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ELEVENTH EDITION
ACCOUNTING
AND FINANCE
FOR NON-SPECIALISTS
Peter Atrill
Eddie McLaney
Harlow, England • London • New York • Boston • San Francisco • Toronto • Sydney
Dubai • Singapore • Hong Kong • Tokyo • Seoul • Taipei • New Delhi
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Pearson Education Limited
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United Kingdom
Tel: +44 (0)1279 623623
Web: www.pearson.com/uk
The Financial Times. With a worldwide network of highly respected journalists, The Financial Times provides
global business news, insightful opinion and expert analysis of business, finance and politics. With over 500
journalists reporting from 50 countries worldwide, our in-depth coverage of international news is objectively
reported and analysed from an independent, global perspective. To find out more, visit www.ft.com/
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NOTE THAT ANY PAGE CROSS REFERENCES REFER TO THE PRINT EDITION
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Brief contents
Preface xv
Acknowledgements xvii
BRIEF CONTENTS v
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Contents
Preface xv
Acknowledgements xvii
CONTENTS vii
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Classifying assets 44
Classifying claims 46
Statement layouts 47
Capturing a moment in time 49
The role of accounting conventions 51
Money measurement 55
Valuing assets 58
Meeting user needs 63
Summary 65
Key terms 67
Reference 68
Further reading 68
Critical review questions 68
Exercises 69
viii CONTENTS
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The main financial statements 137
Dividends 140
Additional financial statements 142
The directors’ duty to account 145
The need for accounting rules 145
Sources of accounting rules 146
The auditors’ role 147
Management commentary 148
Creative accounting 150
Summary 154
Key terms 156
Further reading 157
Critical review questions 157
Exercises 158
CONTENTS ix
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Liquidity 216
Financial gearing 219
Investment ratios 224
Trend analysis 233
Using ratios to predict financial failure 234
Limitations of ratio analysis 234
Summary 237
Key terms 239
Further reading 239
Critical review questions 239
Exercises 240
x CONTENTS
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Overheads as service renderers 295
Activity-based costing 308
Using full (absorption) cost information 316
Summary 319
Key terms 321
Further reading 321
Critical review questions 321
Exercises 322
9 Budgeting 327
Introduction 327
How budgets link with strategic plans and objectives 328
Time horizon of plans and budgets 330
How budgets help managers 331
Budgets and forecasts 333
Limiting factors 334
How budgets link to one another 334
Using budgets in practice 337
Preparing budgets 338
Non-financial measures in budgeting 345
Budgeting for control 345
Measuring variances from budget 346
Making budgetary control effective 353
Behavioural issues 354
The use of variance analysis 355
Summary 357
Key terms 359
Further reading 359
Critical review questions 359
Exercises 360
CONTENTS xi
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Why NPV is better 386
Internal rate of return (IRR) 387
Some practical points 392
Investment appraisal in practice 396
Investment appraisal and strategic planning 398
Summary 399
Key terms 401
Further reading 401
Critical review questions 402
Exercises 402
xii CONTENTS
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Managing cash 484
Managing trade payables 492
Managing working capital 493
Summary 496
Key terms 499
Further reading 499
Critical review questions 499
Exercises 500
CONTENTS xiii
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Preface
■ Students who are not majoring in accounting or finance, but who are, nevertheless,
studying introductory-level accounting and finance as part of their course. The course may
be in business, economics, hospitality management, tourism, engineering or some other
area. For these students, the book provides an overview of the role and usefulness of
accounting and finance within a business or some other organisation.
■ Students who are majoring in either accounting or finance. These students should find
the book a helpful introduction to the main principles, which can serve as a foundation
for further study.
The book does not focus on technical issues, but rather examines basic principles and
underlying concepts. The primary concern throughout is the ways in which financial state-
ments and information can be used to improve the quality of the decisions made by those
who use them. To reinforce this practical emphasis, throughout the text, there are numerous
illustrative extracts with commentary from real life including company reports, survey data
and other sources.
The text is written in an ‘open-learning’ style. This means there are numerous integrated
activities, worked examples and questions throughout each of the chapters to help you
understand the topics fully. In framing these questions and tasks, we have tried to encour-
age critical thinking by requiring analysis and evaluation of various concepts and tech-
niques. To help broaden understanding, questions and tasks often require readers to go
beyond the material in the text and/or to link the current topic with material covered earlier
in the book. Readers are encouraged to interact with the material and to check their prog-
ress continually. Irrespective of whether they are using the book as part of a taught course
or for personal study, we have found that this approach is more ‘user-friendly’ and makes
it easier for them to learn.
We recognise that most readers will not have studied accounting or finance before, and
we have therefore tried to write in a concise and accessible style, minimising the use of
technical jargon. We have also tried to introduce topics gradually, explaining everything as
we go. Where technical terminology is unavoidable we try to provide clear explanations. In
addition, you will find all of the key terms highlighted in the text. These are then listed at the
end of each chapter with a page reference. They are also listed alphabetically, with a con-
cise definition, in the glossary given in Appendix A towards the end of the book. This should
provide a convenient point of reference from which to revise.
PREFACE xv
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A further consideration in helping readers to understand and absorb the topics covered
is the design of the text itself. The page layout and colour scheme have been carefully
considered to enable easy navigation and digestion of material. The layout features a large
page format, an open design and clear signposting of the various features and assessment
material.
In this eleventh edition, we have taken the opportunity to make improvements suggested
by students and lecturers who used the previous edition. We have, for example, substantially
revised the discussion of the conceptual framework of accounting to reflect the very recent
statements of the International Accounting Standards Board. We have updated and
expanded the number of examples from real life and have continued to reflect the latest
international rules relating to the main financial statements. To aid understanding, we have
also increased the number of student progress questions (Activities) and explanatory
diagrams.
This text is supported by its own MyLab Accounting which is an environment that gives
unlimited opportunities for practice using a range of questions, and which provides timely
feedback. Updates to MyLab Accounting for the 11th Edition include the addition of Case
Studies that will be of use to encourage application of concepts to realistic business sce-
narios. Another notable tool within the MyLab is Accounting in Action: a feature that provides
an extended scenario focusing on a small business as it develops, which contains work for
readers to do; its aim is to bring together the reader’s understanding of a number of
concepts.
For access to MyLab Accounting, students need both a course ID and an access card
(see the advert on the inside back cover of the book).
For lecturers, the diagrams in the text, along with other diagrams and key learning points,
are available as PowerPoint slides. These, plus an Instructor’s Manual, can be downloaded
from the ‘Instructor resources’ section of the website www.pearsoned.co.uk/
atrillmclaney.
Finally, the editorial team at Pearson would like to thank the following reviewers for their
very valuable comments on the book:
We hope that you will find the book readable and helpful.
Eddie McLaney
Peter Atrill
xvi PREFACE
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Acknowledgements
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Limited 2017. All Rights Reserved. 226–28 The Financial Times Limited: Smith, T. (2014)
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ACKNOWLEDGEMENTS xix
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Holdings plc, Annual Report 2016, p. 64. 337 Elsevier: Dugdale, D., Jones, C. and Green,
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xx ACKNOWLEDGEMENTS
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Annual Report 2016, p. 123. 425 Whitbread PLC.: Whitbread plc press release, Whitbread
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ACKNOWLEDGEMENTS xxi
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Chapter 1
INTRODUCTION TO
ACCOUNTING AND
FINANCE
INTRODUCTION
Welcome to the world of accounting and finance! In this opening chapter,
we provide a broad outline of these subjects. We begin by considering
the roles of accounting and finance and then go on to identify the main
users of financial information. We shall see how both accounting and
finance can be valuable tools in helping users improve the quality of their
decisions. In subsequent chapters, we develop this decision-making
theme by examining in some detail the kinds of financial reports and
methods used to aid decision-making.
For many of you, accounting and finance are not the main focus of your
studies and you may well be asking, ‘Why do I need to study these
subjects?’ So, after we have considered the key features of accounting
and finance, we shall go on to discuss why some understanding of them
is likely to be important to you.
Learning outcomes
When you have completed this chapter, you should be able to:
■ explain the nature and roles of accounting and finance;
■ identify the main users of financial information and discuss their
needs;
■ distinguish between financial accounting and management
accounting; and
■ explain why an understanding of accounting and finance is likely to be
relevant to you.
Once funds have been raised, they must be invested in a suitable way. When deciding
between the investment opportunities available, an understanding of finance can help in
evaluating the risks and returns associated with each opportunity.
There is little point in trying to make a sharp distinction between accounting and finance;
we have seen that both are concerned with the financial aspects of decision-making. Fur-
thermore, there are many overlaps and interconnections between the two areas. Financial
(accounting) reports, for example, are a major source of information when making financing
and investment decisions.
Employees
Managers and their
representatives
Business
Lenders Government
Investment Community
Suppliers
analysts representatives
Several user groups have an interest in accounting information relating to a business. The majority
of these are outside the business but, nevertheless, have a stake in it. This is not an exhaustive
list of potential users; however, those groups identified are normally the most important.
Activity 1.1
Ptarmigan Insurance plc (PI) is a large motor insurance business. Taking the user groups
identified in Figure 1.1, suggest, for each group, the sorts of decisions likely to be made
about PI and the factors to be taken into account when making these decisions.
Customers Whether to take further motor policies with PI. This might
involve an assessment of PI’s ability to continue in business
and to meet customers’ needs, particularly in respect of any
insurance claims made.
➔
Competitors How best to compete against PI or, perhaps, whether to leave the
market on the grounds that it is not possible to compete profitably
with PI. This may involve competitors using various aspects of
PI’s performance as a ‘benchmark’ when evaluating their own
performance. They may also try to assess PI’s financial strength
and to identify changes that may signal PI’s future intentions (for
example, raising funds as a prelude to market expansion).
Employees Whether to continue working for PI and, if so, whether to
demand higher rewards for doing so. The future plans, profits
and financial strength of the business are likely to be of
particular interest when making these decisions.
Government Whether PI should pay tax and, if so, how much, whether it
complies with agreed pricing policies, whether financial support is
needed and so on. In making these decisions an assessment of
PI’s profits, sales revenues and financial strength would be made.
Community Whether to allow PI to expand its premises and/or whether to
representatives provide economic support for the business. When making these
decisions, PI’s ability to provide employment for the community,
its use of community resources and its willingness to fund
environmental improvements are likely to be important
considerations.
Investment analysts Whether to advise clients to invest in PI. This would involve an
evaluation of the likely risks and future returns associated with PI.
Suppliers Whether to continue to supply PI and, if so, whether to supply
on credit. This would require an assessment of PI’s ability to pay
for goods and services supplied at the due dates.
Lenders Whether to lend money to PI and/or whether to demand
repayment of any existing loans. PI’s ability to pay the interest
due and to repay the principal sum on time would be important
factors in such decisions.
Managers Whether the performance of the business needs to be improved.
Performance to date would be compared with earlier plans or
some other ‘benchmark’ to decide whether action needs to be
taken. Managers may also wish to consider a change in PI’s
future direction. This may involve determining whether it has the
financial flexibility and resources to take on new challenges.
Owners Whether to invest more in PI or to sell all, or part, of the
investment currently held. As with investment analysts (see
above) this would involve an evaluation of the likely risks and
returns associated with PI. Owners may also have to decide on
the rewards offered to senior managers. When doing so, the
financial performance and position of the business would
normally be considered.
Although this answer covers many of the key points, you may have identified other decisions
and/or other factors to be taken into account by each group.
■ Relevance. Accounting information should make a difference. That is, it should be capa-
ble of influencing user decisions. To do this, it should help to predict future events (such
as predicting next year’s profit), or help to confirm past events (such as establishing last
year’s profit), or do both. By confirming past events, users can check on the accuracy
of their earlier predictions. This can, in turn, help them to improve the ways in which they
make predictions in the future.
Activity 1.2
Do you think that what is material for one business will also be material for all other
businesses?
No, it will normally vary from one business to the next. What is material will depend on fac-
tors such as the size of the business, the nature of the information and the amounts involved.
Ultimately, what is considered material is a matter of judgement. When making this kind of
judgement, managers should consider how this information is likely to be used by users. If
a piece of information is not considered material, it should not be included within the
accounting reports. It will merely clutter them up and, perhaps, interfere with the users’
ability to interpret them.
PROVIDING A SERVICE 5
Activity 1.3
In practice, do you think that each piece of accounting information produced will be
perfectly complete, neutral and free from error?
Probably not – however, each piece of information should be produced with these aims in
mind.
Accounting information should contain both fundamental qualities – relevance and faithful
representation – in order to be useful. There is usually little point in producing information
that is relevant, but which lacks faithful representation, or producing information that is
irrelevant, even if it is faithfully represented.
Further qualities
Where accounting information is both relevant and faithfully represented, there are other
qualities that, if present, can enhance its usefulness. These are comparability, verifiability,
timeliness and understandability. Each of these qualities is now considered.
Inflammable Materials
Shell Markings
Training
Bitter experience taught the Allies as well as the Americans that
no matter how efficient the gas mask and other defensive
appliances, they would not take the place of thorough and constant
training. One of the greatest difficulties at first was to get American
troops to realize that a thing as invisible as gas, with in many cases
no offensive smell and producing no immediate discomfort, could be
deadly. Nothing but constant drill and constant reiteration of these
dangers could get this fact impressed on them. Indeed it never was
impressed sufficiently in any of the earlier divisions of American
troops in the line to prevent their taking such chances that each
division suffered heavy loss on one or more occasions from gas
attacks.
A great deal of emphasis had been placed by the English upon
the adjustment of the mask in the shortest possible time, this time
having been officially set at six seconds after the alarm. The
Americans in adopting the mask in toto naturally had to adopt the
rules for adjusting it and wearing it. Experience, however, taught
them in a few months that the effort to attain too great speed was
dangerous. It tended to rattle the soldier and to result in poor
adjustment of the mask, both of which led to casualties. Accordingly
in the latest instructions for defense against gas all reference to six
seconds was eliminated and emphasis placed on the necessity of
accurate adjustment of the mask. Inasmuch as any man, practically
without effort or previous drill, can hold his breath for twenty
seconds, the need for great speed in adjusting the mask is not
apparent.
Psychology in Training
While the importance of impressing upon the soldier the danger
of gas was early appreciated it was deemed necessary not to make
him unduly afraid of the gas. However, as gas defense training in our
Army got a big start over gas offense training, this became a matter
of very great importance. In fact, due to a variety of causes, training
in the offensive use of gas was not available for any troops until after
their arrival in France. This resulted in officers and men looking upon
the gas game, so far as they were individually concerned, as one of
defense only. Accordingly after their arrival in France it became very
difficult not only to get some of our officers to take up the offensive
use of gas but even to get them to permit its use along the front they
commanded.
Notwithstanding all the care taken in training Americans in gas
defense there arose an undue fear of the gas that had to be
overcome in order to get our troops to attack close enough to their
own gas to make it effective. This applied to the use of gas by
artillery as well as to its use by gas troops. However, it should be
said that in every instance where gas was once used on an
American front all officers in the Division, or other unit, affected by it
were always thereafter strongly in favor of it.
Gas at Night
In the early days it was very difficult to get officers to realize the
absolute necessity of night drill in the adjustment of the mask. For
various reasons, including surprise, gas attacks were probably eighty
to ninety per cent of the time carried out at night. Under such
conditions confusion in the adjustment of the mask is inevitable
without a great deal of practice before hand, especially for duty in
trenches with narrow spaces and sharp projecting corners. There are
numerous instances of men waking up and getting excited, who not
only gassed themselves, but in their mad efforts to find their masks,
or to escape from the gas, knocked others down, disarranging their
masks and causing the gassing of from one to three or four
additional men. The confusion inherent in any gas attack was
heightened in the latter stages of the war by heavy shrapnel and
high explosive bombardments that accompanied nearly all projector
and cloud gas attacks for that very purpose. The bombardment was
continued for three or four hours to cause exhaustion and removal of
the mask and to prevent the removal of the gassed patients from the
gassed area.
Detection of Gases
Efforts were made by the enemy and by all the Allies throughout
the war to invent a mechanical detector that would show when gas
was present in dangerous quantities. While scores, perhaps
hundreds, of these were invented none proved simple, quick, or
certain enough in action to make their adoption desirable. In every
case it was necessary to rely on the sense of smell. Thus it was that
as the war wore on, more and more attention was given to training
officers and non-commissioned officers to detect various kinds of
gases in dangerous quantities by the sense of smell.
In the American Gas Defense School for officers this was done
wholly by using captured German gases. This was because certain
gases have quite different smells, depending upon the impurities in
the gas and also upon the solvents sometimes mixed with them.
Thus the German mustard gas has a mustard smell, while the Allies
mustard gas, due to a slight difference in the method of manufacture,
has a very perfect garlic odor. Not only must officers and men who
handle gas training know the smell of the various gases, but they
must know when the concentration of each is high enough to be
dangerous. This is not easy to learn because the strength of the
various gases in dangerous concentrations varies through wide
limits. Not only does the strength of the gases vary and the
sharpness of the odors accordingly, but the mingling of poisonous
gases with other gases from high explosive and shrapnel tends to
obscure these odors and make them more difficult of detection.
Deceptive Gases
A great deal of thought was given toward the end of the war to
the subject of deceptive gases which could by powerful or peculiar
odors mask the dangerous gases. This masking was to deceive the
enemy when dangerous gases were present or to admit an attack
without masks while the enemy was wearing his through thinking
there was a dangerous gas when as a matter of fact none existed.
In gas warfare, the German, as well as the Allies, was exercising
his ingenuity in devising new and startling methods of making gas
attacks. A well known trick with the German was to fire gases for
several days, particularly against green troops, in concentrations so
slight as to do no harm. When he felt that he had lulled those troops
to a sense of the ineffectiveness of his gas, he sent over a deadly
concentration. In spite of the warning that this was what was
happening, he often achieved too great a success. Before the war
closed, however, the American was beginning to out-think and out-
wit the German in this method of warfare.