Professional Documents
Culture Documents
Accounting
Accounting
Definition
Accounting is the process of identifying, measuring and communicating financial information about an entity to permit informed judgments and decisions by users of the information.
MBA INTENSIVE SEMINARS 2004 Page 2
Shareholders funds
MBA INTENSIVE SEMINARS 2004 Page 3
Power of Accounting
Accounting provides a very selective but powerful representation of the corporate identity.. The detailed language of assets, liabilities, costs, profits provide a range of corporate imagery and vocabulary . Accounting provides the categories through which organisational participants perceive both themselves and the organisation. Mike Powers
MBA INTENSIVE SEMINARS 2004 Page 4
Creative Accounting?
Things may exist independently of our accounts, but they have no human existence until they become accountable. They may not exist, but they take on human significance by becoming accountable.. Accounts define reality and at the same time they are that reality. Accounts do not more or less accurately describe things. Instead they establish what is accountable in the setting in which they occur Whether they are ACCURATE OR INACCURATE by some other standards, accounts define reality for a situation in the sense that people act on the basis of what is accountable in the situation of their action.
Ruth Hines
Page 5
Roles of Accounting
Improve problem solving / decision making Manage risks Trust, Assurance Educational - learn about organisations Language of business Construct, define, measure success/failure
Page 8
Roles of Accountants
Assisting the internal management of organisations Complying with external financial reporting, controls and with taxation regulations Expert consultants on financial and organisational performance
Page 9
Financial Accounting
Accounting concepts Profit and Cash distinction Financial statements Organisational impact
MBA INTENSIVE SEMINARS 2004 Page 10
Reliability
Verifiability
Representational Faithfulness
Neutrality
Page 11
Transactions
Buy materials on credit from suppliers Sell goods or services on credit to customers Pay suppliers Receive cash
MBA INTENSIVE SEMINARS 2004 Page 12
When is profit reported? When goods or services are sold NOT when cash is paid or received
Page 13
Example: Antiques dealer Buy 10 chairs for cash $200 each Sell 6 chairs on credit $300 each Profit 6 x $100 each = $600 Cash flow = minus $2,000
MBA INTENSIVE SEMINARS 2004 Page 14
Page 17
Balance Sheet 2 AS AT
31 Dec Year 2
Balance Sheet 3 AS AT
31 Dec Year 3
Page 19
Current assets
Shareholders funds
Page 20
Page 21
Page 22
Creative accounting
What do we want to create? More profit? More assets? More liabilities? Less profit? Fewer assets? Fewer liabilities?
MBA INTENSIVE SEMINARS 2004 Page 24
Off-balance sheet financing , e.g leasing, Sale and buyback, special purpose vehicles Recognising profits that arent really there foreign exchange rates affecting values of assets and loans Corporate takeovers ACCOUNTING MINEFIELD adjusting policies, fair values, goodwill, brands, reorganisation costs...
MBA INTENSIVE SEMINARS 2004 Page 26
Page 28
Page 29
Page 30
However.
Accounts are main source of systematically produced regulated information Good as it gets Usually reliable 3rd party verified Follow the same basic rules Most of the information is there (in the small print) You can never eliminate the risk of fraud / criminal misrepresentation
Page 32
Managing its assets effectively? Sufficiently liquid? Financed properly? Able to meet its financial obligations? Viewed favourably by financial markets?
MBA INTENSIVE SEMINARS 2004 Page 33
Financial ratios
Quick and simple check on financial health Small number of ratios gives a picture of the business. Easy to calculate, harder to interpret. Provide a starting point for further investigation.
Page 34
Page 35
Page 36
Managing liquidity
Can we pay the bills as they fall due? Can we pay the wages of employees? Buy stock (inventory) on credit Sell on credit = accounts receivable Pay suppliers = accounts payable Ideally, match cash flows in and out
Page 37
Asset management
Use fixed assets to earn sales revenue Manage working capital stocks (inventory) debtors (accounts receivable) creditors (accounts payable) working capital cycle
Page 38
Financial structure
Is it a good idea to borrow? Creates greater risk - interest payments and capital repayments Benefits to shareholders when profits are rising Risks to shareholders when profits are falling
Page 39
Advantages of ratios
Comparisons are relative to other figures Compare businesses of different size Gives picture of company strategy Financial and trading performance Compare with industry averages Simple summary of complex information
Page 40
Page 41
Applications of analysis
Predictions of corporate earnings Construct projected financial statements Predict corporate failure Indicators of financial distress e.g. Altmans models, combination of ratios
Page 42
Page 44
Creative accounting
Could involve: Inflating reported profits and EPS Accounting for losses via balance sheet reserves and all profits through P & L Reporting profits without generating equivalent cash Reporting lower borrowings
Page 45
Page 46
Page 49
Page 50
Page 51
Page 52
Page 53
Page 54
Current Ratio
Current Assets Current Liabilities Solvency = Ability to meet obligations as they fall due Working capital = CA minus CL
MBA INTENSIVE SEMINARS 2004 Page 55
Current Ratio
Top line questions What affects levels of stocks, debtors, cash Bottom line questions What affects levels of bank borrowing, trade creditors, other short term creditors Overall - How does the company manage its working capital?
MBA INTENSIVE SEMINARS 2004 Page 56
Page 58
Page 59
Page 61
Average or year-end? Year-end is less trouble but check there are no major changes.
Bottom line questions Are all sales made for credit? Think about the nature of the business.
MBA INTENSIVE SEMINARS 2004 Page 62
Average or year-end?
Bottom line questions Opening stock + purchases - closing stock = Cost of goods sold. Should be Purchases but Cost of goods sold is Ok if stocks are constant.
MBA INTENSIVE SEMINARS 2004 Page 64
Gearing
Long Term Debt Long Term Debt plus Equity Look carefully at balance sheet and use notes to accounts. Add Preference shares to Debt Omit Provisions
MBA INTENSIVE SEMINARS 2004 Page 65
Gearing
Top line question What are the sources of finance that create fixed commitments to pay interest and repay capital? Bottom line question What is the total long-term financing of the business, based on borrowings and equity?
Page 66
Interest Cover
Profit before interest and tax Interest expense
EBIT = Earnings Before Interest and Taxation Interest expense: either in profit and loss account or in detailed notes.
MBA INTENSIVE SEMINARS 2004 Page 67
Interest Cover
Top line questions What is the amount of profit available to cover interest payments? Is the company generating sufficient wealth to meet interest payments? Bottom line questions What is the cost of servicing borrowings?
MBA INTENSIVE SEMINARS 2004 Page 68
Page 69
Management accounting
Integral part of management identify, present and interpret information for strategy, planning and control, for decision taking and use of resources for disclosure to employees to safeguard assets
Page 70
Page 71
Measuring and analysing performance Implementing plans Action plans and budgets Operating plans Examining future environment Developing objectives
Formulating strategy
MBA INTENSIVE SEMINARS 2004 Page 72
Importance of costing
Many organisational decisions rely on costings Costing is complex but essential An accountant knows the cost of everything but the value of nothing Oscar Wilde
Page 73
Describing costs
Direct (identified with a saleable unit) Indirect (spread across saleable units) Indirect costs = Overheads How to find a fair way of spreading the overheads?
Page 74
Confusing terminology
Allocate = give all cost to one unit or centre Apportion = share across units or centres Absorb (Absorption) Soak up into the units of output See page 142 of text book
Page 75
Terminology (contd)
What are the direct costs? Allocate these to units of output What are the indirect costs? Allocate to cost centres if we know where they belong. Otherwise Apportion (share) across cost centres. Absorb costs from production centres into products.
MBA INTENSIVE SEMINARS 2004 Page 76
Absorption bases
Absorb as cost per unit cost per labour hour cost per of labour cost per kilo of material cost per machine hour Different bases give different answers
MBA INTENSIVE SEMINARS 2004 Page 77
Cost behaviour
Pairs of classifications Direct or indirect? Fixed or variable? Period or product? Case: Bus company sends buses to 10 schools for taking children home each day. How does the company describe the costs?
MBA INTENSIVE SEMINARS 2004 Page 78
Direct or indirect?
Direct for each school: Drivers working time, fuel for bus, bridge tolls Indirect to spread across all journeys: Insurance, repairs, maintenance, licences, depreciation, drivers idle time, holiday pay
Page 79
Fixed or variable?
Variable change with activity level Fuel, repairs, bridge tolls Fixed regardless of activity level Drivers wages, Insurance, Licences, Maintenance checks, Depreciation
Page 80
Period or product?
What is the product? A person-mile. Product costs Drivers time, fuel, bridge tolls Period costs Insurance, Licences, routine maintenance, depreciation
MBA INTENSIVE SEMINARS 2004 Page 81
Examples of decisions
Price setting, tendering for contracts Product profitability analysis Product design modifications R & D management Value Engineering General Cost Management Contracting out / Buying in Plant / Department Closure
MBA INTENSIVE SEMINARS 2004 Page 82
Short-term decisions
In the short term business can continue if the selling price covers variable costs and makes a contribution to fixed costs. Contribution = Selling price - variable cost
Page 83
Contribution analysis
Break even point = Fixed costs Contribution per unit Pay 1,000 rent for market stall. Buy toys for 6 each, sell for 8 each. What is breakeven volume? 1,000/2 = 500 toys
MBA INTENSIVE SEMINARS 2004 Page 84
Page 85
Scarce resources
Sell gardening services and house cleaning. Contribution per job 10 and 8. Gardening needs 2 hours per job, House cleaning needs 1 hour per job. Shortage of labour. Which has priority? House cleaning 8 per hour, Gardening 4 per hour. Contribution per unit of limiting factor
MBA INTENSIVE SEMINARS 2004 Page 86
Page 87
Page 89
Costing Problem
In contemporary organisations the fixed/variable classification is not relevant Logical impossibility of attributing all costs to products Wrong approach to the problem Solution based in the accounting world not the organisational world
Page 93
Activity Solution
Costs dont drive activities, activities cause costs Organisations do things that consume resources and (should) create value Costing should start with what the firm does activities in organisational world
Page 94
Money
cost
Resources
consume Collect Data
Activities
produce
Outputs
creates
Value
MBA INTENSIVE SEMINARS 2004 Page 96
Benefits of ABC
Makes visible the activities that drive the costs Prevents misallocation of costs Links costs more closely to responsibility for causing costs BUT does not save money or generate profit. It only gives more accurate information
Page 97
Page 98
What is a budget?
Quantified format management plans and strategies for decision making communication medium
Page 100
Long term strategy Market opportunities Long term planning Forecasting assumptions Short term strategy Organisational capability Budget/ short term planning
Modify assumptions
Page 102
Budget process
Formalises planning and control Defines goals Goal congruence - brings goals together Authority and responsibility are clear Framework to judge performance
Page 103
operating
+
Master budget
+
financial
Budget preparation
Start with sales budget (demand driven) Then match with cost of sales Is this a production organisation? Plan: inventories of raw materials, finished goods purchases to cover sales and inventories
Page 105
Cash budget
Most important part of budget cycle Monthly, quarterly? Cash receipts from operations Cash payments for operations Other cash receipts (new finance, sale of fixed assets) Other cash payments (tax, dividends, interest)
MBA INTENSIVE SEMINARS 2004 Page 107
Page 108
Page 110
Alternative approaches
Easy approach = Last year plus inflation Zero-based budgeting Start with a clean sheet Justify every item Focus on goals and objectives
Page 111
Not-for-profit organisations
Goals and objectives measured differently Need to be cost effective Planning programming budget system Focus on outputs rather than inputs joined-up government
Page 113
Behavioural aspects
Budgets can motivate employees to achieve goals of the organisation. What helps? degree of difficulty top management participation perceived fairness feeling of ownership avoid discontent about preparation
MBA INTENSIVE SEMINARS 2004 Page 114
Not foolproof
Why might budgets fail? Fail to understand changing environment using unsuitable existing structures fail to understand business systems lack of senior management support fail to understand central role of budgeting
Page 115
Page 116
Page 117
Performance Measurement
Page 118
Strategic planning
Five year plan, rolling forward. Profitability Growth of sales, profit Market share Customer satisfaction Rate of innovation How to measure achievement of strategy?
MBA INTENSIVE SEMINARS 2004 Page 119
Page 122
Page 123
Residual income
Ask: What is the income (profit) remaining after deducting a notional interest charge for the use of capital? X Z 000s Operating profit (EBIT) 18 1,500 Capital employed 100 10,000 ROCE 18% 15%
MBA INTENSIVE SEMINARS 2004 Page 124
Performance of a division
Divisions are created by decentralisation Gives greater responsiveness Allows faster decisions Motivates managers Uses specialist experience of managers But needs a measure of performance
Page 127
Page 128
Page 130
Transfer pricing
What price is charged for transfers between divisions within an organisation? Variable cost? Variable cost plus a profit margin? Variable cost plus portion of fixed cost? Variable + fixed + profit margin? Negotiated price? Reflect market?
MBA INTENSIVE SEMINARS 2004 Page 131
Page 132
Page 133
Page 138
Page 139
Page 141
Page 142
Non-Financial Measures
Non-financial is any information not valued in s. It has the following advantages: Expressed in terms/language understandable to managers (non-accountants) Requires very little "translation" by managers
Page 143
Page 144
Balanced Scorecard
Financial Perspective
Customer Perspective
Page 146
Balanced Scorecard
systematic attempt to design performance measurement system that integrates organisational objectives, co-ordination of individual decision making need for organisational learning. create an environment that facilitates continual improvement
Page 147
Page 149
Page 150
Not-for-profit organisations
Economy Cost at which resources are acquired Efficiency Compare inputs and outputs Effectiveness How resources are used Value for Money
MBA INTENSIVE SEMINARS 2004 Page 151