ACCT 5906 – Topic One

Introduction to Financial Literacy

Topic One Notes

1. Introduction
Introduction
A business creates a profit if it can sell goods and services to customers at
prices that are greater than the total costs incurred to provide those goods
and services. To be successful, a business must be effective in meeting the
needs of customers by providing goods and services demanded by
customers at prices they are willing to pay. Also, a business must be
efficient in controlling costs so that the prices charged to customers exceed
the costs to the company of acquiring and selling its products. If a
company is successful, it creates value for its owners as well as for other
stakeholders. Profit is a measure of the value created by a business for its
shareholders.
In Financial Literacy for Business Decisions we spend a considerable
amount of time on explaining how to measure changes in shareholder
value.
However, as you will see in subsequent weeks, the information from an
accounting systems plays an important role in determining the price of
products/services and will be an input into discussions on how a product is
made or a service is provided.

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Learning outcomes
After studying this topic you should be able to:
 understand what drives shareholder value
 describe the role of financial accounting information in capital markets
 identify the users of accounting information and the decisions they
make which require accounting information
 describe the types of organizational arrangements, and alternative ways
of financing
 describe the basic components of the financial statements

Key concepts
1. What drives shareholder value
Before going any further let’s consider a model of the business value
creation for a firm.

Figure 1: The firm and its environment – a model of business value creation

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Some key issues to consider about this model:
 firms have resources such as equipment, people, know-how, patents,
and these resources are used in the value creation process
 as part of the value creation process it is necessary to manage the
following:
– products and services
– customers
– people
– financial resources
 how well each of the above is managed will be a big determinant on
value creation
 it is necessary to measure the value created
 information systems are needed to provide the appropriate information
to manage
One of the key information systems is accounting information. The
purpose of accounting is to help people make decisions about the
allocation of scarce resources. People allocate scarce resources any time
they exchange money, goods, or services. These activities are so common
that almost every person in our society uses the accounting process to
assist in decision making.
Accounting provides information for managers, owners, creditors, and
other stakeholders who make decisions about organisations. Stakeholders
include those who have an economic interest in an organisation and those
who are affected by its activities.
Earlier weeks will consider the accounting and finance information
required as part of the business value generation process in Figure 1:
 Make decisions about products/services, customers and people, e.g.
what is the cost of providing products/services; which
products/services are most profitable; how will changes in prices,
advertising, etc. impact sales made to customers; which customers are
most profitable; what is the cost and benefits of hiring new staff; what
is the impact of incentives on staff.

 Managing financial resources which includes financing activities

(providing financial resources via contributions from shareholders or
by borrowing), investing activities (how a company uses financial
resources to acquire long-term assets to be used by the company) and
operating activities (using financial resources and long-term assets to
acquire and sell its products/services).
 Assessing performance of business processes, e.g. measuring the cost
of various business processes such as purchasing, production,
marketing and distribution.

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 Measuring shareholder value created. Companies transfer resources
into goods and services for sale to customers. Accounting measures
and reports the results of the transformation process. Specifically,
accounting measures the increase in value created by the
transformation process as the difference between the price of the
products/services sold and the total cost of resources consumed in the
developing, producing, distributing and selling the products/services
(known as ‘profit’).
Companies earn profits by providing products/services demanded by
customers. Shareholders (owner) invest in a company in order to receive a
return on their investment from profits earned by the company. Return on
investment (ROI) is usually expressed as a ratio that compares the amount
of profit to the amount invested in the business by the owners:
Profit
Return on Investment =
Amount Invested
In the case of companies the shareholders want a return on shareholders’
equity (the amount they invested in the company [called ‘share capital’]
and the amount of profits earned by the company in previous years that has
not been returned to shareholders in the form of dividends [called ‘retained
profits’] ).
Profit
ROE =
Shareholders’ Equity
ROE is commonly used as a measure of shareholder value.
Improvements in ROE depend on two main factors: how well a company
uses its assets (return on assets) and how it is financed (whether assets are
financed by debt or equity – called ‘leverage’). In turn, the return on assets
depends on how well a company manages its margins (profit margins) and
how much in sales it can generate with a given level of assets (asset
turnover).
Thus
ROE = Profit Margin x Asset Turnover x Leverage

Profit = Profit x Sales x Assets

SE Sales Assets SE

where SE = shareholders’ equity. This model is referred to as the

Shareholder Value Model (also called the DuPont model).
Later weeks expand on these concepts. In Topics 2 to 4 we cover the basic
financial statements: balance sheet, income statement and cash flow
statements and the key concepts contained in these statements: revenues,
expenses, assets, liabilities and shareholders’ equity.
Topic 5 ties many of the early weeks together by considering by
considering how you would create an overall business plan from an
accounting perspective.

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Topic 6 considers specific aspects of managing profit margins, which
includes the concepts of cost-volume, profit analysis and product costing.
In Topics 7 we then consider customer relationship and profitability
analysis. Topic 8 then considers the management of assets including
working capital (e.g. inventory, accounts receivable).
In Topic 9 we acknowledge the limitations of accounting performance
measures and consider a broader approach to measuring company
performance including the Balanced Scorecard, as well as considering the
overall budget process.
Within companies, managers make investment decisions regarding the
types of products and services produced as well as the equipment
necessary to produce and deliver the products/services. Managers also
must decide how to finance the company, that is, what mix of debt and
equity should be used and what specific types of debt equity should be
used. Finance managers must also decide what percentage of profits to pay
out as dividends and what proportion to retain and re-invest in the
business. Each of these investment and financial decisions impacts a
company’s share price. This will be covered in Topic 10.
The remainder of Topic 1 will cover background material to put the
subject in perspective; the role of financial accounting in providing
information for decision makers; types of organisations; alternative ways
to finance an organisation; functions of capital markets and the role of
accounting information in capital markets; an introduction to the key
financial statements used in financial markets.

2. The social setting of financial accounting

Reading
Bazley and Hancock Chapter 1. p.1-27.

In this section you should consider the role of financial accounting in

society and who are the main users of the financial statements.

3. Background: types of business organisations and how they

are financed

Reading
Bazley and Hancock Chapter 2. p.29-36.

This section is to give you some background on the types of organisations

that exist and how they finance their assets.

ACCT 5906 Financial Literacy for Business Decisions 1.5

4. Key financial statements

Reading
Bazley and Hancock Chapter 2. p.37-71.

This week’s readings

Essential readings
Selected sections from the designated chapters in Bazley and Hancock,
Contemporary Accounting 9th Edition

Optional readings
B Trotman K and Gibbins M, 2009, Financial Accounting: An Integrated
Approach, 4th Edition

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Preparation for seminar
Prior to the seminar, attempt the following problems. Please note, your
answers to these problems and cases will be collected at random by the
seminar leader during the seminars.

PROBLEM 1.6 USERS AND THEIR NEEDS

Accounting information is demanded by a wide range of users, including

shareholders, company management, suppliers, bankers, trade unions, the
Australian Securities and Investments Commission (ASIC) and the
Australian Taxation Office (ATO). Which user is likely to seek each of
the following types of information?
1. The likelihood of the company meeting its interest payments on time?
2. The profitability of each division in the company?
3. The financial position and performance of a company issuing shares to
the public for the first time?
4. The prospects for future dividend payments?
5. The probability that the company will be able to pay for its purchases
on time?
6. The profitability of the company based on the tax law?
7. The profitability of the company since the last contract with employees
was signed?

PROBLEM 1.7 ACCRUAL PROFIT

During the accounting period, Green Limited received $750,000 from
sales and paid out $580,000 in wages and other expenses. However, an
extra $260,000 worth of sales were made during the year but the cash has
not been collected yet. The company also owes $240,000 for various
expenses.
What is the accrual profit?

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PROBLEM 1.9 ACCRUAL PROFIT

1. During the year ended 30 June 2009, French Horn Ltd made cash sales
of $100,000, credit sales of $200,000 ($50,000 of which were still to
be collected at year-end), and received $25,000 owing from credit
sales, which occurred in May 2008. What is French Horn’s sales
revenue for the year ended 30 June 2009?
2. Also during the year ended 30 June 2009, French Horn paid $60,000
and owed $10,000 in employee wages. Of the $60,000 paid, $5,000
related to wages payable as at 30 June 2008. What is the total of
French Horn’s accrual accounting expenses?
3. What is French Horn’s accrual accounting profit for the year ended 30
June 2009?

PROBLEM 1.25 CALCULATE SHAREHOLDERS’ EQUITY

Given the following information relating to Penguin Ltd, what is the
balance of shareholders’ equity?
$
Property, plant and equipment 1,500,000
Accounts receivable 400,000
Cash 100,000
Inventory 500,000
Bank loan 250,000
Wages payable 90,000

PROBLEM 1.14 THE ACCOUNTING EQUATION

Cardigan Ltd has total assets of $150,000 and liabilities that add up to
$70,000 as at 30 June 2008.
1. What is Cardigan’s owners’ equity as at 30 June 2008?
2. During the year to 30 June 2009, Cardigan’s total assets increase by
$63,000 while total liabilities increase by $25,000. What is the amount
of Cardigan’s owners’ equity on 30 June 2009?
3. Now assume that in the year to 30 June 2009, Cardigan’s total
liabilities increase by $20,000 and its owners’ equity decreases by
$12,000. On 30 June 2009, what is the level of Cardigan’s total assets?
4. Assume that in the year to 30 June 2009, Cardigan’s total assets double
while its owners’ equity remains unchanged. What are its total
liabilities as at 30 June 2009?

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CASE 1A WOOLWORTHS LIMITED

Refer to the extracts of the annual report of Woolworths Limited on your

Moodle Website under Topic 1. All questions relate to the consolidated
accounts.
1. Provide indicators that Woolworths uses accrual accounting
2. What were total assets at 30 June 2017?
3. What were total liabilities at 30 June 2017?
4. What was shareholders’ equity at 30 June 2017?
5. State the accounting equation in dollar figures at 30 June 2017.
6. What was the Earnings before Interest and Tax?
7. What was the Group Net Profit after Tax?
8. What was the largest cash inflow and outflow relating to operating
activities?
9. Why is the cash flow from operations a different figure from operating
profit after tax?
10. What types of products does it sell?
11. Did the chief executive officer (CEO) and executive chairman of the
board believe that the company had a good year? What do they cite as
indicators of their company’s recent performance?
12. On what date does Woolworths’ most recent reporting year end?
13. For how many years does it present complete:
a. Balance sheets?
b. Income statements?
c. Cash flow statements?
14. Are its financial statements audited by an independent firm? How do
you know?
15. Did its total assets increase or decrease over the last year?
16. How much inventory (in dollars) did Woolworths have as at 30 June
2017?
17. Who is the auditor for the company?

ACCT 5906 Financial Literacy for Business Decisions 1.9