Accounting Foundations: Information for Decisions

Chapter 1Accounting and organisations

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Accounting Scandals

• Your perception

of Accounting

• What do you think a balance sheet tells a reader?

• What does the income statement tell a reader?

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1. What role does Accounting serve?Basic: to help people in organisations make decisions about economic activities

2. Does Accounting have economic consequences?Yes: it affects organisation plans, employment, future value (like share prices)

3. Are Ethics important in Accounting?Very important. Unethical accounting practices can ruin the fortunes of employees, suppliers and investors

Initial questions

Transactions

Identification

Quantification

in $ terms

Measurement

Recording

classification

summarisation

Recording

Accounting

Reports,

Analysis,

Interpretation

and advice

Communication

The Nature of Accounting

Value - low Value - high

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• Definitions of Accounting?• “The process of identifying, measuring, and

communicating economic information to permit informed judgements and decisions by users of the information” (American Accounting Association 1966)

• “Accounting is the art of being excruciatingly exact about a lot of arbitrary assumptions” (Austin Donnelly, about 1975)

Correct - but implies a deterministic process – i.e. if do this the outcome is valid

Insight?

3 May 20237

Alternative definitions of Accounting"Systematic method of converting organisational

activity into numbers in order to provide one explanation of what has occurred“ ?

• “Accounting is a way of making the invisible (performance, value) visible (profit, cost, value).”

• “Accounting is story telling with numbers”

• Insight?

Insight?

Insight?

Purpose of Accounting• Individual Level

– planning– controlling– decision support

• Organisation Level– planning– controlling– decision support– external reporting – why?

Questions

• Who are the stakeholders affected by managerial choices around accounting and financial reporting practices?

• • What purposes should drive the manager’s

decisions around accounting and financial reporting practices?

Accounting & Financial

Management

Unit 2

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1-10Exhibit 4Exhibit 4 Transformation of

resources into goods and services

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If the transformation of resources meets a need of

society, it creates value because more people are

better off after the transformation than before.

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Creating value

A market is any location or process that permits resources

to be bought and sold.

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Creating value

Accounting measures the increase in value created by a

transformation as the difference between the total price of goods

and service sold in a market and the total costs of resources

consumed in developing, producing, and selling the goods

and services.

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(A)Sales price of one box of biscuits

(B)Total cost of resources

consumed to produce and

make one box of biscuits available

(A) – (B)Value Added

$3.50 $3.00 $0.50– =

Exhibit 5Exhibit 5 Value added by transforming resources

}

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Profit is the difference between the price a seller receives for

goods or services and the total cost to the seller of all resources

consumed in developing, producing, and selling these goods

or services during a particular period.

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Mum’s Biscuits Pty LtdProfit Earnedfor January

Resources created from selling biscuits $11 400Resources consumed:

Cost of merchandise inventory sold $7600Wages 1000Rent 600Supplies 300Utilities 200 Total cost of resources consumed 9700

Profit earned $ 1700

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Risk Accounting involves risk. It will be used to calculate the amount of profit a business will earn.

It relies on a number of assumptions and constraints which, if they don’t turn out to be valid, may mean that the profit calculation is misleading

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The Accounting Game!• Assumptions

– Entity– Monetary unit– Going concern– Period– Realisation– Matching– Prudence / conservatism

• Characteristics– Relevance– Reliable– Comparable– Understandable

• Constraints– Timely– Materiality– Benefit versus Cost

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Key: return on their investments from profits earned by that business.

ROI = ProfitAmount invested

The role of accounting in business organisations

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If Megan and Ryan invested $10 000 to start Mum’s Biscuits

Pty Ltd and earned a $1700 profit, what would be the return on

investment?

ROI = ProfitAmount Invested

$1700$10 000

=17%

The role of accounting in business organisations

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An effective businessAn efficient business

The role of effectiveness and efficiency

Choice of Accounting Systems• Must consider

– organisational goals– organisational structure– size of the organisation– information needs of management

Choice of Accounting Systems• Computer-based:

– Packages• Ledger - MYOB

– Data base• Microsoft Access• Enterprise resource planning (erp) - SAP

– Analysis• Excel

Economic Consequences1. Management’s accounting policies

affect the numbers that appear in financial statements.

2. Financial statements affect wealth of owners / lenders/ managers / society via:

– management compensation plans– debt contracts– political costs

Economic ConsequencesManagement Compensation• Jodee Rich and Brad Keeling: each

collected a $7.5 million pay packet in 2000-01 from One-Tel, based on company market capitalisation, not profit.

Political cost• Depreciation of railway rolling stock in

nineteenth century – to justify ticket prices

Environmental Considerations• Economic

– e.g. interest rates, currency translation rates, expectations (boom, etc), obsolescence.

• Regulatory– Company regulations– Accounting Standards – Accounting

Policies

• Social and Environmental– (un)employment, pollution, health issues

Management selection of accounting policies

Management selection is a function of:

1. Need to provide information for economic decision-making.

2. Desire to influence economic consequences.

Values informing SelectionSelf interest

wealth, power, fame, authority(Pre-conventional ethical reasoning – Kohlberg)

Concern for othersfairness, justice, trust in social institutions(conventional ethical reasoning)

Doing what is rightdo the social institutions still represent the best way to do what is right?(post-conventional ethical reasoning)

What is “Ethics”?

The central question of ethics is: "what should you do?"

Morality – how we actually behave. Answers the question “How?”

Ethics – theoretical reflection on that behaviour. “Why did s/he behave so badly/well?” What values made her/him behave that way? Answers the question “Why?”

Tend to get confused – but are linked.