above are true

· As Liabilities and Equity are Credit in nature they are increased by putting amounts on the _________ hand side of the ledger account, the ________ side.

· As Liabilities and Equity are Credit in nature they are decreased by putting the amounts on the _________ hand side of the ledger account, the _______ side

· As Income increases Equity, and Equity is increased with a Credit (entry on the right of the ledger account), Income must have a ________ balance.

· Therefore Income accounts must be increased with a _______ and decreased with a _______.

· As Expenses decrease Equity, and Equity is decreased with a Debit (entry on the left of the ledger account), Expenses must have a ________ balance.

· Therefore Expense accounts must be increased with a _______ and decreased with a _______.

Expressed in the Accounting Equation

A = L + Eq

Expanded A = L + [ Eq + ( I - Ex ) ]

A = L + Eq. + I – Ex

OR A + Ex = L + Eq. + I

Where debits = credits

4. The steps of the cycle

(i) Source Documents - Function of source documents

Different forms of source documents

Information from source documents

For each transaction:

1. which accounts would be affected?

2. By how much?;

3. Are they increasing or decreasing?;

4. A, L, Eq, I or Exp?

5. Debit or Credit?

LECTURE EXAMPLE:

The following transactions relate to a computer programming service called Quick Smart:

DATE TRANSACTION

1/9 The proprietor C. Drive, contributed $40,000 cash as capital to start the business

2/9 Bought a computer for the business on credit for $3,000. Paid a $500 deposit with the balance payable within 30 days.

3/9 Purchased vehicle for the business for $10,000 cash

4/9 Paid wages to the secretary, $400

5/9 Service fees for the week of $1,050 cash were banked

Owner withdrew $150 for own use

7/9 Paid rent on office space $340

(ii) General Journal - Preparation of journal entries

Definition of double entry accounting

Rules of Debit & Credit

The Accounting Equation

GENERAL JOURNAL

DATE	PARTICULARS	DEBIT	CREDIT
		$	$
Sept. 1	Cash at Bank	40,000
	Capital, C. Drive		40,000
	(Owner invested capital)
2



3


4


5





7

(iii) General Ledger Account - a device used to record increases and decreases for each individual item that appears in a financial statement.

Ledger - a collection of accounts relating to an entity.

Format of ledger Accounts

Individual components of ledger accounts

Posting from the journal

GENERAL LEDGER

Debit CASH AT BANK ACCOUNT Credit
Date	Details	$	Date	Details	$
Sept. 1	Capital	40,000	Sept. 2
5			3
			4
			5
			7
	29,660

COMPUTER EQUIPMENT
Date	Details	$	Date	Details	$
Sept. 2

VEHICLES
Date	Details	$	Date	Details	$
Sept. 3

ACCOUNTS PAYABLE
Date	Details	$	Date	Details	$
			Sept. 2

CAPITAL - C. Drive
Date	Details	$	Date	Details	$
			Sept. 1	Cash at Bank	40,000


DRAWINGS
Date	Details	$	Date	Details	$
Sept. 5

FEES INCOME
Date	Details	$	Date	Details	$
			Sept. 5

RENT EXPENSE
Date	Details	$	Date	Details	$
Sept. 7

WAGES EXPENSE
Date	Details	$	Date	Details	$
Sept. 4

(iv) Trial Balance - Preparation and format

Balance does not necessarily mean correct!

Errors that may have occurred and would not effect the balancing of the ledger are:

1. A correct amount posted to the wrong account.

2. A journal entry omitted.

3. A journal entry posted twice.

4. Incorrect amounts posted to both correct accounts.

Errors that may have occurred and will cause the trial balance not to balance may be:

1. Transposition error, e.g. $627 was written as $672.

2. Only one side of a transaction has been recorded.

3. A credit entry has been wrongly entered as a debit, or vice-versa.

4. A mathematical mistake has been made in calculating the footings or in adding the Trial Balance.

QUICK SMART PROGRAMMING

TRIAL BALANCE

AS AT 7 SEPTEMBER

	DEBIT	CREDIT
	$	$
Cash at Bank
Computer Equipment
Vehicles
Accounts Payable
Capital - C. Drive
Drawings
Fees Income
Rent Expense
Wages Expense

(v) Income statement

QUICK SMART PROGRAMMING INCOME STATEMENT FOR THE WEEK ENDED 7TH SEPTEMBER
	$	$
Fees Income		1,050
Less Expenses:
Rent	340
Wages	400	740

Profit		$ 310

(vi) Statement of Changes in Equity

QUICK SMART PROGRAMMING STATEMENT OF CHANGES IN EQUITY FOR THE WEEK ENDED 7TH SEPTEMBER
		$
Capital contributions		40 000
Add: Profit		310
		40 310
Less: Drawings		150

Closing Capital		$ 40 160

(vii) Balance Sheet (Statement of Financial Position)

QUICK SMART PROGRAMMING BALANCE SHEET AS AT 7TH SEPTEMBER
	$		$
ASSETS		LIABILITIES
Cash at Bank	29,660	A/c's Payable	2,500
Computer Equipment	3,000
Vehicles	10,000	EQUITY	40,160
TOTAL	$ 42,660	TOTAL	$ 42,660

TOPICS 4 and 5 Preparation of financial statements from accounting data

Topics 4 and 5

Preparation of financial statements from accounting data

Topic introduction

Over the next two topics you are introduced to the procedures to be carried out at the end of an accounting period to produce a properly classified Balance Sheet and Income Statement. First we explore the need for accrual accounting and what balance day adjustments are required to properly reflect the income and expenses for the accounting period in question.

Second we review the Balance Sheet (which you were introduced to in topic 2) and expand upon its information providing qualities. We will discuss the classification and measurement of assets, liabilities and equity.

Finally, you will be introduced to the worksheet. Worksheets simplify the recording and analysis of adjusting entries and subsequent preparation of financial statements.

Study objectives

At the end of this topic you should:

· understand the difference between cash and accrual accounting and appreciate the need for accrual accounting. This is the most important thing you will need to understand to succeed in this course.

· be able to define and interactively apply the terms income, expense, materiality, conservatism, going concern and accounting period;

· understand the reason and be able to make adjustments for accruals, deferrals (prepayments), depreciation and doubtful debts;

· know the characteristics and measurement principles for assets, liabilities and equity;

· be able to appropriately classify assets and liabilities;

· be able to prepare Income Statements, Statements of Changes in Equity and Balance Sheets from an adjusted trial balance; and

· be able to use a worksheet as a medium for the preparation of financial statements.

Graduate Qualities

The Graduate Qualities (generic skills) developed by studying this topic include:

· body of knowledge

· lifelong learning

· effective problem solving

· work autonomously and collaboratively

· communicates effectively

Required reading

Topic 4

Resource: text reading

Hoggett, J, Medlin, J, Edwards L, Tilling, M, & Hogg, E. (2012). Chapter 4 'Adjusting the accounts and preparing financial statements' and Chapter 18 ‘Receivables’. In Accounting. 8th edition. Brisbane: John Wiley and Sons, pages 124-147 and 751 (2nd half) - 753 and 834 (bottom) – 836 (1st half).

Topic 5

Resource: text reading

Hoggett, J, Medlin, J, Edwards, L, Tilling, M, & Hogg, E. (2012). Chapter 4 'Adjusting the accounts and preparing financial statements' & Chapter 16 `Companies: formation and operations’. In Accounting. 8th edition. Brisbane: John Wiley and Sons, pages 148 - 154, (1st half). 656 (2nd half) - 658 (1st half).

Possible study activities – Topic 4
	Recommended time

Visit the web site and familiarise yourself with its contents.	0.5 hour
Required reading for topic 4	2.0 hours
Attend lecture	2.0 hours
Attend Tutorial (topic 3 questions)	3.0 hour
Review lecture notes	0.5 hour
Prepare the topic 4 tutorial answers to be covered during tutorials in week 5	2.0 hours
	10.0 hours

Tutorial questions (Can be found on the course website under the relevant week)

At the end of each chapter in the text the questions are in the order:

· Discussion Questions

· Exercises

· Problems

Supplementary questions

Extra materials provided by the text book publisher are available on the course web site under the link for Text Book Student Resources.

WileyPLUS Topic 4 www.wileyplus.com

Possible study activities – Topic 5
	Recommended time

Visit the web site and familiarise yourself with its contents.	0.5 hour
Required reading for topic 5	2.0 hours
Attend lecture	2.0 hours
Attend Tutorial (topic 4 questions)	3.0 hour
Review lecture notes	0.5 hour
Prepare the topic 5 tutorial answers to be covered during tutorials in week 6	2.0 hours
	10.0 hours

Tutorial questions (Can be found on the course website under the relevant week)

At the end of each chapter in the text the questions are in the order:

· Discussion Questions

· Exercises

· Problems

Supplementary questions

Extra materials provided by the text book publisher are available on the course web site under the link for Text Book Student Resources.

WileyPLUS Topic 5 www.wileyplus.com

Problem 4.7 Catamaran Rentals

Worksheet for the year ended 30 June 2013

	Trial Balance	Adjustments	Adjusted Trial Balance	Income Statement	Balance Sheet
	Dr.	Cr.	Dr.	Cr.	Dr.	Cr.	Dr.	Cr.	Dr.	Cr.
Cash at bank
Accounts Receivable
GST Outlays
Prepaid Insurance
Catamarans
Accumulated Depreciation
Office equipment
Accumulated Depreciation
Accounts Payable
Loan Payable
Unearned Rental Revenue
GST Collections
J. Kanaris, Capital
J. Kanaris, Drawings
Rental Revenue
Salaries Expense
Rent Expense
Repairs and Maint. Exp
Marine Supplies Expense
Telephone Expense
Totals	204135	204135
Depr. Exp. -- Off. Equip
Depr. Exp. -- Catamarans
Telephone Exp. Payable
Repairs/Maint. Exp Pyble
Interest Payable
Interest Expense
Insurance Expense
Salaries Payable
Totals			25321	25321	224253	224253
LOSS

EVERTON REMOVALISTS

Worksheet for the year ended 30 June 2013

	Unadjusted trial balance	Adjustments	Adjusted trial balance	Income statement	Balance sheet
Account Title	Debit	Credit	Debit	Credit	Debit	Credit	Debit	Credit	Debit	Credit
Cash at Bank	8 140
Accounts Receivable	12 860
GST Outlays	1 500
Office Supplies	640
Removal Vans	93 600
Accum. Depr. Removal Vans		39 400
Office Equipment	6 200
Accum. Depr. Office Equip.		3 500
Accounts Payable		10 800
Unearned Removal Fees		2 260
GST Collections		3 240
G. Everton, Capital		76 600
G. Everton, Drawings	20 600
Removal Fees Revenue		92 700
Insurance Expense	8 180
Wages Expense	54 620
Advertising Expense	3 880
Maintenance Expense	7 600
Fuel and Oil Expense	10 680
	$228 500	$228 500








Loss for the year

B, C & D From the above trial balance you are required to draw up an Income Statement, a Statement of Changes in Equity and a Balance Sheet (SFP). We have not provided pro formas as we want you to get practice at doing this for parts B and C of question 1 of the final exam.

TOPIC 5 BLANK WORKSHEET

, END OF PERIOD WORKSHEET – YEAR ENDED

Unadjusted Trial Balance Adjustments Adjusted Trial Balance Income Statement Balance Sheet (SFP)

Account Name	Dr	Cr	Dr	Cr	Dr	Cr	Dr	Cr	Dr	Cr





































Profit/Loss

Lecture Outline Topic 4

Preparation of Financial Statements from Accounting Data - Part 1

___________________________________________________________________________

1. Introduction

2 Cash v Accrual accounting

"A person's income is the maximum value they can consume and still expect to be as well off at the end of the week as they were at the beginning", J.R. Hicks (1946)

2.1 Cash Basis

Profit = Cash Inflows from Income - Cash Outflows from Expenses

2.2 Accrual Basis

Profit = Income Earned - Expenses Incurred

Lecture Illustration 1

"Pie in the Eye" produced 50 pies in a week, sold them for $2.50 each and at the end of the week still had 5 pies not sold. During the week they received an order for 15 pies @ $2.50 each for the following week. The client paid $37.50 when the order was placed. Pie in the Eye's cash payments for the week were:

Bag of flour (half used) $20

Bag of sugar (quarter used) $16

Butter (10kg @ $2 8kg used) $20

Apples (40kg @ $1 15kg left) $40

Spices (10% used) $8

Rental of stall for month $20

Packaging (quarter used) $10

Income according to		Income according to
CASH BASIS		ACCRUALS BASIS
CASH RECEIVED:	$	INCOME		$
Pies sold (45 x $2.50)	112.50	Pies sold		112.50
Orders Received	37.50	Less: EXPENSES
	150.00	Flour USED	10
CASH PAYMENTS:		Sugar USED	4
All cash paid out	134.00	Butter USED	16
PROFIT	$ 16.00	Apples USED	25
		Spices, Packaging, Rental	8.3
		TOTAL EXPENSES		63.30
		PROFIT		$ 49.20

3. Assumptions / Concepts

3.1 Interaction of the accounting period assumption and going concern assumption

Accounting period assumption: the life of the business is broken up into equal accounting periods

Going concern: in the absence of evidence to the contrary, the entity is assumed to have an indefinite life

Accrual accounting: attempts to match income to the period in which it is earned and expenses to the period in which they are incurred

____________________________________________________________________

Figure 1

Accounting Periods

|-----------------------|------------------------|-----------------------|---> Going Concern

0 1 2 3

Income Income Income

Earned Earned Earned

Expenses Expenses Expenses

Incurred Incurred Incurred

__________________________________________________________________

3.2 Some commonly desired attributes of information contained in financial reports.

3.2.1 Materiality

Information that is likely to affect the decisions of users of financial statements should be separately disclosed (Rivett & Jones).

3.2.2 Prudence (Conservatism)

A notion concerning the accountant's desire to exercise care and caution as part of ensuring the reliability of information. Consequently, the accountant is cautious not to overstate assets and profit and not to understate liabilities and expenses. (Hoggett, Medlin, Edwards, Tilling & Hogg).

4. The need for adjusting entries as a result of the points made in 3. above.

4.1 Classification

Deferrals include items that have been prepaid. Accruals include expenses incurred but not yet paid and income earned not received.

___________________________________________________________

Figure 2

DEFERRALS

PAY EXPENSE

CASH |-------------------------------------------------------------> RECORDED

CASH |--------------------------------------------------------------> INCOME

RECEIVED RECORDED

ACCRUALS

EXPENSE |---------------------------------------------------------> PAY

RECORDED CASH

INCOME |--------------------------------------------------------->CASH

RECORDED RECEIVED

___________________________________________________________

4.2 Simple rules

· the adjustment entries will always involve a Income Statement item and a Balance Sheet item

· adjustment entries never adjust the cash account

· also, in AFB we do not adjust Accounts Receivable or Accounts Payable as these are control accounts and we do not cover them in detail in this course

5. Types of adjusting entries

5.1 Deferrals

5.1.1 Prepayments of expenses (Adjustment a)

5.1.2 Precollection of income (Adjustment b)

5.1.3 Stocks of supplies (Adjustment c)

5.1.4 Depreciation (Adjustment d)

Depreciation is a method which is used to _ _ _ _ _ _ _ _ the cost of the asset over the accounting periods in which it is used. The purpose of depreciation is _ _ _ _ _ _ _ _ _ _ _ _ _ _, _ _ _ _ _ _ _ _ _ _ _ - _ _ _ _ _ _ _ _ _.

Accumulated depreciation is a Contra Asset account.

Read pages 834-835 of the text.

5.2 Accruals

5.2.1 Expenses incurred but not yet paid for (Adjustment e)

5.2.2 Income earned but not yet received (Adjustment f)

5.3 Doubtful Debts Adjustment (Adjustment g)

Lecture Illustration 2

For each of the following examples relating to Cartwright's Crockery, the details of the initial accounting treatment during the year ended 30th June along with required further information is detailed. The resultant adjusting journal entries are to be carried out on the journal proforma.

(a) On 1st January, Cartwright purchases a two year insurance policy on the factory and its contents for $2,000. At that time Cartwright made the following journal entry in the books:

January 1	Insurance Expense	2,000
	Cash at Bank		2,000

(b) On 1st June, a customer asks Cartwright to make 10 custom-made bowls at $25 each and pays for them in advance. At the time of payment, Cartwright made the following entry:

June 1	Cash at Bank	250
	Sales Income		250

By 30th June, Cartwright had only made and delivered two of the bowls. There are still eight that have not been completed.

June 30	Office Supplies Exp	450
	Cash at Bank		450

On the 30th June Cartwright did a count of all office supplies still on hand. The historic cost of the supplies still on hand is $175.

(d) Cartwright purchased a special painting machine on 1st February for $20,000. The machine will have a useful life of ten years after which it will be obsolete and will have no scrap value. Assume that Cartwright depreciates the machine on a straight-line basis (ie equally over the life of the machine).

(e) On 20th June, Cartwright had all the factory machinery checked and serviced by the company which supplied it. Cartwright was invoiced on 3rd July for $1,300 and given 30 days to pay.

(f) On 13th June Cartwright delivered 15 tea cups worth $150 to M. Landy, but issued no invoice until 2nd July.

(g) On the 30th June Cartwright estimated that $250 of its accounts receivable would not be collectable

Cartwright's Crockery - General Journal

Date	Particulars	Debit	Credit

Cartwright's Crockery - General Ledger (extract)

INSURANCE EXPENSE
Date	Details	$	Date	Details	$
January 1	Cash at Bank	2,000	June 30	Prepaid Insurance	1,500
	500

5.4 Alternative ways to account for deferrals and accruals

Lecture Illustration 3

Mr. Kryton opens a florist shop on 1 March, and pays a year’s rent of $12,000 ($1,000 per month) in advance.

There are two different ways in which Mr. Kryton may choose to record this transaction:

Dr. Rent Expense 12,000 or Dr. Prepaid Rent 12,000

Cr. Cash 12,000 Cr. Cash 12,000

Either way he will still need to prepare a balance-day-adjustment entry at the end of the accounting period to ensure the expense is properly matched to the accounting period.

Depending upon the initial treatment, the adjusting entry at 30 June (balance date), will be as follows:

Dr. Prepaid Rent Dr. Rent Expense

Cr. Rent Expense Cr. Prepaid Rent

____________________________________________________________________

Lecture Illustration 4

On Tuesday 29 April, Mr. Kryton receives an order from an accounting firm to provide them with a $50 floral arrangement for their reception desk each Tuesday morning starting immediately and continuing up to and including Tuesday 22 July. The accounting firm pays in advance (13 weeks x $50).

There are two different ways in which Mr. Kryton can record this transaction:

Dr. Cash 650 or Dr. Cash 650

Cr. Sales Income 650 Cr. Income in Advance 650

Either way he will still need to prepare a balance-day-adjustment entry at the end of the accounting period to ensure the income is properly matched to the accounting period.

Depending upon the initial treatment, the adjusting entry at 30 June, will be as follows:

Dr. Sales Income Dr. Income in advance

Cr. Income in advance Cr. Sales Income

6. Preparation of financial statements from adjusted ledger account data

“Unadjusted Trial Balance”

=> balance day adjustments

=> “Adjusted Trial Balance”

Cartwright's Crockery

UNADJUSTED TRIAL BALANCE

as at 30 June

Account Title	Debit ($)	Credit ($)
Cash at Bank	12,000
Accounts Receivable	7,000
Factory Equipment	56,000
Accumulated Depreciation - Factory Equipment		22,000
Accounts Payable		6,000
H. Cartwright, Capital		28,900
H. Cartwright, Drawings	10,000
Sales		80,050
Advertising Expense	1,500
Insurance Expense	2,000
Materials Expense	23,000
Office Supplies Expense	450
Rent Expense	10,000
Salary Expense	15,000
	136,950	136,950

Cartwright's Crockery

ADJUSTED TRIAL BALANCE

as at 30 June

Account Title	Debit ($)	Credit ($)
Cash at Bank	12,000
Accounts Receivable	7,000
Allowance for Doubtful Debts		250
Office Supplies	175
Prepaid Insurance	1,500
Accrued Income	150
Factory Equipment	56,000
Accumulated Depreciation - Factory Equipment		22,833
Accounts Payable		6,000
Accrued Expenses		1,300
Unearned Sales Income		200
H. Cartwright, Capital		28,900
H. Cartwright, Drawings	10,000
Sales		80,000
Advertising Expense	1,500
Depreciation Expense - Factory Equipment	833
Insurance Expense	500
Maintenance Expense	1,300
Materials Expense	23,000
Office Supplies Expense	275
Rent Expense	10,000
Doubtful Debts Expense	250
Salary Expense	15,000
	139,483	139,483

Cartwright's Crockery

INCOME STATEMENT

for the year ended 30 June

Income:
Sales		$ 80,000
Expenses:
Advertising Expense	$ 1,500
Depreciation Expense - Factory Equipment	833
Insurance Expense	500
Maintenance Expense	1,300
Materials expense	23,000
Office Supplies Expense	275
Doubtful Debts Expense	250
Rent Expense	10,000
Salary Expense	15,000	52,658
Profit		$ 27,342

Cartwright's Crockery

STATEMENT OF CHANGES IN EQUITY

for the year ended 30 June

H. Cartwright, Capital - 1 July, last year		$ 28,900
Add: Profit for year ended 30 June, this year		27,342
		56,242
Less: Drawings		10,000
H. Cartwright, Capital - 30 June, this year		$ 46,242

7. Balance Sheet

7.1 Format

7.2.1 Account or "T" form

7.2.2 Narrative form

7.2 Classification of assets and liabilities

Current Assets - one that is expected to be realised within twelve months of the reporting date or in the normal course of the entity’s operating cycle or that is held primarily for trading purposes or that is cash or a cash-equivalent asset

Non-Current Assets - not expected to be realised within twelve months of the reporting date or in the normal course of the entity’s operating cycle

Current Liabilities - one that is expected to be settled within twelve months of the reporting date or in the normal course of the entity’s operating cycle

Non-Current Liabilities – not expected to be settled within twelve months of the reporting date or in the normal course of the entity’s operating cycle

Cartwright's Crockery

BALANCE SHEET

as at 30 June

ASSETS
*Current*
Cash at Bank		$ 12,000
Accounts Receivable	$7,000
less: Allowance for Doubtful Debts	(250)	6,750
Office Supplies		175
Prepaid Insurance		1,000
Accrued Income		150	$20,075
*Non-current*
Prepaid Insurance		500
Factory Equipment	56,000
less: Accumulated Depreciation	(22,833)	33,167	33,667
TOTAL ASSETS			$ 53,742

LIABILITIES
*Current*
Accounts Payable		6,000
Accrued Expenses		1,300
Unearned Sales Income		200	7,500
NET ASSETS			$ 46,242

EQUITY
H. Cartwright, Capital			$ 46, 242

Lecture Outline Topic 5

Preparation of Financial Statements from Accounting Data - Part 2

____________________________________________________________________________

1. Introduction

2. The end of period worksheet and its purpose

To assist in preparation of interim financial statements without having to make adjusting or closing entries in the accounting journal and ledger

To improve organisation and minimise errors when preparing financial statements at the end of the accounting period.

3. Comprehensive Example

Lotta Monet - Financial Consultant

Unadjusted Trial Balance

as at 30 June,

Account	Debit($)	Credit ($)
Cash at Bank	2,360
Accounts Receivable	5,670
Office Supplies	600
Prepaid Insurance	200
Office Equipment	26,000
Accumulated Depreciation - Office Equipment		11,500
Investments	5,400
Accounts Payable		3,560
Unearned Fees		320
L. Monet, Capital (1/7/last year)		18,380
L. Monet, Drawings	2,450
Consulting Fees		32,000
Interest Income		30
Advertising Expense	1,050
Rent Expense	5,300
Salary Expense	15,000
Telephone Expense	260
Travel Expense	1,500	.
	$65,790	$65,790

Additional Information:

1. Lotta took office supplies worth $50 home for her own use during the year and this has not yet been recorded.

2. The office supplies on hand, determined by physical count, were $200.

3. The prepaid insurance was for twelve months commencing 1st January.

4. Unpaid salaries earned by employees amounted to $1,400.

5. The balance in the unearned fees account includes an amount of $100 for work that has not yet been completed. The remaining fees in the account were earned this period.

6. The estimated depreciation expense for the year was $2,000.

7. Interest was earned on the investments at 15% p.a. and none of this has been recorded for the year.

8. The rent expense includes an amount of $300 paid in advance for July.

9. Lotta has estimated that $270 of the period's income owed on credit will prove uncollectable.

TOPIC 5 LECTURE ILLUSTRATION

LOTTA MONET, END OF PERIOD WORKSHEET – YEAR ENDED 30 JUNE

Unadjusted Trial Balance Adjustments Adjusted Trial Balance Income Statement Balance Sheet

Account Name	Dr	Cr	Dr	Cr	Dr	Cr	Dr	Cr	Dr	Cr
Cash at Bank	2,360
Accounts Receivable	5,670
Office Supplies	600
Prepaid Insurance	200
Office Equipment	26,000
Accumulated Dep’n – Office Equip.		11,500
Investments	5,400
Accounts Payable		3,560
Unearned Fees		320
L.Monet, Capital (1/7/last year)		18,380
L.Monet, Drawings	2,450
Consulting Fees		32,000
Interest Income		30
Advertising Expense	1,050
Rent Expense	5,300
Salary Expense	15,000
Telephone Expense	260
Travel Expense	1,500

	65,790	65,790

















Profit/Loss

Lotta Monet - Financial Consultant
Income Statement
for the year ended 30 June
Income
Consulting Fees	$32,220
Bank Interest	840	$33060
Expenses
Advertising Expense	$1,050
Depreciation Expense	2,000
Insurance Expense	100
Office Supplies Expense	350
Rent Expense	5,000
Salary Expense	16,400
Telephone Expense	260
Travel Expense	1,500
Doubtful Debts Expense	270	26,930
PROFIT		$6,130

Lotta Monet - Financial Consultant
Statement of Changes in Equity
for the year ended 30 June
L. Monet, Capital - 1 July, last year	$18,380
add: Profit for year ended 30 June	6,130
	24,510
less: Drawings	2,500
L. Monet, Capital - 30 June	$22,010

Lotta Monet - Financial Consultant
Balance Sheet
as at 30 June
ASSETS
Current assets
Cash at Bank		$2,360
Accounts Receivable	$5,670
less Allowance for Doubtful Debts	270	5,400
Accrued Income		810
Prepaid Rent		300
Office Supplies		200
Prepaid Insurance		100	$9,170
Non-current Assets
Investments		5,400
Office Equipment	26,000
less Accumulated Depreciation	13,500	12,500	17,900
TOTAL ASSETS			27,070

LIABILITIES
Current Liabilities
Accounts Payable		3,560
Accrued Salaries		1,400
Unearned Fees		100	5,060
NET ASSETS			$22,010

EQUITY
L. Monet, Capital			$22,010

4. Equity accounting for companies

SOLE TRADER v. COMPANY EQUITY

symbol 183 \f "Symbol" \s 10 \h J. Crisp invested $100,000 in capital in a real estate firm.

symbol 183 \f "Symbol" \s 10 \h The opening balance of capital at the start of this period was $125,000.

symbol 183 \f "Symbol" \s 10 \h During the period a profit of $60,000 was made.

symbol 183 \f "Symbol" \s 10 \h During the period $30,000 was distributed to the owner.

As a Sole Trader As a company

J. CRISP REAL ESTATE CRISP REAL ESTATE PTY. LTD.

Statement of Equity Statement of Retained Earnings

for the year ended 30 June for the year ended 30 June

Capital, 1 July (last year) $125,000 Retained Earnings, 1 July (last year) $25,000

Add: Profit 60,000 Add: Profit 60,000

185,000 85,000

Less: Drawings 30,000 Less: Dividends 30,000

Capital, 30 June $155,000 Retained Earnings, 30 June $55,000

Balance Sheet (SFP) Extracts as at 30 June:

EQUITY EQUITY

Capital $155,000 Share Capital $100,000

Retained Earnings 55,000

$155,000

TOPIC 6 Accounting for Merchandise

Topic 6

Accounting for merchandise

Topic introduction

Business activities are designed to produce income either by the provision of services (for example, plumbers, accountants and law firms) or the sale of goods (for example, department stores and timber merchants). This topic we look at the accounting approach to retailing firms that purchase and sell goods as their primary business activity.

The relevant accounting standards are AASB 102 `Inventories’ and International Accounting Standard 2 (IAS 2) `Inventories’. This is the first time you have been referred to an accounting standard in this course. Although the standard applies to the way inventory is accounted for by accounting professionals, it brings up issues that you are not required to cover in this topic and are foreign to your understanding. There are some differences in the interpretation of a few finer points between AASB 102 and IAS 2 but these do not affect any of the issues covered by this topic.

Study objectives

At the end of this topic you should:

· understand the nature of a merchandise retailing;

· be able to record sales, purchases, freight and returns transactions;

· be able to distinguish between cash and trade discounts and their different treatment in the ledger, and subsequently in reports;

· understand the principles underlying the perpetual and periodic inventory systems and be able to identify the differences between the two systems;

· be able to prepare a worksheet for both the perpetual and periodic inventory systems; and

· be able to prepare a properly classified Income Statement for a retailing firm.

Graduate Qualities

The Graduate Qualities (generic skills) developed by studying this topic include:

· body of knowledge

· lifelong learning

· effective problem solving

· work autonomously and collaboratively

Required reading

Resource: text reading

Hoggett, J, Medlin, J, Edwards, L, Tilling, M, & Hogg, E. (2012). Chapter 6 'Accounting for retailing. In Accounting. 8th Edition. Brisbane: John Wiley and Sons, pages 230-257.

Note: although this reading includes GST, in Accounting for Business you are not expected to understand or account for GST.

Possible study activities – Topic 6
	Recommended time

Visit the web site and familiarise yourself with its contents.	0.5 hour
Required reading for topic 6	2.0 hours
Attend lecture	2.0 hours
Attend Tutorial (topic 5 questions)	3.0 hour
Review lecture notes	0.5 hour
Prepare the topic 6 tutorial answers to be covered during tutorials in week 7	2.0 hours
	10.0 hours

Tutorial questions (Can be found on the course website under the relevant week)

At the end of each chapter in the text the questions are in the order:

· Discussion Questions

· Exercises

· Problems

Supplementary questions

Extra materials provided by the text book publisher are available on the course web site under the link for Text Book Student Resources.

WileyPLUS Topic 6 www.wileyplus.com

Supplementary questions

Extra materials provided by the text book publisher are available on the course web site under the link for Text Book Student Resources.

WileyPLUS Topic 6 www.wileyplus.com

FIONA’S FASHIONS PTY LTD - Worksheet for the year ended 30 June 2014

	Unadjusted trial balance	Adjustments	Adjusted trial balance	Income Statement	Balance Sheet
Account Title	Debit	Credit	Debit	Credit	Debit	Credit	Debit	Credit	Debit	Credit
Cash at Bank	17 457
Accounts Receivable	18 667
GST Outlays	500
Inventory	24 530
Supplies	341
Store Equipment	39 105
Acc. Depr. Store Equip.		8 734
Accounts Payable		3 960
GST Collections		1 000
Loan Payable		11 000
Share Capital		36 597
Retained Earnings		8 872
Sales		125 609
Sales Returns & Allowances	1 133
Discount Received		1 072
Cost of Sales	72 842
Freight Inwards	1 204
Discount Allowed	495
Sales Salaries Expense	20 570
	$196 844	$196 844
Supplies Expense
Depr. Exp. – Store Equip.
Interest Payable
Income Tax Expense
Current Tax Liability
Interest Expense
Inventory Shortage
			12 746	12 746	209 229	209 229	108 990	126 681	100 239	82 548
Profit							17 691			17 691
							126 681	126 681	100 239	100 239

QUESTION 5 - Financial Reporting

You are presented with the following information for “How Does Your Garden Grow”, a nursery that is owned by Silvia Bells, for the year ended 30 June 2012.

How Does Your Garden Grow - TRIAL BALANCE AS AT 30 JUNE 2012

	Debit ($)	Credit ($)
Cash	58 000
Accounts Receivable	76 000
Inventory (1 July, 2011)	116 000
Prepaid Rent	12 000
Term Deposit	130 000
Gardening Equipment	62 000
Accum. Dep. Gardening Equipment		18 000
Delivery Van	35 000
Accumulated Depreciation Van		12 500
Accounts Payable		63 000
Unearned Revenue		6 200
Mortgage		20 000
Ms S Bells, Capital (1 July 2011)		346 150
Ms S Bells , Drawings	8 300
Sales		315 870
Sales Returns & Allowances	12 370
Purchases Returns & Allowances		3 450
Interest Income		6 600
Purchases	156 900
Freight Inward	19 000
Freight Outward	9 400
Wages Sales Staff	62 000
Van Maintenance Expense	8 100
Discount Allowed	900
Nursery Rent Expense	14 000
Advertising Expense	7 000
Accountants Wages	4 800	. .
	$791 770	$791 770

(continued.....)

The following additional information is also provided:

(i) A physical stock take of inventory at 30 June 2012 revealed $128 600 on hand.

(ii) The unearned revenue was for a new species of plant that had to be pre-ordered. On balance day half of the plants ordered had been delivered.

(iii) Van Maintenance includes an annual service in June with a cost of $1900. This account has not been paid or recorded.

(iv) It is estimated that 4% of the accounts receivable will never be received from the customers by whom it is owed.

(v) The service potential of both the equipment and the delivery van is expected to be used evenly over their useful lives. The equipment is expected to have a residual value of $2 000 at the end of its useful life. The van will have a residual value of $5,000 at the end of its useful life. The expected useful lives of both assets as at the date of their purchase is as follows:

Gardening Equipment - 10 years

Delivery Van - 6 years

(vi) The nursery rent expense is prepaid half yearly on February 1 and August 1.

(vii) $5 000 of the term deposit matures on December 1 2012, the remainder matures in 2014. One quarter of the mortgage will be paid in the next accounting period.

(viii) Examination of the firm's accounting records showed that the part-time accountant had not been paid for May and June. The cost of accounting was $3,200 but had not been recorded or paid for yet.

REQUIRED:

a. Complete the worksheet provided to prepare the above information for assembly into financial statements.

(19 marks)

b. Prepare a fully classified Income Statement for the period in question. (7 marks)

a. Prepare a Statement of Changes in Equity and a fully classified Balance Sheet in narrative form as at the end of the period.

(7 marks)

TOTAL FOR QUESTION 1: 33 Marks

How Does Your Garden Grow, END OF PERIOD WORKSHEET - YEAR ENDED 30 JUNE 2012

Unadjusted Trial Balance Adjustments Adjusted Trial Balance Income Statement Balance Sheet

Account Name	Dr	Cr	Dr	Cr	Dr	Cr	Dr	Cr	Dr	Cr
Cash	58 000
Accounts Receivable	76 000
Inventory (1 July, 2011)	116 000
Prepaid Rent	12 000
Term Deposit	130 000
Gardening Equipment	62 000
Accum. Dep Gardening Equipment		18 000
Delivery Van	35 000
Accumulated Depreciation Van		12 500
Accounts Payable		63 000
Unearned Revenue		6 200
Mortgage		20 000
Ms S Bells, Capital (1 July, 2011)		346 150
Ms S Bells, Drawings	8 300
Sales		315 870
Sales Returns and Allowances	12 370
Purchases Returns and Allowances		3 450
Interest Income		6 600
Purchases	156 900
Freight Inwards	19 000
Freight Outwards	9 400
Wages Sales Staff	62 000
Van Maintenance Expense	8 100
Discount Allowed	900
Nursery Rent Expense	14 000
Advertising Expense	7 000
Accounting Wages	4 800









	791 770	791 770
Profit/Loss

Note: There are no marks awarded for adding up any of the columns. You do not need to add the columns to be able to do parts b and c of the question. You are welcome to add up the columns if you would like to check your answers but you are not required to do so.

Lecture Outline Topic 6

Accounting for Merchandise

1. Introduction

AASB102 “Inventories”

IAS2 “Inventories”

2. Nature of Inventory

Definition:

Inventories are assets:

(a)

held for sale in the ordinary course of business;

(b)

in the process of production for such sale; or

(c)

in the form of materials or supplies to be consumed in the production process or in the rendering of services.

(AASB 102, 6)

When the sale of goods occurs record:

- the sales transaction itself

- the Cost of Sales (COS)

PROFIT = INCOME – EXPENSES

SALES INCOME – COST OF SALES = GROSS PROFIT

GROSS PROFIT – EXPENSES = PROFIT

3. Accounting for sales transactions

3.1 Sales Returns and Allowances

3.2 Cash (settlement) discounts

4. Accounting for Inventory and Cost of Sales

Allocation of the cost of inventory over:

- goods sold during the period

- the goods held at the end of the period

4.1 The Classification of Expenditure (Rivett & Jones 1990 p. 134)

COST

Expenditure to

acquire future

benefits are

recorded as

Expenditures accompanied

by the consumption of

benefits are

recorded as

ASSETS

(unexpired

costs)

EXPENSES

(expired

costs)

When benefits are used

or expire,

record costs as

Example Assets:

•

Buildings and LT

assets

•

Inventory

•

Prepayments:

•

Insurance

Example Expenses:

•

Depreciation

•

Cost of Sales

•

Expired Costs:

•

insurance exp.

When benefits

are used, or

expire, costs are

charged as

If benefits not used up or

expired by balance date

record cost as

4.2 The Perpetual System

Definition: A perpetual inventory system involves a continuous record of the physical quantities and costs of inventory on hand, and of the physical quantities and costs of inventory sold. The cost of inventory purchased is recorded as an asset at the date of purchase. When the inventory is sold, the cost expires and is recorded as cost of sales expense.

(Rivett & Jones p.246)

Lecture Illustration 1 - THE PERPETUAL SYSTEM

Flimsy Furniture Co. had 4 reclining chairs on hand at 1 July. Each of the chairs originally cost $100. During the year, on various dates, the company purchased a further 25 chairs for $100 each. At the end of the financial year 30 June a physical inventory stock take revealed the company had 5 reclining chairs on hand which cost $100 each. 23 of the chairs were sold for $150 each at various dates.

The following Stock Account contains the information for the year:

Stock Ledger Account Item: Reclining Chairs Location: Mile End Store Code No.: B12
Date	IN	OUT	Balance
	Qty	Unit Cost	Value	Qty	Unit Cost	Value	Qty	Unit Cost	Value
July 1							4	$100	$400
Aug 3	5	$100	$500				9	$100	$900
Sept 4				7	$100	$700	2	$100	$200
Sept 10	10	$100	$1,000				12	$100	$1,200
Jan 1				11	$100	$1,100	1	$100	$100
Mar 12	10	$100	$1,000				11	$100	$1,100
June 3				5	$100	$500	6	$100	$600
June 30				1	$100	$100	5	$100	$500
				Cost of Sales	$2,400	Inventory on hand	$500

REQUIRED:

1. Show the journal entries for the above transactions and post them to the ledger showing the Inventory account, the Sales account and the Cost of Sales account.

2. Calculate the gross profit for the year.

FLIMSY FURNITURE CO. - GENERAL JOURNAL

DATE	PARTICULARS	DEBIT	CREDIT
3 Aug



4 Sep







10 Sep



1 Jan







12 Mar



3 Jun







30 Jun

FLIMSY FURNITURE CO. - GENERAL LEDGER (extract)

INVENTORY ACCOUNT (asset)

Date	Details	$	Date	Details	$
30/6	Balance b/d	400	4/9	COS	700
3/8	Bank/A/c's Pay.	500	1/1	COS	1,100
10/9	Bank/A/c's Pay.	1,000	3/6	COS	500
12/3	Bank/A/c's Pay.	1,000	30/6	Inventory Short	100

	500

SALES ACCOUNT (income)

Date	Details	$	Date	Details	$
			4/9	Bank/A/c's Rec.	1,050
			1/1	Bank/A/c's Rec.	1,650
			3/6	Bank/A/c's Rec.	750

				3450

COST OF SALES ACCOUNT (expense)

Date	Details	$	Date	Details	$
4/9	Inventory	700
1/1	Inventory	1,100
3/6	Inventory	500

	2,300

INVENTORY SHORTAGE ACCOUNT * (expense)

Date	Details	$	Date	Details	$
30/6	Inventory	100

* For the role of this account see Hoggett, Medlin, Edwards, Tilling & Hogg p. 244

Flimsy Furniture Co.

Income Statement (extract)

for the Year Ended 30 June

Sales $3,450

less COS 2,400 #

GROSS PROFIT $ 1,050

(# balance of COS account + inventory shortage)

4.3 The Periodic System

Definition: In a periodic inventory system, a continuous record of the cost of inventory purchased is maintained. The total purchases are added to the cost of opening inventory to determine the cost of goods available for sale. The cost of sales is then determined by deducting the cost of ending inventory from the cost of goods available for sale. A physical stock take is needed.

(Rivett & Jones p.246)

· large volume low cost inventory

· cost of maintaining perpetual system would be relatively high

4.3.1 COS Calculation for the periodic method

Cost of Cost of goods Cost of

Sales = Available for Sale - Ending Inventory

= Cost of Cost of Cost of

Beginning + Purchases - Ending

Inventory Inventory

Where:

Cost of Beginning Inventory is recorded as an asset account at the beginning of the period.

Cost of Purchases is accumulated during the period in a temporary expense account.

Cost of Ending Inventory is determined by physical stocktake at the end of the period x cost price.

Lecture Illustration 2 - THE PERIODIC SYSTEM

Using the information supplied earlier for Flimsy Furniture Co, record transactions in the journal, post to the ledger and calculate gross profit assuming the use of a periodic inventory system.

FLIMSY FURNITURE CO. - GENERAL JOURNAL

DATE	PARTICULARS	DEBIT	CREDIT
3/8



4/9



10/9



1/1



12/3



3/6

FLIMSY FURNITURE CO. - GENERAL LEDGER (extract)

INVENTORY ACCOUNT (asset)

Date	Details	$	Date	Details	$
1/7	Balance b/d	400	30/6	Closing Entry*	400
30/6	Closing Entry*	500

	500

SALES ACCOUNT (income)

Date	Details	$	Date	Details	$
			4/9	Bank/A/c's Rec.	1,050
			1/1	Bank/A/c's Rec.	1,650
			3/1	Bank/A/c's Rec.	750

				3450

PURCHASES ACCOUNT (expense)

Date	Details	$	Date	Details	$
3/8	A/c's Pay/Bank	500
10/9	A/c's Pay/Bank	1,000
12/3	A/c's Pay/Bank	1,000

	2,500

Flimsy Furniture Co.

Income Statement (extract)

for the Year Ended 30 June

Sales		$3,450
less COS:
Inventory at Start	$400
add Purchases	2,500
Cost of Goods Available for sale	2,900
less Inventory at End	500	2,400
GROSS PROFIT		$1,050

4.4 Differences Between the Perpetual and the Periodic System

· Perpetual Inventory System

=> continuous record of inventory on hand and COS

=> physical stock take only to verify ending inventory

=> a Cost of Sales account

· Periodic Inventory System

=> a physical stock take is required

=> a purchases account is used

=> the cost of sales is a residual amount

5. Use of a worksheet

5.1 Perpetual system

WORKSHEET FOR PERPETUAL SYSTEM (extract)

Account	Unadjusted Trial Balance	Adjustments	Adjusted Trial Balance	Income Statement	Balance Sheet (SFP)
	Dr	Cr	Dr	Cr	Dr	Cr	Dr	Cr	Dr	Cr
Inventory	600
Sales		3450
COS*	2300
Inv. Short*

· The choice of showing the inventory shortage as a separate item or as part of COS is largely a materiality/disclosure judgement on the part of the accountant.

5.2 Periodic system

WORKSHEET FOR PERIODIC SYSTEM (extract)

Account	Unadjusted Trial Balance	Adjustments	Adjusted Trial Balance	Income Statement	Balance Sheet (SFP)
	Dr	Cr	Dr	Cr	Dr	Cr	Dr	Cr	Dr	Cr
Inventory (Beginning)	400
Sales		3450
Purchases	2500

6. Income Statement classification - (example, Hoggett, Medlin, Edwards, Tilling & Hogg p. 254)

6.1 For retailing firms:

Cost of Sales

The costs of acquiring goods and placing them in a condition suitable for sale. (Rivett & Jones p. 129)

Gross Profit

The difference between net sales and the cost of goods sold. The term gross indicates that this is the amount available to meet all other expenses, and to provide for profit. (Rivett & Jones p.129)

6.2 For all firms:

6.2.1 Selling and Distribution

Expenses that result from efforts to store, sell and deliver goods to customers. (Hoggett, Medlin, Edwards, Tilling & Hogg p. 231)

6.2.2 Administrative

Outlays associated with the general administration of the entity. Frequently, expenses that are common to both administrative and selling activities are apportioned between the two. where this is considered too expensive, or impracticable, the particular item is usually classified as administrative. (Rivett & Jones p. 129)

6.2.3 Finance and Other

Expenses incurred in relation to the financing of the enterprise, collecting debts and running the credit department. (Hoggett, Medlin, Edwards, Tilling & Hogg p.231)

TOPIC 7 Using financial accounting reports for decision-making (part 1)

Topic 7

Using financial accounting reports for decision-making (part 1)

Topic introduction

This topic concentrates on techniques to analyse financial accounting information. We will provide an introduction to this highly developed process of using accounting data to gain additional information that assists both internal and external users of accounting information in making decisions.

The techniques you learn this topic are useful for deciding on investments, for comparing alternative investment proposals and for a range of other decisions relating primarily to the profitability or financial condition of a particular entity.

You may find a change in the emphasis of this topic's material compared to previous topics. Some students delight in the opportunities provided by this topic to employ their inherent or previously learnt analytical skills, while other students may struggle to conquer the skills required. If you happen to be the 'struggler', please don't feel discouraged—many students studying this topic for the first time need to proceed at their own pace before they can master it.

Study objectives

At the end of this topic you should:

· appreciate the objectives of financial statement analysis;

· be able to perform horizontal analysis, trend analysis and vertical analysis;

· be able to calculate common financial ratios; and

· be able to use analysis tools to interpret financial statements.

Graduate Qualities

The Graduate Qualities (generic skills) developed by studying this topic include:

· body of knowledge

· lifelong learning

· effective problem solving

· work autonomously and collaboratively

· Communicates effectively

Required reading

Resource: text reading

Hoggett, J, Medlin, J, Edwards, L, Tilling, M, & Hogg, E. (2012). Chapter 25 'Analysis and interpretation of financial statements' (pages 1056-1071 and 1076-1079) and Chapter 22 `Liabilities’ re debt vs. equity (pages 927 – 928) and Chapter 16 `Companies: formation and operations’ re preference shares and dividends (pages 666 - 669) and Chapter 10 `Cash management and control” re cash management (pages 436-437). In Accounting. 8th edition. Brisbane: John Wiley and Sons.

Notes on the reading

Please ensure that you only read the sections specified by the page numbers.

Additional reading

Some suggestions for additional references on this topic include:

Bazley, M and Hancock, P (2006). Contemporary Accounting. 6th edition. South Melbourne: Thomas Nelson.

Jackling, B., Raar, J., Wigg, R., Williams, B. and Wines, G. (2010). Accounting: a Framework for Decision Making. 3rd edition. Sydney: McGraw-Hill.

Horngren, C T; Harrison, W T, Bamber L S, Best P, Fraser D, and Willett R. (2010). Accounting. 6th edition. Sydney: Prentice-Hall.

Kloot, L; Sandercock, E; Meigs, W and Meigs, R (1995). Accounting: The Basis for Business Decisions. 2nd edition. Sydney: McGraw-Hill.

Possible study activities – Topic 7
	Recommended time

Visit the web site and familiarise yourself with its contents.	0.5 hour
Required reading for topic 7	2.0 hours
Attend lecture	2.0 hours
Attend Tutorial (topic 6 questions)	3.0 hour
Review lecture notes	0.5 hour
Prepare the topic 7 tutorial answers to be covered during tutorials in week 8	2.0 hours
	10.0 hours

Tutorial questions (Can be found on the course website under the relevant week)

At the end of each chapter in the text the questions are in the order:

· Discussion Questions

· Exercises

· Problems

Supplementary questions

Extra materials provided by the text book publisher are available on the course web site under the link for Text Book Student Resources.

WileyPLUS Topic 7 www.wileyplus.com

Lecture Outline Topic 7

Using Financial Accounting Reports for Decision Making, Part 1

1. Introduction

Analysis of financial statements - the identification, separation and other manipulation of elements of information in financial statements.

Interpretation - the translation of analysis information into a form useful for decision making.

2. Goals of Interpretation

2.1 Profitability

· to evaluate the entity’s performance for the period

· to evaluate future prospects for survival

2.2 Liquidity

· to evaluate the entity’s ability to meet its short term liabilities

2.3 Financial Stability

· to evaluate the entity’s ability to continue operations in the long term

3. Techniques of analysis

3.1 Dollar and Percentage Analysis

Percentage Analysis - the conversion of dollar amounts reported in a financial statement into percentages of a base amount contained in that statement.

3.1.1 Vertical Analysis

The analysis of relationships between items within a single financial statement of an entity. A vertically analysed Income Statement would express all items as a percentage of sales. The Balance Sheet would express items as a percentage of total assets.

3.1.2 Horizontal Analysis

A percentage analysis performed on items contained in 2 financial statements over consecutive accounting periods.

3.1.3 Trend Analysis

A horizontal analysis which is extended over 3 or more accounting periods to reveal trends in the items reported in the financial statements.

VERTICAL ANALYSIS

Comparative Income Statements

for the years ended 30 June 2012 and 2011 (in $'000's)

Common Size

2012 2011 2012 2011

Net Sales 900 750 100.0

less COS 530 420 56.0

Gross Profit 370 330 44.0

less Expenses-.

Selling 117 75 10.0

Administrative 126 95 12.7

Total 243 170 22.7

Earnings Before Interest & Tax (EBIT) 127 160 21.3

Interest 24 30 4.0

Profit before income tax 103 130 17.3

Income Tax 28 40 5.3

Profit 75 90 12.0

Preference dividends 9 9

Ordinary dividends 24 20.8

___________________________________________________________________________

Dollar and Percentage Analysis of Financial Statements

HORIZONTAL ANALYSIS

Extract from Income Statements

	2012	2011	2010	2009	2008
Sales ($)	900,000	750,000	700,000	690,000	650,000
Profit ($)	75,000	90,000	80,000	70,000	60,000

Horizontal Change

	2012-11	2011-10	2010-09	2009-08
$ Change
% Change

Trend

	2012	2011	2010	2009	2008
Sales %					100
Profit %					100

3.2 Ratio Analysis

(Note: Students must understand the use of the ratios on pp. 1078-1079 of Hoggett, Medlin, Edwards, Tilling & Hogg except those relating to Cash sufficiency and Cash Flow efficiency which do not form part of this topic and are not required to be used).

A calculative analysis performed upon financial statement data that shows structural relationships between items in the report.

Note, that if you have already done a vertical analysis of the Financial Statements you have already been calculating ratios. Calculation of separate similar ratio information is superfluous as it is repeating information that you already have.

4. Performing analysis

Comparative Balance Sheet
As at years ended 30 June 2012 and 2011 (in $’000’s)
	2012	2011	2010
Current Assets
Cash assets	38	40
Debtors	117	86	80
Inventory	180	120	100
Other current assets	55	42
Total Current Assets	390	288
Non-Current Assets	560	572	. .
Total Assets	950	860	820

Current Liabilities	112	94
Non-Current Liabilities	200	250
Total Liabilities	312	344
Net Assets	638	516

Preference Shares	100	100	100
Ordinary Shares	380	300	300
Retained earnings	158	116	. 56
Equity	638	516	456

Number of ordinary shares	500,000	400,000
Ordinary shares’ market price	$0.90	$1.45

Ratio	Significance of ratio	Method of calculation	2012	2011
Profitability Ratios
Return on total assets	Measures rate or return earned through operating total assets provided by both creditors and owners.	Profit from ordinary activities before income tax + Borrowing costs Average total assets	103 + 24 = (860 + 950)/2	130 + 30 = (820 + 860)/2
Return on ordinary shareholders’ equity	Measures rate of return earned on assets provided by owners	Profit – Preference dividends . Average ordinary equity	75 – 9 = (416 + 538)/2	90 – 9 = (356 + 416)/2
Profit margin	Measures profitability of each dollar of sales.	Profit from ordinary activities after income tax Income	75 = 8.3% 900	90 = 12% 750
Gross profit margin	Measures the gross profit earned per dollar of sales.	Gross profit Sales	370 = 41% 900	330 = 44% 750
Expense ratio	Attempts to measure the proportion of a specific expense type as a proportion of sales.	Selling expense Income	117 = 13% 900	75 = 10% 750
Earnings per share	Measures profit earned on each ordinary share.	Profit from ordinary activities after tax – Preference dividends Weighted average number of ordinary shares issued	75 – 9 = 14.7c (500+400)/2	90 – 9 = 20.3c 400
Price-earnings ratio	Measures the amount investors are paying for a dollar of earnings.	Market price per ordinary share Earnings per ordinary share	$0.90 = 6.1 times $0.147	$1.45 = 7.1 times $0.203
Earnings yield	Measures the return to an investor purchasing shares at the current market price.	Earnings per ordinary share . Market price per ordinary share	$0.147 . = 16.3% $0.90	$0.203 . = 14.0% $1.45
Dividend yield	Measures the rate of return to shareholders based on current market price.	Annual dividend per ordinary share Market price per ordinary share	24/500 = 5.3% $0.90	20.8/400 = 3.6% $1.45
Dividend payout	Measures the percentage of profits paid out to ordinary shareholders.	Total dividends to ordinary shareholders Profit – Preference dividends	24 . = 36% 75 - 9	20.8 . = 26% 90 - 9
Liquidity Ratios
Current ratio	A measure of short-term liquidity. Indicates the ability of an entity to meet its short-term debts from its current assets.	Current assets Current liabilities	390 = 112	288 = 94
Quick ratio	A more rigorous measure of short-term liquidity. Indicates the ability of the entity to meet unexpected demands from liquid current assets.	Cash assets + Receivables Current liabilities	38 + 117 = 112	40 + 86 = 94
Receivables turnover	Measures the effectiveness of collections; used to evaluate whether receivables balance is excessive.	Net credit sales income Average receivables balance	900 .= 8.9 times (86 + 117)/2	750 . = 9.0 time (86 + 80)/2
Average collection period	Measures the average number of days taken by an entity to collect its receivables.	365 . Receivables turnover	365 = 41 days 8.9	365 = 41 days 9.0
Inventory turnover	Indicates the liquidity of inventory. Measures the number of times inventory was sold on the average during the period	Cost of sales Average inventory balance	530 .= 3.5 times (120 + 180)/2	420 .= 3.8 X (100 + 120)/2
Average days to sell	Measures the average number of days taken by an entity to sell its inventory.	365 . Inventory turnover	365 = 104 days 3.5	365 = 96 days 3.8
Operating cycle	Measure of the total average time it takes from the receipt of inventory to the point at which the customer pays the debt. It is a measure of the overall efficiency of a retail firm’s core operations.	Average collection period + Average days to sell	104 + 41 = 145 days	96 + 41 = 137 days
Financial Stability Ratios
Debt ratio	Measures percentage of assets provided by creditors and extent of using gearing.	Total liabilities Total assets	312 = 33% 950	344 = 40% 860
Equity ratio	Measures percentage of assets provided by shareholders and the extent of using gearing.	Total equity Total assets	638 = 67% 950	516 = 60% 860
Capitalisation ratio	The reciprocal of the equity ratio and thus measures the same thing.	Total assets Total equity	950 = 1.5 times 638	860 = 1.67 X 516
Times interest earned	Measures the ability of the entity to meet its interest payments on borrowings out of current profits.	Profit from ordinary activities before tax + Borrowing costs Borrowing costs	103 + 24 = 24	130 + 30 = 30
Asset turnover ratio	Measures the effectiveness of an entity in using its assets during the period.	Income Average total assets	900 .= (860 + 950)/2	750 .= (820 + 860)/2

	Hoggett, Medlin, Edwards, Tilling & Hogg (2012) pages 1078 – 1079 adapted

Profitability

· Use percentage analysis (horizontal, trend & vertical) of the Income Statement and the Balance Sheet items used in the ratios, e.g. total assets and equity accounts

· Use the profitability ratios, using the percentage analysis above to explain the changes in the ratios

e.g Return on total assets

1. Describe: The ROA and ROE have decreased

2. Explain: - Use % analysis & ratios to explain WHY? as the EBIT has decreased due to cost of sales increasing more than sales increased, reducing the gross profit margin. This is occurring at the same time as the asset base used to earn these returns increased by 10.47%.

This may be due to competitive reasons. Also selling & admin expenses increased at twice the rate that sales did.

The overall result is a drop in EPS. The market responded with a drop in the share price

3. Interpret: this suggests that profitability is decreasing and is a negative sign for the

owners

potential owners

creditors

managers etc.

Liquidity

· Use percentage analysis (horizontal, trend & vertical) of the Balance Sheet and the Income Statement items used in the ratios, e.g. sales, cost of sales

· Use the liquidity ratios, using the percentage analysis above to explain the changes in the ratios

e.g. current and quick ratios

1. Describe: The current and quick ratios have both increased, & on the face of it, show adequate immediate debt coverage.

2. Explain: Although current liabilities increased 19.15% (in line with sales), the debtors and inventory increased 36% & 50% respectively even though sales only increased 20%. Underlying this, there seems to be slow inventory T/O and slowish debt recovery.

3. Interpret: The improvement in these ratios is not as positive as might first appear as they seem to be due to debtors and inventory increasing excessively, relative to sales while cash actually decreased. Other current assets are only 5% of total assets and not significant.

Liquid??

Financial Stability

· Use percentage analysis (horizontal, trend & vertical) of the Balance Sheet and the Income Statement items used in the ratios, e.g. interest expense, sales

· Use the profitability ratios, using the percentage analysis above to explain the changes in the ratios

e.g. debt, equity and capitalisation ratios

1. Describe: these three ratios show a decreasing reliance on debt to finance the assets of the company.

2. Explain: the liabilities have decreased by 9.3% while total equity has increased by 23.6% due to an increase in shares issued and retained earnings.

3. Interpret: this would suggest that the firm is more financially stable and this would be a positive sign for a potential investor or creditor. Given that the times interest earned has remained stable due to decreasing profitability, this is just as well.

Financially Stable?

5. Standards, benchmarks, measuring devices

5.1 Past results

5.2 Assets required to produce profit

5.3 Other businesses

5.4 Other investment alternatives

5.5 Budgets

6. Questions Addressed by Analysis

6.1 How efficient is the business?

6.2 Asset management

6.3 Profit rate comparisons

6.4 Financing issues

6.5 Share market performance

6.6 Solvency questions (both short & long term)

7. Major Assignment on this topic

Refer to the Major Assignment Material link on the course web site.

TOPIC 8 Using financial accounting reports for decision-making (part 2)

Topic 8

Using financial accounting reports for decision-making (part 2)

Topic introduction

As was alluded to in topic 1 of this course, the preparation of accounting information involves complying with various generally accepted accounting principles which have been incorporated formally into accounting standards and into legislation. In topic 1 it was made clear that the accounting profession is bound by these requirements. But the question needs to be put 'How do these requirements impact upon the information that accountants produce, the users of accounting information, and ultimately the decisions that are made using this information?' Put simply, since the information produced by accounting is done according to a set of assumptions and rules, it makes sense that the users of such information need to recognise and adjust for these assumptions and rules.

Conventional accounting principles are fundamental to recording and reporting accounting information. These principles have been progressively introduced up to this point in the course. Now we have the opportunity to consolidate these underlying accounting principles as well as demonstrate their impact on the end product of accounting—which is to provide information for decision-making and accountability.

This consolidation of principles uses a conceptual framework for financial accounting as a vehicle. It is very important not to get lost in the terminology. All that this title refers to is a structure for ordering the principles (or concepts) that satisfy and provide the means to achieve the objectives of financial accounting, i.e. “… an attempt to derive a theory for determining the information to be provided in financial reports” (H,M,E,T & H. 710).

In addition to telling us what information accounting reports can impart, a good understanding of the conceptual framework underlying the reports also allows us to appreciate what these reports are not telling us (that is, it helps us to know the limits of the usefulness of such information). The latter point is just as important as the former, considering the many, and possibly inappropriate, decisions made using accounting information.

If you have a good grasp of the principles introduced to date, there should be little new here. The difference is in the level of thoroughness you must use to articulate some of the concepts; the presentation of the interrelationship of the concepts in a diagrammatical framework (you will find this a useful memory tool) and most importantly, applying the framework to decision-making based on financial accounting information.

Study objectives

At the end of this topic you should:

· know the objectives of financial reporting;

· know the qualitative characteristics desired of financial reports;

· know the concepts that underpin the selection of events to be accounted for and reported upon;

· know the assumptions underlying financial reporting

· know the concepts that form the basis of the measurement of accounting events;

· be able to critically analyse the components of the conceptual framework; and

· be able to articulate the limitations of the information contained within financial reports prepared in accordance with accepted accounting principles and practice.

Graduate Qualities

The Graduate Qualities (generic skills) developed by studying this topic include:

· body of knowledge

· lifelong learning

· effective problem solving

· work autonomously and collaboratively

· Communicates effectively

Required reading

Resource: text reading

Hoggett, J, Medlin, J, Edwards, L, Tilling, M, & Hogg, E. (2012). Extracts from Chapter 17 'Regulation and the conceptual framework' and Chapter 25 'Analysis and interpretation of financial statements'. In Accounting. 8th edition. Brisbane: John Wiley and Sons, 710-730 and 1076-1077(again).

E-Resource: reading

Astachnowicz, S G J (1994) (Revised 2006 by John Medlin). An introduction to the limitations inherent in using conventionally prepared accounting information for decision-making. Revised edition. Adelaide: University of South Australia, pages 1-7.

Possible study activities – Topic 8
	Recommended time

Visit the web site and familiarise yourself with its contents.	0.5 hour
Required reading for topic 8	2.0 hours
Attend lecture	2.0 hours
Attend Tutorial (topic 7 questions)	3.0 hour
Review lecture notes	0.5 hour
Prepare the topic 8 tutorial answers to be covered during tutorials in week 9	2.0 hours
	10.0 hours

Tutorial questions (Can be found on the course website under the relevant week)

At the end of each chapter in the text the questions are in the order:

· Discussion Questions

· Exercises

· Problems

Supplementary questions

Extra materials provided by the text book publisher are available on the course web site under the link for Text Book Student Resources.

WileyPLUS Topic 8 www.wileyplus.com

Lecture Outline Topic 8

OBJECTIVES

1. Decision Making

2. Accountability

(SAC2)

QUALITATIVE

CHARACTERISTICS

(Understandability

( Relevance - materiality

( Reliability - prudence

( Comparability

SELECTION OF EVENTS TO ACCOUNT FOR

ELEMENTS OF FINANCIAL STATEMENTS

( Assets	( Liabilities	( Equity
(Income	( Expenses

RECOGNITION CRITERIA

( Measurability ( Probability

SHAPE \* MERGEFORMAT

Using Financial Accounting Reports for Decision Making - Part 2

1. Introduction

Review the concepts we’ve looked at in the course and see how they interact to produce the information in General Purpose Financial Reports

We will see that by understanding what information contained within accounting reports does say, gives us some clues about what it does not say.

From 1 January 2005 the conceptual framework consists of the Australian SAC1 and SAC2 and the international Framework for the Preparation and Presentation of Financial Statements (FPPFS). Internationally the FPPFS only applies to for-profit entities but in Australia it is applied to all reporting entities.

2 The relevance of the underlying concepts of accounting reports to users

The conceptual framework is designed to enable regulators to:

· develop standards which were consistent and logically formulated

· provide guidance to accountants in areas where no standard exist

· enable users of financial reports to understand better the standards developed.

3. The conceptual framework, diagram 1

3.1 Objectives

· to provide information about the financial position, financial performance and cash flows of an entity that is useful to a wide range of users in making economic decisions. (FPPFS, 12)

· Financial reports also show the results of the stewardship of management, or the accountability of management for the resources entrusted to it. (FPPFS, 14)

3.2 Qualitative Characteristics

· Understandability - An essential quality of the information provided in financial reports is that it is readily understandable by users. (FPPFS, 25)

· Relevance - Information has the quality of relevance when it influences the economic decisions of users by helping them evaluate past, present or future events or confirming, or correcting, their past evaluations. (FPPFS, 26) Materiality - Information is material if its omission or misstatement could influence the economic decisions of users taken on the basis of the financial report. (FPPFS, 30)

· Reliability - Information has the quality of reliability when it is free from material error and bias and can be depended upon by users to represent faithfully that which it either purports to represent or could reasonably be expected to represent. (FPPFS, 31) Prudence – try not to overstate assets and profits or to understate liabilities and expenses.

· Comparability – ability to compare the financial reports of one firm over time or compare different firms at a point in time.

3.3 Selection of Events

Criteria for selection:

· the event would affect an element of the financial statements

· meets standard recognition criteria

· must be measurable

· high probability that one of the financial statement elements will actually be affected

3.4 Assumptions Underlying Financial Reporting

· Accounting entity – the boundaries of the entity being accounted for must be clearly identified. Activities of the entity are separated from both the personal activities of it owners or members and those of other entities.

· Accrual basis - Incomes are recognised when earned and wherever possible, expenses are recognised in the period in which they are incurred or consumed.

· Going concern - In the absence of evidence to the contrary, the entity is assumed to have an indefinite life.

· Period assumption – the life of an entity can be subdivided into arbitrary time periods of equal length for the purpose of determining financial performance and position periodically.

· Monetary – accounting financial statements only include economic activity that can be recorded in terms of money. Other information is not recorded in the financial statements but can be reported in the notes that accompany them.

3.5 Measurement Concepts

· Historical cost – assets are recorded at the amount of cash or equivalents used to acquire them while liabilities are recorded at the amount of cash or equivalents that will need to paid out to satisfy them.

· Current cost – the amount of cash or cash equivalents that would be paid if the same or equivalent asset was acquired currently.

· Realisable or settlement value – the amount of cash or cash equivalents that could be obtained currently by selling the asset in an orderly disposal, or in the normal course of business. e.g. inventory in topic 6.

· Present value – discounted future cash inflows, covered in topic 12.

3.6 Lower of Cost and Net Realisable Value Rule

Fone From Afar sells mobile phones and their COS for the year was $80,000 while the historic cost of stock on hand at the end of the period was $6 000. Assume that the estimated selling price of the stock on hand less cost of sales is $9 000, i.e. Net Realisable Value (NRV) = $9 000.

Reported Expense: Reported Asset:

COS $80 000 Stock on hand $6 000

Assume instead that the estimated NRV of the stock on hand was $5 000

Reported Expense: Reported Asset:

COS $80 000 Stock on hand $5 000

Holding loss 1 000

Total $81 000

The use of this rule is an application of:

· Prudence/Conservatism (lower asset and higher expense)

· Recognising expenses in the period in which there is a decrease in net assets (capital)

Net realisable value is the estimated selling price in the ordinary course of business less the estimated costs of completion and the estimated costs necessary to make the sale. (AASB 102,6)

4. Capital Maintenance

Profit emerges after maintaining capital intact.

“Financial capital maintenance Under this concept, a profit is earned only if the financial (or money) amount of the net assets at the end of the period exceeds the financial (or money) amount of net assets at the beginning of the period, after excluding any distributions to, and contributions from, owners during the period. Financial capital maintenance can be measured in either nominal monetary units or units of constant purchasing power.” FPPFS, 104 (a)

Physical capital maintenance is also allowed under the FPPFS but is beyond the scope of this course.

That profit emerges after maintaining capital intact may seem like a fairly obvious statement to make, but its practical implications are quite important:

SYMBOL 183 \f "Symbol" \s 10 \h It provides a common definition for profit which is applicable to all entities.

SYMBOL 183 \f "Symbol" \s 10 \h It defines an issue which has importance for business dealings. E.g. Corporations law states that dividends can only be paid from profits.

5. What is it that is or is not included in the framework outlined above that runs counter to its objectives as listed under 3.1?

The information that is contained within accounting reports is very valuable for decision-making, but only if you are educated in both what it does and doesn't say.

The limitations of the conceptual framework will be tackled in reverse order to demonstrate how the lower level assumptions of the framework work to limit the achievement of the objectives of financial reports.

5.1 Capital Maintenance

Capital Maintenance – profit is measured as the increase in net assets (equity) during a period. This will change depending on how we measure equity.

Example 1

Firm A commenced trading at the start of the year with $1m capital. During the year, using historical cost accounting, it made a profit of $80,000. It then distributed the entire profit to its shareholders as a dividend. During the year, the inflation rate was 10% pa. Has the concept of capital maintenance been upheld and what amount of profit was made?

5.2 Measurement Concepts

There are four measurement concepts allowed and although the FPPFS states that historic cost is usually used it also suggests that:

“The measurement basis most commonly adopted by entities in preparing their financial report is historical cost. This is usually combined with other measurement bases. For example, inventories are usually carried at the lower of cost and net realisable value, marketable securities may be carried at market value and pension liabilities are carried at their present value.” (FPPFS, 101)

Example 2

MICROSOFT CORPORATION

BALANCE SHEETS

(In millions)
June 30,	2009	2008
Assets
Current assets:
Cash and cash equivalents	$ 6,076	$10,339
Short-term investments (including securities pledged as collateral of $1,540 and $2,491)	25,371	13,323
Total cash, cash equivalents, and short-term investments	31,447	23,662
Accounts receivable, net of allowance for doubtful accounts of $451 and $153	11,192	13,589
Inventories	717	985
Deferred income taxes	2,213	2,017
Other	3,711	2,989
Total current assets	49,280	43,242
Property and equipment, net of accumulated depreciation of $7,547 and $6,302	7,535	6,242
Equity and other investments	4,933	6,588
Goodwill	12,503	12,108
Intangible assets, net	1,759	1,973
Deferred income taxes	279	949
Other long-term assets	1,599	1,691
Total assets	$ 77,888	$72,793
Liabilities and stockholders’ equity
Current liabilities:
Accounts payable	$3,324	$ 4,034
Short-term debt	2,000	–
Accrued compensation	3,156	2,934
Income taxes	725	3,248
Short-term unearned revenue	13,003	13,397
Securities lending payable	1,684	2,614
Other	3,142	3,659
Total current liabilities	27,034	29,886
Long-term debt	3,746	–
Long-term unearned revenue	1,281	1,900
Other long-term liabilities	6,269	4,721
Commitments and contingencies
Stockholders’ equity:
Common stock and paid-in capital – shares authorized 24,000; outstanding 8,908 and 9,151	62,382	62,849
Retained deficit, including accumulated other comprehensive income of $969 and $1,140	(22,824)	(26,563)
Total stockholders’ equity	39,558	36,286
Total liabilities and stockholders’ equity	$ 77,888	$ 72,793

Extract from notes to accounts:

Goodwill

Goodwill is tested for impairment on an annual basis and between annual tests if indicators of potential impairment exist, using a fair-value-based approach. During the second quarter of fiscal year 2009, we changed the date of our annual impairment test from July 1 to May 1. The change was made to more closely align the impairment testing date with our long-range planning and forecasting process. We believe the change in our annual impairment testing date did not delay, accelerate, or avoid an impairment charge. We have determined that this change in accounting principle is preferable under the circumstances and does not result in adjustments to our financial statements when applied retrospectively.

2009 2008 2007

NET INCOME $14,569m. $ 17,681m. $14,065m.

[Source: http://www.microsoft.com/msft/reports/ar09/10k_fr_not.html]

Microsoft’s market value is US$269 billion

[Source: http://finapps.forbes.com/finapps/jsp/finance/compinfo/CIAtAGlance.jsp?tkr=MSFT]

5.3 Assumptions Underlying Financial Reporting

Accounting entity – there are some complex inter-company ownership arrangements

Accrual Accounting – it is not always easy to allocate incomes and expenses to a particular period, e.g. how do we allocate the incomes and expenses related to a major building that takes a number of accounting periods to complete

Going Concern and Monetary unit - the problem that the use of each of these assumptions has for decision makers using accounting reports is to the extent that they reflect the use of historic cost in measurement.

5.4 Selection of Events to For Which to Account

Elements of financial statements – generally accepted internationally.

Recognition criteria – Events need to be measurable in monetary terms. Qualitative information can be included.

Example 3

Sales have increased 150% during this past year due to the appointment of an excellent sales manager. The appointment of the manager, and the changes that this person made to the sales methods of the firm are not financially quantifiable in themselves. Thus a user of the reports who may be contemplating investing in the firm, is unable to gauge through the accounting information how much of the improvement is due to the presence of the new manager, and how much is due to the new systems that the new manager may have put into place (which would still exist and produce sales even if the manager resigned). The very fact that the increase in sales is due to the appointment of the new manager is itself not something that would appear in the accounting information (though it may be found elsewhere – e.g. in a chairman's report in the case of a public company's financial statements).

5.5 Qualitative Characteristics

Understandability - users are assumed to have a reasonable knowledge of business and economic activities and accounting and a willingness to study the information with reasonable diligence (FPPFS, 25). Complex information should still be included and if users can’t understand it they should seek professional help.

Relevance vs. Reliability – the use of historic cost accounting may result in reliability taking precedence over relevance.

Materiality – subjective in application, e.g. one accountant may treat a certain item of expenditure as an expense where as another may treat it as an asset.

Prudence - sometimes this may not be appropriate or could make accounts from different companies not comparable

Example 4

In the area of inventories, AASB 102 and IAS 2 Inventories, states that in financial statements, inventory should be reported at the lower of its historic cost and net realisable value (net realisable value refers to the current market selling price of the item, less any costs of disposal - eg advertising and delivery). This rule is a direct application of the prudence principle.

If the inventory on hand for a firm at the end of a period has a historic cost of $1,000, but a net realisable value of $800, the effect of applying the standard would be to report the inventory at the lower value. Thus the $200 gap needs to added to the inventory expense and deducted from the asset value. In such a case both the inventory asset and expense values have been adjusted to reflect current market conditions.

If, on the other hand, the net realisable value of the inventory was $1,300, it would be required that it continue to be reported at the $1,000 value. Thus, the first part of the example shows that holding losses are recognised when they occur, but holding gains are not.

Comparability – difficult because of the subjectivity involved in many of the concepts.

Example 5

A user is trying to establish the relative profitability of two firms. One firm depreciates its non-current assets using a different method to that of the other resulting in different depreciation expense being reported. In reality, about the same amount of service potential has expired for both. What does this mean for analysis interpretation and subsequent decision-making?

5.6 Objectives

Although the current conceptual framework does have faults, the lack of any kind of framework at all for general purpose accounting reports would be worse.

6. Limitations of the current framework in meeting its objective of providing information for decision making:

6.1 Subjectivity in the application of measurement concepts.

6.2 Influence of the use of historic cost upon the application of measurement assumptions.

6.3 The relevance v. reliability trade-off.

6.4 Accounting’s difficulty with reporting qualitative information. (monetary assumption)

7. Other limitations of using analysed financial data for decision-making (Hoggett, Medlin, Edwards, Tilling & Hogg pp. 1076-1077):

7.1 Caution in using historic data for future predictions.

7.2 Year end data of the reports may not be representative of the period.

7.3 Influence of one-off or non-recurring items in an income statement.

TOPIC 9 Statement of Cash Flows

Topic 9

Statement of Cash Flows

Topic introduction

To this stage of the course, it has been assumed that the only external reports available for decision-making are the Balance Sheet, Statement of Changes in Equity and Income Statement. However it has been established that these statements do not provide sufficient information about the financial condition and activities of a business enterprise.

In the early part of this course the case was made that cash accounting was not an appropriate basis for measuring periodic performance (profit). Rather, it was felt that accrual accounting more appropriately reflected periodic performance, since it allows for a more accurate matching of incomes and expenses. That's fine for the measurement of periodic performance, however as we saw in topic 7, there are many facets involved in judging an entity's financial health apart from profit, such as liquidity and solvency.

The difficulty with assessing liquidity from conventional financial statements is that the information contained within the Balance Sheet is merely a 'snapshot' of the financial position at a given point in time, which may or may not be indicative of the situation over a period of time. For example, in topic 7 we saw that the financial statement analyst often needs to choose between the current ratio and the quick ratio as the most appropriate measure of overall liquidity for the entity. Normally the only criterion is the type of goods or services (for example, an antique dealer's inventory is expected to move slowly relative to the inventory of a fresh produce merchant). However, basing decisions on such assumptions is fraught with the dangers of over-simplification (for example, the specific antique dealer may only deal in high demand goods, whereas the fresh produce merchant may be relatively inefficient and suffer from a high proportion of spoilage). An analyst's appreciation of an entity's liquidity would be vastly enhanced if, in addition to the Balance Sheet, he or she had information regarding the past flows of cash into and out of the entity over a period of time. This type of information is provided by the Statement of Cash Flows. (The term 'past liquidity' is used here. Like the Income Statement and Balance Sheet, the Statement of Cash Flows is a historical document and thus cannot directly tell the user much about the current situation. Hoggett, Medlin, Edwards, Tilling & Hogg (2012) explain this issue further.)

Past liquidity performance is not the only information supplied by the Statement of Cash Flows (Hoggett, Medlin, Edwards, Tilling & Hogg (2012), page 978). However the investing public's inability to gauge the danger signs of low liquidity and poor solvency in companies reporting large accrual accounting profits during the economically booming 1980s was the main catalyst for introducing the cash flow reporting requirement.

This topic requires selective reading of the prescribed text as you only need a basic working knowledge of the preparation of Statement of Cash Flows and its purpose and limitations. Sections in the chapter are fairly complex and there is a heavy emphasis on the specific requirements of the relevant accounting standard. The accounting standard determines how the statement is prepared and you must follow the requirements, but it is not the intention of this topic's study that you develop a detailed knowledge of the standard.

In Australia AASB 107 “Statement of Cash Flows” outlines the reporting of a Statement of Cash Flows. Compliance with AASB 107 will ensure conformity with International Accounting Standard IAS 7 “Statement of Cash Flows”.

Study objectives

At the end of this topic you should:

· know the purpose of and information revealed by Statement of Cash Flows;

· be able to evaluate the cash position of a business;

· be able to demonstrate your understanding of the difference between cash and accrual accounting by preparing part of a Statement of Cash Flows using the direct method; and

· be able to identify and describe the limitations of a Statement of Cash Flows.

Graduate Qualities

The Graduate Qualities (generic skills) developed by studying this topic include:

· body of knowledge

· lifelong learning

· effective problem solving

· work autonomously and collaboratively

Required reading

Resource: text reading

Hoggett, J, Medlin, J, Edwards, L, Tilling, M, & Hogg, E. (2012). Chapter 24 'Statement of Cash Flows'. In Accounting. 8th edition. Brisbane: John Wiley and Sons, pp. 976 – 994, half way down 996 – 998, near bottom 1001 – 1005, and 1009 - 1018.

Additional reading:

Birt, J, Chalmers, K, Beal, D, Brooks, A, Byrne, S and Oliver, J (2005) Chapter 8 `Statement of cash flows’ in Accounting: business reporting for decision making. Brisbane: John Wiley and Sons.

Juchau, R, Flanagan, J, Mitchell, G, Tibbits, G, Ingram R, Albright, T, Baldwin, B and Hill, J (2007) Chapter 5 `Reporting cash flows’ in Accounting information for decisions. South Melbourne: Thomson.

Notes on the reading

There is a difference in position of this topic's chapter in the textbook compared to the order of this course's topics. This means that there are a number of items that you are not expected to address either in your study or your assessment, which are included in the chapter. An introductory course such as this does not cover revaluation, and although you have previously covered the allowance for doubtful debts, you are not expected to be able to apply it to Statement of Cash Flows preparation. In topic 5 you were introduced to the simple form of company shareholders' equity involving paid-up capital and retained earnings accounts. This topic is relevant to this course.

Concentrate your reading on the first part of the chapter up to and including page 994. This part is mainly concerned with how a Statement of Cash Flows is prepared. The text has a good step-by-step approach which can be followed confidently, but ignore the constant reference to the accounting standard requirements.

The section ‘Comprehensive example' commencing on page 1009 can be followed until the end of step 5. Finally, 'Analysing the Statement of Cash Flows' (page 1017) and 'Limitations of the Statement of Cash Flows' (pages 1018) are the only other sections of the chapter that are relevant.

Possible study activities – Topic 9
	Recommended time

Visit the web site and familiarise yourself with its contents.	0.5 hour
Required reading for topic 9	2.0 hours
Attend lecture	2.0 hours
Attend Tutorial (topic 8 questions)	3.0 hour
Review lecture notes	0.5 hour
Prepare the topic 9 tutorial answers to be covered during tutorials in week 10	2.0 hours
	10.0 hours

Tutorial questions (Can be found on the course website under the relevant week)

At the end of each chapter in the text the questions are in the order:

· Discussion Questions

· Exercises

· Problems

Supplementary questions

Extra materials provided by the text book publisher are available on the course web site under the link for Text Book Student Resources.

WileyPLUS Topic 9 www.wileyplus.com

Possible study activities – Week 10
	Recommended time

Visit the web site and familiarise yourself with its contents.	0.5 hour
Review reading for topic 9	2.0 hours
Attend lecture	2.0 hours
Attend Tutorial (topic 9 questions)	3.0 hour
Review lecture notes	0.5 hour
Prepare the topic 10 tutorial answers to be covered during tutorials in week 11	2.0 hours
	10.0 hours

Tutorial questions (Can be found on the course website under the relevant week)

At the end of each chapter in the text the questions are in the order:

· Discussion Questions

· Exercises

· Problems

Supplementary questions

Extra materials provided by the text book publisher are available on the course web site under the link for Text Book Student Resources.

WileyPLUS Topic 9 www.wileyplus.com

Week 10 Additional Question:

Statement of Cash Flows

You are provided the following financial information for Billy Bones Gym:

BILLY BONES GYM LTD

COMPARATIVE BALANCE SHEETS

AS AT JUNE 30

2012 2011

	$'000's		$,000's
Current Assets
Cash on Hand	3		7
Cash at Bank			18
Accounts Receivable (net)	15		27
Inventory	23		18
Prepaid Rent Expense	9	50	3	73
Non-Current Assets
Gym Equipment	318		310
less Acc. Depreciation	70	248	150	160
Investments		42	-	. .
Total Assets		340		233

Current Liabilities
Bank Overdraft	20
Accounts Payable	18		32
Accrued Wages Expense	3		1
Tax Payable	9	50	20	53
Non-Current Liabilities
Loan		160		50
Total Liabilities		210		103
Net Assets		130		130

Equity
Share Capital	85		80
Retained Earnings	45	130	50	130

(continued)

BILLY BONES GYM LTD

INCOME STATEMENT

FOR THE YEAR ENDED JUNE 30, 2012

	$'000's

Net Sales	736
Cost of Sales	366
Gross Profit:		370
Other Revenue:
Gain on Sale of Assets	1
Interest Revenue	2
Discount Received	4	7
		377
Expenses:
Selling & Admin Expense	289
Doubtful Debts Expense	7
Depreciation Expense	20
Interest Expense	11	327
Profit before tax		50
Income tax expense		15
Profit		35

Additional Information:

Gymnasium Equipment with a historic cost of $110, 000 was sold for cash making the company a profit of $1000.

REQUIRED:

Answer part a. of this question on the pro forma provided on the next page.

a. Using the pro forma provided prepare a cash flow statement in the format required by applicable accounting standard. Show all calculations.

b. Comment on the fact that cash flow for the period was negative despite making a profit. Highlight any items that may have contributed to this result

You must show your calculations for part a. of this question.

Part a.

Billy Bones Gym Ltd

Statement of Cash Flows

for the year ended 30 June 2012

Cash Flows from Operating Activities $’000 $’000

Receipts from customers

Payments to suppliers & employees ______

Cash generated from operations

Dividends received

Interest received

Interest paid

Income tax paid ______ ______

Cash Flows from Investing Activities

Purchase of Equipment

Purchase of Investments

Proceeds of Sale of Assets ______ ______

Cash Flows from Financing Activities

Proceeds from Loan

Proceeds of Share Issue

Dividends Paid ______ ______

Net increase / decrease in cash held

Cash at the beginning of the year ______

Cash at the end of the year ______

Show your calculations & part b on separate paper and attach them to this pro forma.

Extra Practice Question

Problem 24.5 on page 990 – 992 of Hoggett, Edwards and Medlin (2003) amended to current accounting standards.

Gold Ltd is seeking additional finance from its bank and the bank manger has asked for a statement of cash flows which shows the flow of cash into and out of the business. Use the data presented.

*GOLD LTD* *Balance Sheet* *as at 30 June*
	*2004*	*2005*
*Cash at bank*		*$ 17 500*		*$ 33 250*
*Debtors*		*77 000*		*120 000*
*Inventory*		*80 000*		*150 000*
*Furniture and fittings*	*$ 110 000*		*$ 75 000*
*Less: Accumulated depreciation -*
*furniture and fittings*	*30 000*	*80 000*	*20 000*	*55 000*
*Buildings*	*330 000*		*430 000*
*Less: Accumulated depreciation -*
*buildings*	*80 000*	*250 000*	*110 000*	*320 000*
		*$504 500*		*$68 250*

*Creditors*		*$ 60 000*		*$ 116 250*
*Current tax liability*		*7 500*		*13 500*
*Loan due 2007*		-		*80 000*
*Share capital*		*400 000*		*420 000*
*Retained earnings*		*37 000*		*48 500*
		*$504 500*		*$678 250*

(continued)

*GOLD LTD* *Income Statement* *for the year ended 30 June 2005*
*INCOME*
*Sales revenue*	*$485 000*
*Rent revenue*	*14 000*
*Discount received*	*1 000*	*$500 000*
*EXPENSES*
*Cost of sales*	*365 000*
General *	*45 000*
*Loss on sale of furniture and fittings*	*5 000*
*Depreciation - buildings*	*30 000*
*- furniture*	*10 000*	*455 000*
*PROFIT BEFORE TAX*		*45 000*
*Income tax expense*		*13 500*
*PROFIT*		*$ 31 500*

* Includes bad debts written off $4500, and discount allowed $1500.

Additional information

(a) New buildings were purchased for cash. No buildings were sold.

(b) During the year, the dividend paid was $20 000.

(d) Some furniture and fittings, which had cost $35 000 and had been depreciated by $20,000, were sold for cash for $10 000.

(e) The company has permission from the ATO to pay income tax in one instalment.

Required:

Prepare the statement of cash flows complying with AASB 107.

Solution:

Problem 24.5		Statement of cash flows – company

GOLD LTD

Required:

Prepare the statement of cash flows complying with AASB 107.

GOLD LTD Statement of Cash Flows for the year ended 30 June 2005
		Inflows (Outflows)
Cash flows from operating activities:
Receipts from customers	$436 000
Payments to suppliers and employees	(416 750)
Cash generated from operations	19 250
Rent received	14 000
Income tax paid	(7 500)
Net cash provided by operating activities		$25 750

Cash flows from investing activities:
Payment for buildings	(100 000)
Proceeds from sale of furniture & fittings	10 000
Net cash used in investing activities		(90 000)

Cash flows from financing activities:
Proceeds from issue of shares	20 000
Proceeds from borrowings	80 000
Dividends paid	(20 000)
Net cash provided by financing activities		$80 000
Net increase (decrease) in cash held		15 750
Cash at beginning of year		17 500
Cash at end of year		$33 250

Workings

Accounts Receivable
1/7/04	Balance	$77 000		Cash Receipts	436 000
				Discount Allowed	1 500
				Bad Debts	4 500
30/6/05	Sales	485 000-	30/6/05	Balance	120 000
		$562 000			$562 000

Inventory
1/7/04	Balance	$80 000
				Cost of Sales	365 000
	Purchases	435 000
			30/6/05	Balance	150 000
		$515 000			$515 000

Accounts Payable
	Cash paid supplier	377 750	1/7/04	Balance	60 000
	Discount received	1 000
				Purchases	435 000
30/6/05	Balance	116 250-
		$495 000			$495 000

45 000 Expenses – 4 500 bad debts – 1 500 discount allowed = 39 000

377 750 + 39 000 = 416 750

Furniture & Fittings
1/7/04	Balance	$110 000	30/6/05	Carrying amount Furn & Fittings Sold	35 000
30/6/05	Purchases	-	30/6/05	Balance	75 000
		$110 000			$110 000

Accumulated Depreciation – Furniture & Fittings
30/6/05	Carrying Amount Furn. & Fittings Sold	20 000	1/7/04	Balance	30 000
30/6/05	Balance	20 000	30/6/05	Deprc. expense	10 000
		$40 000			$40 000

Retained Profits
30/6/05	Dividend Paid	20 000	1/7/04	Balance	37 000
30/6/05	Balance	48 500	30/6/05	Profit after Tax	31 500
		$68 500			$68 500

Current Tax Liability
30/6/05	Cash	7 500	1/7/04	Balance	7 500
30/6/05	Balance	13 500	30/6/05	Income Tax Expense	13 500
		$21 000			$21 000

Lecture Outline Topic 9

Statement of Cash Flows

___________________________________________________________________

1. Introduction.

The difficulty with judging liquidity from conventional financial statements is that the judgement can only be based upon the information contained within the Balance Sheet, which is merely a "snapshot" of financial position at a given point in time, and may or may not be indicative of the situation over a period of time.

2. Simple demonstration to introduce the nature, purpose and structure of a Statement of Cash Flows.

3. The elements of a Statement of Cash Flows

Compliance with the Australian standard AASB 107 will ensure conformity with IAS 7.

3.1 Definition of cash as used in a Statement of Cash Flows prepared under AASB 107

“Cash comprises cash on hand and demand deposits.”

“Cash equivalents are short term, highly liquid investments that are readily convertible to known amounts of cash and which are subject to an insignificant risk of changes in value.”

In AFB the cash position will be made up of:

+ 2.

-- 3.

3.2 The format as defined by AASB 107

3.2.1 Operating Activities

are the principal revenue-producing activities of the entity and other activities that are not investing or financing activities.

3.2.2 Investing Activities

are the acquisition and disposal of long-term assets and other investments not included in cash equivalents.

3.2.3 Financing Activities

are activities that result in changes in the size and composition of the contributed capital and borrowings of the entity.

NOT expected to do/know for this course:

· revaluations of assets

· alternative method for recording company capital. reserves

· tracing the cash flow effect of changes in the allowance for doubtful debts (though you will be required to deal with bad debts)

· reconciliation of cash flows from operating activities

· notes to the statement (H,M,E,T & H p.1015)

3.3 Specific inclusions required

3.3.1 Separate disclosure of items (AASB 107).

Cash flows from interest and dividends received and paid shall each be disclosed separately. Each shall be classified in a consistent manner from period to period as either operating, investing or financing activities. AASB 107, 31

3.3.2 Cash flows arising from taxes on income shall be separately disclosed and shall be classified as cash flows from operating activities unless they can be specifically identified with financing and investing activities. AASB 107, 35

4. Steps involved in the preparation of a Statement of Cash Flows

· Determine changes in Balance Sheet items

· Calculate cash flows from operating activities

· Determine cash flows from investing and financing activities

· Reconstruct any accounts if some information is not provided

· Prepare a Statement of Cash Flows

Table 1 - Sources of information for SCF preparation

Sources of information for Statement of Cash Flows preparation

The information required for the three main headings of the Statement of Cash Flows can be obtained from the following sources:

Cash flows from operating activities

Income Statement - Operating items excluding items relating to non-current asset disposals.

Balance Sheet - Changes in current assets and current liabilities.

Cash flows from investing activities

Income Statement - Items related to non-current asset disposals.

Balance Sheet - Changes in non-current assets.

Cash flows from financing activities

Balance Sheet - Changes in non-current liabilities and equity.

5. Lecture Illustration 1 - sole trader – Hoggett and Edwards (2000) 4th Ed. Problem 19.1 adapted

Balance Sheet for the years ended 30 June 2009 and 30 June 2010 for R. Rogers follow:

R. ROGERS
Comparative Balance Sheets
	30 June 2009	30 June 2010
Cash at bank	$ 6 000	$ 13 000
Accounts receivable	10 000	15 000
Inventory	30 000	29 000
Plant	300 000	350 000
Accumulated depreciation – equipment	(100 000)	(120 000)
Furniture	20 000	10 000
Accumulated depreciation – furniture	(6 000)	(4 000)
	$ 260 000	$ 293 000
Accounts payable	$ 50 000	$ 70 000
R. Rogers, Capital	210 000	223 000
	$ 260 000	$ 293 000

The Income Statement for the year ended 30 June 2010 is shown below:

R ROGERS
Income Statement
for the year ended 30 June 2010
Sales revenue Less: Cost of goods sold		$ 146 000 60 000
GROSS PROFIT		86 000
Gain on sale of furniture		2 000
		88 000
Expenses:
Selling and general expenses	$ 30 000
Depreciation of equipment	20 000
Depreciation of furniture	4 000	54 000
PROFIT		$ 34 000

Additional information

Rogers withdrew $21 000 for private use during the year ended 30 June 2010. Furniture which had cost $10 000 and had been written down to $4 000 was sold for $6 000 cash. No furniture was purchased during the year.

R. ROGERS

Statement of Cash Flows

for the year ended 30 June 2010

Cash Flows from Operating Activities $ . $ .

Receipts from customers

Payments to suppliers & employees ________

Cash generated from operations

Dividends received

Interest received

Interest paid

Income tax paid ________ ________

Cash Flows from Investing Activities

.........................................................

......................................................... ________ ________

Cash Flows from Financing Activities

.........................................................

Dividends (Drawings) Paid ________ ________

Increase/Decrease in cash held

Cash at beginning of year ________

Cash at end of year $________

Calculations

Cash Received from customers:

Method: Assume all sales are on credit and reconstruct the Accounts Receivable account to establish cash received. Adjust this figure (if necessary) with any change to Prepaid Revenue (Revenue Received in Advance).

ACCOUNTS RECEIVABLE ACCOUNT

Date	Details	$	Date	Details	$
30/6/09	Balance b/d	10,000	In year	Cash	?
In year	Sales	146,000		Disc. All'd	-
				Bad Debts	-
		.	30/6/10	Balance c/d	15,000
		156,000			156,000
30/6/10	Balance b/d	15,000

+ Inc. in P.P Rev. - Inc. in A/c Rec

Sales/services fees or - disc. all'd - bad debts or

- Dec. in P.P.Rev. + Dec. in A/c Rec

period's revenue from customers

period's gross potential receipts from customers

period's net potential receipts from customers

receipts from customers this period

Payments to suppliers & employees:

a. Cash paid to suppliers:

INVENTORY

Date	Details	$	Date	Details	$
30/6/09	Balance b/d	30,000	In year	Cost of Sales	60,000
In year	Purchases	.	30/6/10	Balance c/d	29,000
		89,000			89,000
30/6/10	Balance b/d	29,000

ACCOUNTS PAYABLE ACCOUNT

Date	Details	$	Date	Details	$
In year	Cash	?	30/6/09	Balance	50,000
	Purch. Ret's	-		Purchases	59,000
	Disc. Rec'd	-
30/6/10	Balance c/d	70,000			. .
		109,000			109,000
			30/6/10	Balance b/d	70,000

b. Cash paid for employee & other expenses:

Method: If total expense commitments made in the current period is known (ie there are no prepaid expenses at the start or end of the period), simply assume that all expenses are initially owed (ie no instantaneous cash expenses occurred) and reconstruct the accrued expenses account. If total expense commitments for the period are not known, you will need to establish this in a similar way to the periodic COS calculation (ie assume prepaid expenses as an "inventory" of future expenses).

Such a calculation is unnecessary in this example since neither a prepaid expense nor accrued expense account exists. The answer for cash flow must therefore be identical to the accrual expense figure.

a. Cash paid to suppliers:

+ Inc. in Inv. - Inc. in A/c Pay

COS or - disc. rec'd. or

- Dec. in Inv. + Dec. in A/c Pay

period's inventory expense

period's net inventory transactions (ie purchases)

period's net potential payments for purchases

payment made this period for purchases

b. Cash paid for employee & other expenses:

Selling & general Expenses =

Total (a. + b.)

Investing Activities:

By Reconstruction

PLANT ACCOUNT

Date	Details	$	Date	Details	$
30/6/09	Balance b/d	300,000	In year	(disposals)	-
In year	(acquisitions)	.	30/6/10	Balance c/d	350,000
		350,000			350,000
30/6/10	Balance b/d	350,000

Financing Activities:

In this case, you are told what the drawings were. But what if you were not told? - work it out yourself, of course!

By reconstruction

R. Rogers CAPITAL ACCOUNT

Date	Details	$	Date	Details	$
In year	(Drawings)		30/6/09	Balance	210,000
			In year	(further investment)	-
30/6/10	Balance c/d	223,000	30/6/10	Profit	34,000
		244,000			244,000
			30/6/10	Balance b/d	223,000

6. Preparation of a Statement of Cash Flows - Operating Activities

Cash flows resulting from day to day operations (ie cash flows relating to operating profit items)

6.1 Receipts from customers (i.e. how much income from customers has actually been received this period?).

6.2 Payments to suppliers and employees

Most easily calculated by breaking up into two parts:

6.2.1 Payments to suppliers of goods (i.e. how much cash was paid to suppliers for purchases this period?)

6.2.2 Payments for other goods or services consumed as general expenses (ie how much was paid for expenses other than COS this period?)

7. Preparation of a Statement of Cash Flows - Investing Activities

Changes in non-current assets resulting in a cash flow this period:

7.1 Inflows from asset disposals (note accrual gains and losses irrelevant see Appendix 2)

7.2 Outflows from asset acquisitions

7.3 Inflows from interest and dividends

8. Preparation of a Statement of Cash Flows - Financing Activities

Changes in non-current liabilities and equity resulting in a cash flow:

8.1 Inflows from further borrowings

8.2 Outflows from repayments of borrowings

8.3 Inflows from capital contributions by owners.

8.4 Outflows from distributions to owners (i.e. drawings or dividends).

NOTE:

To demonstrate their understanding of the difference between accrual accounting and cash accounting, and so that students gain a deeper understanding of why there is a difference, in this course students will be required to be able to calculate and explain the calculations of:

· Cash position

· Cash receipts from customers

· Cash payments to suppliers employees and others

· An example of a cash flow from investing activities where there is a purchase and sale of an asset

· Dividends: by reconstructing Retained Earnings

9. Lecture Illustration 2 - company - Bits Ltd

You are provided the following financial information for Bits Ltd:

BITS LTD

COMPARATIVE BALANCE SHEETS

AS AT JUNE 30

2010 2009

Current Assets:
Cash on Hand		$ 7,500		$ 3,000
Cash at Bank		30,000		180,900
Debtors		190,800		166,950
Inventory		412,500		331,800
Prepaid Expenses		34,200		34,500
		675,000		717,150
Non-Current Assets
Buildings	$958,500		$508,500
less Accum. Dep'n.	167,100	791,400	146,400	362,100
Equipment	541,800		496,800
less Accum. Dep'n.	134,850	406,950	100,500	396,300
Land		252,000		58,500
Long-term investments		120,000		240,000
Total Assets		2,245,350		1,774,050
Current Liabilities
Creditors		322,500		327,000
Accrued Expenses		15,750		21,000
Income Tax Payable		116,550		108,000
		454,800		456,000
Non-current Liabilities
Loan Due 30/6/12		300,000		225,000
Debentures due 1/12/13		450,000		300,000
Total Liabilities		1,204,800		981,000
Net Assets		1,040,550		793,050
Equity
Share Capital		753,150		582,150
Retained earnings		287,400		210,900
Total Equity		1,040,550		793,050

BITS LTD

INCOME STATEMENT

FOR THE YEAR ENDED JUNE 30, 2010

Net Sales Income		$1,313,400
less Cost of Goods Sold		787,950
Gross Profit		525,450
add other income:
Gain from sale of investments		52,500
		577,950
less expenses:
Operating Expenses	224,100
Bad Debts	5,250
Dep'n - Buildings	20,700
Dep'n - Equipment	34,350	284,400
Profit before tax		293,550
Income tax expense		113,550
Profit		$180,000

Additional Information for the year:

SYMBOL 183 \f "Symbol" \s 10 \h All asset purchases were made in cash unless otherwise specified.

SYMBOL 183 \f "Symbol" \s 10 \h Long term investments which had an original cost of $135,000 were sold during the year for $187,500 cash.

SYMBOL 183 \f "Symbol" \s 10 \h Some additional land was purchased for $193,500. A secured loan extension of $75,000 was made and the remainder was paid in cash.

BITS LTD

Statement of Cash Flows

for the year ended 30 June 2010

Cash flows from operating activities $ $

Cash receipts from customers

Cash paid to suppliers & employees _______

Cash generated from operations

Interest paid

Income taxes paid (105 000)

Net cash used in operating activities 77 100

Cash flows from investing activities

Payment for building additions (450 000)

Payment for equipment (45 000)

Payment for land (118 500)

.........................................................

......................................................... ______

Net cash used in investing activities (441 000)

Cash flows from financing activities

Proceeds from borrowing – debentures 150 000

Proceeds from share issues 171 000

Dividends paid ______

Net cash used in financing activities 217 500

Net decrease in cash and cash equivalents

Cash and cash equivalents at beginning of period ______

Cash and cash equivalents at end of period $. .

Account reconstruction method of calculation:

Cash receipts from customers:

Debtors
30/6/09	Balance b/d	166,950	In year	Cash	?
In year	Sales	1,313,400		Disc. All'd	-
				Sales Returns	-
				Bad Debts	5,250
			30/6/10	Balance c/d	190,800
		1,480,350			1,480,350
30/6/10	Balance b/d	190,800

Cash receipts from customers:

+ Open. A/c Rec

Sales/services fees - disc. all'd - bad debts – sales returns

- Closing A/c Rec

period's gross potential receipts from customers

period's net potential receipts from customers

receipts from customers this period

Cash paid to suppliers & employees:

a. Cash paid to suppliers:

Inventory
30/6/09	Balance b/d	331,800	In year	Cost of Sales	787,950
In year	Purchases		30/6/10	Balance c/d	412,500
		1,200,450			1,200,450
30/6/10	Balance b/d	412,500

Creditors
In year	Cash	?	30/6/09	Balance	327,000
	Purch. Ret's	-		Purchases	868,650
	Disc. Rec'd	-
30/6/10	Balance c/d	322,500
		1,195,650			1,195,650
			30/6/10	Balance b/d	322,500

b. Cash paid for employee & other expenses:

Prepaid Expenses
30/6/09	Balance	34,500	1/7/09	Expiration of PP expenses	34,500
In year	Cash		30/6/10	Balance c/d	34,200
		68,700			68,700
30/6/10	Balance b/d	34,200

Accrued Expenses
In year	Cash		30/6/09	Balance	21,000
			30/6/10	Accrual of exp
30/6/10	Balance c/d	15,750		at year end	15,750
		36,750			36,750
			30/6/10	Balance c/d	15,750

Operating Expenses
1/7/09	Expiration of
	PP Expenses	34,500
30/6/10	Accrual of exp
	at year end	15,750
In year	Cash		30/6/10	P&L Summary	224,100
		224,100			224,100

Cash paid for employees & other expenses =

Alternative method:

Payments to suppliers & employees:

a. Cash paid to suppliers:

- Open. Inv. + Open. Creditors

COS - disc. rec'd.

+ Closing Inv. - Closing Creditors

period's inventory expense

period's net inventory transactions (ie purchases)

period's net potential payments for purchases

payment made this period for purchases

b. Cash paid for employee & other expenses:

Accrual Operating expenses (other - Open. prepaid exp. + Open. accrued exp.

than those previously calculated and

those related to non-current assets) + Closing prepaid exp. - Closing accrued exp.

period's other operating expenses

period's net potential payments for operating expenses

payment made for operating expenses this period

Total (a. + b.)

Investing Activities:

By Reconstruction

Long Term Investments
30/6/09	Balance b/d	240,000	In year	(disposals)	135,000
In year	(acquisitions)		30/6/10	Balance c/d	120,000
		255,000			255,000
30/6/10	Balance b/d	120,000

Financing Activities:

By reconstruction

Retained Earnings
In year	Cash (ie Divd)		30/6/09	Balance	210,900
30/6/10	Balance c/d	287,400	30/6/10	Profit	180,000
		390,900			390,900
			30/6/10	Balance b/d	287,400

Alternately, the process of uncovering the missing figure can be executed intuitively without the aid of an account:

Retained earnings at start of period 210,900

add: Profit for the period 180,000

Total profits available for dividend 390,900

less: Retained earnings balance at end 287,400

Dividend paid during period 103,500

10. Interpreting cash flows

AASB 107, commentary paragraphs 4 & 5).

A Statement of Cash Flows, when used in conjunction with the rest of the financial report, provides information that enables users to evaluate the changes in net assets of an entity, its financial structure (including its liquidity and solvency) and its ability to affect the amounts and timing of cash flows in order to adapt to changing circumstances and opportunities. Cash flow information is useful in assessing the ability of the entity to generate cash and cash equivalents and enables users to develop models to assess and compare the present value of the future cash flows of different entities. It also enhances the comparability of the reporting of operating performance by different entities because it eliminates the effects of using different accounting treatments for the same transactions and events.

Historical cash flow information is often used as an indicator of the amount, timing and certainty of future cash flows. It is also useful in checking the accuracy of past assessments of future cash flows and in examining the relationship between profitability and net cash flow and the impact of changing prices.

10.1 Students’ cash flows

Operating Activities

are the principal revenue-producing activities of the entity and other activities that are not investing or financing activities.

Similar to every day cash income and expenditure of students.

Investing Activities

are the acquisition and disposal of long-term assets and other investments not included in cash equivalents.

Similar to students buying laptops, cars, units or paying for education.

Financing Activities

are activities that result in changes in the size and composition of the contributed capital and borrowings of the entity.

Similar to students borrowing or repaying loans and incurring HECS debt.

10.2 Expansion and consolidation (Juchau et al. p204)

Expansion – operating cash flows positive but investing large and negative and financing large and positive

Consolidation – operating cash flows positive but investing small negative or positive and financing negative.

10.3 Negative cash flows from operations (Juchau et al. p.204)

Common in start up phase but otherwise a not a good sign.

Negative cash flows from operations with positive investing cash flows and positive financing cash flows is clearly a bad sign.

10.4 Cash flow warning signals (Birt et al., p. 212)

10.4.1 Cash received less than cash paid

10.4.2 Operating outflow

10.4.3 Cash receipts from customers being less than cash payments to suppliers and employees

10.4.4 Cash from operating activities being lower than operating profit after tax

10.4.5 Proceeds of share capital being used to finance operating activities

10.4.6 Consistent inflows from investing activities

10.4.7 Proceeds from borrowing continually much greater than the repayment of borrowings

10.5 Summary of interpretation table

	*Positive Cash Flows*	*Negative Cash Flows*
*Operating Activities*	*Good*	*Okay in start up phase* *Generally bad*
*Investing Activities*	*Okay if NC assets not needed* *Bad if selling NC assets to cover –ve operating CF*	*Okay if investing in NC assets that will provide a good return & increase operating CF*
*Financing Activities*	*Okay if issuing shares or borrowing to invest* *Not good if being used to cover –ve operating CF*	*Good as repaying loans or paying dividends*

Interpretation example 1:

Hills Ltd.

www.hills.com.au => Corporate information => annual reports => Concise annual report year ended 30 June 2009 => Statement of cash flows p. 34 => comments on cash flows p.35

Interpretation example 2:

Bits Ltd and Pieces Ltd

Comparative Statement of Cash Flows

for the year ended 30 June 2010

Bits Ltd. Pieces Ltd

Cash flows from operating activities $ 77,100 $ (81,600)

Cash flows from investing activities (441,000) (150,750)

Cash flows from financing activities 217,500 82,500

Net increase (decrease) in cash and cash equivalents(146,400) (149,850)

Cash and cash equivalents at beginning of period 183,900 185,000

Cash and cash equivalents at end of period $37,500 $ 35,150

What does this comparison say about the relative cash flow performance of these entities?

11. Limitations of Statement of Cash Flows (pp. 1018 of text)

12. An overview of Statement of Cash Flows - Refer to Figure 1.

Figure 1:

ACCRUAL ACCOUNTING CASH ACCOUNTING

Income Statement: Measures financial performance Statement of Cash Flows

- Income earned - Income received

- Expenses incurred or consumed - Expenses paid

Balance Sheet : Measures financial position

2009 2010

Difference

Cash Position XXX XXX

( ? ( ?

Dr Cash

Cr Cash

( (

	Cash
	Sales	XX	Purchases	XX
CF Operations	Debtors	XX	Interest paid	XX
			Taxes paid	XX
CF Investing	Sale of NCA	XX	Purchase NCA	XX
	Dividends rec.	XX
	Interest rec.	XX
CF Financing	Debentures	XX	Dividends paid	XX
	Capital	XX	Loan repaid	XX

Lecture Illustration 3

Disposals of non-current assets

Non-current assets are purchased for the purpose of long term use within the entity. At some stage, however, the non-current asset will be disposed of in some way (either by sale or scrapping).

When the non-current asset is disposed of, the gain (profit) or loss made on disposal is calculated by subtracting the book value (or carrying amount) of the asset from its disposal price (if any). The carrying amount is calculated by subtracting the expired service potential of the asset (ie accumulated depreciation) from the asset's historic cost.

At the time of disposal, the historic cost of the asset sold is removed from the ledger, as is its associated accumulated depreciation since the asset is no longer in control of the entity being accounted for.

Example:

A refrigerator with a historic cost of $20,000, and accumulated depreciation to the date of sale of $12,000 is sold for $6,000.

Carrying amount = $20,000 - $12,000 = $8,000.

Profit (Loss) on disposal = $6,000 - $8,000 = $(2,000)

When a non-current asset is disposed of, the resultant profit/loss is reported in the Income statement. From the perspective of the preparation of the Statement of Cash Flows, there are two issues of importance.

The disposal represents proceeds being received for the sale of the equipment. The amount of any cash received should be recorded in the Statement of Cash Flows.

Cash at Bank (B/S) 6,000

Gain on Sale (IS) 6,000

The accumulated depreciation on the asset sold is used in calculating the accrual based gain or loss on the sale. This does not have any influence upon the Statement of Cash Flows since merely stating accumulated depreciation does not involve a flow of cash.

Gain on sale (IS) 8,000

Accumulated depreciation (B/S) 12,000

Refrigerator (B/S) 20,000

TOPIC 10 Management accounting 1—planning and control through budgeting

Topic 10

Management accounting 1—planning and control through budgeting

Topic introduction

Much of our attention has been directed towards historical information. Income Statements (departmental or otherwise), Statement of Changes in Equity, Balance Sheets (Statements of Financial Position) and Statement of Cash Flows are collations of 'old news'. In themselves they tell us little about the present and the future. For predictive value we need to couple this information with expectations for the future (for example, economic forecasts, movements in fashion and increases in the firm's productive capacity).

Once past data has been combined with future expectations, we have all elements required to prepare a budget. Budgets provide goals to which to the firm's operations can aim to achieve (that is, planning), and when the budgetary period is complete, budgetary expectations can be compared with actual outcomes so that significant deviations can be analysed for rectification (that is, control).

In essence, the ultimate aim of the budgeting process is much the same as what we discussed in the early part of this course—the preparation of the main financial statements. An obvious difference is that instead of producing these statements from historical data (for example, from the ledger balances) they are being prepared in the context of future expectations. The source data is generally previously known data (for example, the sales figure from last year's profit and loss) adjusted for future expectations (for example, we expect sales to decrease by 6% this year).

Study objectives

At the end of this topic you should:

· be able to define the term budget;

· appreciate the purpose, benefits and pitfalls of preparing budgets;

· know the function of each type of budget and how they interrelate to form the master budget;

· be aware of the various sources of data used in budgets;

· be able to prepare sales forecasts, budgets and budgeted financial statements from supplied data; and

· demonstrate an ability to use budgets for performance reporting and financial control.

Graduate Qualities

The Graduate Qualities (generic skills) developed by studying this topic include:

· body of knowledge

· lifelong learning

· effective problem solving

· work autonomously and collaboratively

Required reading

Resource: text reading

Hoggett, J, Medlin, J, Edwards, L, Tilling, M, & Hogg, E. (2012). Chapter 12 'Budgeting for planning and control'. In Accounting. 8th edition. Brisbane: John Wiley and Sons, pages 492 - 509 and 513 - 519.

Notes on the reading

Ignore all of the manufacturing budgets and any references to GST.

Possible study activities – Topic 10
	Recommended time

Visit the web site and familiarise yourself with its contents.	0.5 hour
Required reading for topic 10	2.0 hours
Attend lecture	2.0 hours
Attend Tutorial (week 10 questions)	3.0 hour
Review lecture notes	0.5 hour
Prepare the topic 10 tutorial answers to be covered during tutorials in week 12	2.0 hours
	10.0 hours

Tutorial questions (Can be found on the course website under the relevant week)

At the end of each chapter in the text the questions are in the order:

· Discussion Questions

· Exercises

· Problems

Supplementary questions

Extra materials provided by the text book publisher are available on the course web site under the link for Text Book Student Resources.

WileyPLUS Topic 10 www.wileyplus.com

Problem 24.5 (adapted) from Hoggett & Edwards. 2001. Accounting in Australia, 4th edition. John Wiley & Sons Australia.

Ding Chan Produce Ltd is preparing a quarterly budget covering the 3 months ending 31 March 2006. The information available for the budget is as follows:

1. Cash sales represent 30% of all monthly sales. Seventy per cent of all credit sales are collected in the month of sale and the remainder are collected in the month following the sale.

2. Inventory purchases that are made on account equal 60% of the sales forecast for that month. Sixty per cent of the purchases are paid for in the month of purchase and 40% are paid for in the following month.

3. Ending inventory on 31 March 2006 is projected to be $55 200.

4. Equipment purchases for the first quarter are budgeted at $4800.

5. Other quarterly expenses are budgeted as follows: light and power, $11 040; rent, $31,200; salaries, $60 000. These expenses are paid when incurred.

6. Depreciation for the first quarter is $9600.

7. The trial balance as at 1 January 2006 will have the following account balances: Cash at bank $17 040 Accumulated depreciation $57 600 Accounts receivable 11 760 Accounts payable 5 760 Inventory 24 000 Share capital 49 200 Equipment 134 400 Retained profits 74 640

8. Budgeted sales are: January, $124 800; February, $120 000; March, $115 200.

Required:

Prepare a budgeted Income Statement and a budgeted Balance Sheet for the quarter ending 31 March 2006. Ignore income tax.

Problem 24.5 Solution

DING CHAN PRODUCE LTD

Budgeted Income Statement

for the quarter ending 31 March 2006

Sales ($124,800 + 120,000 + 115,200) $360,000

Cost of goods sold:

Beginning inventory $24,000

Purchases 0.6 (360,000) 216,000

240,000

Less: Ending inventory 55,200 184,800

Gross profit 175,200

Operating expenses:

Light and power 11,040

Rent 31,200

Salaries 60,000

Depreciation 9,600 111,840

Profit $63,360

Cash flow information

Beginning cash at bank balance $17,040

Expected cash receipts:

Beginning accounts receivable $11,760

January sales 124,800

February sales 120,000

March cash sales 30% (115,200) 34,560

March credit sales collected 70% (70% x 115,200) 56,448 347,568

Total cash available $364,608

Less: Expected cash payments:

Beginning accounts payable $5,760

January purchases 60% (124,800) 74,880

February purchases 60% (120,000) 72,000

March purchases 60% (60% x 115,200) 41,472

Light and power 11,040

Rent 31,200

Salaries 60,000

Equipment purchase 4,800 301,152

Cash at bank 31 March 2006 $63,456

DING CHAN PRODUCE LTD

Budgeted Balance Sheet

as at 31 March 2006

Assets Liabilities and Equity

Cash at bank $63,456 Accounts payable (2) $27,648

Accounts receivable (1) 24,192 Share capital 49,200

Inventory 55,200 Retained earnings 138,000

Equipment 139,200

Less: Acc Dep 67,200 72,000 ________

Total assets $214,848 $214,848

(1) Accounts receivable (0.3) (0.7) (115,200) = $24,192

(2) Accounts payable (0.4) (0.6) (115,200) = $27,648

Lecture Outline Topic 10

Management Accounting 1 - Planning and Control through Budgeting

___________________________________________________________________

1. Introduction

Budgeting is important in fulfilling the decision-making and discharge of accountability functions of accounting.

2. Budget

A detailed written financial plan that shows how resources are expected to be acquired and used during a specified time period to achieve an organisation’s objectives. (H, M, E, T & H. 2012. p. 494)

3. Benefits of budget preparation and use:

SYMBOL 183 \f "Symbol" \s 10 \h Provision of direction

SYMBOL 183 \f "Symbol" \s 10 \h Coordination of activities

SYMBOL 183 \f "Symbol" \s 10 \h Motivating force

SYMBOL 183 \f "Symbol" \s 10 \h Communication medium

SYMBOL 183 \f "Symbol" \s 10 \h Control device

4. Budget participation

· Bottom-up

· Top-down

Participation leads to greater acceptance and a more positive attitude to the budget but not necessarily improved performance.

Budgeting involves negotiation as departments compete for the same scarce resources.

5. Master Budget

A set of interrelated budgets representing a comprehensive plan of action for a specified time period. (H, M, E, T & H. 2012. p.497)

6. Preparation of the master budget

H, M, E, T & H. (2012) pp. 498-500

Sources of information to prepare the master budget:

· prior year’s Balance Sheet

· budgeted Income Statement

· cash budget

· capital expenditure budget

6.1 Sales forecasts and budgets

Factors to consider in forecasting sales include:

· patterns of past sales

· predictions made by marketing personnel

· analysis of general and industry economic conditions

· evaluation of competitors

· expectations regarding future price changes

· future plans for advertising and sales promotion

6.2 Budgeted Income Statement

6.3 Cash budget

6.4 Budgeted Balance Sheet (Statement of Financial Position)

Lecture Illustration 1

A student working at a hamburger shop wants to budget and has compiled the following data in preparation for their quarterly budget for the 3 months ended 31 March:

1. Their assets and liabilities at 31 December included the following information

Cash at Bank $380

Amounts owed by employer 330

Text books 400

Clothes 2 000

Computer 2 000

Accumulated Dep. Computer 1 500

Amounts owed to parents 150 (excluding the $300,000 for the cost of the first 18 years of rearing them)

Credit Card 460

Equity 3 000

2. The student earns $15 per hour at the hamburger shop and expects the hours worked for the quarter to be as follows:

January 90 hours

February 80 hours

March 76 hours

3. The student estimates that they receive 75% of wages in the month they are earned and the rest at the beginning of the following month.

4. The student buys $200 of clothes each month and $80 of prepaid mobile phone calls per month using their credit card for both of these purchases. The phone calls are expensed when purchased but the clothes are recorded as an asset. The credit card balance is paid in the month after the purchases.

5. General living expenses are about $600 per month and these are paid for in cash. The computer is depreciated equally over 4 years.

6. All other living expenses are paid for by the students parents and they may pay the $150 back one day.

REQUIRED:

Prepare a budgeted Income Statement and cash budget for the quarter ended 31 March and Balance Sheet as at the end of the period.

Income Budget

	January	February	March	Quarter
Hours	90	80	76	246
Dollars

90 * $15 80 * $15 76 * $15 246 * $15

Student

Budgeted Income Statement

for the quarter ended 31 March

Income		$ .	from income budget
less expenses
Mobile phone	$ .		Note 4
General expenses			Note 5
Depreciation (2 000/4/4)	. .	.	Note 5
		$ .

Student

Cash Budget for the quarter ended 31 March


Beginning cash at bank balance		$ .
Expected Collections:
Beginning amounts owed by employer	$ .
January income
February income
March income ($1 140 * 75%)	.	.
Total Cash Available
Expected Payments:
Opening credit card
January credit purchases
February credit purchases
General Expenses	.	.
Ending cash at bank balance		$ .

Student

Budgeted Balance Sheet

as at 31 March

Assets

Cash at Bank $ .

Amounts owed by employer ($1 140 * 25%)

Text books

Clothes

Computer $ .

Accum. depreciation - computer . .

$ .

Liabilities

Credit card

Amounts owed to parents .

Equity

Opening balance

Profit . .

$ .

7. Preparation of a Master Budget

Lecture Illustration 2: Problem A24.5 from Hoggett and Edwards.2000,4th ed. CD-ROM (adapted)

We will work through the preparation of this budget in class.

Lecture Illustration 2

McStill Ltd compiled the following data to prepare quarterly budgets for the 3 months ending 30 June:

1. Merchandise purchases are made on account and monthly purchases amount to 55% of the forecasted sales for that month. Seventy per cent of the purchases are paid for in the current month and 30% are paid for in the following month.

2. Sales on account represent 80% of all monthly sales. Sixty per cent of all credit sales are collected in the month of the sale, and the remainder are collected in the month following the sale.

3. Principal repayments on a loan during the quarter are budgeted at $12,000.

4. Other quarterly expenses are budgeted as follows: salaries, $240,000 (provided by the human resource department); rent, $24,000; insurance, $7,200, interest $2,880. These are paid when incurred.

5. The depreciation expense per quarter is $14,400.

6. The ending inventory as at 30 June is projected to be $28,800.

7. The projected Balance Sheet (Statement of Financial Position) as at 1 April included the following items:

Cash at bank $ 21,600

Accounts receivable 82,800

Inventory 24,000

Equipment 124,800

Accumulated depreciation 18,720

Accounts payable 43,200

Loan payable 60,000

Share capital 24,000

Retained earnings 107,280

8. The sales and marketing department provided the following budgeted sales: April, $244,800; May, $264,000; June, $276,000.

Example: McStill Ltd

Master Budget for the quarter ended 30 June

Sales Budget

	April	May	June	Total
Cash (20%)
Credit (80%)	______	______	______	______
Total	$244,800	$264,000	$276,000	$784,800

McSTILL LTD

Budgeted Income Statement

for the quarter ended 30 June

Sales ( 244,800 + 264,000 + 276,000)
Cost of sales:
Beginning inventory
Purchases (0.55 x 784,800)
Goods available
Ending inventory		. .
Gross profit
Expenses:
Depreciation
Insurance
Interest
Rent
Salaries		. .
Profit		$. .
.

McStill Ltd

Cash Budget

for the quarter ended 30 June

Beginning cash at bank balance	$21,600
Expected cash collections
Beginning accounts receivable
April sales
May sales
June sales – cash
June sales – credit (0.6 x 220,800)	_______
Total cash available	800,880
Expected cash payments
Beginning accounts payable
April purchases (0.55 x 244,800)
May purchases (0.55 x 264,000)
June purchases (0.7 x 0.55 x 276,000)
Loan principal
Interest
Insurance
Rent
Salaries	_______
	715,380
Ending cash at bank	$ 85,500

McStill Ltd

Budgeted Balance Sheet

as at 30 June

Assets

Cash at Bank

Accounts receivable 1

Inventory

Equipment

Accum. depreciation – equip. ______ _______

$294,300

Liabilities

Accounts payable 2

Loan payable _______

Equity

Share capital

Retained earnings _______ ______

$294,300

1. 276,000 x 0.80 x 0.40

2. 276,000 x 0.55 x 0.30

8. Using budgets for planning and control - performance reporting.

Lecture Illustration 3

Assume that the actual Income Statement for McStill Pty Ltd for the quarter ended 30 June has now been established.

Prepare a Income Statement report for the quarter.

McStill Ltd.

Income Statement Report

for the quarter ended 30 June

	Budgeted	Actual	Variance
Sales	$784 800	$765 000
less COS	426 840	415 000
Gross Profit	357 960	350 000
less expenses
Depreciation	14 400	14 400
Insurance	7 200	7 200
Interest	2 880	2 680
Rent	24 000	24 000
Salaries	240 000	250 000
Total Expenses	288 480	298 280
Profit	$ 69 480	$ 51 720

Main causes of material variances include:

· inappropriate targets being set

· very good or very poor performance by responsible personnel

· variance out of control of management, e.g. GST increase

Conclusion

You have now come to the end of the materials for the introductory course Accounting for Business. This course was designed to expose you to:

· the rationale for the existence of accounting to meet user needs

· the main reports prepared by firms for external users (financial reporting)

· the need to appreciate both the conceptual justification for accounting and its practices, along with a systematic method of data capture and storage to ensure that the resultant reports are consistent, reliable and meet user needs. From this understanding of how the information relates comes a better appreciation of what accounting information does and doesn't tell you as a user.

Hopefully your study of the material has allowed you to appreciate these broad issues and, if it has not, this might be your first aim in revision—to find the 'big picture'. In assessment, however, the 'big picture' is examined through a series of smaller snapshots of your learning. Therefore, in preparation for your final examination you will need to revisit the study objectives for each topic along with the accompanying tutorial examples.

For whatever reason you enrolled in this course, we hope that you achieve the goals that you set for yourself and that the time you spent at your study provides you with a strong grounding for examination success.

All the best with your future studies!

Financial Reporting Council (FRC)

Strategic direction

Australian Accounting Standards Board (AASB)

technical

standard setter

Accounting standards

Australian Securities & Investment Commission (ASIC)

enforcement

Profession

education &

enforcement

International Accounting Standards Board (IASB)

Treasurer

Establish goals

Gather information

on alternatives

Determine

consequences

Choose a

course of action

Other Information, e.g. economic, marketing etc.

Accounting Information

Transactions

Identification

Quantification

in $ terms

Measurement

Recording

classification

summarisation

Recording

Accounting

reports

Analysis and

interpretation

Communication

MEASUREMENT CONCEPTS (PHILOSOPHIES)

Historical cost

Current cost

Realisable or settlement value

Present value

Capital Maintenance Concept

ASSUMPTIONS UNDERLYING FINANCIAL REPORTING (RULES)

Accounting entity

Accrual basis

Going concern

Time period

Monetary

Diagram 1: A Conceptual Framework for Accounting based on SAC2 & FPPFS

_1169635434.ppt

School of Accounting and Information Systems

Educating Professionals  Creating and Applying Knowledge  Serving the Community

INCOME STATEMENT

for the period

I - Ex = PROFIT

BALANCE SHEET

(as of beginning

of year)

A1 - L1 = Eq1

BALANCE SHEET

(as at end of year)

A2 - L2 = Eq2

STATEMENT

OF CHANGES IN EQUITY

for the period

Eq1 + Profit - Drawings = Eq2

John Medlin

_1258970142.ppt

School of Accounting and Information Systems

Educating Professionals  Creating and Applying Knowledge  Serving the Community

Example Assets:

Buildings and LT assets
Inventory
Prepayments:
Insurance

Example Expenses:

Depreciation
Cost of Sales
Expired Costs:
insurance exp.

John Medlin