ACCOUNTING FOR DECISION

MAKERS

Sanjaya Bandara
B. Sc
(Accountancy) Sp,
FCA, ACMA, MBA

COURSE CONTENT
Introduction to accounting.
Accounting concepts.
Preparation of financial statements.
Financial statement analysis.
Working capital management.
Budgeting.
Breakeven analysis.

ASSESMENT STRUCTURE.
Close book examination. Two exam papers.
1) MCQ Paper - 1.5 Hours , 40 questions.
2) Paper for 2.5 Hours , 3 questions
RECOMMENDED READING.
Peter atril Finance for Non
specialists

finance

What is accounting ?
Accounting is all about collecting,
analyzing and communicating financial
information to the stake holders of
organizations. For example, the managers
of
business
may
need
accounting
information to decide whether to:
Increase or decrease the price or
quantity of existing products or services
Borrow money to help finance the
business
Change the methods of purchasing,
production or distribution

What are accounting and finance?

(Contd..)
Though managers working within a particular
business are likely to be significant users of
accounting information about that particular
business, they are by no means the only
ones. There are those outside the business
(whom we shall identify later) who may need
information to decide whether to:
invest or disinvest in the ownership of the
business;
Lend money to the business;
Offer credit facilities;
Enter into contracts for the purchase of
products or services.

USERS OF ACCOUNTING
INFORMATION
(STAKE HOLDERS)

Owners / Shareholders
Management
Employees
Government
Potential investors
Suppliers
Lending organizations
Managers
competitors

Accounting as a service
function

One way of viewing accounting is as a form

of service.
The quality of the service
provided would be determined by the extent
to which the information needs of the various
user groups have been met. It can be argued
that, to be useful, accounting information
should posses certain key qualities, or
characteristics. They are called qualitative
characteristics of financial statements.
Relevance. Accounting information must
have the ability to influence decisions.
Unless this characteristic is present, there is
really no point in producing the information.

Accounting as a service
function (Contd..)
Reliability. Accounting should be free from
significant error or bias. It should be capable of
being relied upon by users to represent what it is
supposed to represent.
Comparability. This quality will enable users to
identify changes in the business over time. It will
also help users to evaluate the performance of
the business in relation to other similar
businesses.
Comparability is achieved by
treating items that are basically the same in the
same manner for accounting purposes.
Comparability tends also to be enhanced by
making clear the policies that have been adopted
in measuring and presenting the information.

Accounting as a service
function (Contd..)
Understandability.
Accounting
reports should be expressed as
clearly as possible and should be
understood by those at whom the
information is aimed.

MEASURING AND REPROTING FINACIAL

POSITION
The major financial statements an
overview
The objective of the major financial accounting
statements is to provide a picture of the overall
financial position and performance of the
business. To achieve this objective, the businesss
accounting system will normally produce the
following statements on a regular, recurring basis.
The statement of comprehensive income
The statement of financial position
The cash flow statement
Statement of changes in equity , notes to the
fin.statements and accounting policies.
Taken together, they provide an overall picture of
the financial health of the business.

Statement of Financial
position
The purpose of the this statement is
simply to set out the financial position of
a business at a particular moment in
time.
We can, however, be more specific about
the nature of the balance sheet by saying
that it sets out the assets of the business
on the one hand, and the claims against
the business on the other.

Assets
An asset is essentially a resource held by the
business. For a particular item to be treated
as an asset for accounting purposes it should
have the following characteristics:
A probable future benefit must exist. This
simply means that the item must be
expected to have some future monetary
value. This value can arise through its use
within the business or through its hire or
sale.

Assets (Contd.)
The business must have an exclusive right to
control the benefit / ownership of the asset.
The assets must be capable of measurement
in monetary terms. Unless the item can be
measured in monetary terms, with a
reasonable degree of reliability, it will not be
regarded as an asset for inclusion on the
balance sheet.
Note that all of these conditions must apply.
If one of them is missing, the item will not
be treated as an asset, for accounting
purposes, and will not appear on the balance
sheet.

The sorts of items that often appear

as assets in the balance sheet of a
business include:

freehold premises;
Machinery and equipment;
Fixtures and fittings;
Patents and trademarks;
Receivables (debtors);
investments

Note that an asset does not have to be a

physical item it may also be a nonphysical right to certain benefits. Assets
that have a physical substance and can
be touched are referred to as tangible
assets.
Assets have no physical
substance but which, nevertheless,
provide expected future benefits (such as
patents) are referred to as intangible
assets.

 Capital/ Equity
This represents the claim of
the owner(s) against the
business.
This claim is
sometimes referred to as the
owners equity.

 Liabilities.
Liabilities represent
the claims of all other individuals
and organizations, apart from the
owner(s).
Liabilities must have
arisen from past transactions or
events such as supplying goods or
lending money to the business.
Once a claim has been incurred by a
business, it will remain as an obligation
until it is settled.

The
classification
assets

of

To help users to understand more

clearly the information that is
presented, assets and liabilities are
usually grouped into categories.
Assets may be categorized as being
either current or non-current.

Current Assets
Current assets are basically assets that are held
for the short term. To be more precise, they are
assets that meet any one of four criteria. These
are:
They are held for sale or consumption in the
normal course of a businesss operating cycle;
They are for the short term
They are held primarily for trading
They are cash, or near cash such as easily
marketable, short-term investments.

The most common current assets are inventories

(or stock), customers who owe money for goods
or services supplied on credit (known as trade
receivables of debtors), and cash.

Non-current assets
They are held for the long-term operations
of the business. Essentially, they are the
tools of the business and are held with
the objective of generating wealth.
Examples of assets that may be defined as
being non-current are:

freehold premises;
Plant and machinery
Motor vehicles
patents

The classification of liabilities

Liabilities can be divided into,
Current liabilities are basically amounts
due for settlement in the short term.
Non-current liabilities represent those
amounts due to outside parties that
are not current liabilities.

Accounting
concepts

Conventions

Accounting is based on a number of

rules or conventions that have
evolved over time.
They have
evolved as attempts to deal with
practical problem experienced by
preparers and users, rather than to
reflect some theoretical ideal.

Business entity convention

For accounting purposes, the business
and its owner(s) are treated as being
quite separate and distinct. This is why
owners are treated as being claimants
against their own business in respect of
their investment in the business. The
business entity convention must be
distinguished from the legal position
that may exist between businesses and
their owners.

Money measurement convention

Accounting normally deals with only those
items that are capable of being expressed in
monetary terms.
Accrual basis of accounting
An entity shall prepare its financial
statements using the accrual basis of
accounting.

Historic Cost Convention

Assets are shown on the balance sheet
at a value that is based in their historic
cost (that is, acquisition cost). This
method of measuring asset value has
been adopted by accountants in
preference to methods based on some
form of current value. Many people find
the historic cost convention difficult to
support, as outdated historic costs are
unlikely to help in the assessment of
current financial position.

Going Concern Convention

The going concern convention holds
that the financial statements should
be prepared on the assumption that
the business will continue operations
for the foreseeable future, unless this
is known not to be true. In other
words, it is assumed that there is no
intention, or need, to sell of the noncurrent assets of the business.

Dual aspects convention

The dual aspect convention asserts
that each transaction has two
aspects, both of which will affect the
balance sheet. Thus the purchase of
a motor car for cash results in an
increase in one asset (motor car) and
a decrease in another (cash). The
repayment of a loan result in the
decrease in a liability (loan) and the
decrease in an asset (cash /bank)

Prudence Convention
The prudence is the inclusion of a
degree of caution in the exercise of
the judgments needed in making the
estimates required under conditions
of uncertainty , such that assets or
income will are not overstated and
liabilities and or expense are not
understated.

Substance over form

If information is to represent
faithfully the transactions and
other events that it purports to
represent, it is necessary that
they are accounted for and
presented in accordance with their
substance and economic reality
and not merely the legal form.

Objectivity Convention
The objectively convention seeks to
reduce personal bias in financial
statements.
As far as possible,
financial statements should be based
on objective verifiable evidence
rather than on matters of opinion.

The basis of valuation of assets on

the balance sheet
It was mentioned earlier that, when
preparing the balance sheet, the
historic cost convention is normally
applied for the reporting of assets.
However, this point requires further
elaboration as, in practice, it is not
simply a matter of recording each asset
n the balance sheet at its original cost.

The basis of valuation of assets on

the balance sheet
It was mentioned earlier that, when
preparing the balance sheet, the
historic cost convention is normally
applied for the reporting of assets.
However, this point requires further
elaboration as, in practice, it is not
simply a matter of recording each asset
on the balance sheet at its original
cost.

Tangible non-current assets

(property, plant and equipment)
Tangible non-current assets tend to be
referred to as property, plant and
equipment. Items of property, plant and
equipment should be measured initially at
their historic cost. However, they will
normally be used up over time as a result
of wear and tear, obsolescence and so on.
The amount used up, which is referred to
as depreciation, must be measured for
each accounting period that the assets
are held.

Tangible non-current assets (property,

plant and equipment) (Contd)
Although using depreciated cost is the
benchmark treatment for these assets,
an alternative is allowed. Property, plant
and equipment can be measured using fair
values provided that these values can be
measured reliably. The fair values, in this
case, are usually the current market
values.
By using fair value, a more up-to-date
figure than the depreciated cost figure is
provided to users, which may be more
relevant to their needs.

Intangible non-current assets

The benchmark treatment is that they are
measured initially at historic cost and any
depreciation (or amortization as it is
usually termed in the context of intangible
non-current assets) incurred following
acquisition will be deducted to obtain a net
book value. Once again, the alternative or
revaluing intangible assets using fair
values is available. However, this can only
be used where fair values can be properly
determined by reference to an active
market.

The impairment of non-current assets

There is always a risk that both types of
non-current asset (tangible and nontangible) may suffer a significant fall in
value. This may be due to factors such as
changes in market conditions, technological
obsolescence and so on. In some cases,
this fall in value may lead to the net book
value, or carrying amount, of the asset
being higher than the amount that could be
recovered from the asset through its
continued use. When this situation arises,
the asset figure on the balance sheet
should be reduced to its recoverable
amount. Unless this is done, the asset will
be over stated on the balance sheet.

MEASURING AND REPORTING

FINANCIAL PERFORMANCE
The statement of comprehensive income
Businesses exist for the primary purpose of
generating wealth, profit, and it is the profit
generated during a period that is the main concern
of many users of financial statements. Although the
amount of profit generated is of particular interest
to the owners of a business, other groups such as
managers, employees and suppliers will also have
an interest in the profit-making ability of the
business. The purpose of the income statement or
profit and loss account, as it is sometimes called is
to measure and report how much profit (wealth) the
business has generated over a period.

The statement of comprehensive

income (Contd.)
The measurement of profit requires that the
total revenue of the business, generated
during a particular period, be identified.
Revenue is simply a measure of the inflow
of economic benefits arising form the
ordinary activities of a business.
The total expenses relation to each
accounting period must also be identified.
Expenses is really the opposite of revenue.
It represents the outflow of economic
benefits arising form the ordinary activities
of a business.

The statement of comprehensive

income (Contd.)
The income statement for a particular
period simply shows the total revenue
generated during the period and
deducts from this the total expenses
incurred in generating that revenue.
The difference the total revenue and
total expenses will represent either
profit or loss