WACE Revision - Accounting theory

management accounting

Produced for the benefit of the company’s managers to enable them to make planning and controlling judgements that will enable them to improve the company’s financial performance

financial accounting

Primarily deals with the recording and reporting of business transactions to stakeholders outside the business and is based on past performance

internal reporting

Is for management and efficiency purposes

Used for managerial decision making to assist with the managing of a business’ assets, liabilities, income and expenses

Is important for enabling the business to reach its goal and improve performance

external reporting

For users of information who are removed from the business and not able to make decisions about the business unless they have access to this information

Enable external users to assess the performance, position, and liquidity of an entity

Facilitates accountability for the manager’s decision making and shows how they’ve invested the resources of the business on behalf of the owners / shareholders.

capital investment decisions 

Long term business decisions involving the commitment of large sums of money and are usually related to the acquisition of non-current assets

capital investment decisions - characteristics 

Long term decisions that relate to large amounts of money and expenditures which are used over many years

Cannot be easily reversed as once purchased it is usually costly for the business

Has impacts on the generation of future cashflow and profits

business planning

Involves the working out of goals and objectives for a business and how they're obtained

Due to limited capacity and resources, planning helps to allocate scarce resources to competing users

Cost leadership vs cost differentiation requires businesses to make a choice as to the type of product / service they’re offering to the market and customer base

Generic business strategies include meeting industry targets, maintaining sale and production volumes from year to year and maintaining sales composition

strategic initiative and performance management 

Focuses on the performance of an organisation, department, employee or the process to build a product of service

Includes activities which ensure that goals are consistently being met in an efficient and effective manner

Process by which organisations align their resources, systems and employees to strategic objectives and practices, and is put in place to help the business gain a competitive advantage

cost volume profit

Enables decision makers to assess how changes in selling prices, cost, and volume impact the performance of the business

Where a constraint or manufacturing capacity exists, management of a multi-product business is able to determine the optimal production mix for maximising profits

Identification of the breakeven point which can reveal what margin of safety the business has with budgeted sales being above the breakeven point

Facilitates the making of special decisions and can calculate the financial impact of these decisions such as make or buy, special orders, and closing down a line

master budget

Covers a 12-month period and shows a forecast of results from the implementation of strategic plans

Purpose is to show business owners and managers a complete overview of planned business activity and changes

Is important as it shows the expected results of the business as a whole and readers can see expected liquidity and profitability for the period

capital expenditure budget

Reviews and plans the capital expenditure the business needs to achieve its goals and includes planned purchases, replacements or upgrades to non-current assets, and costs associated with business expansion

financial budget

Includes the cash budget, projected cash flows and a budgeted balance sheet

operating budget

Provides all the information necessary to prepare a budgeted income statement and includes revenue projections, cost of goods sold projections, estimates selling and distribution, general and administrative, and financial expenses of a period

Separate budgets are combined into an overall budget and projected income statement showing expected profit at the end of the period

income statement budget

Is based on accrual accounting

Its purpose is to allow users of the reports to anticipate the income and expenses and the resultant profit/loss over the budget period

If the budgeted profit/loss is lower than expected, management can plan to work and improve income or expense control to bring about the desired result.

cash budget 

Is based on cash accounting

Is a forecast of estimated receipts, payments, and the resultant cash position for a period of time

Is important in maintaining a business’ viability and helps to maintain a tight control over their cash and assess its liquidity position

To remain viable, it must be able to meet its short-term debts and have enough cash to keep operating

purpose of a cash budget 

It enables management to see when its commitments are due and make sure money is available at that time, otherwise they would get a poor reputation and not be able to maintain credit

It can reveal any weaknesses in the business’ debt collect policy and means steps can be made to improve this

Can reveal when shortages of funds may occur and can seek the best source to minimise interest paid

performance reports 

is prepared to show the differences between budget estimates and actual results, this difference shown as variances, these variances may be favourable or unfavourable.

If the unfavourable variance is significant, then further investigation is required and corrective action taken to help achieve the business’ targets and goals

insolvency

A situation where a company is unable to pay its debts when they fall due

To determine whether a company is insolvent, consideration must be given to the company’s capacity to source additional funds to meet their obligations

If liabilities exceed assets the company would be considered to be insolvent

voluntary admission

A procedure where the directors of a troubled company or a secured creditor with charge over most of the company’s assets, appoints an external administrator, called a ‘voluntary administrator’.

liquidation 

The orderly winding up of a company’s affairs and involves realising the company’s assets, cessation, or sale of its operations, distributing the proceeds of realisation amongst its creditors and distributing any surplus amongst its shareholders.

receivership 

A company most commonly goes into receivership when a receiver is appointed by a secured creditor who holds security over some or all of the company’s assets

Main duty owed is an obligation take reasonable care to sell charge property for not less than market value, or if there is none, the best price reasonably attainable

order of priority of the distribution of funds 

Fees and costs for the liquidators, administrators, or receivers for conducting the liquidation

Secured creditors ranked on their debt instrument

All outstanding employee entitlements

Unsecured creditors ranked on a pro-rata basis

Shareholder

benefits of equity financing 

Avoids a business being too highly geared which provides financial stability

no interest repayments

Better for funding long term assets

costs of equity financing 

Having too much equity can lead to an ineffective utilization of funds

Could limit the ability of the business to expand and buy new assets

Could miss out on taxation benefits gained by writing off interest

benefits of debt financing 

By borrowing from outside sources, the business may be able to expand and purchase new assets

Having too much equity can lead to an ineffective utilization of funds which leads to an overall fall in returns

costs of debt financing 

The costs of arranging the finance

There is a commitment to repay the finance

Financial risk is involved

A business needs to be careful to not become too highly geared as this may lead to becoming financially unstable

internal auditing -HaOAiO,E+I

Helps an organisation accomplish its objectives, evaluate and improve the effectiveness of risk management, internal control, and accountability processes

It is done internally by accountants within the organisation and not by an independent external auditor

company 

An organization established under the Corporations Act 2001 as a separate legal entity

corporations act

is a Commonwealth Act which sets out the laws dealing with the business entities in Australia at a federal and state level, and iIt primarily deals with companies and is administered by ASIC

purpose of the corporations act 

Define and give legal existence to a company

Set out the duties of the directors of a company

Sets out the external audit requirements for a company

Sets out the different types of companies that are permitted to exist under the Act

duties of directors

Protecting the rights of shareholders

Setting officer’s salaries

Recommending dividends

Reviewing internal control within a company

rights of shareholders

Participate in the profits of the company in proportion to their shareholdings in a manner determined by the directors

Receive due notice of meetings of shareholders

Attend general meetings, participate in discussions and vote on resolutions

Dispose of their shares to whoever they choose at a price of their choosing

Possible return of capital on liquidation

rights issue

Existing shareholders are given the right to subscribe to new shares in proportion to their existing shareholdings, which enables them to maintain their current value in the company if they wish

prospectus 

A document issued to the public to invite them to buy shares in a company, and contains all the information potential investors need to make informed investment decisions

financial reporting council

Is an Australian Statutory board who has control over appointments and budgeting for the Australian Accounting Standards Board

Has legal, business, government, and other interests

Current memberships include representatives from the Business Council of Australia, the G100, the Australian Shareholders Association, the Institute of Chartered Accountants, and many other government and non-government bodies

australian securities and investments commission 

Is an independent government body that enforces company and financial service laws to protect consumers, investors, and creditors

Regulates and informs the public about Australian companies

Has substantial enforcement powers relating to financial reporting and audit under the Corporations Act, ASIC Act, and various state criminal acts

ASIC can make orders to require compliance

australian accounting standards board 

Board to develop and amend accounting standards for the purpose of the Corporations Act

Has the force of the law and is applied to entities who comply with the Corporations Act

Role is to develop the conceptual framework, develop and issue accounting standards, and review and revise standards so that they reflect changing political and economic standards

australian securities exchange 

The ASX provides facilities for the listing and transfer of equities of listed public companies, but extends only to those public companies which are listed on the stock exchange

ASX ensures that all the listed companies act in a manner which is at all times in the best interest of shareholders and the general public

purpose of accounting standards - protecting external users 

By complying with accounting standards, a company will fairly present its financial position, financial performance, and cash flows

This information will be useful to existing and potential investors, creditors, and other external parties in making and evaluating decisions about the allocation of scarce economic resources.

purpose of accounting standards - assisting directors in discharging their obligations 

As general purpose financial reports are one of many ways for the management and board of directors to be accountable to those who provide resources to a company.
compliance with accounting standards ensures a higher level of accountability is achieved and promotes accurate reporting

purpose of accounting standards - providing confidence in australian capital markets

By complying with accounting standards, companies produce reports that can be relied upon by investors, therefor encouraging confidence in the information available to them and the processes used to produce the reports

purpose of annual reporting for external stakeholders - potential investors

potential investors are entitled to have sufficient information available to them on the company’s financial position and performance, which enables them to make informed judgments about whether to invest in the company or not.

The company can meet this obligation by publishing regular, timely reports that can be used by investors to evaluate the company

purpose of annual reporting for external stakeholders - lenders 

Institutions and individuals who have lent money to the company are entitled to receive information that informs them about the security of their investment and the likelihood of receiving interest and repayments

The company satisfies their needs through thes annual published reports

purpose of annual reporting for external stakeholders - government agencies 

There are a number of government agencies concerned in the supervision and regulation of companies, including ASIC and the ATO

They need this information to ensure that the company is meeting its legal obligations under company and tax law

The company must conduct its business and maintain its records in accordance with the law, and submit to the relevant authorities the report and returns required

key performance indicators

Is a measurable objective that the company has decided will indicate if its on the way to meeting its mission and goals

are financial or non-financial, quantifiable measures that assist business to evaluate how successful they have been in achieving their goals

they should never be used in isolation from other measures of performance and the purpose of each measure should always be reflected upon

function of the external audit

Is to protect external users of financial statements as there is a separation between ownership and control of reporting entities

Is an independent verification of the reporting entity’s financial documents to make sure that the financial reports produced at the end of a financial year accurately represent the entity’s performance and position for the period

Gives confidence to stakeholders in Australian Capital Markets that that accounts can be relied upon to make financial decisions

role of the external auditor 

Is to protect external users of financial statements by conducting an independent audit of the financial statements and forming an opinion as to whether the financial statements are a true and fair view of the company’s performance and position

Performs this role by checking the entity’s accounting procedures and records, this can include the testing of individual transactions that are of high risk of misstatement due to their nature or size

limitations in assessing performance and position

Lack of comparability between entities - hard to compare the ratios between companies as different accounting methods may have been chosen that will affect ratio calculations e.g., methods of depreciation.

Lack of disclosure - public companies are not required to show the details of individual expenses in their annual accounting reports.  Therefore, it may be difficult to calculate some ratios.

Historical cost accounting - information used to calculate ratios is based on past results and are usually recorded at their historical cost not their current market values.  Therefore, ratio analysis does not necessarily represent future company performance.

purpose of the conceptual framework 

Is to describe the objectives of and the concepts for general purpose financial reporting

This assists the AASB to ensure that the accounting standards they develop are based on concepts which are consistent across all standards, and this consistency brings transparency, accountability, and efficiency to Australian financial markets

fundamental characteristics

relevance and faithful representation

enhancing characterisitics

comparability, timeliness, verifiability, and understandability

faithful representation

to be useful, financial information must not only represent the relevant phenomena, but it must also faithfully represent the substance of the phenomena that it purports to represent

To be a perfectly faithful representation, it must be complete, neutral and free from error

Requires elements to be displayed in monetary terms

relevance 

to be included in financial reports, financial information must have relevance, as it is capable of making a difference in the decisions made by users

Materiality is a concept of relevance, and means ‘what is important’ so it could relate to the nature or size of the transaction.

asset definition

Is a present economic resource controlled by the entity as a result of past events. An economic resource is a right that has the potential to produce economic benefits

asset and liability recognition

Is recognised only if the recognition of that A/L and of any resulting income, expenses or changes in equity provides users of financial statements with information that is useful

Must include relevant information, as it can make a difference in decisions made by users even if some users choose not to take advantage of it

 Must be a faithful representation

liability definition 

a present obligation of the entity to transfer an economic resource, as a result of past events

equity definition 

The residual interest in the assets of the entity after deducting its liabilities

income definition 

increases in assets, or decreases in liabilities that results in increases in equity, other than those relating to contributions from holders of equity claims

income recognition

recognition occurs at the same time as the initial recognition of an asset or the derecognition of a liability

expense definition

decreases in assets, or increases in liabilities that result in decreases in equity, other than those relating to distributions to holders of equity claims

expense recognition

recognition occurs at the same time as the initial recognition of a liability or the derecognition of an asset

nature of the reporting entity 

A reporting entity is an entity that is required, or chooses, to prepare financial statements

Not necessarily a legal entity and is required to prepare financial statements if it has public accountability

general purpose financial reporting importance

Provides information about the financial position and performance of the company that is useful to a wide range of users in making economic decisions

purpose of cashflow statement

Useful in providing users of financial statements with a basis to assess the ability of the entity to generate cash and cash equivalents, and the need of the entity to utilize those cashflows

benefits of cashflow statement 

It provides information that enables users to evaluate, changes in net assets, changes in financial structure, the ability of the business to adapt to changing circumstances and opportunities, and the relationship between profitability and net cash flows

Cash and cash equivalents

Are short term, highly liquid investments that are readily convertible to known amounts of cash and are subject to insignificant risk of changes in value

Are held for the purpose of meeting short term cash commitments rather than long term investments