Chapter 1 – Introduction to finance and accounting

Discussion Questions – Intermediate

1.12. LO1 ‘Relevance’ and ‘reliability’ represent two key qualitative characteristics of accounting
information. What do these two terms mean in an accounting context? Are they in conflict?
Relevance relates fundamentally to ‘bearing upon’ the decision at hand in either a
confirmation or prediction capacity.
Reliability relates to ‘faithfully representing’ what it purports to represent, and is a link to the
dual ideas of objectively and neutrality.
The possible conflict relates to obtaining the appropriate balance between the two as
relevance is often inversely related to the passage of time, while reliability is positively
related to the passage of time.
1.14 LO3 Reconcile financial accounting with management accounting. Your textbook clearly
distinguishes between them. What are the similarities?

The link between management and financial accounting is in the actual statement of financial
performance and statement of financial position.
For management accounting the actuals are required to compare with budgets and standards
as part of the control function. For financial accounting the actuals are the substance of the
financial reports.
1.16 LO6 Describe two advantages for each type of business organisation.
Sole trader – easy and inexpensive to create
– owner maintains control of the business
Partnership – easy and inexpensive to create
– greater access to financing and skills
Limited company – limited liability
– unlimited life
1.17 LO7 In relation to recent corporate crashes, what have been the main lessons in relation to the
accounting process (recording and reporting procedures)?
Possible lessons from corporate crashes. A review of corporate crashes from the perspective
of accounting recording and reporting processes invariably highlights a similar list of issues:
Asset values are overstated. They should have been expensed in earlier years through
depreciation, amortisation, impairment, bad debts or other write-downs. More recently, it has
been the intangibles that have featured prominently in the overstated assets (e.g. goodwill,
rights, licences, development costs, patents, franchises, copyrights).
Liabilities understated. The use of off-balance sheet financing arrangements.

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 Liabilities misclassified as equity or as non-current when in fact they are current (e.g. leases
and preference shares).
Expenses understated or deferred. This is closely aligned with overstated assets and
understated liabilities.
Revenues are overstated or recognised too early (brought forward). Subsequently, the
revenues are not realised.
A cash crisis. Businesses are undercapitalised with too little equity and too much short-term
debt. They grow too quickly and the working capital management is at best ineffective.
1.19. LO5,6 Accounting is said to perform a ‘decision-usefulness role’ as well as an ‘accountability
(stewardship) role’. Distinguish between these two roles and provide an example of each.

Stewardship or accountability is traditionally identified with objectively tracking transactions

and events to ensure that they have been fully and appropriately accounted for. It would
include the use of historical cost and objectivity as underlying rationale, and focuses on asset
security and past transactions and events.

Decision-usefulness identifies the decision-making process and the relevance of financial

information to the decision. It would therefore tolerate greater use of estimates and future
projections.

Discussion Questions – Challenging

1.25 LO5 ‘The statement of financial performance reflects the financial performance for the period and
explains the changes in the statement of financial position.’ Do you agree or disagree with
this statement? Why?

The statement of financial performance aims to communicate the financial performance or

financial progress of an entity for a given period of time (e.g. one year).
However, the extent to which it reflects financial performance will be determined by how
well the accounting rules for the recognition and measurement of income and expenses
facilitate this process, and also how effectively and faithfully they have been applied by the
entity.
The statement of financial performance will explain partially the change in the statement of
financial position for the period. That is, if there is undistributed profit for the period then we
would expect that the owners’ equity retained account (e.g. Retained Profits), will have
increased, and also that net assets (assets minus liabilities), will have increased.
However, the statement of financial performance will not explain all changes in the net assets
and owners’ equity of the entity for the period, and it will not explain the structure of those
changes.
There will be other transactions outside of the statement of financial performance that will
impact on the owners’ equity accounts and the net asset changes for the year.
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/Atrill/Accounting: An Introduction/6th edition Page 2
 Examples of such transactions would include:
– Contributions from, and distributions to, owners.
– Transfers to and from reserve accounts.
– Adjustments directly against retained profits rather than through the statement of
financial performance. These might relate to the introduction of a new accounting
standard with retrospective adjustment, and prior period error corrections.

1.26 LO7 It has been suggested that the global financial crisis might have been avoided if we used cash-
based accounting. Discuss.
While this suggestion has some merit it is unlikely that cash-based accounting would have
prevented the GFC. There is considerably more scope for the overstatement of assets and
understatement of liabilities with accrual accounting than there is with cash-based
accounting. However, the general consensus is that accrual accounting provides a better view
of the financial position and performance than that provided by cash accounting. The
statement of cash flows is provided to supply the information not provided by accrual
accounting.

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