Accounting and finance for non specialists 10th by atrill

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Peter Atrill Eddie McLaney

Cover image © Getty Images

Peter Atrill & Eddie McLaney

• Progress checks, activities and exercises reinforce learning

• Focus on decision making prepares you for careers in business

New to this edition

• Increased number of activities

• New and updated real-world cases to help students understand the

theory in practice

• Up-to-date coverage, including the latest IFRSs

The 10th edition of this market-leading text offers an accessible, effective introduction to key accounting and finance topics With a focus on decision

making, Accounting and Finance for Non-Specialists teaches you how to apply

your learning to real-world business scenarios

Peter Atrill is a freelance academic and author who has worked with leading

institutions in the UK, Europe and SE Asia He was previously Head of Accounting and Law and Head of Business and Management at the Plymouth University Business School

Eddie McLaney is Visiting Fellow in Accounting and Finance at Plymouth University

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Accounting And Fin

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Accounting And Fin

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PEARSON EDUCATION LIMITED

First published 1995 by Prentice Hall Europe (print)

Second edition published 1997 (print)

Third edition published 2001 by Pearson Education Ltd (print)

Fourth edition published 2004 (print)

Fifth edition published 2006 (print)

Sixth edition published 2008 (print)

Seventh edition published 2011 (print)

Eighth edition published 2013 (print and electronic)

Ninth edition published 2015 (print and electronic)

Tenth edition published 2017 (print and electronic)

The rights of Peter Atrill and Eddie McLaney to be identified as authors of this work have been asserted by them

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trademarks imply any affiliation with or endorsement of this book by such owners.

Contains public sector information licensed under the Open Government Licence (OGL) v3.0

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ISBN: 978-1-292-13560-1 (print)

978-1-292-13561-8 (PDF) 978-1-292-13565-6 (ePub)

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NOTE THAT ANY PAGE CROSS REFERENCES REFER TO THE PRINT EDITION

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Brief conTenTs v

Brief contents

Preface xv Acknowledgements xvii

part one FinAnciAl Accounting 27

part two MAnAgeMent Accounting 247

Index 580

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conTenTs vii

contents

Preface xv Acknowledgements xvii

Introduction 1

Summary 23 Key terms 24 Further reading 25 Review questions 25

part one FinAnciAl Accounting 27

Introduction 28

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Statement layouts 47

Summary 65 Key terms 67 Further reading 67 Review questions 68 Exercises 68

Introduction 115

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conTenTs ix

Introduction 164

Introduction 195

Profitability 203 Efficiency 210

Liquidity 218

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Trend analysis 234

part two MAnAgeMent Accounting 247

Introduction 248

Contribution 265

Introduction 289

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conTenTs xi

Introduction 329

part three FinAnce 367

Introduction 368

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Some practical points 395

Introduction 411

Summary 451 Key terms 454

References 454

Further reading 455 Review questions 455 Exercises 455

Introduction 460

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PrefAce xv

Preface

This book provides an introduction to accounting and finance It is aimed at:

■ 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

■ 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 the technical aspects, but rather considers principles and

underlying concepts It also examines the ways in which financial statements and other

financial information may improve the quality of decision making To reinforce the practical

emphasis of the book, there are illustrative extracts from company reports, survey data

and other sources throughout

In this tenth edition, we have made improvements suggested by students and lecturers

who used the previous edition We have also increased the number of diagrams in order

to aid learning Examples from real life have been updated and their number has been

increased Finally, we have improved the range and quality of self-assessment material

The book is written in an ‘open-learning’ style This means that there are numerous

integrated activities, worked examples and questions throughout the book to help you to

understand the subject fully You are encouraged to interact with the material and to check

your progress continually Irrespective of whether you 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 you to learn

We recognise that most of you 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

explana-tions You will find all of the key terms highlighted in the book, and then listed at the end

of each chapter with a page reference All of these key terms are also listed

alphabeti-cally, with a concise definition, in the glossary towards the end of the book This should

provide a convenient point of reference from which to revise

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A further important consideration in helping you to understand and absorb the topics covered is the design of the book itself The page layout and colour scheme have been

carefully considered to allow for the 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

We hope that you find the book both readable and helpful

Peter Atrill Eddie McLaney

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AcknowLedgeMenTs xvii

Acknowledgements

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

Figures

Figure 3.9 from European Payment Index 2014, www.intrum.com, Intrum Justitia;

Figure 4.8 from Guidance on the strategic report p20, https://www.frc.org.uk/Our-Work/

Publications/Accounting-and-Reporting-Policy/Guidance-on-the-Strategic-Report.pdf,

further information, please visit www.frc.org.uk or call +44 (0)20 7492 2300; Figure 5.6

from BP plc Annual Report 2014 P.18 www.bp.com BP plc; Figure 6.2 adapted from Office

of National Statistics, ‘Profitability of UK companies Q1 2015, www.statistics.gov.uk 8 July

2015, Crown copyright, © Crown copyright Contains public sector information licensed

under the Open Government Licence (OGL) v3.0 http://www.nationalarchives.gov.uk/

doc/open-government-licence/version/3/; Figure 8.11 adapted from Activity Based

Costing: A Review with Case Studies CIMA Publishing (Innes J and Mitchell F 1990) CIMA

Reproduced with permission of The Chartered Institute of Management Accountants;

Figure 8.12 from A survey of factors influencing the choice of product costing systems in

UK organisations Management Accounting Research December (Al-Omiri, M and

Drury, C 2007), Reproduced with permission of The Chartered Institute of Management

Accounts; Figure 8.13 adapted from Management accounting tools for today and

tomor-row, CIMA (2009) 12, Reproduced with permission of The Chartered Institute of

Management Accounts; Figure 9.9 adapted from Management Accounting Tools for Today

and Tomorrow CIMA CIMA (2009) 12, Reproduced with permission of The Chartered

Institute of Management Accountants; Figure 11.10 from Office for National Statistics

(2015), Ownership of quoted shares for UK domiciled companies 2014, 2 September,

Contains public sector information licensed under the Open Government Licence v3.0

http://www.nationalarchives.gov.uk/doc/open-government-licence/version/3/; Figure 12.9

adapted from Table 2 p6 in All Tied Up: Working Capital Management Report 2014, Ernst

and Young, p 7, www.ey.com., Ernst and Young

Text

Real World 1.1 from K Inagaki Sony seeks delay in releasing full results in wake of cyber

attack, 23 January 2015, ft.com, Financial Times, © The Financial Times Limited 2015 All

Rights Reserved; Real World 1.2 from www.standardlife.com, accessed 24 October 2015,

of Standard Life; Real World 1.3 from adapted from Waters, R Apple has incentive to

worry about worker’ rights 25 February 2012, ft.com, Financial Times, © The Financial

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we’ve poisoned the well of wealth, Financial Times, 15 February., ft.com, Financial Times,

Playing dice with your money 4 September 2015, ft.com, Financial Times, © The Financial

to write down value of mining assets by up to $4bn July 16, 2015 ft.com, Financial Times,

Balance sheets: the basics accessed 14 April 2010 www.businesslink.gov.uk, Crown

Copyright, © Crown copyright Contains public sector information licensed under the

Open Government Licence (OGL) v3.0

http://www.nationalarchives.gov.uk/doc/open-government-licence/version/3/; Real World 3.5 from British Airways Annual Report and

Accounts 2008/09 Note 15, www.britishairways.com, British Airways; Real World 4.1 from

Urquhart, Lisa (2003) Monotub Industries in a spin as founder gets Titan for £1, Financial

World 4.4 adapted from UK Corporate Governance Code, Financial Reporting Council,

September 2014, pages 5 and 6, www.frc.org.uk, Financial Reporting Council, © Financial

org.uk or call +44 (0)20 7492 2300; Real World 4.5 from Ryanair Holdings plc, Annual

Report 2015, p 156, Ryanair; Real World 4.7 from H Mance, Betfair admits to £80m

pay-outs mistake, 3 August 2014, ft.com, Financial Times, © The Financial Times Limited 2014

proposing 8.1% dividend rise, 11 June 2015, ft.com, Financial Times, © The Financial

dan-gerous unforced errors 9 July 2013, ft.com, Financial Times, © The Financial Times

Limited; Real World 5.3 adapted from Tesco plc, Annual Report and Financial Statements

2015, P.87 www.tescoplc.com, Tesco plc; Real World 5.5 from Ryanair Holdings plc

Annual Report 2015 Pages 161, 108 and 109; Real World 6.4 adapted from Wild, J

‘Ryanair sees sharp fall in profits due to higher fuel costs’, 29 July 2013., ft.com, Financial

S Gordon UK small businesses spend £11bn chasing payments 16 July 2015, ft.com,

from Smith, T (2014) ‘How investors ignored the warning signs at Tesco’ 5 September, ft

com, Financial Times; Real World 7.1 adapted from Foley, S Is a university degree a good

investment? 7 September 2014, ft.com, Financial Times, © The Financial Times Limited

of product costing systems in UK organisations, Management Accounting Research,

December, 399–424 (Al-Omiri, M and Drury, C 2007), Reprinted with permission of

Elsevier; General Displayed Text on page 329 from 2015 annual report, BSkyB Group plc,

Sky News; Real World 9.1 from Greene King plc Annual Report 2015, page 40; Real

World 10.3 from RECKONING WITH RISK: LEARNING TO LIVE WITH UNCERTAINTY

Reproduced by permission of Penguin Books Ltd and CALCULATED RISKS: How to know

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AcknowLedgeMenTs xix

from Murray S It pays for companies to be part of the scenery, 2 June 2015, ft.com,

from A multinational survey of corporate financial policies, Exhibit 3, Journal of Applied

Finance 17(1), 62 (Cohen G and Yagil J 2007), Financial Management Association; Real

World 11.2 from Wembridge, M and Felsted, A HMV plunges 40% on covenant warning,

3 December 2012 and information contained in both Felstead, A and Sakoui, A Hilco

strikes deal to rescue HMV, 5 April 2013 and Masters, B HMV proves that down does not

mean out 16 January 2015, ft.com, Financial Times, © The Financial Times Limited 2012

the original article; Real World 11.3 from McLannahan, B Manchester United is calling the

shots 4 June 2015 ft.com, Financial Times, © The Financial Times Limited 2015 All Rights

Reserved; Real World 11.4 from Lex column Sony – group bonding, 15 November 2012,

World 11.6 from Thomas, D Orange looks to offload Spanish mobile masts to cut costs

14 August 2014, ft.com, Financial Times, © The Financial Times Limited 2014 All Rights

Reserved; Real World 11.8 from Moules, J RBS has driven us to wall, says bricks

busi-ness, 25 November 2013, ft.com, Financial Times, © The Financial Times Limited 2013 All

Rights Reserved.; Real World 12.5 from www.atradius.us/news/press-releases, 13 August

2008 Atradius Trade Credit Insurance, Inc; Real World 12.9 from Daeshkhu, S Diageo

backs down on extended payment terms, 13 March 2015, ft.com, Financial Times, © The

Merin, D Uncovering cash and insights from working capital McKinsey and Company,

July 2014, www.mckinsey.com, McKinsey

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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;

■ explain why an understanding of accounting and finance is likely to be relevant to your needs

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WhAt Are AccountIng And FInAnce?

Let us begin by trying to understand the purpose of each Accounting is concerned with

collecting, analysing and communicating financial information The ultimate aim is to help

those using this information to make more informed decisions Unless the financial

informa-tion being communicated can lead to better decisions being made, there really is no point

in producing it

Sometimes the impression is given that the purpose of accounting is simply to prepare financial (accounting) reports on a regular basis While it is true that accountants undertake

this kind of work, it does not represent an end in itself As already mentioned, the ultimate

aim of the accountant’s work is to give users financial information to improve the quality

of their decisions This decision-making perspective of accounting provides the theme for

this book and shapes the way in which we deal with each topic

Finance (or financial management), like accounting, exists to help decision makers

It is concerned with the ways in which funds for a business are raised and invested This

lies at the very heart of what business is about In essence, a business exists to raise funds

from investors (owners and lenders) and then to use those funds to make investments (in

equipment, premises, inventories and so on) in order to create wealth As businesses often

raise and invest large amounts over long periods, the quality of the financing and investment

decisions can have a profound impact on their fortunes

Funds raised may take various forms and the particular forms chosen should fit with the needs of the business An understanding of finance should help in identifying:

■ the main forms of finance available;

■ the costs and benefits of each form of finance;

■ the risks associated with each form of finance; and

■ the role of financial markets in supplying finance

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

Who Are the users oF AccountIng InFormAtIon?

For accounting information to be useful, the accountant must be clear for whom the

infor-mation is being prepared and for what purpose it will be used There are likely to be various

groups of people (usually known as ‘user groups’) with an interest in a particular

organi-sation, in the sense of needing to make decisions about it For the typical private sector

business, the more important of these groups are shown in Figure 1.1 Take a look at this

figure and then try Activity 1.1

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Who Are the users oF ACCountIng InFormAtIon? 3

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

Your answer may be along the following lines:

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)

➔

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

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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.

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 representatives

Whether to allow PI to expand its premises and/or whether

to 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

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ProvIdIng A servICe 5

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 factors

such as the size of the business, the nature of the information and the amounts involved

provIdIng A servIce

One way of viewing accounting is as a form of service The user groups identified in

Figure 1.1 can be seen as the ‘clients’ and the accounting (financial) information produced

can be seen as the service provided The value of this service to the various ‘clients’ can

be judged according to whether the accounting information meets their needs

To be useful to users, the information provided must possess certain qualities

In particular, it must be relevant and it must faithfully represent what it is supposed to

represent These two qualities, relevance and faithful representation, are regarded as

fundamental qualities and are explained in more detail below:

■ Relevance Accounting information should make a difference That is, it should be

capa-ble of influencing user decisions To do this, it must 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

To be relevant, accounting information must cross a threshold of materiality An item

of information should be considered material, or significant, if its omission or misstatement

could alter the decisions that users make

Ultimately, what is considered material is a matter of judgement In making this

judge-ment, managers should consider how the information is likely to be used by the various

user groups

Where a piece of information is not considered to be 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

■ Faithful representation Accounting information should represent what it is supposed

to represent To do this, the information should be complete In other words, it should

reflect all of the information needed to understand what is being portrayed It should

also be neutral, which means that the information should be presented and selected

without bias Finally, it should be free from error This is not the same as saying that it

must always be perfectly accurate; this is not really possible Estimates may have to be

made that eventually turn out to be inaccurate It does mean, however, that there should

be no errors in the way in which the estimates are prepared and described

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Accounting information must contain both of these fundamental qualities if it is to be useful

There is little point in producing information that is relevant but 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.

■ Comparability Users of accounting information often want to make comparisons They

may want to compare performance of the business over time (such as profit this year compared with last year) They may also want to compare certain aspects of business performance with those of similar businesses (such as the level of sales achieved during the year) Better comparisons can be made where the accounting system treats items that are basically the same in the same way and where policies for measuring and pre-senting accounting information are made clear

■ Verifiability This quality provides assurance to users that the accounting information

provided faithfully represents what it is supposed to represent Accounting information

is verifiable where different, independent experts would be able to agree that it provides

a faithful portrayal Verifiable information tends to be supported by evidence

■ Timeliness Accounting information should be produced in time for users to make their

decisions A lack of timeliness will undermine the usefulness of the information Normally, the later accounting information is produced, the less useful it becomes

■ Understandability Accounting information should be set out as clearly and

concisely as possible It should also be understood by those for whom the information

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WeIghIng uP the Costs And beneFIts 7

It is probably best that we regard accounting reports in the same way that we regard

a report written in a foreign language To understand either of these, we need to have

had some preparation When producing accounting reports, it is normally assumed that

the user not only has a reasonable knowledge of business and accounting but is also

prepared to invest some time in studying the reports Nevertheless, the onus is clearly on

accountants to provide information in a way that makes it as understandable as possible

to non-accountants

It is worth emphasising that the four qualities just discussed cannot make accounting

information useful; they can only enhance the usefulness of information that is already

relevant and faithfully represented

WeIghIng up the costs And beneFIts

Even when a piece of accounting information may have all the qualities described, it does

not automatically mean that it should be collected and reported to users There is still one

more hurdle to jump Consider Activity 1.5

In theory, a particular item of accounting information should be produced only if the costs

of providing it are less than the benefits, or value, to be derived from its use In practice,

however, these costs and benefits are difficult to assess

To illustrate the practical problems of establishing the value of information, let us assume

that we accidentally reversed our car into a wall in a car park This resulted in a dented boot

and scraped paintwork We would like the dent taken out and the paintwork re-sprayed at

a local garage We know that the nearest garage would charge £350 but we believe that

other local garages may offer to do the job for a lower price The only way of finding out

the prices at other garages is to visit them, so that they can see the extent of the damage

Visiting the garages will involve using some fuel and will take up some of our time Is it worth

the cost of finding out the price for the job at the various local garages? The answer, as we

Activity 1.5

Suppose an item of information is capable of being provided It is relevant to a particular

decision and can be faithfully represented It is also comparable, verifiable, timely and

could be understood by the decision maker

Can you think of a good reason why, in practice, you might decide not to produce the information?

You may judge the cost of doing so to be greater than the potential benefit of having the

information This cost–benefit issue will limit the amount of accounting information provided

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have seen, is that if the cost of discovering the price is less than the potential benefit, it is

worth having that information

To identify the various prices for the job, there are several points to be considered, including:

■ How many garages shall we visit?

■ What is the cost of fuel to visit each garage?

■ How long will it take to make all the garage visits?

■ At what price do we value our time?

The economic benefit of having the information on the price of the job is probably even

harder to assess in advance The following points need to be considered:

■ What is the cheapest price that we might be quoted for the job?

■ How likely is it that we shall be quoted a price cheaper than £350?

As we can imagine, the answers to these questions may be far from clear – remember that

we have only contacted the nearest garage so far When assessing the value of accounting

information we are confronted with similar problems

Producing accounting information can be very costly The costs, however, are often difficult to quantify Direct, out-of-pocket costs, such as salaries of accounting staff,

are not usually a problem, but these are only part of the total costs involved There

are other costs such as the cost of users’ time spent on analysing and interpreting the

What about the economic benefits of producing accounting information? Do you think it

is easier, or harder, to assess the economic benefits of accounting information than to assess the costs of producing it?

It is normally much harder to assess the economic benefits We must bear in mind that accounting information will be only one factor influencing a decision; other factors will also

be taken into account Furthermore, the precise weight attached to each factor when making the decision cannot normally be established

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ACCountIng As An InFormAtIon system 9

AccountIng As An InFormAtIon system

We have already seen that accounting can be viewed as the provision of a service to

‘clients’ Another way of viewing accounting is as a part of the business’s total

informa-tion system Users, both inside and outside the business, make decisions concerning the

allocation of scarce resources For these resources to be efficiently allocated, they often

need financial (accounting) information on which to base decisions It is the role of the

accounting system to provide this information

The accounting information system should have certain features that are common to

all information systems within a business These are:

■ identifying and capturing relevant information (in this case financial information);

■ recording, in a systematic way, the information collected;

■ analysing and interpreting the information collected; and

■ reporting the information in a manner that suits users’ needs

The relationship between these features is set out in Figure 1.3

There are two fundamental qualities that determine the usefulness of accounting information

In addition, there are four qualities that enhance the usefulness of accounting information The

benefits of providing the information, however, should outweigh the costs

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Given the decision-making emphasis of this book, we shall be concerned primarily with the final two elements of the process: the analysis and reporting of financial information

We shall focus on the way in which information is used by, and is useful to, users rather

than the way in which it is identified and recorded

Most businesses rely on computerised systems to process financial information When

these systems fail, it can be both costly and disruptive Real World 1.1 describes the

problems experienced by Sony Corporation, the electronics and entertainments business,

following a cyber attack from an outside source

reAL WorLd 1.1

Hacked off

The fallout of the November 2014 cyber attack on Sony continued, as the Japanese group said it expects to delay the release of its full financial results due to continuing system disruptions at its movie studio In a statement on Friday, the company said the financial and accounting systems of Sony Pictures will not be fully restored until early next month after they were damaged by the attack, which the US government has blamed on North Korea It added that the studio was taking care to avoid further damage by prematurely restarting its systems

Pyongyang has denied responsibility of the hacking which came as Sony was

prepar-ing to release The Interview, a comedy about an assassination attempt on Kim Jong

Un, North Korea’s leader

Sony asked Japanese financial regulators to extend the deadline for submitting its third-quarter earnings to the end of March from mid-February, citing ‘the amount of destruction and disruption that occurred’

Source: Extract from Inagaki, K (2015) ‘Sony seeks delay in releasing full results in wake of cyber attack’,

ft.com, 23 January

There are four sequential stages of an accounting information system The first two stages are concerned with preparation, whereas the last two stages are concerned with using the informa-tion collected

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mAnAgement ACCountIng And FInAnCIAl ACCountIng 11

mAnAgement AccountIng And FInAncIAL

AccountIng

Accounting is usually seen as having two distinct strands These are:

■ management accounting, which seeks to meet the accounting needs of managers; and

■ financial accounting, which seeks to meet the needs of the other users identified earlier

in the chapter (see Figure 1.1)

The difference in their targeted user groups has led each strand of accounting to develop

along different lines The main areas of difference are as follows:

■ Nature of the reports produced Financial accounting reports tend to be general-purpose

Although they are aimed primarily at providers of finance such as owners and lenders,

they contain financial information that will be useful for a broad range of users and

deci-sions Management accounting reports, meanwhile, are often specific-purpose reports

They are designed with a particular decision in mind and/or for a particular manager

■ Level of detail Financial accounting reports provide users with a broad overview of the

performance and position of the business for a period As a result, information is

aggre-gated (that is, added together) and detail is often lost Management accounting reports,

however, often provide managers with considerable detail to help them with a particular

operational decision

■ Regulations The financial accounting reports of many businesses are subject to

regu-lations imposed by the law and by accounting rule makers These reguregu-lations often

require a standard content and, perhaps, a standard format to be adopted Management

accounting reports, on the other hand, are not subject to regulation and can be designed

to meet the needs of particular managers

■ Reporting interval For most businesses, financial accounting reports are produced on an

annual basis, though some large businesses produce half-yearly reports and a few

pro-duce quarterly ones Management accounting reports will be propro-duced as frequently as

needed by managers A sales manager, for example, may need routine sales reports on

a daily, weekly or monthly basis so as to monitor performance closely Special-purpose

Activity 1.7

Why do you think management accounting reports are not subject to the same

regula-tions imposed on financial accounting reports?

Management accounting reports are produced exclusively for managers and are for internal

use only Financial accounting reports, on the other hand, are for external publication To

protect external users, who depend on the quality of information provided by the business,

they are subject to regulation

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reports can also be prepared when the occasion demands: for example, where an ation is required of a proposed investment in new equipment.

evalu-■ Time orientation Financial accounting reports reveal the performance and position of

a business for the past period In essence, they are backward-looking Management accounting reports, on the other hand, often provide information concerning future per-formance as well as past performance It is an oversimplification, however, to suggest that financial accounting reports never incorporate expectations concerning the future

Occasionally, businesses will release forward-looking information to other users in an attempt to raise finance or to fight off unwanted takeover bids Even preparation of finan-cial accounting reports for the past period typically requires making some judgements about the future, as we shall see in Chapter 3

■ Range and quality of information Two key points are worth mentioning First, financial

accounting reports concentrate on information that can be quantified in monetary terms

Management accounting also produces such reports, but is also more likely to duce reports that contain information of a non-financial nature, such as physical volume

pro-of inventories, number pro-of sales orders received, number pro-of new products launched, physical output per employee and so on Second, financial accounting places greater emphasis on the use of objective, verifiable evidence when preparing reports Manage-ment accounting reports may use information that is less objective and verifiable, but nevertheless provide managers with the information they need

We can see from this that management accounting is less constrained than financial

account-ing It may draw from a variety of sources and use information that has varying degrees of

reliability The only real test to be applied when assessing the value of the information

pro-duced for managers is whether or not it improves the quality of the decisions made

The main differences between financial accounting and management accounting are summarised in Figure 1.4

The differences between management accounting and financial accounting suggest differences in the information needs of managers and those of other users While differences

undoubtedly exist, there is also a good deal of overlap between the information needs of both

Activity 1.8

Can you think of any areas of overlap between the information needs of managers and

those of other users? (Hint: Think about the time orientation and the level of detail of

accounting information.)Two points that spring to mind are:

■ Managers will, at times, be interested in receiving a historical overview of business tions of the sort provided to other users

opera-■ Other users would be interested in receiving detailed information relating to the future, such as the planned level of profits, and non-financial information, such as the state of the sales order book and the extent of product innovations

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sCoPe oF thIs book 13

To some extent, differences between the two strands of accounting reflect differences

in access to financial information Managers have much more control over the form and

content of the information that they receive Other users have to rely on what managers

are prepared to provide or what financial reporting regulations insist must be provided

Although the scope of financial accounting reports has increased over time, fears

concern-ing loss of competitive advantage and user ignorance about the reliability of forecast data

have meant that other users do not receive the same detailed and wide-ranging information

as that available to managers

scope oF thIs book

This book covers both financial accounting and management accounting topics The next

five chapters (Part 1, Chapters 2 to 6) are broadly concerned with financial accounting, and

the following three (Part 2, Chapters 7 to 9) with management accounting The final part

of the book (Part 3, Chapters 10 to 12) is concerned with the financial management of the

business, that is, with issues relating to the financing and investing activities of the business

Although management and financial accounting are closely linked and have broadly common

objectives, there are a number of differences in emphasis

Trang 35

the chAngIng FAce oF AccountIng

Over the past four decades, the business environment has become increasingly turbulent

and competitive Various reasons have been put forward to explain these changes, including:

■ the increasing sophistication of customers;

■ the development of a global economy where national frontiers become less important;

■ rapid changes in technology;

■ the deregulation of domestic markets (for example, electricity, water and gas);

■ increasing pressure from owners (shareholders) for competitive economic returns; and

■ the increasing volatility of financial markets

This new, more complex environment has brought fresh challenges for managers and other users of accounting information Their needs have changed and both financial

accounting and management accounting have had to respond This has led to a radical

review of the kind of information to be reported

The changing business environment has given added impetus to the search for a clear conceptual framework, or framework of principles, upon which to base financial accounting

reports Various attempts have been made to clarify their purpose and to provide a more

solid foundation for the development of accounting rules The conceptual frameworks that

have been developed try to address fundamental questions such as:

■ Who are the users of financial accounting information?

■ What kinds of financial accounting reports should be prepared and what should they

contain?

■ How should items such as profit and asset values be measured?

The internationalisation of businesses has created a need for accounting rules to have

an international reach It can no longer be assumed that users of accounting information

are based in the country in which the particular business operates or are familiar with

the accounting rules of that country Thus, there has been increasing harmonisation of

accounting rules across national frontiers

Activity 1.9

How should the harmonisation of accounting rules benefit:

(a) An international investor?

(b) An international business?

An international investor should benefit because accounting terms and policies used in paring financial accounting reports will not vary across countries This should make the com-parison of performance between businesses operating in different countries much easier

pre-An international business should benefit because the cost of producing accounting reports in order to comply with the rules of different countries can be expensive Harmoni-sation can, therefore, lead to significant cost savings It may also broaden the appeal of the business among international investors Where there are common accounting rules, they may have greater confidence to invest

Trang 36

Why do I need to knoW AnythIng About ACCountIng And FInAnCe? 15

In response to criticisms that the financial reports of some businesses are opaque and

difficult for users to interpret, great efforts have been made to improve reporting rules

Accounting rule makers have tried to ensure that the accounting policies of businesses are

more comparable and more transparent and that the financial reports portray economic

reality more faithfully

Management accounting has also changed by becoming more outward-looking in its

focus In the past, information provided to managers has been largely restricted to that

collected within the business However, the attitude and behaviour of customers and rival

businesses have now become the object of much information-gathering Increasingly,

suc-cessful businesses are those that are able to secure and maintain competitive advantage

over their rivals

To obtain this advantage, businesses have become more ‘customer driven’ (that is,

concerned with satisfying customer needs) This has led to the production of

manage-ment accounting information that provides details of customers and the market, such as

customer evaluation of services provided and market share In addition, information about

the costs and profits of rival businesses, which can be used as ‘benchmarks’ by which to

gauge competitiveness, is gathered and reported

To compete successfully, businesses must also find ways of managing costs The cost

base of modern businesses is under continual review and this, in turn, has led to the

devel-opment of more sophisticated methods of measuring and controlling costs

Why do I need to knoW AnythIng About

AccountIng And FInAnce?

At this point you may well be asking yourself, ‘Why do I need to study accounting and

finance? I don’t intend to become an accountant!’ Well, from the explanation of what

accounting and finance is about, which has broadly been the subject of this chapter so far,

it should be clear that the accounting/finance function within a business is a central part of

its management information system On the basis of information provided by the system,

managers make decisions concerning the allocation of resources These decisions may

concern whether to:

■ continue with certain business operations;

■ invest in particular projects; or

■ sell particular products

These decisions can have a profound effect on all those connected with the business

It is important, therefore, that all those who intend to work in a business should have a fairly

clear idea of certain important aspects of accounting and finance These aspects include:

■ how financial reports should be read and interpreted;

■ how financial plans are made;

Trang 37

■ how investment decisions are made;

■ how businesses are financed; and

■ how costs are managed

Many, perhaps most, students have a career goal of being a manager within a ness – perhaps a human resources manager, production manager, marketing manager or

busi-IT manager If you are one of these students, an understanding of accounting and finance

is very important When you become a manager, even a junior one, it is almost certain that

you will have to use financial reports to help you to carry out your role It is equally certain

that it is partly, perhaps largely, on the basis of financial information and reports that your

performance as a manager will be judged

As part of your management role, it is likely that you will be expected to help in plotting the future path of the business This will often involve the preparation of forward-looking

financial reports and setting financial targets If you do not understand what the financial

reports really mean and the extent to which the financial information is reliable, you will find

yourself at a distinct disadvantage to those who do Along with other managers, you will

also be expected to help decide how the limited resources available to the business should

be allocated between competing options This will require an ability to evaluate the costs

and benefits of the different options available Once again, an understanding of accounting

and finance is important to carrying out this task

This is not to say that you cannot be an effective and successful human resources duction, marketing or IT manager unless you are also a qualified accountant It does mean,

pro-however, that you need to become a bit ‘streetwise’ in accounting and finance if you are to

succeed This book aims to give you that street wisdom

the quest For WeALth creAtIon

A business is normally formed to enhance the wealth of its owners Throughout this

book we shall assume that this is its main objective This may come as a surprise, as

other objectives might be pursued that would fulfil the needs of others with a stake in the

business A business may, for example, seek to provide good working conditions for its

employees, or it may seek to conserve the environment for the local community While it

may pursue these objectives, it is normally set up primarily with a view to increasing the

wealth of its owners In practice, the behaviour of businesses over time appears to be

consistent with this objective

Within a market economy there are strong competitive forces at work that ensure that failure to enhance owners’ wealth will not be tolerated for long Competition for the funds

provided by the owners and competition for managers’ jobs will normally mean that the

owners’ interests will prevail If the managers do not provide the expected increase in

own-ership wealth, the owners have the power to replace the existing management team with a

new team that is more responsive to the owners’ needs

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meetIng the needs oF other stAkeholders 17

meetIng the needs oF other stAkehoLders

The points made above do not mean that the needs of other groups with a stake in a

busi-ness, such as employees, customers, suppliers, the community and so on, are unimportant

In fact, the opposite is true, if the business wishes to survive and prosper over the longer

term For example, a business with disaffected customers may well find that they turn to

another supplier, resulting in a loss of owners’ wealth Real World 1.2 provides examples

of businesses that acknowledge the vital link between satisfying customers’ needs and

creating wealth for their owners (shareholders)

Other stakeholders that contribute towards the wealth-creation process must also be

considered A dissatisfied workforce can lead to low productivity and strikes while

dis-satisfied suppliers can withhold vital supplies, or give lower priority to orders received A

discontented community can withdraw access to community resources In each case, the

owners’ wealth will suffer

Real World 1.3 describes how one well-known business became concerned with

how labour ‘sweatshop’ practices could damage its brand and lead to a reduction in

Mitchells and Butlers plc is a leading restaurant and pub owner It states:

Our vision is to run businesses that guests (customers) love to eat and drink in, and as a result grow shareholder value

Sources: Standard Life plc, www.standardlife.com, accessed 24 October 2015; and Mitchells and Butlers plc,

www.mbplc.com, accessed 25 October 2015.

Trang 39

It is clear from the above that creating wealth for the owners is not the same as trying

to maximise the current year’s profit Wealth creation is concerned with the longer term;

it relates not only to this year’s profit but to that of future years as well In the short term,

corners can be cut and risks taken that improve current profit at the expense of future profit

Real World 1.4 provides some examples of how the focus on short-term profit, without

any consideration of the long-term consequences, can be very damaging

reAL WorLd 1.3

Upsetting the Apple cart

Imagine a company generating an extra $1.5 billion in sales every week compared to what it earned only a year ago – and nearly all of that coming from products that it had dreamt up from scratch within the last half decade These were things the world didn’t know until recently that it needed This gives some idea of the enormity of Apple’s recent success on the back of the iPhone and iPad

This surge in demand, however, has consequences In late 2010, it was shipping 1.8 million shiny new iPhones and iPads a week A year later, it had upped that weekly quota by nearly 1.5 million – and still couldn’t satisfy demand This has created one

of the great historic challenges of manufacturing The supply chain of the electronics industry, with its hub in south China, was already one of the most impressive mani-festations of the forces that have brought a new, globally distributed workforce into play But this system is now being tested in the extreme

Apple’s handling of the supply chain labour problems are a central concern, not just for its own future but for the industry at large Its scale and conspicuous brand have brought it unwelcome attention But it is already ahead of its main rivals in trying to grapple with the underage labour, excessive forced overtime and inadequate safety standards that continue to be alleged against it – and the new standards it is helping

to set will be felt across the industry

Transparency appears to be one problem Apple executives argue strenuously that they audit suppliers thoroughly and have identified any problems Tim Cook, chief executive, says that he gets weekly data on the working hours put in by 500,000 work-ers around the world Yet independent investigations – most recently one by the New York Times – continue to point to significant shortcomings

Apple’s leaders certainly have plenty of incentive to get to the root of this problem

The consequences of failing to deal with it would be significant As Nike and Reebok found a decade ago, customers can rebel against brands associated with sweatshop practices For Apple’s brand to thrive as it moves into its new phase of global manu-facturing superpower it will have to show that their company is dedicated to the bet-terment of a large slice of the world’s working population

Source: Adapted from Waters, R (2012) ‘Apple has incentive to worry about workers’ rights’, ft.com,

15 February

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meetIng the needs oF other stAkeholders 19

reAL WorLd 1.4

Short-term gains, long-term problems

For many years, under the guise of defending capitalism, we have been allowing

our-selves to degrade it We have been poisoning the well from which we have drawn

wealth We have misunderstood the importance of values to capitalism We have

sur-rendered to the idea that success is pursued by making as much money as the law

allowed without regard to how it was made

Thirty years ago, retailers would be quite content to source the shoes they wanted

to sell as cheaply as possible The working conditions of those who produced them

was not their concern Then headlines and protests developed Society started to hold

them responsible for previously invisible working conditions Companies like Nike

went through a transformation They realised they were polluting their brand Global

sourcing became visible It was no longer viable to define success simply in terms of

buying at the lowest price and selling at the highest

Financial services and investment are today where footwear was thirty years ago

Public anger at the crisis will make visible what was previously hidden Take the

building up of huge portfolios of loans to poor people on US trailer parks These loans

were authorised without proper scrutiny of the circumstances of the borrowers

Some-body else then deemed them fit to be securitised and so on through credit default

swaps and the rest without anyone seeing the transaction in terms of its ultimate

human origin

Each of the decision makers thought it okay to act like the thoughtless footwear buyer

of the 1970s The price was attractive There was money to make on the deal Was it

responsible? Irrelevant It was legal, and others were making money that way And

the consequences for the banking system if everybody did it? Not our problem

The consumer has had a profound shock Surely we could have expected the clever

and wise people who invested our money to be better at risk management than they

have shown themselves to be in the present crisis? How could they have been so

gul-lible in not challenging the bankers whose lending proved so flaky? How could they

have believed that the levels of bonuses that were, at least in part, coming out of their

savings could have been justified in ‘incentivising’ a better performance? How could

they have believed that a ‘better’ performance would be one that is achieved for one

bank without regard to its effect on the whole banking system? Where was the

stew-ardship from those exercising investment on their behalf?

The answer has been that very few of them do exercise that stewardship Most have

stood back and said it doesn’t really pay them to do so The failure of stewardship

comes from the same mindset that created the irresponsible lending in the first place

We are back to the mindset that has allowed us to poison the well: never mind the

health of the system as a whole, I’m making money out of it at the moment

Responsi-bility means awareness for the system consequences of our actions It is not a luxury

It is the cornerstone of prudence

Source: Extract from Goyder, M (2009) ‘How we’ve poisoned the well of wealth’, Financial Times,

15 February

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