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. One paper carrying three
sections.
1) MCQ 10 questions. (20 Marks)
2) 7 -8 short answer questions ( 30 marks)
3) 3 Essay type questions out of which two will have
to be answered (50 marks)

RECOMMENDED READING.
Peter atril “Finance for Non finance specialists”
 What is accounting ?

Accounting is all about collecting,

analyzing and communicating
financial information to the stake
holders of organizations.
 Why Accounting is needed?
Accounting is needed for the stake holders
to take the decisions about the business
organization. For example they need
financial information to take the decisions
such as ,
 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 information.

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
Components of financial statements – an overview
The objective of the financial accounting statements is to
provide a picture of the overall financial position and
performance of the business. To achieve this objective,
the 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 financial 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 statement of financial
position 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 non-physical
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 owner’s 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 of assets
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 business’s operating cycle;
 They are for the short term
 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 Conventions / concepts

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 non-current
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.
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 non-tangible) 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