The everything accounting notes
Chapter 1 - Theory
The User of Accounting Information
Internal Users who have access to this type of information include business managers, sole proprietors, and partners in a business.
External Users of accounting information includes shareholders, potential investors, creditors, employees and ATO.
Types of Accounting
Management Accounting This is for preparation for internal users for people who operate the business. This information includes cost of manufacturing, break even point of a product and the expected cash at bank balance for each of the next 12 months.
Financial Accounting This is for preparation for external users. This includes accounting resorts such as cash flow, income statement and balance sheet.
Nature of Accounting Reports
External Accounting Reports
Statement of profit or loss and other comprehensive income over a period of time.
The balance sheet or statement of financial position which lists assets, liabilities, and equity on a particular date.
The statement of cash flows including inflows and outflows over a period of time and the opening/closing balance.
The statement of changes in equity over a period of time.
Internal Accounting Reports
Some accounting reports are prepared for the use of business managers and are not issued to external parties. These reports include budgets. A budget is a plan for the future of a business expressed in money terms.
The AASB Accounting Standards
The financial statements of a company should be accurate and fairly record the performance of the company for a period of time.
A reporting entity is an organisation that is required or chooses to prepare financial statements.
A reporting entity is required to prepare financial statements if it has public accountability.
Public accountability means accountability to those existing and potential resource providers and other external entities who make economic decisions but are not in position to demand reports trailers to meet their particular information needs.
The Role of the Accountant in Managing a Business
Preparation of financial statements, such as balance sheets.
Preparation of budgets, such as cash budget.
Calculation of the cost of a new product.
Calculation of the break even point of a product.
Preparation of the payroll of a business.
Periodic review of the internal control system of a business.
Preparation of individual and company income tax returns.
Auditing
Auditing is the process of checking the external accounting reports of a business to ensure all reports are correct and complete; and their operating system and policies of a business to ensure they are efficient.
Internal Auditing
Auditing Internal auditing is the checking of the operating systems of a business to ensure they are working properly.
A review of the efficiency of the internal control system. Internal control is the name given to the set of rules to help produce the assets of a business, help prevent fraud and aid in operating the business efficiently.
A review of the efficiency of other systems, such as the supply chain.
A check that the policies of the business are being followed and that the business is complying with all laws. The detection of errors made in the accounting system.
Internal auditor is an employee of the business and may carry out other duties assigned by management
External Auditing
The external auditor conducts an independent review of a business and produces the users of the financial statements prepared by the business.
The external auditor expresses an option as to whether or not the financial statements of a public company 1.Give a true and fair view of the financial positions of the company 2.Comply with the AASB Accounting Standards
The external audit process gives confidence to shareholders and potential investors in public companies that the financial statements of the company accurately reflect the financial performance and health of the company.
The external auditor must inform ASIC of any breach of the Corporations Act and of any failure by a reporting entity to comply with the FASB Accounting Standards The external auditor is appointed by the shareholders and is re-appointed at the annual general meetings.
Ethical Dilemmas facing Business Managers
Exploitation of employees: Employees may be required to work excessive hours of unpaid overtime or be expected to find a new job.
Exploitation of overseas workers: A business that is operating in a third world country may take advantage of its employees in that country by paying them very low wages and requiring that they endure unsafe working conditions.
Exploitation of investors: The shareholders of a public company may be exploited if the senior management of the company decides to invest the company’s money in high risk ventures.
Acceptance of gifts from suppliers: A manager of a business may be offered gifts from a supplier of inventory. If a cheaper supplier of inventory is found the manager may have to decide whether to stay with the existing supplier or change to the new supplier but lack the objectivity required to make this decision.
Breaches of confidentiality: A manager may be asked to pass on confidential business information to a friend who is working for a competitor.
Exploitation of foreign consumers: For example, a cigarette company may sell to a country where consumers are not fully aware of the dangers of smoking.
Conflict of interest: The manager may have to choose between their own duty to act in the interest of the company and self interest.
Corporate Social Responsibility
Corporate Social Responsibility (CSR) exists when a business builds a concern for the protection of the environment and of the good of society into its activities/
A business can develop a CSR program by
Recycling as much waste as possible or reducing the amount of pollution it emits or reducing its energy consumption (protection of the environment), or by Contributing to a charity fund reading appeal or sponsoring disadvantages groups (concerning for the community)
Advantages of Implementing a Program of CSR
Community respect and reputation: A business that has a reputation of acting with concern for the environment and for the welfare of the community is likely to be respected by the public. This may, in turn, generate higher sales.
More enthusiastic and better motivated employees: The morale of employees of a business that has a reputation for acting in a socially responsible manner is likely to be high and this may lead to a high level of work motivation.
A greater ability to recruit high quality employees: A business that has a reputation for responsible conduct may be able to attract a large number of quality jobs candidates than other businesses.
Disadvantages of Implementing a Program of CSR
The cost of community support programs run by a business, such as, sponsorship of local sporting teams or donations to charities.
The cost of producing corporate social disclosure reports.
A cost of protecting the environment may be the need to purchase new energy saving or pollution reducing plant and equipment.
Principles of Asset Management
Appropriate Management of Cash
The handling of cash should be separated from the recording of cash transactions REASON: An employee cannot steal money and make false entries in the accounting records to cover the theft.
All cash receipts should be banked daily. REASON: This practice will minimise the amount of cash that could be stolen from the business premises.
All payments should be approved by a senior employee and large payments should be approved by two employees. REASON: This practice will help reduce fraud and unauthorised payments.
Cash budgets should be prepared on a continuing basis. REASON: This practice will help ensure that a business has sufficient cash on hand to pay its debts as they fall due.
Appropriate Management of Accounts Receivable
A business should have a set of rules in place to try and ensure that only good customers are sold products on credit and that money owing from debtors is collected in an efficient manner.
A business may conduct credit checks on new customers before agreeing to sell them inventory on credit and may impose credit limits on new consumers.
A monthly statement should be sent to all debtors setting out the transactions that have taken place during the month and the amount owing at the end of the month.
A business may decide to follow up overdue debtor accounts as soon as they exceed the payment date. An overdue debtor may be contacted, reminded of the amount owing and asked to settle the debt.
The recording of debtor transactions should be separated from the handling of cash so that an employee cannot steal cash and make false entries in the accounting records to cover the theft.
Appropriate Management of Inventory
The handling of inventory should be separated from the recording of inventory transactions. REASON: An employee cannot steal Inventory and make false entries in the accounting records to cover the theft.
Inventory should be stored in a secure location. Access to this location should be restricted. REASON: This practice will reduce the risk of inventory being stolen.
The inventory records should be maintained using the perpetual inventory system. REASON: The perpetual inventory system provides information on fast moving items of stock and reduces the possibility of the business running out of inventory.
An Appropriate Level of Investment in Non-Current Assets
A business must have the non-current assets it needs to provide a satisfactory service to customers. However, a too large of an investment in non-current assets will mean that a business has assets that it is not using efficiently.
Appropriate Management of Liabilities (Debt) and Equity
The assets of a business are obtained either from money supplied by the owner or from debt, that is, loans from banks and other creditors. Loans must be repaid on time and interest is paid on loans. A business must ensure that its debt level is not excessive.
Company Insolvency
A company is insolvent if it cannot pay its debts as they become due.
Company insolvency is covered by the Corporations Act (Cwith) 2001.
The main forms of company insolvency are: Voluntary administration, Receivership and liquidation
Voluntary Administration
The directors of a company that is insolvent or heading towards insolvency or a secured creditor who has not been paid, may appoint an external administrator known as a voluntary administrator.
A voluntary administrator will assess the health of the company, report to the creditors and recommend if the company should be liquidated or returned to the control of the directors.
A voluntary administration gives a company time for its future to be worked out. Creditors cannot take action to recover amounts owing to them without court approval or without the approval of the administrator.
Receivership
A receiver is usually appointed by a secured creditor who has not been paid on time.
A receiver will sell the secured assets of the company to repay the creditor. The receivership ends when the money owing is repaid.
Liquidation
A liquidation occurs when an external person is appointed to:
collect and sell off the assets of an insolvent company
distribute the money to the creditors and the shareholders
investigate the conduct of the directors and other company officeholders and
close the company.
Order of Repayment of the Creditors of a Company
The assets of a company that is in liquidation are often distributed to stakeholders in the following order.
the fees and costs of the liquidator
the secured creditors employee entitlements owing, such as, wages, superannuation and annual leave
the unsecured creditors
the shareholders.
The Duty of a Company Director in Relation to Insolvency
A director of a company must be aware, at all times, of the financial health of the company, and when a company incurs a debt, the director must consider where or not the company can repay this debt. A director must ensure that the company does not trade while insolvent.
Short Term Investment Options
Cash Management Trusts
A trust is a legal relationship in which one party manages property for the benefit of one or more other parties.
A cash management trust manages the money of investors. Interest is paid on the money deposited with the trust.
Term Deposits
A term deposit is money invested with a bank or other financial institutions, for a fixed period of time, such as, 12 months, at a fixed rate of interest.
Long Term Investment Options
Shares in Companies Listed on the ASX
The Australian Securities Exchange is a marketplace for the buying and selling of shares of companies listed on the exchange.
Term Deposits
A term deposit is money invested with a financial institution, such as, a bank, for a fixed period of time, at a fixed rate of interest.
Debentures
A debenture is a loan to a company. A debenture is secured by a right to sell certain property of the company if the loan is not repaid on time.
Unsecured Notes
An unsecured note is a loan to a company. The loan is not secured by any right to sell the property of the company if the loan is not repaid on time.
Short Term Sources of Finance
A Bank Overdraft
A bank overdraft is a loan that allows a business to withdraw more money from its bank account than has been deposited in the bank account.
Credit Terms offered by Suppliers
A trading business may be able to negotiate 30 day or more payment terms from a supplier of inventory.
Factoring of Debtors
A business may be able to sell its accounts receivable to a factoring company
The factoring company, may, for example, buy the accounts receivable at a price equal to 80% of the amount owing. The business receives the cash and the factoring company collects the full amount owing on the due date.
Commercial Bills
A commercial bill is a bill of exchange issued by a bank or by a company. It is a form of loan and may be for a period of 1 to 6 months or for a number of years.
A bills of exchange is 'an unconditional order in writing, addressed by one person to another, signed by the person giving it, requiring the person to whom it is addressed to pay on demand, or at a fixed or determinable future time, a sum certain in money or to the order of a specified person, or to bearer.
Long Term Sources of Finance
Share Capital
Public companies can raise money by issuing shares to the public. Proprietary companies cannot raise money from the public.
Bank Loan
A business can borrow money from a bank, for periods of 5 years or more. This type of loan should be used to purchase plant and equipment that will be used by the business for many years
Lease Finance
A lease is an agreement to rent a particular item of plant and equipment for a fixed number of months or years. There are two types of leases. A finance lease means that the business has the right to purchase the item of plant and equipment at the end of the lease agreement. An operating lease means that the business can use the plant and equipment for the length of the lease agreement but the plant and equipment must be returned to the finance company at the end of the lease agreement.
Debentures
A debenture is a type of loan agreement made with a company. The investor receives interest, at a fixed rate, on the money loaned. The debenture is backed by a right to sell certain assets of the company if the loan is not repaid on time.
Unsecured Notes
An unsecured note is a type of loan agreement with a company where the money loaned to the company is not secured by any right to sell the property of the company if the loan is not repaid.
Business Strategies
Cost Leadership
Cost leadership is a situation in which a business has lower costs than its competitors and is able to sell its products at lower prices than its competitors. Cost leadership may be achieved by setting up a chain of large retail shops, buying large volumes of products at low prices and having a management team that is focused on finding other cost savings.
Example: Bunnings Warehouse operates a chain of large hardware stores. Bunnings Warehouse can purchase large quantities of products at the one time, achieve bulk discounts and pass on these cost savings to consumers.
Product Differentiation
Product differentiation occurs when a business offers customers a product that has superior benefits to competing products
Example: Google became the number one Internet search engine because it had a higher number of relevant search "hits" than other search engines.
Strategic Initiatives
A strategic initiative is a major plan of a business that, once implemented, is likely to have a significant impact on the future of the business.
Performance Management
Performance management is the process in which the employees of a business are made aware of the level of performance expected of them and involves the periodic review of their performance.
Methods of Profit Calculation
Cash Accounting
Cash accounting is a method of profit calculation in which income is recognised as existing when cash is received and an expense is recognised as existing when it is paid.
Fictional Example 1:We Move Couriers prepares monthly income statements. In May it provided a service on credit valued at $900. In June it received the $900. When cash accounting is used the $900 will be revenue in the June income statement.
Fictional Example 2:
We Move Couriers received a $300 electricity bill in May. The electricity bill will be paid in June. When cash accounting is used the $300 of electricity expense will be included in the June income statement.
Accrual Accounting
Accrual accounting is a method of profit calculation in which income is recognised as existing when a service has been carried out or when inventory has been sold and an expense is recognised as existing when it is consumed.
The AASB accounting standards require the use of accrual accounting in preparing financial statements.
Fictional Example 1: Efficient Couriers prepares monthly income statements. In May it provided a service on credit valued at $900. In June it received the $900. When accrual accounting is used the $900 will be revenue in the May income statement.
Fictional Example 2: Efficient Couriers received a $300 electricity bill in May. The electricity bill will be paid in June. When accrual accounting is used the $300 of electricity expense will be included in the May income statement.
Chapter 2 - Classification of Costs I
Definition of Cost
A cost is the value of a resource used in the manufacturing of a product (like timber) or the carrying of other business activities (like electricity).
Types of Costs
Fixed Costs Fixed costs do not change with the number of products manufactured. These costs are typically over a period of time such as annual rent where the number of products produced don’t affect the rent. Examples include rent, insurance, advertising, depreciation, interest on loan and the salary of a manager.
Variable costs change in proportion to the amount of product being produced. Examples include raw materials and the wages of employees.
Mixed Costs: A combination of Fixed and Variable costs where there is typically a base component (the fixed costs) paired with a variable when more of a product is being produced (the variable costs). Examples include electricity and telephone services.
Chapter 3 - CVP: Profit or Loss Calculation
CVP definition
Cost Volume Profit (CVP for short) analysis explores the relationship between the revenue, expenses and the profit of a business.
Contribution Margin
The contribution margin is the revenue available after subtracting the variable expenses of a business.
Chapter 4 - Break Even Analysis
Break Even Point Definition
The break even point is where the revenue of a business is equal to the expenses of the business. At this point, the business does not make a profit nor a loss.
Limitation of Break Even Analysis
Fixed expenses are fixed for only a short period of time. In the long term, expenses will naturally increase.
The variable expenses per unit may decrease as a manufacturing business expands due to the economies of scale.
A business may be able to obtain a bulk purchase of inventory, reducing the variable expenses
Chapter 5 - Capacity Constraints
What are Capacity Constraints
Most businesses have a limited number of products they are able to make. This may be causes from machine hours available or lack of skilled workers to operate the machines
If a manufacturing business makes and sells two or more products but faced with capacity constraints, it will have to calculate how many of each product it can actually make and how to maximise profits
Chapter 6 - Other Business Decisions
What are Other Business decisions
Special Order Decisions
A business may be offered a special order and has to make a decision on whether to accept or reject
Keep Open or Close Down Decisions
CVP analysis is useful for debating whether a business should be kept open or not on certain days
Make or Buy Decisions
A business may make the decision to produce their own product or delegate the service to another manufacturer to make it themselves.
Chapter 7 - Classifications of Costs
What are Direct and Indirect Costs
A direct cost that can easily be linked to a particular cost object
Examples include wages, wood and metal
An indirect cost cannot easily be linked to a particular cost object
Examples include ink, glue and nails
What is the difference between product and period costs
Product costs is easily linked to the manufacturing of a product
Examples include wood and metal
Period costs is linked to a particular accounting period but cannot be linked to a particular product
Examples include advertising, rent and telephone
What are the types of Product Costs
Direct Material
Direct Materials are the raw materials that are turned into finished products and can be easily linked to a product
Examples include wood, metal and cloth
Indirect Material
Indirect materials are raw materials that are included in the final product but cannot be easily linked to a particular product or are consumers in the manufacturing process. Indirect materials are included in factory overhead.
Examples include glue and nails
Direct labour
The wages of the employees who manufactures a product or provide a service to customers
Indirect Labour
Indirect labour is the wages of the factory supervisors and other people working in the factory but not directly involved in the manufacture of the product
Factory Overhead or Manufacturing Overhead
Factory overhead are the costs incurred in manufacturing a product that cannot be easily linked to a product
Examples includes:
Wages of the factory supervisor
Rent of factory
Electricity of the factory
Oil and grease used to keep the machinery operating
Depreciation of machinery
Indirect material
Factory cleaning
Repair and maintenance
The finished products of a manufacturing business are the inventory of this business. The cost price of the inventory is the value of the direct material, direct labour and factory overhead incorporated into the finished products.
What is the classification of time
Not all costs should be considered when making a business decision. Costs, for decision making purposes, can be divided into relevant costs and sunk costs
Sunk costs are past costs that cannot be changed in the future
Relevant costs are future costs linked to a particular investment proposal
Chapter 8 - Job Order Cost
What is job order costs
A manufacturing business has to calculate the costs of every product
Process costing is used when a manufacturing a large number of identical products such as televisions and water bottles
Job order costing is used when a business manufactures a small number of identical products (often called a batch) or when a product is made to be unique. These businesses can include printers, house painters and tailors where each case is unique.
Chapter 9 - Standing Costs
What is standing costs
Standing costing is an account system that can be combined with job order costing. When a business uses standard costing calculation, on a yearly basis the most efficient cost of manufacturing each of its products. These records are called standard costs and compared later with actual manufacturing costs.
What are advantages of standing costs
Standard costing allows a business to establish expected costs for direct material, direct labour and factory overhead and thus become a target to aim to reach
It can be used as a benchmark against which the business can compare the actual performance which is beneficial in identifying inefficient practises
Standard costing also ensures that management is focused on keeping the costs down
Direct Material Variance
A direct material price variance occurs when there is a difference between the actual purchase price of the direct material and the standard purchase price of the direct material.
Reasons
Favourable: A cheaper supplier was found
Unfavourable: An unexpected increase in price of raw materials
Direct Material Usage Variance
A direct material usage variance occurs when there is a difference between the actual quantity of direct material used in manufacturing a product and the standard quantity of direct material that should have been used in making the product
Reasons
Favourable: The use of a higher grade of material described in the standard may result in a business using a smaller quantity of raw material
Unfavourable: The wastage of raw material by poorly trained or inexperienced workers.
Direct Labour Rate Variance
A direct labour rate variance occurs when there is a difference between the actual direct labour rate (price) per hour and the standard direct labour rate per hour
Reasons
Favourable: Greater than expected use of low qualified, cheap to employ, workers.
Unfavourable: Unexpected wage rise or higher paid workers to do jobs normally carried out by lower paid workers
Direct Labour Efficiency Variance
A Direct Labour Efficiency Variance occurs when there is a difference between the actual direct labour hours worked and the standard direct labour hours that should have been worked for the actual number of products made.
Reasons
Favourable: Improved producitvity achieved by better motivated employees. The introduction of new, more efficient plant and equipment
Unfavourable: Poorly trained or inexperienced workers. Plant and equipment break downs forcing employees to take time off work
Chapter 10 - Capital Budgeting
What is capital budgeting
A capital investment is the spending of a large amount of money from a business with the idea of making a return in the future
This can include starting a new business; replacement of plant and equipment; opening a new shop; manufacturing of a new product; purchasing of another business
Factors affecting Capital Investment Decisions
Customer Preference
A business that wants to develop a new product should make sure that it understands the needs of the intended consumers of thai product before proceeding with the investment
If there isn’t a market for a good, no one will want to buy it meaning there is a loss bound to occur
Competitors
A business should understand the strengths and weaknesses of other competitors in the space. A business should consider the likely reaction of its competitors to any investment
It should look at other competitors compared to their own to see if they can create a niche or footing in a market
Government Policy
A business must ensure that any investment proposal takes into account the cost of complying with government regulations
If there is laws on how much pollution a business can be made, extra cost
What is the time value of money
The time value of money states that a dollar today is worth more than one dollar received on some future date. Money today can be invested with a bank and will grow into a larger amount of money over time as interest is added to the original amount.
Methods of Evaluating Capital Investment Decisions
Payback Period and NPV
Payback Period
The payback period is the length of time a proposal expected to take to repay the initial cash outlay
A business can set a maximum acceptable payback period. Any proposal takes longer the maximum payback period should not be expected
When two competing proposals are being evaluated and both proposals have acceptable payback periods, the proposal with the shorter payback period will be chosen
Advantages:
Simple to calculate
Easy to understand
A good indicator of the risk of an investment
Disadvantages:
The payback period does not take into account the time value of money
The payback period cannot determine if a proposed investment is likely to general an acceptable return
The payback period ignores cash inflows after the payback period is reached
The payback period makes assumptions about future cash flows that may not be accurate, particularly for the latter years of a project
Net Present Value Method
The net present value method determines if the expected rate of return of an investment proposal is above, equal to or below the rate of return required by a business
If the expected rate of return is higher than or equal to the required rate of return of the business then the business should proceed with the investment
The present value is the value of an amount invested for a fixed number of future periods at a given rate of interest per period
The rate of interest that is used in the present value calculations is known as the discount rate or the cost of capital
Advantages:
Takes into account the time value of money
Has a simple decision rule
If Positive = Should be accepted
If Negative = Should be rejected
Established if a required rate of return should be achieved
Disadvantages
The net present value method makes assumptions about future cash flows that may not be accurate, particularly for the latter years of a project
More complex to calculator than the payback period
Less easy to understand than the payback period
Chapter 11 - Budgets
What is a budget
A business should plan for the future
This is achieved through a budget as it is a plan for the future of business activities expressed in money terms
Advantages of Budgets
A budget provides a business with a set of objectives to be met
A budget helps identify problems like shortages of cash
A budget helps coordinate business activities
A budget can motivate employees to achieve a deadline
A budget can help evaluates its performance and reflected on accordingly
The Master Budget
A master budget is the name given to the full set of budgets prepared for a business prepared
This can be divided into Operating Budgets and Financial Budgets
Operating Budgets
The operating budgets are the set of budgets that provide the information required to prepare a budgeted income statement.
The operating budgets, for a manufacturing business include: Sales budget; production budget; raw materials budget; direct labour budget; cost of sales budget; other expenses budget; budgeted income statement
Financial Budgets
The financial budgets are the remaining budgets prepared by a business
This include: cash budget; budgeted balance sheet; capital expenditure budget
The Capital expenditure budget set out the type and cost of the non-current assets that must be purchased in order to meet the objectives of the business for a given future period of time
Budgeted Income Statement
A budgeted income statement sets out the expected income, expenses and profit or loss for a future period of time. The budgeted income statement is prepared in the same way as an actual income statement. However, the expenses do not need to be classified.
Budgeted Income Statement Performance Report
A budgeted income statement performance report sets out the expected and actual income, expenses and profit or loss for a future period of time.
A budgeted income statement performance report is set out the same way as a cash budget performance report.
Chapter 12 - Companies
Definition of Company
A company is an organisation established under the Corporations Act 2001 (Cth) as a separate legal entity. A company can enter into legal agreements in its own name, can own property and can be sued in its own name.
Corporations Act 2001
All aspects of company formation and certain aspects of company operation are controlled by an Act of the Commonwealth Parliament known as Corporations Act 2001. This applies to all the Australian States and Territories.
Purpose of the Corporations Act 2001
Defines and gives a legal existence to a company.
Sets out the duties of the directors of a company.
Sets out the external audit requirements of a public company.
Sets out and defines the different types of companies that are permitted to exist under the Act, such as, public or proprietary companies.
Requires that the financial report for a financial year of public and large proprietary companies must comply with the AASB accounting standards.
Company Capital
The capital of a company is divided into parts known as shares. Each share has an associated value in terms of money. People who purchase shares become owners of the company, known as shareholders or members.
Company Directors
Shareholders of a company elect or appoint people to act on their behalf. These representatives of the shareholders are known as directors. The directors appoint managers who are responsible for the day-to-day running of the company
Powers of Directors
The Corporations Act provides that the directors are to manage the company. The company constitution or replaceable rules set out the powers of the directors and these powers may include the right to issue shares, to borrow money and to appoint and dismiss the senior managers of the company.
Duties of Directors
A director must carry out the duties with reasonable care and diligence.
A director must act in the best interests of the company.
A director must ot make importer use of their position to gain an advantage for themselves or for another person.
A director must not make improper use of information obtained as a director to gain an advantage for themselves or for another person. For example, if a director knows a business is going to turn a major profit, they are unable to buy shares until the information is known to the public
A director must ensure that a company does not trade when it is insolvent.
Companies Limited by Shares
There are different types of companies. The most common type of company is the company limited by shares.
A company limited by shares is one in which the liability of the shareholders for company debts is limited to the amount owing on their shares.
A company limited by shares must have the word “Limited” or the letters “Ltd” included in its name.
Proprietary Company
A proprietary company cannot raise money from the public
A proprietary company must have at least 1 shareholder and a maximum of 50 non-employee shareholders.
A proprietary company must have at least 1 director.
A proprietary company must have the word “Proprietary” or “Pty” included its name
Small and Large Proprietary Companies
A large Proprietary company must satisfy two of the following criteria
The total revenue, for the financial year, is $25 million or more
The total gross assets, on the last day of the financial year, is $12.5 million or more
The company, at the end of the financial year, has 50 employees or more.
The financial year runs from 1 July of one year to 30 June of th next year
A large Proprietary must lodge a financial report with the Australian Securities and Investment Commissions (ASIC) each year. This financial report includes a statement of comprehensive income (a report that shows the profit or loss), a statement of cash flows, and a balance sheet. Also, the accounting records of the company must be audited each year unless ASIC grants an exemption.
Public Company
A public company is any company that is not a proprietary company.
A public company must have at least 1 shareholder and there is no upper limit for the number of shareholders.
A public company can ask the public to purchase shares in the company and can issue debentures to the public.
A public company must have at least 3 directors.
A public company limited by shares must have the word “Limited” or the letters “Ltd” in their name.
Prospectus
A prospectus is a document issued by a public company that invites the public to purchase the shares or debentures of the company. A prospectus must contain all the information that an investor would reasonably expect it to contain in order to make an informed assessment of the future prospects of the company.
What does a prospectus includes
Financial information about the company, such as, the assets and liabilities of the company and the recent and expected future sales.
The number of shares that are being offered for sale and the offer price.
Key facts about the directors of the company.
An application form that investors wishing to apply for the shares must complete and return to the company.
A copy of the prospectus must be lodged with ASIC.
Advantages of Companies Limited by Shares
Public companies listed on the ASX can raise large amounts of capital by issuing shares.
Public companies can borrow large amounts of money from the public.
Shareholders of companies limited by shares know that they have the protection of limited liability.
A company has a continuous existence
A person who has no business skills can become a part owner of a company listed on the ASX. Also, the shareholders in these companies can easily sell their shares.
Annual General Meeting
Every public company that has more than one shareholder must hold an annual meeting of the shareholders and the directors. This meeting is known as the annual general meeting and gives the shareholders the opportunity to question the directors about the performance of the company over the previous 12 months. Also, at the annual general meeting the shareholders elect the directors and, if required by the constitution of the company, approve a final dividend recommended by the directors.
Company Income Tax
A company pays income tax on the profit it makes. Income tax is calculated annually by the company and is entered in the profit and loss ledger account as an expense. Income tax is also shown as a liability in the balance sheet.
Company Management
The rules for the management of a company are contained in either a document known as the replaceable rules or in the company’s constitution.
Replaceable Rules
The Corporation Act contains a set of rules, known as replaceable rules, which can be used to manage a company.
A company can choose to have its own constitution or use the replaceable rules or use a combination of its own constitution and one or more of the replaceable rules.
The replaceable rules cover matters, including:
The appointment and removal of directors.
How a shareholder can obtain the right to inspect the accounting records.
How voting is to be carried out at a meeting of shareholders.
Who has the authority to approve the payment of a dividend.
Company Constitution
The constitution of a company is a set of rules for the management of a company. It can be used to modify or completely replace the replaceable rules.
The constitution is a contract between the company, the shareholders, and the directors. All parties agree to follow the rules set out in the constitution.
Characteristic of Companies
Limited Liability
The liability of a shareholder for the debts of a company limited by shares is restricted to the amount the shareholder owes on these shares.
Number of Owners
A public and a proprietary company must have a minimum of 1 shareholder. There is no upper limit on the number of shareholders of a public company. A proprietary company can have a maximum of 50 non-employee shareholders.
Number of Directors
A public company must have a minimum of 3 directors. A proprietary company must have at least 1 director.
Continuity of Existence
The ownership of a company will change from time to time as shareholders die or sell their shares but the company continues to exist until it is deregistered.
Separate Legal Entity
A company is a separate legal entity. A company can own property and can enter into contracts in its own name and can sue and be sued in its own name.
Transfer of Ownership
A shareholder in a public company can sell their shares at any time, without restriction. A shareholder in a proprietary company may be prevented by the constitution of the company from selling their shares without the approval of the other shareholders.
Separation of Ownership and Management
In a company there is a separation of ownership and management. The owners of a company are the shareholders. The shareholders appoint directors to supervise the management of the company. In a proprietary company a person may be the only shareholder and the only director. However, the role of a director is still separate from the role of a shareholder.
Types of Shares
Preference Shares
Preference shares have one or more rights attached to them that are not attached to ordinary shares.
The usual right of preference for shareholders is the right to receive a fixed rate of dividend.
Ordinary Shares
Ordinary shares have no special rights attached to them. Ordinary shareholders do not have a right to a dividend at a fixed rate.
Rights of Ordinary Shareholders
If a company is liquidated, the ordinary shareholders are entitled to the repayment of their capital after all the creditors have been paid.
The right to vote at meetings of shareholders and to elect the directors of the company.
The right to receive a copy of the annual financial report of the company.
The right to receive a dividend once the dividend has been approved for payment.
What the two types of dividends
Final dividend: Is usually recommended by the directors, approved by the shareholders at the annual general meeting and then paid out
Interim Dividend: Is declared and paid by the directs without shareholder approval. The authority to pa an interim dividend must be given to the directors in the constitution of the company.
Chapter 13 - The Statement of Cash Flows
What is the purpose of Cash Flows
Assess the ability of a company to generate net cash flows from the sale of products or the providing of services
Check the accuracy of past predictions of the cash generating ability of a company
Compare the cash generating ability of different companies
Assess the ability of a company to pay its debts
Definition of Cash and Cash equivalents
AASB 107 Statement of Cash Flows states that cash inflow and outflows are made of cash and cash equivalents
The word “cash” means notes and coins held on the business premises and deposits held at call with a financial institution, such as a bank. The term “at call” means money that a business can withdraw from a financial institution at any time.
The term “cash equivalents” means short-term investment that can be easily converted into cash and have an insignificant risk of change in value. An example is money held in a six months, fixed term bank deposit, with 90 days to maturity.
A cash equivalent is usually convertible into cash within three months.
What are specific disclosures in Cash flows
Income tax paid
Interest received
Dividends received
Interest paid
Dividends paid
How do you comment on the analysis of cash flow
Comment on the net cash from operating
A positive net cash from operating activities is a healthy indicator for a business
A business cannot survive, in the medium to long term, unless it generates positive cash flows from operating activities
Comment on the net cash from investing activities by answering the following questions
Has the business purchased non-current assets that can be used to generate income in the future? A sensible investment in non-current assets is a positive indicator for a business.
Has the business sold non-current assets to finance a negative net from operating activities? This is a negative indicator.
Comment on the net cash from financing activities by answering the following questions
Did the business have to borrow money or raise additional share capital to cover a negative net cash from operating activities? This is a negative indicator for the business
Has the business used a short term loan (one year or less) to purchase non-current assets? Non-current assets should be purchased using either long term loans or equity.
Is any dividend paid to the shareholders larger than the net cash from operating activities? This my indicate excessive drawings.
Chapter 14 - Ratios
Liquidity
The word liquidity means the ability of a business to pay its debts as they are due for payment
Two ratios current ratio, quick asset
Current Ratio
The current ratio or the working capital ratio is a measure of the ability of a business to pay its short term debts, that is, debts payable within 12 months.
If the business had a current ratio of 155%, it has $1.55 of current assets to pay $1 of its current liabilities
Interpretation:
Current Ratio of less than 100%: The business may find it difficult to pay its short term debts or the business is operating in an industry in which money is collected from sales very quickly. Examples, Coles and Woolworths.
Current Ratio of between 100% and 200%: A current ratio of between 100% and 200% indicates that a business should be able to pay its short term debts.
Current Ratio of more than 200%. A current ratio of more than 200% indicates that a company should be able to comfortably pay its short term debts or that a company has an excessive level of current assets and is not making the best use of its resources to generate revenue.
Quick Asset Ratio
The quick asset ratio is a measure of the ability of a business to pay its short term debts (excluding any bank overdraft) using only its more liquid current assets
If the business had a current ratio of 85%, it has 0.85 of highly liquid current assets to pay $1 of its current liabilities except for the bank overdraft.
Interpretation
A quick asset ratio of 100% or more indicates that a business should be able to pay its short term debts.
A quick asset ratio of less than 100% indicates that a business may not be able to pay its short term debts.
Stability
A business can purchase assets using borrowed money, share capital or form the cash generated from the profit
Stability ratios measure the medium to long term survival prospects of a business based on the extent of the borrowings of that business.
Gearing or leverage is the term used to describe the extent of the borrowings of a business. A highly geared business has a large interest and loan repayments and has an increased risk of failure.
Debt to Equity Ratio
Measures the debt to equity ratio of the gearing of the business
Total liabilities/Equity
Interpretation:
There is no acceptable figure for the debt to equity ratio. It should be compared with industry averages and past performance. Generally, the higher the ratio, the worse off the business is due to liabilities increasing
Times Interest Earned
The number of times that the interest of a company is covered by the profit before tax.
Interpretation
Anything within 3-4 times offer a good safety margin for a company
Profitability Ratios
Profit Margin Ratio
Percentage of profit after income tax that is contained in each dollar of sales
Profit (after tax)/ Net Sales
The profit after tax is used as this is the profit available to the shareholders
Interpretation
An increase in the profit margin may be caused by:
A reduction in expenses
An increase in selling prices compared to cost of sales
Cheaper supplier of inventory has been found
A decrease in the profit margin may be caused by:
Expense increases that are not being fully passed on to consumers in the form of increased selling prices
Increase competition causing the business to lower its selling prices
Rate of Return on Assets
The rate of return on assets measures how efficiently a business has used its assets to generate a profit
Interpretation
Should be compared to industry standards. Bigger number better.
Market Ratios
Market ratios are used by investors to review the performance of public companies listed on the ASX
Earnings per Ordinary Share
The portion of the company’s annual profit after tax and preference dividends allocated to each issued ordinary share.
Interpretation
Should be compared to past profits and other companies. Bigger number better.
Price Earnings Ratio
The number of times earnings per ordinary share that an investor is prepared to pay to purchase an ordinary share in the company.
Interpretation
A high price earnings ratio (compared to industry average) indicates investors believe good future economic growth or is overconfident
A low price earnings ratio indicates that investors believe the company has poor profit growth prospects or is underconfident.
Dividend Yield
Shows how much a company has paid out in dividends in a year relative to its share price
Interpretation
Just how much return on profit it can generate
Efficiency ratio
Evaluate the performance of the management of a company in the areas of inventory and accounts receivable
Debtors Collection Period
Measures how quickly a business collects the money owing from credit sales.
Interpretation
An increase in the debtors collection may be caused by:
Poor debt collection procedures
The slow process of sales invoice.
Failing to check credit rating of new customers
A business may offer longer credit terms to potential customers
A decrease in this ratio would indicate it has improved
Inventory Turnover
How many times a business each year replaces its inventory.
Interpretation
An increasing inventory turnover ratio mean that the products sold by the company are doing well
A decreasing inventory turnover ratio indicates the inventory management policy is inefficient, out of they over ordered inventory or slow moving/obsolete inventory
Limitations of Ratio Analysis
Ratios do not identify the causes of problems.
Ratios are usually only of limited value. They often need to be compared to an industry average.
Limited disclosure of information makes it impossible to calculate some ratios
It is not always possible to compare ratios between businesses as different accounting policies may have been chosen that will affect ratio calculations
Diversification of Investment
A rule of thumb is not to put all your eggs in one basket
This is to offset any potential fluctuations
Chapter 15 - Accounting Theory
What is CSD
Corporate Social Disclosure (CSD) refers to the voluntary release of information by companies about their social, environmental, and economic impacts. It involves providing stakeholders with detailed reports on a company's initiatives, policies, and performance related to sustainability and social responsibility.
Benefits of CSD:
Enhanced reputation: CSD helps companies build a positive image by demonstrating their commitment to social and environmental issues. It can enhance stakeholder trust, attract socially responsible investors, and improve brand value.
Stakeholder engagement: CSD provides a platform for companies to engage with stakeholders, including customers, employees, investors, and communities. It allows them to address concerns, gather feedback, and build stronger relationships.
Risk management: By disclosing their social and environmental practices, companies can identify and mitigate potential risks. It enables them to proactively manage issues such as environmental impact, labour practices, and supply chain ethics.
Competitive advantage: CSD can give companies a competitive edge by differentiating them from their peers. It allows consumers to make informed choices based on a company's social and environmental performance, leading to potential market advantages.
Regulatory compliance: CSD can help companies meet legal obligations and regulatory requirements related to sustainability reporting and disclosure.
Limitations of CSD:
Lack of standardisation: There is no universally accepted framework for CSD, resulting in varying reporting practices. This makes it challenging to compare and benchmark companies' performance.
Greenwashing: Some companies may engage in "greenwashing," where they overstate their environmental initiatives to create a positive image without substantial actions. This can mislead stakeholders and undermine the credibility of CSD.
Reporting bias: Companies may selectively disclose positive information while omitting negative aspects of their social and environmental practices. This can lead to incomplete and biased reporting, limiting stakeholders' ability to make informed decisions.
Difficulties Faced by Accounting in Preparing CSD Reports
Accountants may lack the knowledge to prepare CSD
Many of the items included in CSD may not be able to be measured accurately
There is little guidance on what to include in CSD
What is the purpose of general financial reports
A general purpose financial report refers to the reports given to shareholders and other stakeholders. It includes reports such as the statement of comprehensive income, statement of financial position, statement of cash flows, notes, and statement of changes in equity. Its purpose is to provide financial information of a particular business to any current or possible future stakeholders such as investors, lenders, suppliers and other creditors when deciding whether to provide services or resources to the business.
The Financial Reporting Council
Is the branch of government responsible for overseeing the effectiveness of the financial reporting framework in Australia. Its importance lies in the oversight of the accounting standards and quality of auditing standards that both Australian private and public companies are held accountable to. They monitor and provide information to the Minister in relation to the structural integrity of the Australian accounting framework as well as promote the development of a singular set of accounting standards internationally. This is particularly crucial when it comes to multinational companies.
Australian Securities and Investments Commission
Separate from, however still funded by the government, ASIC regulates the credit for Australia including corporate, markets, financial services and consumers. They operate under the ASIC Act 2001 and their role includes; maintaining, facilitating and improving the financial system and entities in it; to promote confident and informed participation by investors and consumers in the financial system; administer the law effectively and with minimal procedural requirements; receive, process and store information received efficiently; make information about companies and other bodies available to the public as soon as practicably possible; and enforce and give effect to the law concerning the financial system within Australia.
International Accounting Standards Board
Composed of a diverse cultural background and current practical experts in accounting and finance, IASB is an independent body responsible for the development and publication of International Financial Reporting Standards. This also includes verifying interpretations of these standards across countries. Like the FRC in Australia, the IASB aims to unify the accounting standards globally to ensure a high set of standards and reduce indistinct areas in accounting internationally. They operate in over 160 countries.
Australian Accounting Standards Board
The Australian Government agency that is responsible for the development of a conceptual framework for accounting standards who are registered in the Australian Securities Exchange. Operating under the ASIC Act 2001 they are entrusted with formulating accounting standards with the objective to reduce the cost of capital and enable Australian entities to compete effectively overseas as well as maintaining investors confidence in the Australian economy and external reporting.
Australian Securities Exchange
ASX refers to the primary stock exchange market in Australia where a range of types of shares can be traded for both Australian and non-Australian companies. Equity, bonds, hybrids, ETFs, ETPs, managed funds, warrants, index derivatives, interest rate derivatives, energy derivatives, grain derivatives, and options can all be accessed through ASX. Its primary purpose is to allow free trade and access to a wide range of industries as well as educate potential investors in the financial positions of each listed company. Its other functions include being a market operator, overseeing the compliance of these operations, corporate governance, and facilitating payment clearing. v
Lobby Groups
Are organisations that attempt to influence decisions made by government officials such as legislators on behalf of a particular group or industry. Lobbying occurs most commonly in accounting during the process of setting accounting standards such as through the IASB and their legislature. Lobby groups act in the interest of creating beneficial economic outcomes for the industries they represent.
Elements of Accounting reports.
Assets - a resource controlled by the entity through past transactions in which future economic benefits are expected to be received from. They can be current e.g. inventory,accounts receivable, prepaid rent. And they can also be noncurrent e.g. motor vehicles, plant and equipment, land.
Liabilities - a present obligation of an entity to transfer resources as a result of past events. They can be current e.g. accrued wages, unearned income. And they can also be noncurrent e.g. loans from the bank.
Equity - the residual interest in the assets of the entity after deducting all its liabilities. Examples include retained earnings and share capital.
Income - increases in assets or decreases in liabilities that result in an increase in equity of a business. This can include sales, fees and interest income.
Expenses - decreases in assets or increases in liabilities that result in an decrease in equity of a business. This can include wages, bad debts and utilities (electricity, telephone etc).
Accounting theory aspects
Accounting principles - refer to the rules and principles companies must follow when recording their financial information in accounting reports. They are the generic frameworks and assumptions that help to keep reporting uniform across most companies. Accounting principles include the business entity concept - the rule stating that the owners personal financing and equity is to be kept separate from the finances, runnings and equity of the business; the monetary principle - all transactions have a monetary value and are expressed in accounting reports as statements involving currency; and the accounting period - each accounting report has a starting and ending date whereby by all transactions appropriate for that report that occurred during this time are included in the report (usually 12 month periods). Other principles include the accrual accounting - transactions will be recorded within the period that they occur; conservatism - all debts and expenses will be recorded as early as possible; consistency - businesses will continue to use the same form of reporting for ease in comparison and recording; and the going concern principle - the business will treat its operations with the assumption that it will continue to run in the future.
AASB accounting standards
Refers to the set of rules companies listed under the Australian Securities Exchange must follow when they prepare accounting reports. They are issued by the Australian Accounting Standards Board and outline the setting out and points of inclusion of accounting reports to create a uniform standard across companies. Their purpose includes helping investors by ensuring the reports are relevant and contain reliable information of the performance of the company, assist the directors in performing their duties, and boost the confidence of potential investors looking on the ASX market.
Conceptual framework of accounting
Sets out the qualities of a good financial statement and defines the following accounting terms; assets, liabilities, equity, income and expenses. This also includes the fundamental and enhancing qualitative characteristics. Fundamental Qualitative Characteristics refers to making sure the relevant financial information is included which may alter the decisions made by users - especially important if misstating it could influence the basis for these decisions (materiality). It also includes making sure that the financial information included is fairly and accurately represented (faithful representation). Enhancing Qualitative Characteristics refers to the concept that improves the usefulness of the information presented in reports. This includes comparability - ability to identify and understand similarities or differences in financial statements; understandability - users should be able to comprehend the meaning of the information presented; verifiability - different, knowledgeable users of the financial statement agree with the faithful representation of the information; and timeliness - information is available to decision makers suitably in advance so it can influence their decisions.
Qualitative Characteristics of Accounting Reports
Relevance: The quality of information that exists when information assists users to make economic decisions by helping them evaluate past, present or future events.
Materiality: Information is material if the omission of this information from an accounting report could influence the investment decisions
Reliability: Quality of information that exists when information is free from significant errors and bias.
Faithful Representation: Must faithfully represent the transaction
Neutrality: Free from Bias
Prudence: Exercises caution
Completeness: Should contain all information
Comparability: Measurement and display of identical transaction should be consistent
Understandability: Exists when the users of financials reports should be able to be understood