Business School

ACCT1501 Accounting and Financial Management 1A

Session 1 2016

Week 2

Measuring & Evaluating Financial Position & Performance

Student Handout

Lecturer:
Dr. Youngdeok Lim
School of Accounting
UNSW

Moodle: https://moodle.telt.unsw.edu.au/login/index.php

Session 1, 2016 ACCT1501

 WEEK 2: Measuring & Evaluating Financial Position &
Performance

1. Introduction
Every commercial entity engages in transactions with other parties. For example,
Woolworths buys products from suppliers, employs shop assistants, builds new stores,
sells groceries and each individual transaction is recorded and reported in the Balance
Sheet and the Income Statement. In this lecture, we will examine the content and use of
the statements measuring financial position at a particular date and measuring financial
performance over a period.

Learning objectives
At the end of this topic, you should be able to:

• Understand the terms, format and function of the Balance Sheet & the Income
Statement
• Identify the components of financial statements
• Describe the relationship between the balance sheet and the income statement
• Understand the implications of the decision to record expenditure as an asset or as
an expense
• Understand the differences between cash profit and accrual profit

Required Reading
Trotman, Gibbins & Carson Chapter 2

Session 1, 2016 ACCT1501

2. Tutorial Questions – Week 3
Preparation Questions
• DQ2.1, 2.2, 2.11
• P1.18, P2.3
• Case 2A

Tutorial Questions
• DQ2.6, 2.20,
• P2.8, P2.10, P2.13, P2.18

Session 1, 2016 ACCT1501

 Billabong posts $126.3m half-year loss
Sue Mitchell
February 21, 2014

Troubled surf and skate wear retailer Billabong International is yet to see signs of a
turnaround, reporting a net loss of $126.3 million for the six months ending December
after booking another $132.6 million in asset writedowns and restructuring costs. The
loss compared with a bottom line loss of $536.6 million in the year-ago period. Before
one-off costs, underlying net profit fell from $19 million to just $1.8 million, falling short
of market forecasts around $6.5 million. Earnings continued to decline in North America
and Europe, offsetting gains in Australasia.

"This is a complex, difficult turnaround,” said chief executive Neil Fiske. "We are not
daunted by challenges we face, but neither do we underestimate them." Mr Fiske
unveiled a major global restructuring of marketing, merchandising, sourcing and HR
functions and announced several key appointments. "This is just the beginning - we
reiterate the turnaround is difficult and complex and the lag effect of months of turmoil
will be with us for a while longer," he said. "But we have confidence in the potential of
the brands and know what we need to do and are getting on with it at an aggressive pace,"
he said.

Billabong shares went into a trading halt after the company launched its previously
announced $50 million rights issue. The funds will be used to repay existing debt. Mr
Fiske, who took the helm last September, hopes to restore profits by building Billabong's
three biggest brands - Billabong, RVCA and Element - as well as supporting emerging
brands and culling those that are cluttering the portfolio.

Mr Fiske also plans to reduce the number of products and stores, develop integrated
marketing strategies for each region, and improve Billabong's supply chain - moving to
fewer, bigger, suppliers - to reduce costs and improve the quality of its products. Last
month, Billabong shareholders approved a $386 million debt and equity rescue package,
which handed 41 per cent of the company to US hedge funds Oaktree Capital and
Centerbridge Partners. The company was in danger of collapse last year after posting a
$860 million loss and writing down the value of the Billabong brand to zero. Group sales
from continuing operations fell 2.4 per cent.

Read more: http://www.smh.com.au/business/retail/billabong-posts-1263m-halfyear-loss-

20140221-335k7.html#ixzz3Tln74Eg7

Session 1, 2016 ACCT1501

 ACCT1501
Semester 1, 2016

Week 2:
Measuring & Evaluating Financial Position
& Performance

Lecturer: Dr Youngdeok Lim

 Recap continued: The 3 key financial statements
Balance sheet
– Financial position of an enterprise at a particular point in time.
– What are the entity’s resources and how were they financed?

Income statement
– Financial performance of an enterprise over a period of time.
– Has the entity used its resources efficiently and effectively?
• Sometimes referred to as the Profit and Loss Statement (P&L)

Cash flow statement:

– Cash inflows and outflows over a period of time.

Notes to the financial statements (additional detail)

2
 Recap continued
Accrual accounting: recognising revenues and expenses
when an economically meaningful event occurs
– Reports revenues earned, and any expenses incurred
– Profit/loss = Revenue – Expenses

3
Recap continued: Financial statement assumptions

• Accrual basis: Revenues and expenses are recognised at

the time they occur
• Entity: the accounting entity is separate from its owners
• Period: the life of the business can be divided into smaller
periods of time e.g., 1 year
• Monetary: currencies are used to measure transactions
• Historical cost: assets are initially recorded at cost
• Going concern: the entity will operate into the forseeable
future

4
 Building the foundations of accounting over the next few
weeks

Week 2: The Balance Sheet and Income Statement (Ch. 2)

Week 3: The Double Entry System – Journal entries (Ch. 3)

Week 4: Accounting Cycle (1) – 9 steps (Ch. 4)

Week 5: Accounting Cycle (2) – Adjusting journal entries (4

types + contra accounts) (Ch. 5)

5
Topic 2: Measuring & Evaluating Financial Position & Performance
• Learning objectives (LO) - You should be able to:
1. Understand the terms, format, and function of the balance
sheet & the income statement
2. Identify the components of financial statements (A, L, OE,
R, E)
3. Describe the relationship between the balance sheet and
the income statement (retained profits)
4. Understand the implications of the decision to record
expenditure as an asset or as an expense (definition of
assets)
5. Understand the differences between cash profit and
accrual profit (cash accounting vs. accrual accounting).

6
 Topic 2

Measuring & Evaluating Financial Position & Performance

Required Reading: Trotman Gibbins & Carson

Chapter 2 & Appendix

7
 “Accounting is a primary function needed in all organizations
and businesses, large and small.”
-Tracy Crude CFO, Crystal Bridges Museum of Art

8
 Topic 2: Outline
1. Balance Sheet – overview
– 1.1.Assets
– 1.2 Liabilities
– 1.3 Equity
2. Connecting the Income Statement and Balance Sheet
3. Income Statement – overview
– 3.1 Revenues
– 3.2 Expenses
4. Capitalise vs. expense
5. Cash profit and accrual profit

9
 1. The Balance Sheet
A statement that summarises the financial position of an enterprise at a
particular point in time
– What are the resources (Assets) of the enterprise
– And what were the sources i.e., how were they financed? (Debt or
Equity)
– Point in time - e.g., June 30, 2015

Provides information about

– Financial structure (mix of debt/equity) – Debt to equity ratio
– Liquidity – ease of converting assets to cash in normal course of
business (short-term focus) – working capital, current ratio (page 32)
– Solvency – ability to pay debts when they fall due (longer-term focus)
– Debt to equity ratio

10
 What is on a Balance Sheet?
A Balance Sheet will always have the following identifying information:
– Name of the reporting entity
– Type of financial statement – Balance Sheet
– Date – what point in time it refers to
– Currency used - $m, $AUD

11
 What is on a Balance sheet?
Next, the three main elements:
– Assets
• Resources - they will benefit the company this year (current) or
in future years (non-current)
• e.g., cash, property, equipment, inventory
– Liabilities
• What the company owes
• e.g., accounts payable, loan payable
– Equity
• What belongs to the owners, the residual i.e. what is left after
liabilities are taken care of e.g., share capital, retained profits

12
We’ve seen the accounting equation several times now.

The accounting equation:

Assets = Liabilities + Equity

Resources i.e., what we have to earn income

Source: What we owe
Source: What owners contributed,
plus any profits that have accumulated

• Remember: the accounting equation always balances!

• Relies on the accounting entity assumption
– The entity is the enterprise/business for which the accounting is being
done
– The financial statements are for the entity only
– Activities of the entity are separate from those of the owners

13
 Increasing shareholders’ equity

Owners:
– Contributions by owners
– Issued Shares for $300,000 cash

Cash Share
Capital
A = L + SE

14
 Balance sheet – example (side by side format)
ABC Ltd
Balance sheet
As at June 30 2015
Assets Liabilities
$m $m
Current assets Current liabilities
Cash $50 Bank overdraft $30
Accounts receivable $75 Accounts payable $73 $103
Inventory $120 $245 Noncurrent liabilities
Noncurrent assets Loan $87
Land $100 Shareholders’ equity
Equipment (net) $150 $250 Share capital $130
Retained profits $175 $305
TOTAL $495 $495

15
 Business Model (Week 3 slide)

Investors (e.g. banks,

shareholders)

Financing activities

Purchase of Inventory Sale of inventory

Suppliers Operating Company Operating Customers

(e.g. farmers) activities (e.g. Woolworths) activities (e.g. You)

Payment Payment
(Cash/Accounts (Cash/Accounts
Payable) Investing activities
Receivable)

Property Plant and Equipment,

financial securities etc

16
 What is on the Balance Sheet cont...
AASB 101 “Presentation of Financial Statements” requires at a minimum
that these items be shown on the face of the Balance Sheet

• Assets • Liabilities
– Cash and cash equivalents – Trade and other payables
– Trade and other receivables – Interest-bearing liabilities
– Inventories – Tax liabilities
– Biological assets – Provisions
– Investments accounted for using the • Shareholder’s Equity
equity method
– Contributed equity/Issued capital
– Other financial assets
– Reserves
– Tax assets
– Retained profits
– Property, plant and equipment
– Investment property – Minority interest/Outside equity
– Intangible assets

17
 Components of the Balance Sheet
Before we look at assets & liabilities in more detail, please note:
Not all assets & liabilities are reported on the balance sheet!

To be reported on a balance sheet, assets and liabilities must

– (1) Meet definition criteria
– And THEN
– (2) Meet recognition criteria!
– If they meet (1) but not (2), they are disclosed in the F/S notes

18
 1.1 What is an asset?

Definition:
A resource that is controlled (not owned) by an entity as a
result of past events, and from which future economic
benefits are expected to flow to the entity.

19
 Three essential characteristics of assets

1. Future economic benefit: assets are used to provide

goods or services with the objective of generating net cash
flows

Consider future economic benefit of cash, receivables,

investments, inventory, prepayments, property plant and
equipment….

20
 Assets

2. Control by the entity relates to the capacity of an entity to

benefit from the asset in pursuing its objectives and to
deny or regulate the access of others

3. Occurrence of past transactions or other past events

means that the transaction or other event giving the
entity control over the future economic benefits must
have occurred, e.g. paid cash or credit

21
 IMPORTANT: Not all assets and liabilities are on the Balance
Sheet!
To be reported on a balance sheet, assets and liabilities must
meet recognition criteria:
• (a) It is probable that any future economic benefit
associated with the item will flow to or from the entity,
and
• (b) The item has a cost or value that can be measured
reliably

– If definition requirements are met, but we can’t say yes to

(a) and (b) above, we disclose details about the item in
the notes to the financial statements!

22
 Examples of assets – Woolworths limited

What assets might Woolworths limited have?

23
 Critical thinking (DQ 2.9)

Q) The CEO of a large Australian company announced at a

recent shareholders’ meeting: ‘Our people are our greatest
assets.’ If this is the case, why are they not included in the
balance sheet?

24
 Examples of assets
Assets are either

– Current (expect to realise the benefits in the next 12

months from the balance sheet date)
– or
– Non-current (realise benefits over a longer period)

25
 Examples of assets (and lots of new terms)

Classify the following as current or non-current:

– Cash & cash equivalents
– Accounts receivable
– Machinery
– Inventory
– Prepayments (< 12 months)
– Investments
• Trading; Non-trading
– Motor vehicles
– Buildings
– Intangible assets e.g., Goodwill
– Your text provides many more examples – you need to familiarise
yourself with them!

26
 1.2 What is a Liability?

Definition:
‘A liability is a present obligation of the entity arising
from past events, the settlement of which is expected to
result in an outflow from the entity of resources
embodying economic benefits.’

27
 Two essential characteristics of a liability

1. A present obligation exists and the obligation involves

settlement in the future

2. It has adverse financial consequences for the entity in

that the entity is obligated to sacrifice economic benefits
to one or more other entities

28
 Examples of liabilities – Woolworths limited

What liabilities might Woolworths limited have?

29
 Example of Liabilities
Liabilities also have to be classified as current or non-current
– Current liabilities are those that will be paid off within one
year of the balance sheet date.
– Non-current liabilities will remain liabilities for at least the next
year.

Reason for this distinction (for both assets and liabilities):

To help the financial statement user assess short-term financial
position.

30
 Examples of Liabilities
Classify the following as current or non-current:
– Accounts payable
– Overdrafts
– Loans
• Portion due within 12 months vs portion due after 12
months
– Taxes payable
– Dividends payable
– Wages payable
– Provision for warranty expense
– Again – your text provides many more examples!

31
 Aside: Working capital and Current ratio

Calculated by subtracting current liabilities from current assets.

– Working capital = CA – CL
– In general, low or negative working capital is an indication of
short-term financial difficulties.
Calculated by dividing current assets by current liabilities.
– Current ratio = CA/CL

32
 1.3 What is Equity?
The residual interest in the assets of the entity after
deducting all its liabilities
– A = L + OE
– A – L = OE
– Also referred to as “net assets”

Common components:
– Share capital
– Retained profits

33
2. Connecting the Balance Sheet & Income Statement

Equity is the link between the Balance Sheet & Income

Statement
Recall that common components of Equity are:
– Share capital
– Retained profits

Let’s now consider measuring changes in owner wealth (i.e.,

changes in net assets)

34
Transactions that Affect Owner’s Equity

OWNER’S EQUITY INCREASES OWNER’S EQUITY DECREASES

Owner Investments Owner Withdrawals

in the Business from the Business

Owner’s Equity

Revenues Expenses

35
 A closer look at shareholder’s equity

How is Shareholders (Owners’) Equity affected by the

following?

– Contributions by owners

– Profit
• Revenues
• Expenses

– Distributions to owners

36
Balance sheet and income statement

Beginning period (t-1) Ending Period (t)

L t-1 Lt
A t-1 At
SE t-1 SE t
Incorporated into B/S

A t-1 = L t-1 + SE t-1 A t = L t + SE t

E R

Capture of income
R – E = Profit during the period

Retained profits: the sum of net profits earned over the life of a company less dividends
declared to shareholders

37
Retained profits
When a company earns a profit, that profit can be distributed to
shareholders as dividends or kept in the business to grow the business.
The profit that is kept is called ‘Retained Profits’
The Retained Profits Account is the link between the balance sheet and
income statement

Opening retained profits

plus Net profit for the period (Revenues – Expenses)
less Distributions (Dividends declared)
= Closing retained profits

Remember: Dividends are NOT AN EXPENSE!

38
 Retained profits (connected in week 4)

• Income statement accounts are temporary accounts.

• Balance sheet accounts are permanent accounts.
• Income statement accounts are ‘closed’ and their
balances transferred to the retained profits account (on the
balance sheet) at the end of each accounting period.
• The retained profits account provides the link between
the income statement and the balance sheet.

39
The Accounting Equation expanded even further!

= +
= + ( + )
= + {
Where:
SC = Share capital
RP = Retained profits
R = Revenue during the period (t-1 to t)
E = Expenses during the period (t-1 to t)
D = Dividend (declared)
t = time t (at the ending period)
t-1 = time t-1 (at the beginning period)

40
 Increasing shareholders’ equity

Owners:
– Contributions by owners
– Issued Shares for $300,000 cash

Cash Share
Capital
A = L + SE

41
 Increasing Shareholders’ equity

Ex. Company receives $3,000 interest on bank deposit.

Cash Retained profits

(Interest
A = L + SE Revenue)

42
 Decreasing Shareholders’ equity

Ex. Company pays $3,000 interest on a bank loan.

A = L + SE
Retained profits (Interest
Cash Expense)

43
 Example (continued from week 1)

• You purchased one bed room apartment at $500,000 on

1/7/2013 and rented it.
• Financing source: Your own money $100,000, Borrowing
from bank $400,000 (Maturity: 3 years, Principal will be paid at
the end of maturity)
• Rent revenue (cash) $400/week, Interest expense (cash)
$200/week, Tax expense (cash) $1000/year
• Assume 52 weeks per year and no depreciation.
• Prepare your B/S as of 1/7/2013 (week 1), 30/6/2014 and
30/6/2015.
• Prepare your I/S for the year ended on 30/6/2014 and
30/6/2015.
44
 Relationship between financial statements

Balance Sheet 2008 2009 Cash Flow Statement

Cash 1,400 2,000 From operating activities 2,500
Other assets 114,000 118,000 From investing activities (2,300)
Total assets 115,400 120,000 From financing activities 400
Liabilities 51,400 53,000 Total net cash flows 600
Share capital` 40,000 40,000 Opening balance 1,400
Retained profits 24,000 27,000 Closing balance 2,000
Total liabilities and
shareholders’ equity 115,400 120,000

Retained Profits Note Income Statement

2008 balance 24,000 Revenues 21,000
+ Net profit 6,000 Expenses* 15,000
30,000 Net profit 6,000
- Dividends 3,000
2009 balance 27,000

45
 Revision Question 1
Which of the following statements about a balance
sheet is true?
1. a balance sheet presents the
financial performance of a
company for a period of time
2. a balance sheet presents the
financial position at a point in time
3. a balance sheet shows which
source of finance produced each
asset
4. a balance sheet includes all the
resources of a company
46
 Revision Question 2
Given only the following information, what is the balance of
shareholders’ equity?

Cash 10 000
Inventory 30 000
Equipment 200 000
Accounts payable 50 000
Taxes payable 40 000
Loans to the company 100 000
1. $40 000
2. $50 000
3. $100 000
4. none of the above
47
 Revision Question 3
Bruce operates a coffee stall at the university. On 30 June
2016, he has $400 in his business bank account, the stall and
equipment are worth $5200, ingredients on hand cost $60 and
paper cups cost $10. Students owe him $120 and he owes his
suppliers $370. He also owes his mother $4100, which
enabled him to get started.

What is Bruce’s owners’ equity?

1. $400.
2. $1320.
3. $4000.
4. $5420.

48
 Revision Question 4
The connecting link between the balance sheet and
the income statement is:

1. dividends paid to
shareholders
2. the opening balance
of retained profits
3. total shareholders’
equity
4. net profit after tax

49
 Where are we now?

1. Balance Sheet – overview

– 1.1.Assets
– 1.2 Liabilities
– 1.3 Equity
2. Connecting the Income Statement and Balance Sheet
3. Income Statement – overview
– 3.1 Revenues
– 3.2 Expenses
4. Capitalise vs. expense

50
3. Income Statement
Shows the results of business operations over a specific time
period
– Relates to the accounting period assumption
– Reports revenues earned, less any expenses incurred
– Provides a measure of organisational efficiency
– Calculates the profit that may be available to
shareholders
• If revenues are greater than expenses, there is a
profit
• If revenues are less than expenses, there is a loss

Remember: Accrual profit is not the same as cash profit!

51
 3.1 Revenue

‘Revenue is gross inflows of economic benefits during the

period arising in the ordinary activities of an entity when those
inflows result in increases in equity other than those relating
to contributions from equity participants.’
(AASB 118, para 7)

Revenue represents an increase in the wealth of the business

It is recognised when it is considered to be ‘earned’
– Requires a ‘trigger point’
– E.g., when goods/services have been provided to customers
– Receipt of cash is not necessary!

52
 So, when is REVENUE earned?
Devising
Receipt an idea Making
of cash purchases

Delivery of Receipt of
goods to orders before
customers production

Receipt of Commencing
orders production

Progressing
Completion
through
of production production

53 53
 Examples of revenue

Sales Revenue
Interest Revenue
Rent Revenue

54
 Revision Question 5
What is total revenue for the period?
(a) Credit sales of $10 000
(b) Cash sales of $8000
(c) $7000 cash received from a customer as a deposit
for work done in the next period

1. $17 000
2. $18 000
3. $25 000
4. none of the above

55
 3.2 Expenses

Expenses represent decreases in the entity’s wealth. They

are incurred in order to earn revenue.

Note: Expenses do not include payments or returns to

owners (i.e. withdrawals by sole traders or partners, or,
dividends to shareholders). Payments to owners are
considered to be ‘distributions’ of net profit to owners.

56
 Wealth decreases because:

• Operating costs have to be paid

• Long term assets wear out
– Referred to as ‘depreciation’ or ‘amortisation’
– Notice this has no direct effect on cash!
– Valuation v.s. cost allocation (matching principle)
• Assets are used up (e.g. prepayments, inventory) –
Accrual accounting adjustments (Week 5)
– Again note that the using up of prepayments and inventory
does not lead to a cash outflow!

57
Billabong posts $126.3m half-year loss
(SMH Feb 21, 2014)
Troubled surf and skate wear retailer Billabong International is
yet to see signs of a turnaround, reporting a net loss of $126.3
million for the six months ending December after booking
another $132.6 million in asset writedowns and restructuring
costs.
The loss compared with a bottom line loss of $536.6 million in
the year-ago period.
Earnings continued to decline in North America and Europe,
offsetting gains in Australasia.
"This is a complex, difficult turnaround,' said chief executive Neil
Fiske. "We are not daunted by challenges we face, but neither
do we underestimate them."

58
Billabong posts $126.3m half-year loss
(SMH Feb 21, 2014)
Billabong shares went into a trading halt after the company
launched its previously announced $50 million rights issue. The
funds will be used to repay existing debt. Mr Fiske, who took the
helm last September, hopes to restore profits by building
Billabong's three biggest brands - Billabong, RVCA and Element
- as well as supporting emerging brands and culling those that
are cluttering the portfolio.

The company was in danger of collapse last year after posting a

$860 million loss.

59 59
 4. Capitalise vs. Expense
• An interesting choice that can make a big difference to a business!
• When we classify a cost as an asset we say we capitalise it.
• If a cost is not capitalised, it is expensed.

• Which of the following is a company likely to capitalise?

– Spent $10,000 cash on new equipment
– Spend $12,000 on 24 months rent in advance
– Pay $4,000 for telephone calls this month?

60
 Classifying a cost as an asset (‘capitalise’ it) or expense

Has a cost Unlikely to be an

been incurred? accounting event
No
Yes

Is there a benefit Relates to the owner or

to the business? No someone else and should
be charged appropriately
Yes

No
Has the benefit been
Report it as an asset
used in this period?
Yes

Charge as an expense

61 61
 5. Cash v accrual profit

• Accrual accounting records:

– Revenues when they are earned, not received.
– Expenses when they are incurred, not paid.
• The earning of a revenue is not necessarily
accompanied by an inflow of cash.
• The incurrence of an expense is not necessarily
accompanied by an outflow of cash
• Accrual profit is not the same as cash profit.

62
Revisit the Accrual concept (week 1)

In June, a company makes cash sales of $10,000 and credit sales

of $20,000 (all to be collected in July)

• What are sales using accrual accounting in June? $30,000

• What are cash inflows using cash accounting in June? $10,000

• What are total sales using accrual accounting in June and July?
$30,000
• What are total cash inflows using cash accounting in June and
July? $30,000

63
Revisit the Accrual concept

In June, a company pays wages of $6,000 and owes $1,000 for

June expenses (to be paid in July)

• What are expenses using accrual accounting in June?

• What are cash outflows using cash accounting in June?

• What are total expenses using accrual accounting in June and

July?
• What are total cash outflows using cash accounting in June and
July?

64
 Revision Question 6: The threshold concept:
Cash v Accrual Profit

Use the information given below to answer the following 2

questions.

During 2014, a company makes credit sales of $500 000, of

which $375 000 is collected at year-end. It pays $200 000 in
expenses and owes $25 000 for electricity used during 2014.
Accrual profit in 2014 is:

1. $300 000
2. $275 000
3. $175 000
4. $150 000

65
 Revision Question 7: The threshold concept:
Cash v Accrual Profit

What would the profit be in 2014 if cash accounting

rather than accrual accounting was used?

1. $300 000
2. $275 000
3. $175 000
4. $150 000

66
 See you next week!

• You will study the ‘Double Entry System’ (chapter 3) and

work through practice questions.

67