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22107: Accounting for Business Decisions A University of Technology Sydney 1 Accounting and the Business Environment Users - People that depend on and use the financial information (provided by financial statements) to make economic decisions.

• Assumptions of Financial Accounting – • Accrual Accounting • Going Concern • Monetary unit • Accounting Period • Historical Cost

Qualitative Characteristics – • Understandability • Relevance

o Materiality • Reliability

o Fair representation (represent what really existed/happened)

o Neutrality (freedom from bias) o Substance over form (reflects the

economic reality) o Prudence (caution in estimates) o Completeness (material info not

omitted, not misleading) • Comparability

Financial Reporting - GAAP (Generally Accepted Accounting Principle) are made up of Authoritative accounting standards and conceptual principles.

Management needs to abide by GAAP, applying them with good judgement to their business model. External auditors are required to confirm that GAAP has been applied appropriately. 2 Recording Business Transactions Accrual Accounting – Record economic impact of transaction as they occur Cash Accounting – Record impact of transaction at time of cash flow Accounting Equation – A = L + SE Asset: Definition: Resource controlled, Provide future economic benefit, Result of past event Recognition: Probable economic benefit, Reliably Measured Liability: Definition: Present Obligation, Outflow of future economic benefit, Result of past event Recognition: Probable outflow of economic benefit, Reliably Measured Shareholders’ Equity: Definition: Residual Interest

A L Rev. Exp. SE

Increase DR CR CR

Decrease CR DR DR

Balance DR CR CR DR CR

3 The Income Statement and Balance Sheet Balance Sheet Asset: a resource that is controlled by the entity as a result of a past event or transaction, which has the potential to generate economic benefits for the firm. Liabilities: A present obligation that arises from a past event, and from which there will be a future sacrifice of economic benefit by the firm to settle that obligation. Shareholders equity: The residual interest of assets of the entity funded by shareholders/ owners. Income Statement Revenue: Inflows of economic benefits (as a result of ordinary operating activities) that result in an increase in total equity (not attributed to owners contributions). Expenses: outflow of economic benefits (as a result of ordinary operating activities that result in a decrease in total equity (not attributed to owners’ distributions).

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4 Adjusting Entries The Accounting Cycle: 1) Source Document 2) Journal Entries 3) Post to Ledger 4) Pre-Closing Trial Balance 5) Adjusting Entries 6) Adjusted Trial balance 7) Closing Entries 8) Post-Closing Trial Balance 9) Financial Statements Expiration of Assets - DR Insurance Expense CR Prepaid Insurance Unearned Revenue - DR Unearned Revenue CR Service Revenue Accrual of Unrecorded Revenue - DR Accrued Revenue CR Service Revenue Accrual of Unrecorded Expenses - DR Wages expense CR Accrued Wages Contra Account - Are accounts that record any detraction from the historical cost of an asset or liability control account Allowance for Doubtful Debt Creating Allowance for Doubtful Debt

DR Bad Debt Expense CR Allowance for Doubtful Debt Writing Off Bad Debt DR Allowance for Doubtful debt CR Accounts Receivable Depreciation DR Depreciation Expense CR Accumulated Depreciation 5. Retailing Operations Perpetual Inventory System - Continually records the impact of transaction on COGS and Inventory control accounts. Purchase Returns and Allowances – DR Inventory CR Cash/ Accounts Payable OR DR Purchase Returns and Allowances CR Accounts Payable Sales Returns or Allowances – DR Sales Returns and Allowances CR Cash/ Accounts Receivables DR Inventory CR COGS Write –off: DR inventory write-down CR COGS Periodic Inventory System – Need to deduce COGS using the formula:

COGS = O/B INVENTORY + PURCHASES - C/B INVENTORY (AFTER A END OF YEAR Stock take). Purchase Returns and Allowances - DR Cash/ Accounts payable CR Purchase Returns and Allowances Sales Returns and Allowances - Sales Returns or Allowance: DR Sales Returns and Allowances CR cash/ accounts receivable 6 Earnings Management FIFO The value of COGS and ending inventory will be equal to the value of the oldest inventory purchased or held. LIFO The value of COGS and ending inventory will be equal to the value of the newest inventory purchased or held. Weighted Average Cost Method The value of COGS and ending inventory will be equal to the weighted average of all inventories. Allowance for Doubtful Debt Income statement approach: requires calculating bad debt as a % of credit sales during the year Balance sheet approach: requires calculating the total balance of allowance for doubtful debt and deducing bade debt for the year. They use the aging

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of accounts receivable method. This method estimates the final balance for bad debt by splitting the pool of accounts receivable into categories (ranging by days). Creating Allowance for Doubtful Debt DR Bad Debt Expense CR Allowance for Doubtful Debt Writing Off Bad Debt DR Allowance for Doubtful debt CR Accounts Receivable Recovery of an Account Written Off

1. DR Accounts Receivable CR Bad Debt Recovered

2. DR Cash at Bank CR Accounts Receivable Depreciation DR Depreciation Expense CR Accumulated Depreciation

𝑆𝑡𝑟𝑎𝑖𝑔ℎ𝑡 − 𝑙𝑖𝑛𝑒 =  𝐶𝑜𝑠𝑡 − 𝑅𝑒𝑠𝑖𝑑𝑢𝑎𝑙  𝑉𝑎𝑙𝑢𝑒𝑈𝑠𝑒𝑓𝑢𝑙  𝐿𝑖𝑓𝑒(𝑖𝑛  𝑦𝑒𝑎𝑟𝑠)

𝑈𝑛𝑖𝑡𝑠  𝑜𝑓  𝑝𝑟𝑜𝑑𝑢𝑐𝑡𝑖𝑜𝑛 =  𝐶𝑜𝑠𝑡 − 𝑅𝑒𝑠𝑖𝑑𝑢𝑎𝑙  𝑉𝑎𝑙𝑢𝑒

𝑈𝑠𝑒𝑓𝑢𝑙  𝐿𝑖𝑓𝑒(𝑖𝑛  𝑢𝑛𝑖𝑡𝑠  𝑝𝑟𝑜𝑑𝑢𝑐𝑒𝑑)

𝑅𝑎𝑡𝑒  𝑓𝑜𝑟  𝑟𝑒𝑑𝑢𝑐𝑖𝑛𝑔  𝑏𝑎𝑙𝑎𝑛𝑐𝑒 = 1 −  𝑅𝑒𝑠𝑖𝑑𝑢𝑎𝑙  𝑣𝑎𝑙𝑢𝑒

𝐶𝑜𝑠𝑡!

𝑅𝑒𝑑𝑢𝑐𝑖𝑛𝑔  𝑏𝑎𝑙𝑎𝑛𝑐𝑒  𝑑𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛= 𝐶𝑢𝑟𝑟𝑒𝑛𝑡  𝐶𝑎𝑟𝑟𝑦𝑖𝑛𝑔  𝑎𝑚𝑜𝑢𝑛𝑡  𝑋  𝐷𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛  𝑟𝑎𝑡𝑒

7 Framework of Accounting Recognising Profit Sales Method: Profit recorded at time of sale Collection Method: Profit recorded upon cash payment Installment Method: Profit recorded with installments Percentage Completion Method: Profit recorded depends on % completion Measuring Assets – Historical Cost: Cost to initially acquire Market Value: Value you could sell for on the market Fair Value: Value it could be bought or sold for between willing parties, does not necessarily require a market place 8 Financial Statement Analysis Analytical Methods – Horizontal/ Trend Analysis: Evaluate series of financial statement data over period of time Vertical Analysis: Expressing each item in financial statement as % of base amount Ratio Analysis: Expresses Relationship among selected items of financial data Useful Ratios – Performance Ratios Return on Assets = !"#$%&'()  !"#$%&  !"#$%"  !"#

!"#$%  !""#$"

Activity Ratios Asset turnover rate = !"#$%  !"#"$%"

!"#$%  !""#$"

Liquidity Ratios Current ratio = !"##$%&  !""#$

!"##$%&  !"#$"%"&'

Financial Structure Ratios Debt  to  Equity  Ratio  =   !"#$%  !"#$"%"&"'(

!"#$%  !!!"#!!"#$%&  !"#$%&  

Du Pont Analysis ROE =

𝑇𝑜𝑡𝑎𝑙  𝐴𝑠𝑠𝑒𝑡𝑠𝑇𝑜𝑡𝑎𝑙  𝑆ℎ𝑎𝑟𝑒ℎ𝑜𝑙𝑑𝑒𝑟𝑠  𝐸𝑞𝑢𝑖𝑡𝑦𝑋

𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔  𝑝𝑟𝑜𝑓𝑖𝑡  𝑎𝑓𝑡𝑒𝑟  𝑡𝑎𝑥𝑇𝑜𝑡𝑎𝑙  𝑆𝑎𝑙𝑒𝑠  𝑅𝑒𝑣𝑒𝑛𝑢𝑒 𝑋

𝑇𝑜𝑡𝑎𝑙  𝑆𝑎𝑙𝑒𝑠𝑇𝑜𝑡𝑎𝑙  𝐴𝑠𝑠𝑒𝑡𝑠

Limitations • Estimates • Atypical Data • Diversification of Entities

9 Introduction to Management Accounting Cost Behaviours – Variable Costs - Costs that vary directly, proportionately with changes in activity levels Fixed Costs - Costs that remain the same, regardless of changes in activity levels. The Budgeting Process

1. Setting business objectives.

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2. Collecting data from company organisations. 3. Forecasting future conditions, including analysis of: a) Economic conditions b) Industry trends c) Previous market share d) Changes in prices e) Anticipated advertising/promotion 4. Develop & prepare: a) Sales budget b) Cost of Sales budget (i.e. inventory required to meet sales forecast) c) Selling/administrative expense budget d) Budgeted income statement 5. Develop and prepare: a) Capital expenditure budget b) Cash forecasts and cash budget c) Budgeted Balance Sheet 6. Prepare Master Budget

Behavioural Aspects of Budgeting – Bias: Tension between upper and lower management Participation: encourage participation by lower management when setting budgets

Slack: Temptation to inflate costs or depress sales forecast 10 Cost – Volume - -Profit Analysis CVP Analysis

!"#$%  !"#$!"#$  !"##$%&  !"#$%!!"#$  !"#$"%&'  !"#$

= Units needed

!"#$%  !"#$#

!"#$%&%'  !"#$%+ 𝑈𝑛𝑖𝑡  𝑉𝑎𝑟𝑖𝑎𝑏𝑙𝑒  𝐶𝑜s𝑡 = Unit Selling Price

𝑝𝑟𝑜𝑓𝑖𝑡  𝑎𝑓𝑡𝑒𝑟  𝑡𝑎𝑥(1 − 𝑡𝑎𝑥  𝑟𝑎𝑡𝑒) + 𝐹𝑖𝑥𝑒𝑑  𝐶𝑜𝑠𝑡𝑠

𝑈𝑛𝑖𝑡  𝑆𝑒𝑙𝑙𝑖𝑛𝑔  𝑃𝑟𝑖𝑐𝑒 − 𝑈𝑛𝑖𝑡  𝑉𝑎𝑟𝑖𝑎𝑏l𝑒  𝐶𝑜𝑠𝑡= 𝑄𝑢𝑎𝑛𝑡𝑖𝑡𝑦  𝑛𝑒𝑒𝑑𝑒𝑑

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