Version: 2.0 © University of Tasmania All rights reserved. CRICOS Provider Code: 00586B Accounting & Financial Decision Making BFA103BFA103

© University of Tasmania 2 My Contact Details  Steve Allen   

© University of Tasmania BFA103_01 3 Handouts today 1.Unit outline

© University of Tasmania BFA103_01 4

© University of Tasmania BFA103_01 5 Week 1 Module 1: Financial accounting Topic 1: The role of accounting in business

© University of Tasmania BFA103_01 6 Reading and Independent Study  Read  Prepare answers to Discussion Questions

© University of Tasmania BFA103_01 7 Learning objectives After studying this topic you should be able to: Explain the term “business”, and identify the role of accounting in business Distinguish between the sole proprietorship and the company form of business organisation Identify the various groups of people who use accounting information, and discuss how their information needs differ Identify the characteristics that accounting information should have if user needs are to be satisfied Distinguish between financial and management accounting

© University of Tasmania BFA103_01 8 What is a business? A business is one person, or a group of people, working to provide goods or services to customers All businesses, in one way or another, aim to transform resources from one form to a different, more valuable form to meet the needs of its customers – by doing so, businesses are said to add value, and therefore contribute to society

© University of Tasmania BFA103_01 9 Why create a business? Some possible business objectives: Maximise profit In the shorter term, maximise sales and grow market share (to improve profits in the future) Maximise the wealth or value of the business (perhaps with a view to selling it in the future) Maximise the return on investment of the owners Provide a fair return to all stakeholders

© University of Tasmania BFA103_01 10 Types of business Businesses vary according to: Service provider Retailer Manufacturer Type of Activity Sole proprietorship Partnership Company Type of Ownership

© University of Tasmania BFA103_01 11 Types of business Business is owned and usually managed by one person Sole proprietorship Two or more people agree to conduct business together Partnership Shareholders are the owners Business is managed by a board of directors elected by sharesholders Company Types of Ownership

© University of Tasmania BFA103_01 12 Types of business Some differences between a sole proprietorship and a company: Separate Legal Entity Limited Liability Subject to more regulation Greater finance options Separation of ownership and management

© University of Tasmania BFA103_01 13 Types of business Some differences between a sole proprietorship and a company: 1.A company is a legal (and taxable) entity separate from its shareholders. It has a perpetual life independent of its shareholders and managers. A sole proprietorship has no legal status, does not pay tax, and has a life that is limited to the period of involvement of its owner 2.Shareholders can not be required to meet the debts of a company from personal assets (limited liability) whereas a sole proprietor has unlimited liability

© University of Tasmania BFA103_01 14 Types of business 3.Companies are more expensive than sole proprietorships to establish and a subject to more regulation 4.The number of shareholders in a company may be large, and so the amount of money that can be raised to finance the operations of the business is much greater 5.With large companies, there will be a separation of ownership and management, with most shareholders not participating in the day-to-day running of a company

© University of Tasmania BFA103_01 15 The role of accounting in business To identify important economic events in the life of a business, to record and analyse those events, and then to communicate information about them in financial statements Not all events affecting a business will be recorded in an accounting system. Accountants focus on transactions (exchanges of resources with other entities that can be measured in $ terms, for example, the sale of inventory). An interview with a prospective employee may be an important event for a business but it is not a transaction.

© University of Tasmania BFA103_01 16

© University of Tasmania BFA103_01 17 The role of accounting in business Not all events affecting a business will be recorded in an accounting system. Accountants focus on transactions (exchanges of resources with other entities that can be measured in $ terms, for example, the sale of inventory). An interview with a prospective employee may be an important event for a business but it is not a transaction.

© University of Tasmania BFA103_01 18 The role of accounting in business Your problem – which, if any of the following events would be considered a transaction, and need to be recorded in an accounting system? 1.Applied to a bank for a bank overdraft 2.Received notification that the overdraft had been approved 3.Drawing on the bank overdraft, made a payment to a supplier by cheque

© University of Tasmania BFA103_01 19 The role of accounting in business Your problem – which, if any of the following events would be considered a transaction, and need to be recorded in an accounting system 1.Applied to a bank for a bank overdraft 2.Received notification that the overdraft had been approved 3.Drawing on the bank overdraft, made a payment to a supplier by cheque Answer – only the 3 rd event involves an exchange of resources and would need to be recorded

© University of Tasmania BFA103_01 20 The role of accounting in business The information in the financial statements needs to be useful for people who have an interest in the business (“stakeholders”), and who have to make decisions about how to allocate scarce resources The information in the financial statements may also plays a stewardship role by ensuring that the managers of a business are held accountable for their decisions. For example, have they taken measures to protect the resources of the business, and have they used those resources to create a satisfactory return for the owners?

© University of Tasmania BFA103_01 21 What makes information useful? If accounting information is to be useful to users of accounting reports, and is to assist them to make decisions then it is worth asking the question: “What is it about information that actually makes it useful?”

© University of Tasmania BFA103_01 22

© University of Tasmania BFA103_01 23 What makes information useful? If accounting information is to be useful then it needs to be: relevant – will make a difference to the decision being considered by the user reliable - free of significant error or bias, accurately represents what it purports to represent comparable – for example, with information from previous years or other businesses Verifiable – can be measured objectively

© University of Tasmania BFA103_01 24 What makes information useful? If accounting information is to be useful then it needs to be: Timely – communicated to users in an efficient manner Understandable (at least by someone with a reasonable knowledge of accounting)

© University of Tasmania BFA103_01 25 What makes information useful? In some cases, information may be useful but not have all these qualities. Trade-offs between the qualities may be unavoidable. For example, a business might change an accounting technique to make the information more reliable, but in doing so, make comparisons with previous years difficult. A question for you – can you think of another situation in which a trade-off between two of these qualities might be required?

© University of Tasmania BFA103_01 26 What makes information useful? Note that the creation of information always has a cost, and the benefits from producing some information, in other words, its usefulness, must be weighed against its cost

© University of Tasmania Users of accounting information External Users Owners Internal Users Potential investors Lenders Government Employees Managers

© University of Tasmania BFA103_01 28 Users of accounting information The people who need to use accounting information can be divided into 2 groups: 1.Internal – managers who must oversee the day-to-day operations of a business, and who will require accounting information to assist them in planning for the future, and in controlling the activities of the business. Management accounting provides information for the managers of a business to be used for internal decision- making

© University of Tasmania BFA103_01 29 Users of accounting information 2.External - people outside a business including recipients of goods and services (customers), resource providers (suppliers of resources including employees, lenders of finance, shareholders), and those who perform a review or oversight function (government agencies, investment analysts) Financial accounting provides information to facilitate the decision-making of people external to a business

© University of Tasmania BFA103_01 30

© University of Tasmania Users of accounting information General Purpose Financial Reports for External Users Very heavily regulated if a company by the Corporations Act 1991 Income Statement Balance Sheet Cash Flow Statement Internal Reports Any type of report that will help managers to make decisions about the business Not regulated at all Any type of report that will help managers. Examples include: budgets, forecasts, formatted income statements etc.

© University of Tasmania BFA103_01 32 Structure of the unit The unit comprises 3 modules Module 1 Financial accounting (5 Topics) When you complete this module, you should be able to examine the published financial statements of a company and understand what they reveal to us. You should be able to identify the main components of these statements, and explain the general principles underlying their preparation

© University of Tasmania BFA103_01 33 Structure of the unit Module 2 Analysis of financial statements (2 Topics) When you complete this module, you should be able to analyse the published financial statements of a company by undertaking a variety of ratio calculations and then interpreting the significance of these calculations. You should also be able to identify various limitations of this form of analysis.

© University of Tasmania BFA103_01 34 Structure of the unit Module 3 Internal decision making (4 Topics) When you complete this module, you should be able to demonstrate how managers use accounting and other financial information in a variety of internal decision- making contexts; for example, cash budgeting, cost- volume-profit analysis, and capital investment

© University of Tasmania BFA103_01 35 Next lecture Module 1, Topic 2 Income statement and balance sheet