ACCOUNTING REPORTS AND ANALYSIS REVIEW:

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1 ACCOUNTING REPORTS AND ANALYSIS REVIEW: Week 1: The Nature of Business: - Before considering the role of accounting it is important to have an understanding of what businesses do - Businesses: A collection of people, assets and capital that come together to satisfy a common goal o That common goal: to create value for stakeholders (i.e. profit maximization) o The primary role of financial statements is to provide information required by stakeholders to assist decision making - Stakeholders: o Entities with an interest in an organization who can act to protect that interest o Their actions can support and/or harm the business o So, who are our stakeholders and what are their needs? Customers: Regulators: Fair price & quality goods, timely and convenient supply, our expertise Compliance with relevant legislation (and the spirit of legislation) Business: - Who are our important stakeholders? - Those whose adverse actions can harm our business Others: Variety Owners: Financiers: Capital growth, income stream, cash flows, reputation Compliance with contractual obligations and repayments of interest

2 Environmental Analysis: - The complex environment in which the business operates can have a significant impact on its ability to meet stakeholders needs - One tool commonly used to assist a business understanding of their environment is a PEST analysis: o Political o Economic o Social Budget / tax policy Industrial relations Competition International trade GDP Inflation Employment Job market Population growth / demographic forecasts Immigration Community attitudes Environmental issues o Technological Infrastructure Costs Options Advances / future potentials Business model: - Having understood their stakeholders and their environment, a business needs to develop the elements necessary to succeed: o Mission statement o Goals and objectives o Strategy

3 The company also must determine how it intends to achieve its goals and objectives: o Strategic elements o What is our target market? o How do we intend to differentiate our products / services from our competitors? Price? Quality? The business must determine its: i) Business structure ii) Funding and investment mix iii) Information system needs These decisions must be made at the formation of a business, but also reassessed on an ongoing basis throughout the life of the entity o Business processes o Business measures i) Business structure: o The business must determine which ownership to adopt: Sole trader Partnership Company (public or private) Characteristics Sole Trader Partnership Company i) Legal status Not a separate legal entity from its owner ii) Risk of owners iii) Life of entity iv) Ownership UNLIMITED LIABILITY Limited to the life or desire of owner Sale by owner establishes new Not a separate legal entity from its owner UNLIMITED LIABILITY Limited to the life or desire of partners Changes in any partner s interest Separate legal entity from its owners LIMITED LIABILITY Indefinite Transferrable by way

4 transferability business v) Accounting treatment Separate accounting entity requires new partnership Separate accounting entity of sale of shares Separate accounting entity ii) Funding and investment mix: - The business must also determine its funding and investment strategies: o Funding: debt versus equity o Investment: represented by the assets purchased by the business - The choices with respect to funding and investing have a number of accounting implications iii) Information systems: - Information systems represent investments in technology and knowledge o Information systems are designed to provide management with the information they need to effectively run the organization o The information generated covers all aspects of the business performance o Developing and maintaining robust and relevant information systems is a key challenge for modern businesses - Business processes: o Having established its general structure, the business then identifies activities and processes through which stakeholder value is created o These activities include: The value chain operations required to produce good/service Support processes o Operational activities (value chain): Across the value chain, management continually performs a number of functions: o Planning o Decision making (directing operational activities)

5 o Control Accounting plays a major role in providing managers with the financial data they need to perform these functions (i.e. management accounting) The role of accounting: - Accounting also assists those external to the business in their decision making i.e. financial accounting - A primary role of accounting is to provide information that is relevant to the decisions made by external stakeholders o Published financial statements represent the primary source of information for external stakeholders - To satisfy the typical range of stakeholder needs, accounting information is provided in respect of: o Profitability relative performance o Efficiency ability to generate cash flows o Liquidity ability to meet short-term debt obligations o Gearing financial structure - Accounting information: o To meet the needs of external stakeholders, the following financial reports are prepared: i) Income statement ii) Cash flow statement iii) Balance sheet I) Income statement: - Presents the revenue earned and expenses incurred by a business over a period of time - Elements of this report are used to assess: o Profitability o Efficiency II) Cash flow statement:

6 - Presents the cash receipts and cash payments of a business over a period of time - Cash receipts and payments are classified into: o Operating o Investing o Financing activities III) Balance sheet - Presents the assets, liabilities and equity of a business at a certain time. - Assets and liabilities are classified as current or non-current. - Elements of this report are used to assess: o Profitability o Efficiency o Gearing o Liquidity The Availability of Choice: - Not all accounting is black and white - Accounting Standards (AASBs) and Corporations Act (CA) provide guidance in most areas, but: o There are still many transactions and events not specifically covered by these o Even where a relevant accounting standard exists, a choice between alternative accounting methods may exist with little guidance provided to make that choice o Accountants are routinely required to make a variety of judgments and estimates in preparing financial reports - During eth preparation of financial statements, the preparing may need to (or have the option) to: o Make choices (e.g. depreciation choice) o Exercise judgment o Make estimates - This provides scope for financial statements to have a range of possible results - Financial statements are intended to present a true and fair view (NOT accurate )

7 - Published financial statements are the major source of information for many stakeholders decisions Agency Theory: - Agency theory suggests decision-makers and preparers of financial statements (i.e. management) may be motivated by self-interest when making policy choice, judgments, estimates etc. o Conflicting interests of agents - This creates a potential conflict of interest when managers are expected to act on behalf of the owners and the debt-holders of a business o Payment of dividends vs retention of cash (payout policy) o Short-term versus long-term investment horizons o Investment in high risk projects risk aversion level o Claim dilution o Asset substitution different positions of debt and equity holders choice of investment - Mutual agency: o To reduce the costs and risks associated with agency relationships, contracts are typically prepared with the aim of aligning the interests of managers and those of owners and debt-holders Directors bonuses linked to share prices Debt covenants within loan agreements o Such contractual details may be measured or influenced by accounting numbers, so accounting policy choice has economic consequences for managers - To sum up: o Accounting is an information system for recording decision making events o Recording and reporting for decision making: Record transactions Prepare reports that summarise results Assist decision making in profitability, efficiency, liquidity and gearing o There is scope for choice, judgment and estimates

8 Agency theory! Week 2: The Mechanics of Accounting Recording and Reporting: The Accounting process: - The steps involved in recording transactions, preparing financial statements and analyzing and interpreting financial statements for decision making Business activities: - Businesses generate value for stakeholders by undertaking funding, investing and operational activities with the intention of generating profit - These activities include: o Obtaining funding through debt and equity financing o Distributing resources back to debt and equity providers (i.e. interest and dividends/capital gains) o Acquiring, maintain and disposing of business assets o Acquiring (and retrenching), developing, remunerating human resources and know-how o Acquiring resources for the purpose of resale o Producing and selling business ouput (services and products) o Collecting cash amounts owing o Paying for resources acquired - The accounting process commences with the capturing of data related to business activities - This is done using: o Source documents - Source documents: o Are crucial to accounting o Source documents include: i) Share certificates ii) Sales invoices