Ebook Financial accounting Part 1

(BQ) Part 1 book Financial accounting An international approach has contents Introduction to financial accounting, key accounting concepts, balance sheet an overall view, revenues and trade receivables, inventories and cost of sales,...and other contents.

Jagdish Kothari Elisabetta Barone

Financial Accounting

An International Approach

Pearson Education Limited

Edinburgh GateHarlowEssex CM20 2JEEnglandand Associated Companies throughout the world

Visit us on the World Wide Web at:

www.pearsoned.co.ukFirst published 2006

© Jagdish Kothari and Elisabetta Barone 2006The rights of Jagdish Kothari and Elisabetta Barone to be identified as authors

of this work have been asserted by them in accordance with the Copyright, Designs and Patents Act 1988

All rights reserved No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without either the prior written permission of thepublisher or a licence permitting restricted copying in the United Kingdom issued by theCopyright Licensing Agency Ltd, 90 Tottenham Court Road, London W1T 4LP

All trademarks used herein are the property of their respective owners The use of anytrademark in this text does not vest in the author or publisher any trademark ownership rights in such trademarks, nor does the use of such trademarks imply any affiliation with orendorsement of this book by such owners

ISBN-13: 978-0-27369-319-2ISBN-10: 0-27369-319-0

British Library Cataloguing-in-Publication Data

A catalogue record for this book is available from the British Library

Library of Congress Cataloging-in-Publication Data

A catalog record for this book is available from the Library of Congress

10 9 8 7 6 5 4 3 2 1

10 09 08 07 06Typeset in 9.25/12pt Stone Serif by 35Printed by Ashford Colour Press Ltd., Gosport

The publisher’s policy is to use paper manufactured from sustainable forests.

Part One The framework of financial reporting 1

2.4 Underlying assumptions 25

Part Two Financial position and financial performance 35

9 Owners’ equity 164

Part Three Preparation of financial statements 179

10 How to record transactions and prepare financial

Contents vii

16.3 Price earnings ratio (P/E) 313

List of figures

10.8 General ledger of Funny Sun with the balances for each account 198

12.10 An ideal pattern of cash flows 248

12.11 Reporting cash flows from operating activities – the indirect

12.12 Main headings of a corporate cash flow statement under IAS 7 254

List of tables

13.2 Puma’s common-size and trend analysis of income statements

Supporting resources

Visit www.pearsoned.co.uk/kothari to find valuable online resources

Companion Website for students

• Full answers to the activities found in the text

• Multiple choice questions to test your learning

• Summary problems to help you check your understanding

• Extensive links to valuable resources on the web

• Glossary to explain key terms

For instructors

• PowerPoint slides that can be downloaded and used as OHTs

• Progress exercises, consisting of material from the text and additionalmaterial exclusive to the website

• A solutions manual providing answers to selected questions posed in the text

Also: The Companion Website provides the following features:

• Search tool to help locate specific items of content

• E-mail results and profile tools to send results of quizzes to instructors

• Online help and support to assist with website usage and troubleshootingFor more information please contact your local Pearson Education sales

representative or visit www.pearsoned.co.uk/kothari

In 2000, the European Commission committed itself to making international ing standards mandatory from 2005 for listed companies within the European Union

account-It has happened and this year has seen the greatest revolution in financial reporting

force for listed companies in all member countries of the European Union and inmany other countries around the world

This accounting reform is more than bookkeeping exercises It will influence theway companies do business, improve market efficiencies and lower risk premiums

Harmonising global accounting standards will also stimulate more cross-bordertransactions

The free flow of capital across borders will contribute to the wealth of nations byallocating capital more effectively and so lowering its cost to companies, institutionsand individuals Yet today’s markets are far from global

One reason for this situation is related to the incompatibility of the world’s variousaccounting standards This matters because disjunctive standards prevent marketparticipants from efficiently comparing investment opportunities across borders Forcompanies, different accounting standards represent a burden that prevents themfrom having access to international funding There is a clear need for global account-ing standards which provide that businesses undertaking similar activities should besubject to broadly the same accounting treatment wherever they are

After a period of transition, mutually acceptable and compatible accounting standards across borders will deliver tangible benefits Comparable and transparentcorporate reports and accounts will foster deeper and more liquid financial marketsand will bolster investor confidence and hence global financial stability

standard-setting body, are aiming to achieve convergence between their two systems by 2007,removing the reconciliation between US generally accepted accounting principlesand international standards Once this convergence is achieved the harmonisationprocess will be complete and the resultant benefits for investors all over the worldwill be enormous

This book, aimed at those students who wish to pursue careers as managers,focuses on the use of financial information rather than technical procedures Recentscandals have clearly underlined the fact that managers today need to have a basic

Foreword xv

understanding of the concepts and principles of financial accounting This bookaddresses these recent scandals and enables students to understand why they aroseand how such scandals can be avoided in the future

The book has a strong European focus, addressing the needs of students acrossEurope; and it is also aimed at students whose first language is not English

It is based on the lectures given by the authors in the course of Accounting andFinancial Statements Analysis for the Degree in International Economics and Man-agement at Bocconi University, which is committed to providing internationallyrecognised education to its students from all over the world

Prof Angelo ProvasoliDean of Università Commerciale Luigi BocconiMilan, October 2005

Why this book?

The introduction of International Financial Reporting Standards (IFRSs) formerlyknown as International Accounting Standards (IASs) has globally happened!

In the European Union and its applicant member countries, listed companiesfrom 1 January 2005 are required to adopt IASs/IFRSs Some 7,000 companies in the European Union are affected Australia, the Russian Federation, Japan and othercountries have introduced IASs/IFRSs Many countries around the world also require/

encourage foreign listed companies to apply IASs/IFRSs with or without tion to national accounting standards

reconcilia-This book is written to reflect this new situation and its implications A basicunderstanding of the requirements of the IASs/IFRSs is now essential for anyonestudying financial accounting and reporting

The style of this book is practical and interactive, as one of the authors has considerable experience of business and accounting practices of multinationals

Thus, we illustrate the importance of concepts such as net operating cash flows, core earnings or EBITDA, trade or operating working capital, etc which are widely dis-cussed and used today by the financial community

We adopt a user approach that focuses on the use of financial information ratherthan on bookkeeping and its mechanics We illustrate some of the fundamentalaccounting issues through examples of recent accounting failures in well-known listedcompanies

This book is for non-accountants It is intended primarily for students who arerequired to study accounting as part of a non-accounting degree or professionalstudies course This book is therefore suitable for undergraduate and postgraduatestudents who are undertaking courses in accounting with an aim to pursue careers

as non-financial managers and thus need a sound understanding of the role offinancial accounting in their organisations The book is particularly appropriate for required core courses in financial accounting, in which many of the students are not planning to take further elective accounting courses It should also be ofpractical use to those working in commerce, industry, legal practices and govern-ment agencies that deal with financial information in their work

Preface xvii

Accounting books written specifically for non-accountants are often extremelydemanding The subject needs to be covered in such a way that non-accounting students do not become confused by too much technical information They do notrequire the same detailed analysis that is essential for professional accountants Someaccounting books specially written for non-accountants go to the opposite extreme.They outline the subject so superficially that they are of little practical help

The aim of this book is to offer a sound introduction to the study of financialaccounting We adopt a gradual progression in the level of rigour We begin with aconceptual framework The ground rules of double-entry bookkeeping (i.e debitsand credits) come later in the book in order not to distract the readers from theunderlying concepts This approach should help students to develop a proper under-standing of these concepts What we emphasise is the importance of understanding

as opposed to the rote memorisation of procedures and terminology This sequenceprovides a framework whereby readers can assimilate and appraise financial account-ing, which is so critical for the proper functioning of the market economy Onlywith such an overall understanding will the reader be able to follow and play anactive part in the managerial role in whichever organisation they are employed.Accounting textbooks are often not easily comprehensible to those from non-English-speaking backgrounds, because of the complexity of the language used Many

of the examples and questions in typical accounting books rely on strong knowledge

of the nuances of the English language to interpret the questions, before studentscan attempt to answer them This book adopts a plain English style that addressesthe needs of students studying in a non-Anglo-Saxon environment

Structure and pedagogy

The book is arranged in five parts Part one investigates the fundamental principlesand conventions that form the basics of accounting thought and practice Part twooutlines the primary financial statements and basic valuation issues Part three pro-vides tools for the preparation of financial reports both for a single entity and for agroup of enterprises Part four outlines the techniques of financial statement analysis

In Part five, issues relating to corporate reporting and corporate governance tices are presented and discussed, as we consider that readers should be aware of theimportance of reliable and timely financial information for the smooth functioning

prac-of capital markets

Guided tour of the book

Activities are practical

questions, integratedthroughout most chapters,allowing you to check yourunderstanding as you progressthrough the text Answers can

be found on the book’scompanion website atwww.pearsoned.co.uk/kothari

Worked examples

provide you with aclear explanation ofkey techniques andmethods

Key terms are

highlighted in colourwhere they are first introduced, anddefinitions can befound in the glossary

at the end of the book

Bullet pointed

objectives at the start

of each chapter showwhat you can expect

to learn from thatchapter, and highlightthe core coverage

Objectives

When you have completed this chapter you should be able to:

standards

com-When an enterprise is formed, the starting position is that there is no balance sheet because there was no enterprise The enterprise will be owned by someone.

Capital is the source of the cash which the enterprise now owns So, after this first

in Table 3.5.

44 3: Balance sheet: an overall view

Table 3.4Interpretation of a balance sheet

Left side of the balance sheet Right side of the balance sheet

Resources owned Sources Assets Where they came from Applications Claims

Table 3.5Effect of initial investment on a balance sheeet

Resources/Applications Claims/Sources

Cash Capital

Table 3.3Sources and uses of funds view

Left side of the balance sheet Right side of the balance sheet

Uses of funds (applications) Sources of funds

3.3 The effect of trading operations on a balance sheet

As we have seen in the previous section, a balance sheet is a document designed to

a balance sheet consists of two lists The first is a list of the resources owned by the

enter-prise as a result of past events and from which future economic benefits are expected

to flow to the enterprise (IASB Framework).

The second list shows where the assets came from, i.e the monetary amounts

of the sources from which the enterprise obtained its resources Since those sources can also be regarded as a list of claims against the resources The enterprise will have

to settle these claims some time, and this second list can therefore be regarded as amounts payable to others.

The first list could also be regarded as the ways in which those sources have been applied at a point in time, that is, as a list of applications These terms are summarised

in the next table.

108 6: Inventories and cost of sales

Example

Inventory valuation and gross profit Suppose that the 9,000 tonnes of coal referred to in the pervious example were sold

is shown below:

FIFO LIFO AVCO

The AVCO method will normally give a figure that is closer to FIFO than LIFO.

The ending inventory figure in the balance sheet will be highest under the FIFO method, because the cost of goods still held will be based on the more recent (and dearer) purchases.

LIFO will give the lowest ending inventory figure as the goods unsold held at the end of an accounting period will be based on the earlier (and cheaper) goods purchased.

Once again, the AVCO method will normally give a figure that is closer to FIFO than LIFO.

Remember that during a period of rising prices, FIFO yields higher inventory and higher gross profit than does LIFO This result is consistent with the accounting equation that requires that:

Assets = Liabilities + Owners’ equity

If inventory is higher under FIFO (higher assets) and the equation should balance, implies higher net profit and higher owners’ equity.

Note that all methods analysed are based on the same basic numbers Nothing in for the related liability in the same way under all three methods All that changes is how we allocate those costs between inventory and cost of sales.

6.5 Lower of cost and net realisable value

Often inventory items for reasons of obsolescence, fashion, seasonality, imperfect

Earnings per share (EPS) 311

Example

Adjusting the number of shares used in the basic EPS calculation

in the event of a share split Refer to the data provided in Activity 16.1 Assume that XYZ plc split the 1,000,000 would be calculated using 2,000,000 shares, it would seem that the basic EPS had halved in 2004.

This is misleading and 2003 basic EPS is therefore restated using 2,000,000 shares.

The total market capitalisation of XYZ is therefore restated using 2,000,000 shares.

prior to the split, each share had a market value of EUR 4 and the company had a

a market price of EUR 2, and the company’ market capitalisation would remain unchanged at EUR 4,000,000.

New issue of shares Issuing more shares to raise additional capital should generate additional earnings.

to adjust any comparative figures However, a problem arises in the year in which the new funds would have been available to generate profits for only a part of the earnings generated during the year by the number of shares in issue at the end of the number of shares.

Activity 16.2 Time-weighted number of shares for the basic EPS calculation

Assume that the following information is available for XYZ plc:

Number of shares (nominal value EUR 0.50 each)

Guided tour of the book xix

In Table 13.2(A) we show each income statement item as a percentage of sales.

This is the common-size analysis of income statement In Table 13.2(B), we took the

in percentage terms using that base.

Sales Sales represent a high-growth driver increasing by EUR 1,067.9 million or 231 per cent from EUR 462.4 million in 2000 to EUR 1,530.3 million in 2004.

270 13: Trends and common-size statements Table 13.1Puma’s comparative income statements (2000 – 2004)

Amounts in millions of euro 2004 2003 2002 2001 2000

• Financial analysts use common-size and trend statements to help spot changes in

an enterprise’s cost structure and profit performance.

• Common-size income statements recast each statement item as a percentage of sales Common-size balance sheets recast each item as a percentage of total assets.

• Trend statements also recast each income statement and balance sheet item in percentage terms, but they do so using a base year number rather than sales or total assets.

• CAGR or compound annual growth rate provides a smoothed rate of growth of financial statement items or investment yields.

Research and references

The following of books and articles take the issues of this chapter further:

• Stephen N Penman, Financial Statement Analysis and Security Valuation, McGraw-Hill, 2004

2nd Edition, Prentice Hall, 2002

• Rick Wayman, CAGR: the Good, the Bad and the Ugly, http://www.investopedia.com/terms/

c/cagr.asp

• Gerald I White, Ashwinpaul C Sondhi and Dov Fried, The Analysis and Use of Financial

Statements, 3rd Edition, Wiley, 2003, Chapters 3 and 4

Questions

13.1 The first step to informed financial statement analysis is a careful evaluation of

the quality of the reported accounting numbers No tool of financial statement

or by management’s reporting choices Discuss.

13.2 (a) Give three sources of information for investors besides accounting

information.

(b) Explain what CAGR is.

Questions 303

References and research

The following are examples of books that take the issues of this chapter further:

• Stephen N Penman, Financial Statement Analysis and Security Valuation, McGraw-Hill, 2004

3rd Edition, Prentice Hall, 2002

• Ciaran Walsh, Key Management Ratios, 3rd Edition, Prentice Hall, 2003.

• Gerald I White, Ashwinpaul C Sondhi and Dov Fried, The Analysis and Use of Financial

Statements, 2nd Edition, Wiley, 2003

Questions

15.1 Which measures of operating performance are combined to give ROTA?

15.2 ‘The tax law discriminates against share capital but favours of debt.’ Do you

agree? Explain why.

15.3 As the manager of Lene division of Elenia SpA, you are interested in determining

the division’s return on investment As division manager you have no control The division controller has given you the following data for the division to aid you in calculating return on investment:

Accounting period 1 January–31 December 2004 (amounts in thousands of euro)

15.4 Casa Comfort is a leading retailer in the home improvement industry Certain

data from its financial statements for the years ended 31 March 2004 and

31 March 2005 follow (euro in millions):

Because an earlier discussion with the accounting professor (see Case study in

a new list of problems as a basis for a second discussion As before, he knew their questions prior to the meeting The professor also required students to raising The list follows:

1 Evidently, there are two ways of handling purchase discounts They can

be either deducted from the cost of the purchased goods, or reported as methods? If so, why argue about which is preferable?

2 It is said that the LIFO method assumes that the goods purchased last are sold first If this is so, the assumption is clearly unrealistic because companies

an unrealistic assumption be supported, other than as a tax gimmick?

3 Are the following generalisations valid?

(a) The difference between LIFO and FIFO is relatively small if inventory turnover is relatively high.

(b) The AVCO method will result in net profit that is somewhere between that produced by the LIFO method and that produced by the FIFO method.

(c) If prices rise in one year and fall by an equal amount the next year, the total income for the two years is the same under the FIFO method as under the LIFO method.

4 A distillery manufactured bourbon whiskey, which it aged in charred, white oak barrels for four years before bottling and selling it Whiskey was carried in inventory at approximately EUR 3 per litre, which was the cost

of ingredients, labour, and factory overhead of the manufacturing process incurred EUR 0.50 of warehousing costs per litre per year, including costs

of interest costs per year The costs of barrels, warehousing and interest were earned pre-tax profit of EUR 1.5 million per year on annual production production to 1.2 million litres per year? At what amounts should it carry its whiskey in inventory?

Give your answers to the issues just discussed, supporting them with calculations.

Each chapter concludes

with a case study

based on a realexample, and includesquestions to test your application ofaccounting skills andtechniques Solutionsare available forlecturers only on thecompanion website

There are approximately six questions at the

end of each chapter These are designed to test

your understanding of the chapter and to help

you practice for exams Solutions to selected

questions are available for lecturers only on the

main issues

Research and References provide full details of sources of

information referred to in the chapter, and suggestions forfurther reading, in order to pursue a topic in more depth

or gain an alternative perspective

Examples of real accounts are included

to demonstrate howwhat you have learnt

is applied in the realworld

Our thanks go to Angelo Provasoli and Alfredo Viganò for their active ment to write this book Also, to Paul De Sury and Andrea Nappa for their valuableinput into Parts one and four respectively

encourage-We should also like to thank our editors, Justinia Seaman, Matthew Smith andSarah Wild, and their colleagues at Pearson Education for all the hard work thatthey have put into producing this book It has been tough going for everyoneinvolved in the process We can only hope that the results will prove that it was allworthwhile

Finally there is a personal acknowledgement we would like to make to MaryKothari Thank you for your encouragement and your help with the review of themanuscript: this book is dedicated to you

Publisher’s acknowledgements

We are grateful to the following for permission to reproduce copyright material:

Table 1.1 adapted from Alexander and Nobes (2004) Financial Accounting: An International Approach, 2nd edition, with permission from Pearson Education Ltd.;

Figures 1.1a, 5.2, 9.1, 14.1 and Tables 3.1, 4.3 from adidas-Salomon Annual Report

2004, with permission of Adidas-Salomon AG, Herzogenaurach, Germany; Figures 1.2, 18.7 and 18.8 from Novo Nordisk Annual Report 2004, with permission from Novo

Nordisk; Figures 6.2, 7.2, 13.3, 13.4, 13.5, 13.6, 13.7, 18.5 and 18.6, and Tables 3.8,

3.9, 4.4, 12.1, 12.2 and Table in Activity 5.3 from Puma 2004 Annual Report, with permission of Puma AG, Herzenogaurach, Germany; Figure 3.6 from Austrian Airlines Group Annual Report 2004, with permission of Austrian Airlines, Vienna, Austria; Figure 5.1 and Figure 17.1 from 2004 Review of Financial Reporting Matters, March 2005 © Huron Consulting Services LLC, 2005, all rights reserved; Figure 6.1

and Tables 6.1, 6.2 and 6.3 from Horngren Charles T., Sundem Gary L and Elliot

of Pearson Education Inc., Upper Saddle River, NJ, USA; Table 9.2 from the Henkel Annual Report 2004, Henkel KgaA, Dusseldorf, Germany, with permission; Figures 4.1,

12.1, 12.2, 12.3, 12.4, 12.7, 12.8, 12.9, 12.10, 12.12, 15.4, 15.5, Table 15.1 and

Acknowledgements xxi

Figures on pp 237, 243 and 244 adapted from Walsh (2002) Key Management Ratios: Master the Management Metrics that Drive and Control your Business, 3rd

edition, withpermission from Pearson Education Ltd.; Income statement on p 280 from DeutschePost Annual Report 2004, with permission of Deutsche Post; Tables 15.2 and 15.3

from Kerry Group plc Annual Report 2004, Kerry Group, Tralee, Ireland, with permission.

We are also grateful to the following for permission to reproduce textual material:

John Wiley and Sons Inc for an extract from International Accounting and national Enterprises by Radebaugh and Gray; Sagalyn Literary Agency for an extract from What Management Is, How it Works, and Why It’s Everyone’s Business by Joan Magretta; and The Economist for ‘Badly In Need of Repair’ published in The Economist 2ndMay 2002, and ‘The Lessons of the Parmelat Scandal’ published in The Economist 15thJanuary 2004.

Multi-Part of the text of Chapter 17 is an extract from ‘Rebuilding Public Confidence in Financial Reporting: An International Perspective’ of the Task Force on Rebuilding

Public Confidence in Financial Reporting, published by the International Federation

of Accountants (IFAC) in July 2003 and is used with permission

Parts of the text in Chapter 18 have been reproduced from PricewaterhouseCooperspublications and are used with permision

Some material has been drawn from publications by the International AccountingStandards Board (IASB) and is reproduced with permission Copyright © 2004International Accounting Standards Committee Foundation All rights reserved Nopermission granted to reproduce or distribute The specific material is listed here:

Chapter 1 includes material drawn from IASB’s Framework for the Preparation and Presentation of Financial Statements: paragraphs 9, 10 and 11.

Chapter 2 includes material drawn from IASB’s Framework for the Preparation and Presentation of Financial Statement: paragraphs 12, 13, 14, 22, 23, 25, 26, 27, 28, 29,

30, 31, 32, 33, 34, 35, 36, 37, 38, 39, 40, 41, 42, 43, 44, 45; and IAS 1

Chapter 3 includes material drawn from IASB’s Framework for the Preparation and Presentation of Financial Statement: paragraph 49(b).

Chapter 4 includes Table from IAS 1

Chapter 5 includes material drawn from IASB’s IAS 18: paragraphs 14, 15, 16, 17, 18and 19

Chapter 7 includes material drawn from IASB’s IAS 16: paragraphs 6, 16, 17; IAS 38:paragraphs 8, 9, 11, 13, 19, 20, 22, 24, 25, 26, 27, 44, 45, 46, 47, 79, 80, 88

Chapter 8 includes material drawn from IASB’s Framework for the Preparation and Presentation of Financial Statement: paragraph 49(b); Figure 8.2 from IAS 37.

Chapter 9 includes Table 9.1 from IAS 1

Chapter 11 includes material drawn from IASB’s IAS 28: paragraph 7; IAS 31: paragraph 10

Chapter 12 includes material drawn from IASB’s IAS 7: paragraphs 14, 16, 17, 19,20(a), 20(b), 20(c)

Glossary includes some definitions from IASB’s Glossary

We are grateful to the Financial Times Limited for permission to reprint the ing material:

follow-Case Study Chapter 11 Branding – the bean counters get into creative accounting,

© Financial Times, 31 August 2004; Case Study Chapter 16 A very secretive success story, © Financial Times, 17 August 2004; Case Study Chapter 18 Good ethics means more than ticking boxes, © Financial Times, 23 August 2005; Extract on p 337 from

We have to prove our own quality, © Financial Times, 21 July 2005.

We are grateful to the following for permission to use copyright material:

Extract on p 23 from Sir David Tweedie – Standard bearer-in-chief from The Financial Times Limited, 14 November 2003, © Rod Newing; Extract on p 329 from Accounts harmony is too big a prize to let go from The Financial Times Limited,

12 February 2004; © Jon Symonds; Extract on p 337 from The best safeguard against

financial scandal from The Financial Times Limited, 12 March 2004, © Thomas

Healey; Extract on p 348 from Sarbanes-Oxley has let fresh air into boardroom from

The Financial Times Limited, 29 July 2005, © Thomas Healey and Robert Steel.

In some instances we have been unable to trace the owners of copyright material,and we would appreciate any information that would enable us to do so

Part One The framework of

financial reporting

1 Introduction to financial accounting

When you have completed this chapter you should be able to:

What is ‘accounting’? And what is it for?

Before answering these questions, we should look at the history and development

of accounting, as this is fundamental to our understanding of present practices.Much of the regulatory and legal framework that we have today has resulted frompast events We will also see that the objectives of enterprises in society and theneeds of users of financial information may influence that framework

1.2.1 The origins of accounting

The precise origins of accountancy are difficult to trace However, there is certainlyevidence of some sort of record-keeping in many civilisations such as the Babylonian,

Assyrian and Egyptian The Sumerian, an early Mesopotamian civilisation, recordedcommercial transactions on stone dating back to 3600 bc and on clay tablets begin-ning about 3200 bc.

In ancient Egypt, accountants were scribes who also practised law In the Pharaoh’scentral finance department, scribes prepared records of receipts and disbursements

of silver, corn and other commodities One recorded on papyrus the amount brought

to the warehouse and another checked the emptying of the containers on the roof

as the contents were poured into the storage building Audit was performed by athird scribe who compared these two records An official order was required for with-drawals, and the scribe in charge of the storehouse recorded the disbursements andretained the order His records of receipts, disbursements and inventory balanceswere periodically audited by another scribe or his superior

In 1939, archaeological excavation at Pylos, Greece (the possible site of the palace of Nestor of Trojan War fame) recovered hundreds of clay tablets written inMinoan script Scholars have concluded that a Cretan scribe had been carried off byMycenaean raiders and set to work keeping the accounting records of the Grecianking (circa 1400 bc) Perhaps from this beginning, it became customary to use slaves

as scribes and auditors in Greece With the growth of governmental revenues, ticularly in Athens, accounting and auditing became more important In the goldenage of Pericles (461– 429 bc), each citizen became an auditor through the custom

par-of requiring contractors par-of public buildings to report their receipts and expenditures

on tablets chiselled in stone on the walls of the building One such tablet indicatesthat the Parthenon cost 469 talents of silver

Roman civilisation was forward-thinking enough to have laws requiring payers to prepare statements of their financial position In fact, the Roman Empiremade effective use of accounting and auditing to control the generals of conqueredterritories The quaestors, who came into being about 200 bc, were financial officersresponsible to Rome, who had custody of the treasury, supervised the scribes in theirduties of recording treasury receipts and disbursements, and examined the accounts

tax-of the governors tax-of subjugated countries The quaestors were required to report odically to Rome and have their records ‘heard’ by an examiner The word ‘auditor’

peri-came into use through this practice

In the Middle Ages accounting suffered a decline because of the general organised condition of government and the economy throughout Europe Gradually,however, accounting was re-established:

dis-The complicated operations of the bankers, the papacy, and the monarchies required a careful system of bookkeeping Archives and account books swelled with records of rents, tax, receipts, expenditures, audits and debits The accounting methods of imperial Rome, lost in Western Europe

in the seventh century, continued in Constantinople, were adopted by the Arabs and were revived

in Italy during the Crusades A fully developed system of double-entry bookkeeping appears in

Several prerequisites have been identified as contributing towards the emergence ofaccounting as we know it today These include:

• a system of writing, necessary to keep records

• arithmetic, necessary for simple computations

• money within the economy, as all transactions are denoted in this denominator

of voyages to be kept, in order to calculate and share profits from overseas trading.The first bank with customer facilities opened in Venice in 1149 Balance sheetswere evident from around 1400 and the Medici family had accounting records of

‘cloth manufactured and sold’ Regular audits of the records of the Medici Bank wereperformed during the period 1397 to 1494 The main office in Florence required that an annual balance sheet be submitted by each branch The general managerand his assistants audited these statements which are still found in the archives ofFlorence

Luca Pacioli, a Franciscan monk, is widely believed to be the inventor of entry bookkeeping However, a rudimentary system of double-entry bookkeepingwas used in Genoa around 1340 In 1494, Pacioli documented the double-entry

double-system being practised at the time by merchants in Venice in his famous book Summa

de arithmetica, geometria, proportioni et proportionalita (The Collected Knowledge of Arithmetic, Geometry, Proportion and Proportionality) The Summa made Pacioli

‘The Father of Accounting’

During the 1550s the rise of nation states and the need to manage public financesunderpinned the importance of good accounting practice:

As commercial traffic shifted from the ports of Venice to the Atlantic shipping routes, Italy slipped

in importance and relatively few new developments took place in accounting The French Revolution in the late 1700s marked the beginning of a great social upheaval that affected governments, finances, laws, and customs Italy came under the influence of the French and then the Austrians, and their system of double-entry accounting was also influenced It is interesting to note that Napoleon was surprised at how efficient the Italian system of accounting was.

(Radebaugh and Gray 2002)

Development of accounting theory also began in this period and has continued to

the present day However, the influence of Pacioli’s Summa continues to be felt in

the double-entry bookkeeping we use today Even the British, who acquired their

knowledge of double-entry accounting soon after Pacioli’s Summa was published,

did not begin adopting the double-entry system until the Industrial Revolution(1760 –1830) At that point, the importance of accounting grew substantially As thescale of enterprise was increased by technological breakthroughs such as mass pro-duction, and fixed costs grew in importance compared to the variable costs, it becamenecessary to account for depreciation, the allocation of overheads, and inventory:

Since the early 1900s, the rapidity of change and the increasing complexity of the world’s industrial economies necessitated still more changes in accounting Mergers, acquisitions, and the growth

of multinational corporations fostered new internal and external reporting and control systems.

With widespread ownership of modern corporations came new audit and reporting procedures and new agencies became involved in promulgating accounting standards: namely, stock exchanges, securities regulation commissions, internal revenue agencies, and so on Finally, with the dramatic increase in foreign investment and world trade and the formation of regional economic groups such

as the European Union, problems arose concerning the international activities for business This phenomenon remains particularly complex, for it involves reconciling the accounting practices

of different nations in which each multinational operates, as well as dealing with accounting problems unique to international business Furthermore, there is growing public concern about the impact of corporations, especially in relation to so-called externalities (e.g., pollution of the environment and the influence of large corporations on national economic and social policies).

(Radebaugh and Gray 2002)

There are several definitions of accounting

The Accounting Principles Board defines accounting as a service activity, thefunction of which is:

to provide quantitative information, primarily financial in nature, about economic entities that is intended to be useful in making economic decisions, in making resolved choice among alternative courses of action.

(Accounting Principles Board, Statement No 4, ‘Basic Concepts and AccountingPrinciples Underlying Financial Statements or Business Enterprises’, New York, American Institute of Certified Public Accountants (AICPA) 1970, paragraph 40)

Accounting is the art of recording, classifying and summarizing in a significant manner and in terms of money, transactions and events which are, in part at least, of a financial character, and interpreting the results thereof.

(‘Review and Resume’, Accounting Terminology Bulletin No 1,American Institute of Certified Public Accountants (AICPA))

The American Accounting Associationdefines accounting as ‘the process of ing, measuring and communicating information to permit informed judgementsand decisions by users of the information’ (A Statement of Basic Accounting Theory1996)

identify-Compared with the previous two definitions, this is a more precise definition, forthe reasons set out as follows:

• It recognises that accounting is a process: that process is concerned with ing business events, recording their financial effect, summarising and reportingthe result of those effects, and interpreting those results

represent-• It is concerned with economic information: while this is predominantly financial,

it also allows for non-financial information

• Its purpose is to support ‘informed judgements and decisions by users’: this phasises the usefulness of financial information in the decision-making process

Forms of business units 7

As we illustrate in section 1.5, this book takes a stakeholder perspective in that users

of financial information should include all those who may have an interest in thesurvival, profitability and growth of a business: shareholders, employees, customers,business trading partners, suppliers, government agencies, tax authorities, sell-sideanalysts, accounting standard setters, rating agencies, market regulators, banks,investment banks, large and small investors, and society as a whole

Accounting for a narrow (shareholders) or a broad (societal) group of users is animportant philosophical debate to which we will return in section 1.5 This debatederives from questions of accountability: to whom is the business accountable andfor what, and what is the role of accounting and accountability?

Accountability is the capacity and willingness to give explanations for conduct,stating how one has discharged one’s responsibilities, an explanation of conductwith a credible story of what happened, and a calculation and balancing of com-peting obligations, including moral ones (Boland and Schultze 1996) Account-ability means explaining what happened and its financial consequences, as in

a collection of systems and processes used to record, report and interpret ness transactions Accounting provides an account – an explanation or report infinancial terms – about the transactions of an organisation It enables managers tosatisfy the stakeholders in the organisation that they have acted in the best interests

busi-of stakeholders rather than for themselves This is the notion busi-of accountability

to others, a result of the stewardship function of managers that takes place throughthe process of accounting Stewardship is an important concept because in all butvery small businesses, the owners of businesses are different individuals from themanagers This separation of ownership from control makes accounting particu-larly influential because of the emphasis given to increasing shareholder wealth.Accountability results in the production of financial statements, primarily for those

interested parties who are external to the business This function is called financial

accounting.

This book refers to businesses as ‘enterprises’, which is the definition used by theInternational Accounting Standards Board (IASB) This word is designed to cover allforms of business operations

Sole tradership (or sole proprietorship)

At one extreme, an enterprise can be run by a single person with no partners Thisenterprise is called sole tradership or sole proprietorship This form of business tends

to be adopted by small retail establishments or shops and individual enterprisessuch as those run by dentists, physicians and attorneys or lawyers

The sole trader has an unlimited liability for the debts of the enterprise and pays personal income tax on the profits If the enterprise is to be sold, then the trader must sell the (net) assets because there is no legal entity to sell From an accounting

viewpoint, each sole proprietorship is a separate entity that is distinct from the prietor Nevertheless, the proprietor keeps the accounts for the enterprise separatefrom other personal activities, in accordance with the business entity conventiondiscussed in section 2.4.

pro-Partnerships

As the enterprise becomes larger, it may be useful to have some joint owners (partners)

which is formalised by a contract between the partners that states their rights andduties In common law countries, a partnership does not have separate legal existencefor most purposes The partners are legally responsible for the enterprise’s assets andliabilities, and they pay tax on their share of the profits

Nevertheless, it is possible to set up a ‘limited liability partnership’ (LLP) This isthe legal form many accountancy firms have chosen today The purpose of this is toseek to protect the partners from some part of the liabilities of the enterprise if thereare large legal claims

Companies

The complete separation of owners from their enterprise is achieved by setting up a

company, usually with limited liability for the owners The ownership of the pany is denoted by shares, which can be transferred from one owner (shareholder

com-or stockholder) to another without affecting the company’s existence A company

is a separate legal entity from its owners The company can buy and sell assets andpays tax on its own profit

In EU and other developed countries, companies can be either private or public

A private companydoes not have its shares listed on the stock exchange, so theycan only be exchanged by private agreement between the owner and the buyer,

com-panies are required to comply with rules fixed by the stock exchanges, regulators ofstock exchanges or other bodies

Groups

As an enterprise continues to increase in size and complexity, it normally finds it

separate entities The reasons for such complex structures are:

• The combination of two enterprises may result in economies of scale and scope,that is to say the cost of producing the combined output will be less than the sum

of the costs of producing the separate outputs or, alternatively, the combinedoutput will be greater for the same total cost Such economies may exist not only

in production but also in administration, marketing, research and development,and financing

• Combining with another enterprise may be one means of eliminating or ing competition Although integration may occur for many reasons, one reason

reduc-Objectives of enterprises in society 9

may be that it is possible to reduce competition both by vertical integration, that

is by combining with an enterprise at an earlier or later stage of the productioncycle, or by horizontal integration, that is by combining with a firm at the samestage in the production cycle

• By combining with another entity which makes different products, an enterprise

is often able to reduce risk Thus one reason for a combination involving nesses in different industries may be a desire to generate an earnings streamwhich is less variable and/or volatile than the separate earnings streams of thetwo individual businesses

busi-• The various entities in the group need to be legally separate when they operate

in several countries under several different laws

• Sometimes there are tax advantages in being separate or there may be tax advantages in combining formerly separate entities

dis-• The legal structures may partially reflect a hierarchical organisational structure

• The (financial and non-financial) performances may improve thanks to a betterintegration of different activities carried out by the various enterprises formingthe group

An important question which is being debated concerns the role of enterprises insociety On one side of this long-running debate are those who argue that ‘the business of business is business’ (to borrow Milton Friedman’s phrase) and, there-fore, its goal is primarily and exclusively to enhance shareholder value On the otherside, there are those who argue that enterprises have a broader purpose: to createvalue by taking into account the interests of employees, customers, suppliers andthe communities in which they operate

Should enterprises seek only to maximise shareholder value or strive to serve the,often conflicting, interests of all stakeholders? In addition to this question, we mayask what is the managers’ duty An answer can be found in exploring two visions

of the enterprise The first one, known as the shareholder theory, is based on the primacy of the shareholders, while the second one, the stakeholder theory, claimsthat other stakeholders deserve consideration, too According to the former, themanagers primarily have a duty to maximise shareholder returns, while the latterclaims that a manager’s duty is to balance the shareholders’ financial interestsagainst the interest of other stakeholders such as employees, customers and the localcommunity, even if it reduces shareholder returns

The shareholder theory asserts that shareholders provide capital to a company’smanagers, who are supposed to use corporate funds only in ways that have beenauthorised by the shareholders As Milton Friedman wrote in 1962:

There is one and only one social responsibility of business – to use its resources and engage in activities designed to increase its profits so long as it engages in open and free competition, without deception or fraud.

On the other hand, the stakeholder theory asserts that managers have a duty toboth the corporation’s shareholders and ‘individuals and constituencies that con-tribute, either voluntarily or involuntarily, to a company’s wealth-creating capacityand activities, and who are therefore its potential beneficiaries and/or risk bearers’

(Post, Preston and Sachs 2002), such as its customers, employees, suppliers and thelocal community According to the stakeholder theory, managers are agents of allstakeholders and have two main responsibilities:

• to ensure that the ethical rights of no stakeholder are violated

• to balance the legitimate interests of the stakeholders when making decisions

The objective of a corporation is, thus, to balance profit maximisation with thelong-term ability of the corporation to remain a going concern

The fundamental distinction between the two approaches is that the stakeholdertheory demands that interests of all stakeholders be considered even if it does notalways maximise profits or wealth of the company or if it sometimes reduces the com-pany profitability In other words, under the shareholder theory, non-shareholderscan be viewed as ‘means’ to the ‘ends’ of profitability; under the stakeholder theory,the interests of all stakeholders (i.e shareholders and non-shareholders) are viewed

as ‘ends’

In recent years we have witnessed a good deal of corporate executive behaviourthat was at best disruptive to the free flow of commerce and, at worst, illegal Fewwould dispute that such behaviour should be discouraged rather than rewarded

The real question, of course, is whether a corporation should prescribe, and fore reward, behaviours that are actually detrimental to society Many of the morestrident critics of the shareholder theory seem to claim that as executives are chargedwith maximising shareholder value and are given large incentives to do so throughstock options or other arrangements, they will respond by embracing whatevermanipulations are necessary to achieve that goal

there-This argument relies, however, on an incomplete and somewhat tive interpretation of the shareholder theory

misrepresenta-In fact, while the mantra of maximising shareholder value was indeed chanted

by many in the economic and financial communities in the late 1990s until thescandals hit in 2002, it is not at all clear that such a goal is completely consistentwith the intent of the shareholder theory Management should worry about increas-ing dividends through profitability rather than increasing share price in the stockmarket with manipulation or fraudulent behaviours

Moreover, the pursuit of profit should be done legally and without deception,and there is little room for the kinds of overtly illegal behaviour alleged in manyrecent financial scandals The executives who broke the law were not operatingaccording to the shareholder theory

Finally, it must be remembered that many of the executives undertook actionsthat were more for their own benefit than for that of the shareholders For example,Enron CFO (Chief Financial Officer) Andrew Fastow, who created a partnership thatwas bankrolled with Enron stock and invested in a portfolio of highly risky ventures,

‘stood to make millions quickly, in fees and profits, even if Enron lost money on the

deal,’ according to the Washington Post (28 July 2002) Actually Enron lost more than

$500 million from these initiatives and filed bankruptcy Similarly, several otherexecutives, including Kenneth Lay of Enron, Garry Winninck of Global Crossing

Objectives of enterprises in society 11

Holdings and Scott Sullivan of WorldCom, also benefited from bonuses and stockoptions at the same time that their companies’ shareholders were suffering losses.Such behaviour is inexcusable, since theoretically executives should act only in theshareholders’ interests and not in their own

Yet business leaders in the past have been too short-term in their orientation, with great damage

to shareholder culture They need to think longer term Yes, they should focus on shareholders; that’s not in question But how they do that, how they create long-term sustainable value, is the issue And to do that, they have to take more account of their employees, their customers, their suppliers, and the health of their communities – and yes, the global economy, too.

( Jeffrey Garten, The Economist, 4 January 2003)

What we wish to emphasise is that profits are a result of satisfying the needs of thesestakeholders As David Packard, the co-founder of Hewlett-Packard said, ‘Profit isnot the proper end and aim of management – it is what makes all of the proper endsand aims possible.’ According to his vision, the real purpose of an enterprise is tocreate value for its customers and to generate profit as a result (Magretta 2002)

adidas-Salomon

strives to be the global leader in the sporting goods industry with sports brands built

on a passion for sports and a sporting lifestyle

→

We are consumer focused.

That means we continuously improve the quality, look, feel and image of our products and our organizational structures to match and exceed consumer expectations

and to provide them with the highest value

→

We are innovation and design leaders

who seek to help athletes of all skill levels achieve peak performance with

every product we bring to the market

→

We are a global organization

that is socially and environmentally responsible, creative and financially rewarding

for our employees and shareholders

In the medium term

we will extend our leading marketing position in Europe, expand our share of the

US footwear market and be the fastest growing major sporting goods supplier in

Asia and Latin America

The resulting top-line growth, together with strict cost control and working capital

improvements, will drive overproportionate earnings growth

Source: adidas-Salomon Annual Report 2004

Novo Nordisk explains its own view of stakeholder theory in its annual report asshown in Figure 1.2.

Our corporate purpose

Unilever’s mission is to add Vitality to life We meet everyday needsfor nutrition, hygiene and personal care with brands that helppeople feel good, look good and get more out of life

Our deep roots in local cultures and markets around the world give

us our strong relationship with consumers and are the foundationfor our future growth We will bring our wealth of knowledge andinternational expertise to the service of local consumers – a trulymulti-local multinational

Our long-term success requires a total commitment to exceptionalstandards of performance and productivity, to working togethereffectively, and to a willingness to embrace new ideas and learncontinuously

To succeed also requires, we believe, the highest standards

of corporate behaviour towards everyone we work with, thecommunities we touch, and the environment on which we have

an impact

This is our road to sustainable, profitable growth, creating long-term value for our shareholders, our people, and our businesspartners

Source: Unilever Annual Report and Accounts 2004

Coloplast’s Mission

Throughout the world we wish, within our selected business areas,

to be the preferred source of medical devices and associatedservices, contributing to a better quality of life

By being close to customers we fulfil their needs with innovative,high quality solutions Through empathy, responsiveness anddependability we seek to earn their loyalty

Our culture attracts and nourishes individuals who are energetic,committed and have a passion for our business

We respect differences and pledge to act responsibly in social,environmental and business contexts

By striving to be best in our business we achieve growth and increased value for our customers, employees and shareholders

Source: Coloplast Annual Report 2003/04

Main users of financial information of an enterprise 13

Source: Novo Nordisk Annual Report 2004

Information on an enterprise and in particular that contained in the annual report

is used by a wide range of operators Let us look closely at these users of financialinformation and, in particular, at the reasons why they need financial informationrelating to an enterprise

The terminology we use is closely based on a document called Framework for the Preparation and Presentation of Financial Statements issued by the IASB.

The users of financial statements include present and potential investors,

their agencies and the public They use financial statements in order to satisfy some

of their different needs for information These needs include the following:

• Owners (or investors) need financial information relating to the enterprise to assess

how effectively the managers are running it and to make judgements about likelylevels of risk and return in the future Shareholders need information to assessthe ability of the enterprise to pay them a return (dividend) The same applies topotential shareholders

• Employees and their representative groups are interested in information about the

stability and profitability of their employers They too need information whichenables them to assess the ability of the enterprise to provide remuneration, retire-ment benefits and employment opportunities

• Lenders (such as banks) need financial information about an enterprise in order

to assess its ability to meet its obligations, to pay interest and to repay the amountborrowed

• Suppliers and other trade creditors need information that enables them to

deter-mine whether amounts owed to them will be paid when due Trade creditors are likely to be interested in an enterprise over a shorter period than lendersunless they are dependent upon the continuation of the enterprise as a majorcustomer

• Customers have an interest in information about the continuance of an

enter-prise, especially when they have a long-term involvement with, or are dependent

on, the enterprise

Management accounting and financial accounting 15

• Governments and their agencies need information in order to regulate the activities

of enterprises, to assess whether they comply with agreed pricing policies,whether financial support is needed, and how much tax they should pay Theyalso require information in order to determine taxation policies and as the basisfor national income and statistics

• Members of the public are affected by enterprises in a variety of ways For example,

enterprises may make a substantial contribution to the local economy in manyways including the number of people they employ and their patronage of localsuppliers Financial statements may assist the public by providing informationabout the trends and recent developments in the prosperity of the enterprise andthe range of its activities

• Investment analysts need financial information relating to an enterprise to assess

the likely risks and returns associated with the enterprise in order to determineits investment potential and to advise clients accordingly

• Competitors need financial information relating to an enterprise to assess the

threat to sales and profits posed by those businesses and to provide a benchmarkagainst which the competitor’s performance can be measured

• Managers need financial information relating to an enterprise to help make

decisions and plans for the business and to exercise control so that the planscome to fruition

While all the information needs of these users cannot be met by financial statements,there are needs which are common to all users As investors are providers of risk capital to the enterprise, the publication of financial statements that meet their needswill also meet most of the needs of other users

It should however, be noted that some user groups (such as suppliers, customers,competitors, public) use financial information, but they have no right to claim thisinformation as other user groups have

The management of an enterprise has the primary responsibility for the tion and presentation of its financial statements Management is also interested inthe information contained in the financial statements even though it has access toadditional management and financial information that helps it carry out its planning,decision-making and control responsibilities

The needs described in the previous section lead to an important distinction betweentwo branches of accounting, namely that between management accounting andfinancial accounting Although this book focuses on the latter, it is useful to high-light the differences between these two branches

The former is concerned with the provision of information intended to be useful

to management within the enterprise, while financial accounting is intended forusers outside the enterprise itself

The differences between the two types of accounting reflect the different user groupsthat they address and, to some extent, the differences in access to financial informa-tion Management accounting should provide timely and accurate information to

facilitate budgetary control over revenues and costs, to measure and improve tivity, and to devise improved production processes In addition to that, managementaccounting must report accurate product costs so that pricing decisions, introduction

produc-of new products, abandonment produc-of obsolete products, and response to rival productscan be made

The Chartered Institute of Management Accountants’ definition of the core activities of management accounting includes:

• participation in the planning process at both strategic and operational levels,involving the establishment of policies and the formulation of budgets

• the initiation of any provision of guidance for management decisions, involvingthe generation, analysis, presentation and interpretation of relevant information

• contributing to the monitoring and control of performance through the sion of reports including comparisons of actual with budgeted performance, andtheir analysis and interpretation

provi-The major differences between management and financial accounting in terms

of nature of the reports produced, level of detail, regulations, reporting interval,time horizon, range and quality of information are described in the following paragraphs:

• Nature of the reports produced Financial accounting reports tend to be general

purpose reports That is, they contain financial information that will be useful for a broad range of users and decisions rather than being specifically designedfor the needs of a particular group or set of decisions Management accountingreports, on the other hand, are often specific purpose reports They are designedeither with a particular decision in mind or for a particular manager

• Level of detail Financial accounting reports provide users with a broad

over-view of the position and performance of an enterprise for a period As a result, information is aggregated On the contrary, management accounting reports pro-vide managers with considerable detail to help them with particular operational decisions

• Regulations Financial reports, for many enterprises, are subject to accounting

regu-lations that exist to ensure that they are produced according to a standardisedformat These regulations are imposed by law and the accounting profession

Because management accounting reports are for internal use only, there is no regulation from external sources concerning their form and content: they can bedesigned to meet the needs of particular managers

• Reporting interval For most enterprises, financial accounting reports are produced

on a yearly basis However, larger companies may produce semi-annual reportsand some produce quarterly reports Management accounting reports may beproduced as frequently as required by managers In many enterprises, managersare provided with certain reports on a daily, weekly or monthly basis, whichallows them to check progress on a need basis

• Time horizon Financial accounting reports reflect the performance and position

of the business for the past period, whilst management accounting reports vide information concerning future performance as well as past performance

pro-However, it is an oversimplification to suggest that financial accounting reports

Notes on terminology 17

Own shares Treasury stock Treasury sharesDebtors Accounts receivable Trade and other receivablesCreditors Accounts payable Trade and other payablesFinance lease Capital lease Finance lease

Turnover Sales (or revenue) Sales (or revenue)

Fixed assets Property, plant and Property, plant and

Profit and loss account Income statement Income statementReducing balance Declining-balance Diminishing balance depreciation method depreciation method depreciation methodSource: adapted from Alexander and Nobes (2004)

never incorporate expectations concerning the future: occasionally, enterpriseswill release forecast information to other users in order to raise capital or to fightoff unwanted takeover bids Although differences undoubtedly exist, there is also a good deal of overlap between the needs of managers and the needs of otherusers with reference to the time horizon For example, managers will, at times,

be interested in receiving an historic overview of the enterprise’s operations ofthe sort provided to other users Equally, the other users would be interested inreceiving information relating to the future, such as the forecast level of profits,and non-financial information such as the state of the order book and productinnovations

• Range and quality of information Financial accounting concentrates on

informa-tion that can be quantified in monetary terms, while management accounting

in addition to such reports, produces reports that contain information of a financial nature, such as measures of physical quantities of inventories and output

Many readers of this book will aim not only to master a subject new to them butalso do so in a language that is not their first One added difficulty is that for

issues its standards in English using a mixture of UK and US terms, while UK termstend to be used by the fourth and seventh EU directives On the whole, this bookuses IASB terms

• There is evidence of some sort of accounting in ancient civilisations dating back

to around 3600 bc

• Luca Pacioli, an Italian Franciscan monk, is widely considered to be the inventor

of double-entry bookkeeping, which is the basis of current financial accounting

• ‘Accounting’ is the process of identifying, measuring and communicating tion to permit informed judgements and decisions by users of the information

informa-• The IASB refers to all forms of businesses as ‘enterprises’

• Throughout this book we consider that an enterprise’s objective is not simply the maximisation of profit or dividends for shareholders, but to create value byalso enriching employees, customers, suppliers and the community in which itoperates

• Financial accounting is designed to give financial information to particular groups

of users Different users have different needs

• This book focuses on the reporting by business enterprises to shareholders andstakeholders

• Accounting terms differ considerably between the UK and US practices In thebook we have opted for the accounting terms used by the IASB

References and research

The IASB document relevant for this chapter is the Framework for the Preparation and tion of Financial Statements.

Presenta-The following are examples of research papers and books that take the issues of this chapterfurther:

• David Alexander and Christopher Nobes, Financial Accounting: An International Introduction,

2ndEdition, Financial Times Prentice Hall, 2004, Chapter 1

• R.J Boland and U Schultze, ‘Narrating Accountability’, Accountability: Power, Ethos and the Technologies of Managing, R Murno and J Mouritsen (eds), Thompson Press: London, 1996

• Raymond de Roover, The Rise and Decline of the Medici Bank, 1397–1494, Harvard University

Press, 1963

• Will Durant, The History of Civilization: Our Oriental Heritage, Vol I, Simon and Schuster,

1935

• Will Durant, The History of Civilization: The Age of Faith, Vol IV, Simon and Schuster, 1950

• M Friedman, Capitalism and Freedom, University of Chicago Press, 1962

• Paul Jackson, David Tinius and William Weis, Luca Pacioli: Unsung Hero of the Renaissance,

South-Western Publishing Company, 1990

• Joan Magretta, What Management is: How it Works and Why it’s Everyone’s Business, Free

Press, 2002, page 131

• Kenneth S Most, ‘Accounting by the Ancients’, The Accountant, May 1959