UTS ABDA Notes

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Accounting for Business Decisions A

Text(s): ACCT2 Financial, Fundamentals of Business Law, ACCT2 Managerial
Module 1 – Accounting in the world of business

Accounting is the process of identifying, measuring and communicating economic information to
permit informed judgement and decisions.
Objective 1 Examine the four assumptions made when communicating accounting information.
The economic entity assumption states that the financial activities of a business can be separated
from those of the business owner or owners.
- Allows financial information to be analysed without concern for the personal affairs of said
owners
- Activities should be accounted for separately
- E.g. if you own a business and a house, those two things will be accounted for separately
o Personal assets and liabilities are not included in the firm’s accounting information
The time period assumption states that business owners and other relevant parties will desire
periodic measurements of business performance
- Economic information can be meaningfully captured and communicated over short periods
of time
o It’s useless to say “a business has a profit of $1000”, what time period was it
generated in?
- Accountants will thus assume that information can be meaningfully captured in short
periods of time, even if they are arbitrarily defined (e.g. every month or quarter)
The monetary unit assumption states that the dollar is the most effective means to communicate
economic activity
- If an activity cannot be expressed in dollar terms, it is not accounted for
- Assumes reasonable stability in terms of inflation and deflation such that a dollar earned in
1996 is assumed to be the same as a dollar earned in 2016
The going concern assumption assumes that a company will continue to operate into the
foreseeable future
- If a firm is going concerns, it’s operating and making a profit, otherwise it is in the process of
liquidation
- An entity is assumed to be a going concern unless evidence suggests otherwise
Objective 2 Describe the purpose and structure of an income statement and the terms and
principles used to create it.
The purpose of an income statement (technically known as a statement of comprehensive income

or even a profit and loss statement) is to determine whether or not a company makes money
- It is a statement of revenues and expenses and the resulting net income over a period of
time
- Demonstrates the financial success or failure of a company in that period of time
A revenue is an increase in resources resulting from the sale of goods or the provision of services
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- Recorded according to the revenue recognition principle, which states that revenue should
be recorded when the resource is actually earned, this occurs when the sale of the good or
service is substantially complete and collection is reasonably assured
o AASB 118 Revenue provides detail on calculating the amount and timing of revenue
recognition
o E.g. If Nathan cleans a car and the client will pay in 6 months’ time, the revenue will
be recorded now rather than in 6 months
§ Revenue is earned when the obligation to the customer is met
An expense is a decrease in resources resulting from the sale of goods or provision of services
- Recorded according to the matching principle, stating that expenses should be recorded in
the period resources are used to generate revenues
o E.g. If a lawn mowing business uses fuel to mow lawns in January then that is a
January expense
- Not the same as a cost
- We just look at the expenses associated with generating revenue
Important: revenues and expenses are associated with goods and services, e.g. the sale of an asset
would not be recognised as a revenue
Once revenues and expenses are calculated, they are reported on an income statement, which will
show the total comprehensive income (aka income aka net loss/profit)
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The income statement should contain the business’ name, the statement name and the time period
Objective 3 Describe the purpose and structure of a balance sheet and the terms and principles
used to create it.
The balance sheet, otherwise referred to as the statement of financial position, reports a business’
assets, liabilities and equity at a specific point in time
- Its purpose is to show a company’s resources and its claims against those resources
- Often referred to as a snapshot of the business
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An asset is an economic resource of a business that is objectively measurable and results from a
prior transaction and will provide future economic benefit
- E.g. Cash: it is measurable as it can be counted, it is received through a transaction with
someone else and it can be used to buy things in the future
- Can be intangible, e.g. copyright and trademarks
- Recorded according to the historical cost principle (also known simply as the cost principle),
which states that assets should be recorded and reported at the cost paid to acquire them
- However, it’s important to note that this is subject to other factors, a lawnmower may have
been purchased at $260, but could have required $50 in repairs over a time period, its cost
becomes $210 (the costing of equipment will be explored more deeply in chapter 8)
A liability is an obligation of a business that results from a past transaction and will require the
sacrifice of economic resources at some future date
- E.g. salaries payable to employees, taxes payable to governments, accounts payable to
employers
Equity is the difference between a company’s assets and liabilities, and represents the share of
assets that are claimed by the business’ owners
- Can be generated in two ways:
o The first is through issued (also known as contributed) capital, issued capital is
defined as the resources that investors contribute to a business in exchange for an
ownership interest
§ E.g. I put $100 into my lawn mowing service, this did not come from
providing a service or selling a product but from a contribution of ownership
interest
§ Commonly generated through shares
o The other is through profitable operations, whereby profit can be distributed to the
owners or retained within the business
§ Dividends are paid to owners (they are not considered an expense but
instead a distribution of company assets to owners)
§ Retained earnings are kept within the business and represent the equity
generated and retained from profitable operations
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Objective 4 Describe the purpose and structure of a statement of changes in equity and how it
links the income statement and the balance sheet.
A statement of changes in equity depicts how equity is growing as a result of profitable operations
and how equity is distributed in the form of dividends as well as retained earnings all in a specific
period of time.
Basic structure:
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The changes in retained earnings component of the statement of changes in equity links the income
statement and the balance sheet
- A business can’t calculate its retained earnings at the end of a time period without factoring
in the profit earned during that period, the statement of changes in retained earnings
provides this link by including a net profit or loss in the calculated of retained earnings,
which is then reported on the balance sheet
- This means that an income statement must be prepared first when preparing financial
statements, followed by the statement of changes in equity and then the balance sheet
These links are shown below:

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Objective 5 Describe the purpose and structure of a cash flow statement and the terms and
principles used to create it.
A cash flow statement reports a business’ cash inflows and outflows from its operating, investing
and financing activities, it details the sources and uses of cash in a specific period of time and has the
purpose of informing users about how and why cashflow changed during that time period
Financing can come in forms such as borrowing money from creditors and receiving contributions
from investors
- E.g. Contributing $100 of your own money to the business
- Debt servicing, dividends etc
Once sufficient capital has been raised from creditors and investors, investing activities can be
conducted through the purchasing and sale of revenue-generating assets
- E.g. Paying $200 for a new lawnmower would be a $200 cash outflow
Operating includes the purchase of supplies, the payment of employees and the sale of products
- E.g. $1000 in sales from mowing lawns and paying $100 for petrol would lead to a total
inflow of $900
o This inflow is not the same as profit!
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Example cash flow statement (Note that outflows are in brackets):

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Objective 6 Question the qualitative characteristics that make accounting information useful.
Understandability refers to the ability of accounting information to be comprehensible to those who

have a ‘reasonable understanding of business and economic activities and accounting and a
willingness to study the information with reasonable diligence’
Relevance refers to the capacity of accounting information to make a difference in decision making
- This occurs when it possesses feedback value (the ability to assess past performance) or
predictive value (the ability to form expectations of future performance)
- It must also be timely
Reliability refers to the extent to which accounting information can be depended upon to represent
what it purports to represent
- It must be verifiable (It can be proven to be free from error), have representation
faithfulness (when the description of information corresponds to the underlying
phenomenon, e.g. recording a petrol can purchase as an asset on a balance sheet is
representationally faithful as the petrol can is treated as what it is – a resource) and neutral
(non-bias reporting about the entity)
Comparability refers to the ability of information to be weighed against or contrasted to the

financial activities of other businesses
- Allows a firm to assess its market position, gauge success against competitors and set future
goals based on industry standards
- Despite comparability being desired, standards across firms are not uniform, as a result it is
required that entities disclose the accounting methods used to allow for comparability
Consistency refers to the ability to use accounting information to compare or contrast the financial
activities of the same entity over time
- It is highest when the same accounting methods are used year after year
- Changes to accounting methods hinder consistency and thus must be disclosed so that
concerned parties can compensate for these changes
Materiality is similar to relevance – it refers to a threshold at which an item begins to affect decision
making, items meeting or exceeding this threshold are said to be material, other items are
immaterial
- The threshold is often set at some percentage of assets or sales
Conservatism refers to the manner in which accountants deal with uncertainty regarding economic
situations
- When uncertain scenarios arise, conservatism dictates that accounting methods that are
least likely to overstate the company’s assets and revenues
Objective 7 Study the conceptual framework of accounting.
Terms used to identify and describe economic information

Term Definition Reported on the
Asset A resource of a business. Balance sheet
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Terms used to identify and describe economic information

Term Definition Reported on the
Liability An obligation of a business. Balance sheet
Equity The difference between assets and liabilities. Balance sheet
Issued (contributed) Equity resulting from contributions from owners Balance sheet
capital (often from issuing ordinary shares).
Retained earnings Equity resulting from profitable operations. Balance sheet and statement
of changes in equity
Revenue An increase in assets resulting from selling a Income statement
good or providing a service.
Expense A decrease in assets resulting from selling a good Income statement
or providing a service.
Dividend (Drawings) A distribution of profits to owners. Statement of changes in
equity
Principles used to measure economic information

Principle Definition Ramification
Revenue Revenues are recorded when they are The receipt of cash is not required to
recognition earned. record a revenue.
Matching Expenses are recorded in the time period For many assets, the cost of the asset
when they are incurred to generate must be spread over the periods when it
revenues. is used.
Cost Assets are recorded and maintained at Except in a few cases, market values are
their historical costs. not used for reporting asset values.
Assumptions made when communicating economic information

Assumption Definition Ramification
Economic The financial activities of a business can be We do not have to worry that the
entity accounted for separately from the business financial information of the owner is
owners. mixed with the financial information of
the business.
Monetary The dollar, unadjusted for inflation, is the All transactions in foreign currencies are
unit best means of communicating accounting converted to dollars.
information in Australia and New Zealand.
Time period Accounting information can be Most businesses prepare half-yearly and
communicated effectively over short annual financial statements.
periods of time.
Going The company for which we are accounting If an entity is not selling its assets, then
concern will continue its operations indefinitely. the cost principle is appropriate.
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Qualitative characteristics that make accounting information useful

Term Definition Ramification
Understandability Accounting information should be Users must spend a reasonable amount
comprehensible by those willing to of time studying accounting information
spend a reasonable amount of time for it to be understandable.
studying it.
Relevance Accounting information should have the Information should have predictive or
capacity to affect decisions. feedback value and should be timely.
Reliability Accounting information should be Information should be free from error, a
dependable to represent what it faithful representation and neutral.
purports to represent.
Comparability Accounting information should be Entities must disclose the accounting
comparable across different businesses. methods that they use so that
comparisons across companies can be
made.
Consistency Accounting information should be An entity should use the same
comparable across different time periods accounting methods year after year and
within a business. disclose when they change methods.
Materiality The threshold over which an item could When an amount is small enough,
begin to affect decisions. normal accounting procedures are not
always followed.
Conservatism When uncertainty exists, accounting An entity should choose accounting
information should present the least techniques that guard against
optimistic alternative. overstating revenues or assets.
Financial statements used to communicate economic information

Statement Purpose Structure Links to other statements
Income Shows a company's Revenue Expenses = Net Net profit goes to the
statement revenues and expenses Profit/Loss statement of changes in equity
over a specific period of to calculate retained earnings.
time.
Balance sheet Shows a company's Assets = Liabilities + Equity The balance in retained
assets, liabilities and earnings comes from the
equity at a specific point statement of changes in equity.
in time. The balance in cash should
agree with the ending cash
balance on the cash flow
statement.
Statement of Shows the changes in a Beginning Retained Ending retained earnings goes
changes in company's retained Earnings + Profits (or to the balance sheet.
equity earnings over a specific Losses) Dividends =
period of time. Ending Retained Earnings
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Financial statements used to communicate economic information

Statement Purpose Structure Links to other statements
Cash flow Shows a company's Operating Cash Flows +/ The ending cash balance on the
statement inflows and outflows of Investing Cash Flows +/ cash flow statement should
cash over a specific Financing Cash Flows = Net agree with the balance in cash
period of time. Change in Cash on the balance sheet.
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Module 2 – Financial statements
Objective 1 Explore the three major forms of business.
A sole proprietorship is a business owned by one person (also known as a sole trader)
- Owner maintains complete control of the business, bears all the risk of failure and reaps all
rewards of success
- Economic entity assumption: the business is accounted for separately from the proprietor’s
personal affairs except for tax purposes (the income from the business is on the owner’s
personal tax return)
- Unlimited liability
A partnership is a business that is formed when two or more proprietors join together to own a
business
- Partnerships are established using a written or oral agreement
- Helps to combine skills and resources and to spread the financial risk of the business among
several people
- A share of partnership income is reported on the partner’s individual tax return
- Unlimited liability
A company or corporation is a separate legal entity established by registering with ASIC

- Shares are sold to individuals who want to own part of the company
- The sale of shares is one of the main reasons to start a company as it enables capital to be
raised
- Income generated by a company is taxed on a company tax return
- In Australia, dividends are not ‘double taxed’ as they are in many other countries
- Limited liability
- Two main types of companies:
o Proprietary (private, Pty)
o Public
§ Ownership is available to the general public
§ Said to be publicly traded or publicly listed
§ Shares listed on an open exchange
§ It costs money to be listed on the ASX
§ In the balance sheet the value of shares is reflected in the value of
contributed capital, not the current market value of the shares
The main difference between the types of businesses manifests within the equity section of the
balance sheet
- Nonetheless, most of the accounting is applied against the business itself and is the same
regardless of structure
Objective 2 Define Generally Accepted Accounting Principles (GAAP) and their origins.
Public companies must follow the GAAP

- They are a set of accounting standards, rules, principles and procedures that comprise
authoritative practice for financial accounting
- Developed by the Australian Accounting Standards Board and enforced by ASIC
- AASB is an agency under the ASIC Act 2001 and is required to produce accounting standards
under Section 334 of the Corporations Act 2001
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- The purpose of high-quality accounting standards is to produce financial statements that are
‘presented fairly’
A fair presentation requires entities to:

- Select and apply accounting policies in accordance with AASB 108
- Present information in a manner that provides relevant, reliable, comparable and
understandable information and
- Provide additional disclosures when compliance with the specific requirements in Australian
Accounting Standards is insufficient to enable users to understand the impact of particular
transactions, other events and conditions on the entity’s financial position and financial
performance
Australia has also adopted and adapted the International Financial Reporting Standards, these are
developed by the International Accounting Standards Board
- Goal is to standardise global accounting standards
Objective 3 Describe the main classifications of assets, liabilities and equity in a balance sheet.
A classified balance sheet includes various denominations for equity, assets and liabilities.
Assets are grouped into two main categories on a balance sheet:

- Current assets
o Any asset that is reasonably expected to be converted to cash or consumed within
one year of the balance sheet date
o E.g. cash, investments that will mature or be sold within a year, accounts receivable
from customers, inventories and other assets such as prepaid insurance
o Listed in order of their liquidity
§ Cash à short-term investments à receivables à inventories à other
assets
- Non-current assets
o Resources used in a company’s operations for more than one year and are not
intended for resale
o E.g. Property, plant and equipment, intangible assets and deferred tax assets
o Includes intangible assets, which are those used in operations for more than one
year, not intended for resale and have no physical substance
§ E.g. trademarks, patents etc
§ Subject to depreciation like other assets, but the technical term used is
amortisation
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Liabilities are also generally classified into two main categories:

- Current liabilities
o An obligation that is reasonably expected to be satisfied within one year
o E.g. accounts payable to suppliers, salaries payable to employees and taxes payable
to taxing authorities
o Long-term debt, if maturing within one year, is a current liability
- Non-current liabilities
o An obligation not expected to be satisfied within one year
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Equity is generated from two main sources:

- Retained earnings (inclusive of reserves)
o The amount of equity a company generates by being profitable and retaining those
profits in the business
- Issued capital is the amount of equity generated through the issuing of shares to investors
(often referred to as share capital or contributed equity)
Objective 4 Describe the main subtotals of income on an income statement.
Companies will generally one of two types of income statement:

- Single-step income statement
o Calculates the total revenues and expenses and then determines net income in one
step by subtracting total expenses from total revenues
o Advantage of simplicity
- Multi-step income statement
o Calculates income by grouping certain revenues and expenses together and
calculating several subtotals of income
o Provide information on the profitability of various aspects of firm operations
o They will generally include some or all of the following subtotals of income:
§ Total revenue
§ Cost of sales
§ Gross profit
§ Expenses
§ Profits before income tax expense
§ Profits after income tax expense
§ Other comprehensive income
§ Total comprehensive income
• Note that it is usually better to look at operating profit to examine
the performance of a business as net profit includes one-off
transactions that don’t reflect actual performance
• Nonetheless it provides a complete picture of a business’ increase or
decrease in economic benefits
Gross profit
- Represents the profit that a company generates when considering only the sales price and
the cost of the product sold
- In a multi-step statement, sales revenue (revenue generated from the sale of goods) is listed
first
- Next is the cost of sales, which represents the cost to the firm of the inventory that was sold
during this period
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Operating (other) expenses

- After gross profit is reported, operating expenses are listed
- Operating expenses are incurred during normal operation, they are recurring
Profits before income tax expense

- Represents the profit generated when considering revenues and expenses other than
income tax
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Other comprehensive income

- Includes movements in equity that are not part of the realised gains or losses in profits
- E.g. movement in translation of foreign operations (such as due to changes in exchange
rates) and gains and losses in cash flow hedges
Objective 5 Analyse the balance sheet and the income statement using horizontal and vertical
analyses.
Horizontal analysis is a method of analysing a company’s account balances over time

- Normally conducted on both the balance sheet and income statement
- Calculates both the absolute and percentage change in each account balance on a financial
statement
- Called horizontal as calculations are made across columns of yearly data along the financial
statement
- Should include more than 2 years of data
- Many annual reports include up to 10 years of data, this can be used to perform trend
analysis
o Such trend analysis is useful for building prediction models to forecast future
problems
- Provides insight into trends
- Quite simply, the dollar change in the account balance is calculated followed by the
percentage change
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Vertical analysis is a method of comparing account balances within one year

- Normally conducted on both the balance sheet and income statement
- Used to create a common-size financial statement, in which all items have been restated as
a percentage of a selected item on the statements
o Removes size as a variable in ratio analysis and can be used to compare companies
of different sizes
§ E.g. despite ME Bank being less than 2% the size of CBA, it can be used to
compare them (particularly their capital structure)
- Calculated by dividing each account balance by a base account, yielding a percentage
- The base account is total assets for balance sheet accounts and sales or total revenues for
income statement accounts
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- Reveals information about the capital structure of a firm, which refers to the degree to
which a company’s assets are generated from liabilities versus equity
Objective 6 Explain the purpose of a statement of changes in equity.
A statement of changes in equity is a financial statement that shows how and why each equity
account in the company’s balance sheet changed from one year to the next
- It focuses not just on retained earnings but also other equity accounts relating to a
company’s contributed capital
Objective 7 Discuss the types of information usually disclosed along with financial statements.
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Three basic types of notes to the financial statements:

- Accounting policies adopted
- Details about numbers in the financial statements
- Additional financial and non-financial information
Notes to the financial statements

- The textual and numerical information immediately following the financial statements that
disclose the accounting methods used to prepare the financial statements, disclose
additional detail and explanation of accounting balances and provide information not
recognised in financial statements
- Financial statements should not be examined without considering the notes to the financial
statements
Auditor’s report
- An independent auditor’s report states an opinion on whether the financial statements give
a fair and true view of the firm and comply with Australian Accounting Standards
- Not about correctness, just accuracy and fairness
- Provides an external assessment of reliability
Management’s discussion and analysis

- Normally precedes financial statements and contains comments on the company’s results of
operations, its ability to satisfy its current obligations and its expansion plans
- Useful in understanding past performance as management can compare the current year’s
operating results to the prior year’s and explain the reasons for any differences
Sustainability reporting
- Not required, but some companies will include information about the sustainability of their
growth
- Useful for stakeholders
Governance information
- Information about board of directors, senior management, board activities and
remuneration of directors and managers
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Module 3 – Recording accounting transactions
Objective 1 Describe the purpose of an accounting information system.
An accounting information system identifies, records, summarises and communicates the various
transactions of a company.
- Made to capture and report the effects of accounting transactions, which is any economic
event that affects a business’ assets, liabilities or equity at the time of the event
o Includes internal transactions (within the business) and external transactions
(between the company and an external party)
Accounting transactions are reflected in accounts, which accumulate the activity of a specific item
and yield its balance
- A chart of accounts is often used to list the accounts held by a company
Objective 2 Analyse the effect of accounting transactions on the accounting equation.
Due to the nature of the accounting equation linking assets, liabilities and equity, every accounting
transaction must affect at least two accounts
- Accounts always have a source and a use
- E.g. a decrease in one asset account must be offset by an equal increase in another asset or
an increase in a liability or equity account
- This is known as the dual nature of accounting (dual-entry system)
Objective 3 Understand how T-accounts and debits and credits are used in a dual-entry accounting
system.
T-account:
Accounts can be represented as above (this is known as a T-account)
Example usage:
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Note that this asset account has a debit balance, in a dual-entry system, asset accounts should have
debit balances whilst liability and equity accounts have credit balances
- This mirrors the accounting equation
- This applies MOST of the time
- This is key to the dual-entry system
- We record increases in an account on the same side as the normal balance and decreases on
the other side
o E.g. an increase in assets would be on the debit side, liability and equity on the
credit side and the debit side for expense and dividend accounts
Objective 4 Explain the purpose of the journal, ledger and trial balance.
Accounting transactions are not recorded directly in T-accounts, and are instead first recorded in a
journal, this information is then transferred or posted to a ledger, which is then summarised in a
trial balance – this information is then used to prepare financial statements
Journals are the row in the spreadsheet and the ledger is a column
Journals are a chronological record of transactions

- Otherwise known as a book of original entry
- Accounting transactions are journalised when they are put in a journal
- The general journal is a basic type of journal, example journal entry is shown below:
o
o It’s useful as it contains all accounting transactions for a business, however the
general journal isn’t as useful for determining the balance of a specific account
- Date Account debited… Amount debited
Account credited… Amount credited note that the credits are indented
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A ledger is a collection of accounts and their balances

- Again, a basic type is called the general ledger, which is a collection of T-accounts for a
business
- When an accounting transaction is recorded in the general journal, the amounts
recorded in the debit and credit columns are transferred to the debit and credit
columns of the respective T-accounts in the ledger
o This is called posting
o Shows the activity and balance of all company accounts
A trial balance is a listing of accounts and their balances at a specific point in time
- Asset accounts are listed first, followed by liability accounts, equity and then revenue,
expense and dividend accounts
- Each balance is listed in the appropriate debit or credit column
- The trial balance proves that total debits equal total balances
- It summarises in one place all accounts
- Useful for making adjustments to account balances at the end of an accounting period
Objective 5 Record and post accounting transactions, and prepare a trial balance and financial
statements.
Examples in textbook.
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Module 4 – Accrual accounting and adjusting entries
Objective 1 Describe how profit is measured and reported under the accrual and cash bases of
accounting.
The cash basis of accounting records revenues when cash is received and records expenses when
cash is paid
- E.g. personal bank account
The accrual basis of accounting records revenues when they are earned and records expenses when
they are incurred
- Revenue recognition and matching principles
Imagine your friend pays you $100 to collect their mail and newspaper in December and January and
you get paid in December
- Additionally, you’re smart so you get a different mate to do the work for you for $40, but
you pay them in January, the effects are seen below:
o The end profit is the same but monthly figures vary greatly
GAAP requires the accrual basis because it provides a better representation of income over the two
shorter periods of time
- As a result, income statements report accrual-based profits/losses
- Nonetheless, cash basis is still useful and is reported on the cash flow statement
Objective 2 Identify the four major circumstances in which adjusting journal entries are necessary.
Adjusting journal entries are entries made in the general journal to record revenues that have been
earned but not recorded, and expenses that have been incurred but not recorded
- These are used to record information under an accrual basis
- They bring about a proper matching of revenues and expenses
- The process of recording and posting adjusting entries is the fourth step in the accounting
cycle after the trial balance is prepared and occurs at the end of each accounting period
- After adjusting entries are journalised and posted, an adjusted trial balance is then prepared
1. Deferred revenue
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The term deferred is used because at the time of cash receipt, the company has not yet
provided the service and therefore cannot record a revenue and must instead record a
liability
- Recording the revenue must be deferred until the revenue is earned
If it is not recorded as a liability and instead is recorded as a revenue immediately (which is
wrong), rather than debiting the unearned revenue account and crediting the earned
revenue account, you could debit the revenue by what you still haven’t earnt and credit the
unearned account that same amount
e.g. if you are paid $1200 at the start of the year for a monthly magazine subscription, the
initial entry sees cash debited $1200 and subscription revenue (mistakenly) credited $1200.
After 4 months, you’d debit $800 to subscription revenue and credit unearned revenue $800
as that is what you haven’t yet earned
2. Accrued revenue
To ‘accrue’ means to accumulate or increase, an accrued revenue is another name for a
receivable
3. Deferred expense
e.g. Rent, you pay for the rent period and then you occupy the property
Deferred is yet again used because at the time of cash payment for the resource the
company has yet to consume the resource it is acquiring and therefore cannot record an
expense and instead must record an asset
If you paid $36k for 12 months of insurance, it could incorrectly be recorded as:
Debit Insurance expense 36k
Credit cash 36k
The adjusting entry after one month would be:

Debit Prepaid Insurance 33k
Credit Insurance expense 33k
4. Accrued expense
Incur an expense and pay for it later, e.g. salaries are paid after labour is provided
Another name for a liability
e.g. Daily payroll is $1,000, the company pays its employees on Saturday for the previous
Monday-Friday. Statements are prepared on April 30 (a Friday)
Adjusting entry:
Salaries expense 5k
Salaries payable 5k
This subsequent transaction is made (NOT an adjustment because it includes cash)

Salaries payable 5k
Cash 5k
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Depreciations:
- Recognising that we have used up part of the services of an asset
- The depreciation expense depends on how much the asset cost, what it will be worth at the
end, how long it will last and the pattern of use (do we get better service at the beginning or
is it even across its useful life?)
- We expense this depreciation and maintain an accumulated depreciation within the assets
account
o This accumulated depreciation is a contra account
- On a balance sheet, the depreciation account is recorded as such:
o Camera 1000
Less: Camera depreciation 100 900
Objective 3 Record and post adjusting journal entries, and prepare an adjusted trial balance and
financial statements.
After adjusting entries, amend the trial balance to create an adjusted trial balance
Financial statements can then be generated using this adjusted trial balance
Objective 4 Describe the purpose of the closing process and prepare closing entries.
The closing process is when all revenue, expense and dividend account balances are transferred to
the retained earnings account, this is needed for two reasons:
- Firstly, these three accounts are temporary accounts, meaning that they accumulate balance
only for the current period, they are reset for the next period and thus the information
within them must be appropriately recorded elsewhere
- Secondly, the transfer updates the retained earnings to its proper end-of-period balance
It is accomplished with several entries, closing entries eliminate the balances in all temporary
accounts and transfer them to the retained earnings account
- Usually one entry is made for each of the three temporary accounts
A post-closing trial balance is constructed after all accounts have been closed, it contains the
balances for the beginning of the next accounting period
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Objective 5 Describe the steps of the accounting cycle.
The accounting cycle is the sequence of steps in which an accounting information system captures,
processes and reports a company’s accounting transactions during a period
Steps:
1. Journalise transactions and then post to the ledger
2. Prepare a trial balance
3. Journalise and post adjusting entries
4. Prepare an adjusted trial balance
5. Prepare financial statements
6. Journalise and post closing entries
7. Prepare a post-closing trial balance
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Module 5 – Cash and internal controls
Objective 1 Identify the role of internal control in a business.
Internal control is the process that a company’s management uses to help the company meet its
operational and financial reporting objectives
- Specifically, it is the system of policies and procedures that a business puts in place to
provide reasonable assurance that:
o Operations are effective and efficient
o Financial reporting is reliable
o Compliance with applicable laws and regulation is practiced
In the USA an internal control report is required to illustrate management’s responsibility for
internal control
Objective 2 Describe the five components of internal control.
Internal control – regulated framework states that good internal control consists of the following
five interrelated components:
1. Control environment
The atmosphere in which members of an organisation conduct their activities and carry out
their responsibilities
This needs to be strong in order to provide a foundation for the other components of
internal control
Factors such as the overall integrity and ethical values of personnel, management’s
philosophy and operating style, the assignment of authority and responsibility and the
general structure of the organisation
2. Risk assessment
Risks are ever-present in business, the identification and analysis of these risks with the goal
of effective management is key to internal control
Risk assessment is an ongoing process throughout business operations due to changes in
economic conditions
Risks can arise from external sources (new competitors, changing customer expectations,
natural catastrophes) or internal sources (inadequate workforce training, errors in financial
reporting, theft of assets by employees)
Once risks are identified, they can be analysed with these processes:
o Estimate the risk’s significance
o Assess the likelihood of its occurrence
o Consider what actions can be taken to manage it
3. Control activities
These are the policies and procedures that management establishes to address the risks that
might prevent the organisation form achieving its objectives, they general fall into one of
several categories:
o Establishing responsibility
Provides accountability for completion of tasks and allows management to know
who to consult if tasks are not completed satisfactorily
o Maintaining adequate documentation
Promote error-free production of accounting information
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e.g. require that sales are documented on a sale invoice, maybe require a password
to create the invoice to establish responsibility for the sale
o Segregation of duties
Limit one person’s control over a particular task or area of a company
Spread responsibility among multiple employees so that one employee’s work can
serve as a check against another’s work
e.g. Divide the processes of ordering, receiving and paying for inventory among
three employees rather than one
o Physical security
Secured facilities, fire and alarm systems, computer passwords and encryption,
periodic counting of inventory and comparison to accounting records
o Independent verification
Reviewing and reconciling information within and organisation
Particularly useful when reconciling an asset balance with the accounting balance
for that asset
Most effective verifications are conducted on a surprise basis and are done by those
who have no connection to the process or employee being verified
4. Information and communication
Refers to the need for the open flow of relevant information throughout an organisation
o Information must be captured and communicated in a form and a timeframe that
enables employees to complete their responsibilities
o Requires information systems that provide relevant and reliable reports
o Requires upward and downward lines of communication (in terms of the hierarchy)
5. Monitoring
Refers to the assessment of the quality of an organisation’s internal control
Done through two methods:
o Ongoing activities: e.g. supervisors can check for evidence that a control activity is
functioning properly during their daily activities
o A separate evaluation can be conducted
Internal controls are limited, it can only provide reasonable assurances that a company is meeting its
objectives. There are two main factors limiting internal controls
- The human element is one factor and refers to the fact that internal controls are based upon
human judgement and action. Human error or even unethical decision making can
undermine internal control policies
- Cost-benefit analysis refers to the cost of implementing a control activity versus the benefit
of actually having a control
o e.g. using a retina scan system for security might be overkill, it may be better to just
go for a lock and key instead
Objective 3 Understand two methods of internal control over cash - bank reconciliations and petty
cash funds.
Cash is the best asset to demonstrate internal control due to the ease of concealing it, taking it and
converting it into other assets
- two of the controls used to control cash are bank reconciliations and petty cash funds
Bank reconciliation is the process of recognising and noting the differences between the cash
balance on a bank statement and the cash balance in a company’s records
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- the purpose is to confirm the accuracy of the bank’s and company’s cash records and to
determine the actual cash balance to be reported on the company’s statement of financial
position
- A bank reconciliation is prepared as follows:
o Reconcile the bank balance to the actual cash balance
§ The bank balance will differ from the actual cash balance and will need
adjustment for two main reasons:
• Firstly, there may be deposits and payments made by the company
that are not reflected on the bank statement. E.g. A deposit in
transit is a deposit that has been made by the company but has not
cleared the bank as of the statement date, since the deposit is now
in the bank it should be added to the bank’s cash balance.
Additionally, outstanding cheques are cheques that have been not
been cleared by the bank as of the statement date, often because it
is yet to be deposited. Since it is no longer in the bank they should
be subtracted from the bank cash balance. Dishonoured cheques
occur when the drawer’s account doesn’t hold sufficient funds to
pay and results in it ‘bouncing’
• The second reason is related to errors by the bank, e.g. erroneously
recording a $1450 deposit as $1540 results in an overstatement of
$90 and should thus be reduced by $90
§ Once adjustments have been made, the adjusted bank balance should equal
the actual cash balance to be reported on the statement of financial position
o Reconcile the company’s book balance to the actual cash balance
§ The next step is to adjust the cash balance in the company’s books to the
actual cash balance, the company’s books may differ from the actual
balance for two main reasons:
• Firstly, bank activities that change the cash balance may have not
been recorded by the company. The bank may notify the company
of an addition to the cash balance on the bank statement. Credit
memoranda arise when the bank collects cash on behalf of the
company, such as through the collection of a company receivable or
interest on a note, this should be added to the company’s book
balance. A debit memorandum is notification of a subtraction from
the cash balance on the bank statement, for example fees charged
for banking services and customer cheques returned for insufficient
funds, they should be subtracted from the company cash balance as
they represent cash that the company no longer has
• The second reason can be due to errors made in the company’s cash
records and should be adjusted appropriately
o Adjust the company’s book balance to the actual cash balance
§ Record the journal entries needed to adjust the book balance to the actual
cash balance. They are based on credit and debit memoranda and errors
identified during the reconciliation of the company’s balance
Most companies require that all disbursements of cash be made with an authorised electronic
transfer or double-signed cheque, this is a control activity that allows a company to better monitor
its cash outflows
- However, in situations where only a minor amount of cash is needed and the effort needed
to write a cheque isn’t worth it (or it’s not possible to use a cheque at all), companies
establish petty cash funds to combat this
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A petty cash fund is an amount of cash kept on hand to pay for minor expenditures. Its operation
involves the following activities:
- Establishing the fund
o Done by writing a cheque for the amount of the fund, cashing the cheque and
placing the cash under the care of an employee designated as custodian
o A journal entry is to made to record this
- Making payments from the fund
o Payments are usually made in one of two ways, cash can be taken from the fund to
make payment, or employees can seek reimbursement from the fund for payments
they have personally made
o The custodian should collect receipts for the use of any cash
o No journal entries are made for payments that use petty cash and instead entries
are only made when the fund is replenished
- Replenishing the fund
o To replenish the fund, the remaining cash is counted and then the company cashes a
cheque for the amount that brings the total cash fund back to the original balance
o The receipts in the fund are used as documentation for recording expenses
o When a fund is replenished, the amount of cash needed should equal the total
amount of receipts
§ This may not always be the case as the custodian may not obtain all receipts
or will give incorrect change, creating a discrepancy between the cash
needed for replenishment and the amount of receipts
• In such cases, the discrepancy is charged to an account called cash
over or cash short (or sometimes cash short and over)
o These are temporary accounts that can have either a debit
or credit balance
o A debit balance increases expenses while a credit balance
decreases expenses
- Nowadays many businesses have done away with petty cash and require employees to
spend their own money and seek electronic reimbursement. In these cases, employees are
issued with a company credit card and are required to justify and receive authorisation for
nay purchases after they are made
o Company cards cannot prevent unauthorised expenditure but can easily detect such
purchases
Objective 4 Outline the reporting of cash.
Companies often hold investments that are so much like cash that they are deemed to be cash
equivalents, more specifically that are readily convertible into a known amount of cash and may be
limited to investments that have a maturity of three months or less
- They can be combined with cash for reporting purposes
Cash is reported as a current asset on the statement of financial position
Objective 5 Evaluate cash through the calculation and interpretation of horizontal, vertical and
ratio analyses.
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After conducting horizontal and vertical analyses to see the changes in a company, it is useful to look
at their operating, investing and financing activities to work out why the changes actually occurred
A company needs cash to generate enough cash to pay its bills as well as to maintain its operating
assets and to reward shareholders with dividends. If a company can generate more cash than it
needs for these commitments it is generating free cash flow, which is defined as the excess cash a
company generates beyond what it needs to invest in productive capacity and pay dividends to its
shareholders
- It is a measure of a company’s ability to generate cash for expansion
@$.ℎ ?%"A. ?*"( ")+*$#/-< $'#/0/#/+. − '$)/#$% +4)+-;/#2*+. − ;/0/;+-;.

= ?*++ '$.ℎ ?%"A
Capital expenditures refer to the amount a company spends on property, plant and equipment
during the year
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Module 6 – Receivables
Objective 1 Describe the recording and reporting of receivables.
A receivable represents a company’s claim on the assets of another entity. The most common type is
an account receivable, which is an amount owed by a customer who has purchased the company’s
product or service
- Sometimes known as debtors or trade receivables
Recording accounts receivable:

Let’s say you sold $1000 of goods and the customer will pay later, you’d journalise it as such:
Accounts receivable 1000
Sales 1000
But what happens if a customer wants to return some of the goods sold? Suppose that $150 of
goods were returned, the following entry would be appropriate:
Sales returns and Allowances 150
Rather than decreasing sales, we use the returns account is a contra-revenue account, meaning that
the balance will be subtracted from sales when calculating net sales later
- Provides a record of returns in each period
- A temporary account: will be zeroed out later
Suppose you wanted to provide a discount of ‘2/10’ (2% if paid within 10 days of invoice) and the
customer in the aforementioned examples pays the remaining $850 within this time. This would be
recorded as such:
Cash 833
Sales discounts 17
n/30=net balance paid in 30 days
Sales discounts is another contra-revenue account and provides a record of discounts during a
period
- Some may treat sales discounts as a financial expense
Reporting accounts receivable

Accounts receivable are classified as current assets as they are expected to be collected within a
month or two
- However, customers don’t always pay their bills and thus receivables are not always paid off
- As a result, conservatism must be followed and accounts must be reported at their net
realisable value, this is the amount of cash that a company expects to collect from its total
accounts receivable
o It is calculated by subtracting from gross receivables the amount that a company
does not expect to collect
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o This amount that is not expected to be collected is called an allowance
Objective 2 Compare the methods used to account for uncollectible receivables.
Losses from the inability to collect accounts receivable are recorded in the accounting system as bad
debt expense
- It is considered a normal operating expense and is included when calculating net income,
however, it is normally grouped with other operating expenses
o If it is listed separately it’s likely because it was a significant expense (bad news)
There are two methods to account for bad debt expense:

- The direct write-off method sees bad debt expenses recorded when a company determines
that a receivable is uncollectible and removes it from its records
o It is eliminated or ‘written off’ from the company’s records and the bad debt
expense is recorded for the amount of the receivable
o e.g. say a receivable was recorded as such:
Sales 4000
The firm later determines it won’t be collected, they will then journalise this:
Bad debt expense 4000
o The main advantage is the simplicity of the method; however, it can violate the
matching principle, which requires that expenses are matched as closely as possible
to the period in which the related revenues are recognised. E.g. You might perform
the service that earns you the receivable in January 2017 but then decide to expense
it as bad debt in November 2018, the expense won’t be recorded in the same year
as the sale
§ Because of this, GAAP prohibits its use except when the bad debt expense is
immaterial to the company (which is when it is small enough that failure to
report it properly won’t alter decision making)
- The allowance method splits the accounting into two entries – one to record an estimate of
bad debt expense and another to write off receivables when they become uncollectible. The
purpose is to match the expense to the period in which those receivables were created
o Recording bad debt expense:
§ In order to comply with the matching principle, a company must record bad
debt expense at the end of each accounting period. However, at the end of
the period the company does not yet know which receivables will be
uncollectable – this creates the need for the company to set up an
allowance for uncollectible receivables when recording bad debt expense,
so instead of writing off specific receivables at year-end, a company
increases a contra-asset account called Allowance for Doubtful debts or
Allowance for Impairment Loss. This represents the dollar amount of
receivables that a company believes will ultimately be uncollectible. Its
balance is subtracted from gross receivables to yield the receivables’ net
realisable value
§ e.g. Imagine you record $8000 of credit sales during 2018:
Sales 8000
Based on past experience, you estimate that $800 of the sales won’t be
received, so at the end of 2018 you do this in order to match the expense:
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Allowance for doubtful debts 800
o Recording a write-off
§ Regardless of method, receivables must be written off when deemed
uncollectible. Under the allowance method, bad debt expense has already
been estimated and recorded and an allowance balance created for
uncollectible receivables, contrasting how bad debt expenses are recorded
at the time of write-off when using the direct write-off method. This means
that instead of increasing bad debt expense at the time of the write-off, the
company reduces the balance in the allowance account
§ E.g. imagine a firm determines that a $2500 receivable is uncollectible,
they’d write it off as such:
This has no effect on the net realisable value of receivables as both the asset
and contra-asset account have been changed by the same amount. Through
the creation of an allowance the company has been able to write off the bad
debt without impacting the cash balance
o Essentially:
§ Step 1: adjusting entry
Bad debt expense (estimated amount)
Allowance for doubtful debt (estimated amount)
Step 2: write off accounts you’re absolutely sure won’t be collected
Allowance for doubtful debt (amount actually lost)
Accounts receivable (amount actually lost)
Sometimes, you may want to recover a receivable that you have written off. Let’s go back to the
most recent example and assume that the customer had a change of heart and decided to pay, we’d
first reverse the original write-off:
We then increase the cash balance to account for the payment:
Cash 2500
Objective 3 Contrast the methods for estimating bad debt expense
Under the percentage-of-sales approach, bad debt expense is a function of the company’s sales and
is calculated by multiplying sales for the period by some percentage set by the company
- E.g. imagine a company with $250000 of sales estimates it will not collect 10% of its sales, it
would journalise this:
- This method is very simple and provides good matching, however, no consideration is given
for the resulting balance in the Allowance for doubtful debts account, it’s just the existing
balance plus the current estimate. Since the account is used to calculate net realisable value
of receivables it provides a less meaningful number
22107 James Burns
Under the percentage-of-receivables approach, bad debt expense is a function of the company’s
receivable balance. The first step is to calculate what the balance in the allowance for bad debts
account should be, this is accomplished by multiplying accounts receivable by a percentage set by
the company. The second step is to adjust the allowance account to that calculated balance, the
amount of the adjustment is bad debt expense for the period
- E.g. imagine a company with $24000 in receivables estimates that 2% of that will be
uncollectible, the allowance must be adjusted to $480
o The allowance method for bad debt relies on estimates and thus the allowance
account can have a debit or credit balance
§ A debit balance means that the company has experienced greater write-offs
during the year than expected, a credit balance indicates the opposite
§ Assume an allowance account already has $100 in it, we’d put in this entry
(Credit entry):
Conversely, imagine the allowance account had a $50 debit balance, a $530
credit would be required instead to get it to $480
- The main advantage of this is that it results in a meaningful net realisable value as the
allowance account is based upon the value of receivables themselves
o However, it doesn’t match expenses as well as the percentage-of-sales approach as
well
An ageing schedule is a listing of accounts receivable by their ages, this is important as receivables
get less collectible as they get older
- Receivables that are 30 days old or less are considered current and grouped together,
accounts older than 30 days are considered past due and grouped in 30-day increments
- Increasing uncollectible percentages are applied to older receivables

- The ageing schedule is utilised to calculate the allowance
- Journalising this allowance is the same as normal (let’s say the account already had $1000 in
it):
- Provides a more accurate estimate of the allowance for doubtful debts and therefore is a
better estimate of bad debt expense
- It’s also a good internal control activity, it provides the information needed to effectively
pursue receivables as well as to make future credit decisions
Objective 4 Evaluate accounts receivable through the calculation and interpretation of horizontal,
vertical and ratio analyses.
The receivables turnover ratio is a comparison of credit sales to receivables that measures a
company’s ability to generate and collect receivables. A higher ratio means that a company collects
its receivables faster
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Where, $0+*$<+ *+'+/0$6%+. = \
A ratio of 4 denotes that the company was able to generate and collect its receivables balance 4
times in the time period
The receivables turnover ratio is sometimes difficult to interpret and is often converted into the
days-in-receivables ratio, dividing it into 365 days to express in days how long it takes a company to
generate and collect its receivables
365
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The allowance ratio compares the allowance account to gross accounts receivable to determine the
percentage of receivables that are expected to be uncollectible in the future
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A higher ratio indicates an expectation that more receivables will be uncollectible
Objective 5 Understand the accounting for notes receivable.
A promissory note is a written promise to pay a specific sum of money on demand or at some
specific date in the future
- They can be used to formalise a receivable or to loan money to another entity, in most cases
they require the payment of both principal and interest
- The company that receives the payment and interest is the payee, whilst the customer is the
maker of the note
When a note is accepted, a note receivable is created
Accounting for a note receivable usually requires entries to record the issuance of the note, interest
earned on the note and collection on the note
Suppose that a firm sells $92000 of goods and accepts a six-month, 8% promissory note as payment.
The agreement is made on the 1st of October 2016 and stipulates that principal and interest will be
received on the 31st of March 2017
Recording the note:
1 Oct 16 Notes receivable 92000
Sales 92000
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Recording interest
Assume that the firm has a financial year-end prior to the maturation of the note, the revenue
matching principle states that an accrual adjusting entry must be made to match the revenue to
when it is earned. Let’s also say that the financial year ends at the calendar year, so 3 months of
interest are recorded
31 Dec 16 Interest receivable 1840
Interest revenue 1840
Collecting the note
31 March 17 Cash 95680
Interest receivable 1840
Notes receivable 92000
Interest revenue 1840
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Module 7 – Inventory
Objective 1 Describe inventory and how it is recorded, expensed and reported.
Inventory is a tangible resource that is held for resale in the normal course of operations
- Note “normal course of operations”, Woolworths may vacate a store and put it up for sale,
but it is not classified as inventory because Woollies is not in the business of selling buildings
Following the cost principle, inventory is recorded at its acquisition cost

- This includes all costs incurred to get the inventory delivered and if necessary, prepared for
resale
- Additionally, any reductions granted by the vendor or supplier after purchase are included
- E.g. purchase price, taxes or duties paid, cost of shipping the product, insurance during
transit, labour required to assemble the product, returns to and allowances from the
supplier, purchase discounts from the supplier
How inventory is recorded into the accounting system is dependent upon the inventory system used
- A perpetual inventory system updates the inventory account each time account is bought or
sold
- A periodic (physical) inventory system updates the inventory account only at the end of an
accounting period
o Purchases are recorded into an account called Purchases, a temporary account that
is closed into inventory at the end of the period
A purchase return is when the company returns inventory to the vendor, a purchase allowance is
when they seek some reduction in the cost due to defective merchandise
Inventory becomes an expense when it is sold

- The account Cost of Goods Sold or Cost of Sales is used to capture the amount of inventory
expensed during a period
- E.g, let’s say a firm sells inventory to a customer for $600 cash and the inventory cost them
$400, we’d have these two entries:
- Cash 600
Sales 600
- Cost of goods sold 400
Inventory 400
*Cost of goods sold is an expense account
- The effect of these entries is a gross profit increase of $200
Inventory is reported as a current asset as it is expected to be sold within a year
Objective 2 Calculate the cost of goods sold using different inventory costing methods.
To determine the cost of inventory sold, there are four methods:

- Specific identification
- Determines the cost of goods sold based on the actual cost of each inventory item sold
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- To use this method, a retailer must know which inventory item is sold and the exact cost of
that particular item, consequently the method is most likely to be used by companies whose
inventory is unique e.g. a jeweller who sells individually designed jewellery
- However, most companies cannot track the actual cost of every item that is sold, so this
method doesn’t work, they must assume that the cost of the inventor sold is the cost of the
first unit purchased, the last unit purchased or an average of all purchases – that is the basis
of the next three methods
- First-in, first-out (FIFO)
- Calculates the cost of goods sold based on the assumption that the first unit of inventory
available for sale is the first unit sold – that is, inventory is assumed to be sold in the order it
is purchased
- E.g. let’s say you sold 50 units of goods, you purchased 40 of these on the 1st of Jan and had
another order for 20 units on the 10th of Jan, you’d sell 40 at the cost of the 1st Jan batch and
then consume 10/20 of the 10th of Jan batch – costing it at the price of that purchase
- Last-in, first-out (LIFO) – note this is banned in Australia but is used elsewhere in the world
- This method calculates cost of goods sold based on the assumption that the last unit of
inventory available for sale is the first unit sold. This is the opposite of the above method
- Moving average
- This calculates the cost of goods sold based on the average unit cost of all inventory
available for sale
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- Once the average unit cost is known, it is multiplied by the units sold to determine the cost
of goods sold
Objective 3 Understand the profit and loss and tax effects of inventory cost flow assumptions.
When a company experiences rising prices for its inventory, different methods will produce different
results:
As a consequence, companies must disclose the inventory costing method that they utilise
- They should be consistent in their methodology
Objective 4 Analyse the effects of inventory errors.
Under a perpetual inventory system, the inventory account is updated each time inventory is bought
or sold, however, most companies take a physical count of inventory at least once a year to verify
their inventory balance
- This is an internal control procedure
- Allows for error detection
- Errors can carry into the next accounting period as an incorrect ending inventory will
become the beginning inventory of the next period
A counterbalancing inventory error is an error whose effect on net income is corrected in the period
after the error
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Objective 5 Demonstrate how inventory can be estimated.
A company must sometimes estimate its balance, such as when it prepares interim financial
statements
- Ending inventory can be estimated with the gross profit method or retail method
The retail method sees ending inventory counted (stocktake) and the selling price recorded (such as
from the computer records that provide the cash register the price), the total sales value of
inventory is reduced by the profit margin
e.g. if inventory is destroyed during a natural catastrophe or when a company prepares its interim
financial statements
Objective 6 Apply the lower-of-cost-and-net-realisable-value rule to inventory.
The cost principle requires that inventory be recorded at its cost, however, because of the principle
of conservatism, accounting rules require that inventory be reported on the balance sheet at its net
realisable value if the market value is lower than the inventory’s cost
- This is known as the lower-of-cost-and-net-realisable-value rule
- It is applied at the end of each accounting period by comparing inventory costs to net
realisable value
- When the cost is lower than the NRV, nothing is done, however, when the NRV is lower than
the cost the company must adjust its inventory down to the NRV
e..g if an item’s NRV is $400 and total cost is $520, a loss of $120 would be recorded as such:
Loss on inventory 120
Inventory 120
Objective 7 Evaluate inventory through the calculation of horizontal, vertical and ratio analyses.
Use horizontal and vertical analysis

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The inventory turnover ratio compares the cost of goods sold during a period to the average
inventory balance during that period, the formula is as follows:
'".#. "? <"";. ."%;
a-0+-#"*9 #2*-"0+* *$#/" =
$0+*$<+ /-0+-#"*9
RNMPLLPLM PLZNLVFIQ[NLEPLM PLZNLVFIQ
Where, $0+*$<+ /-0+-#"*9 =
\
Indicates how many times a company is able to sell its inventory balance in a period
The days-in-inventory ratio converts the inventory turnover ratio into a measure of days
365
;$9. /- /-0+-#"*9 *$#/" =
/-0+-#"*9 #2*-"0+* *$#/"
Objective 8 Appendix: record purchases and calculate the cost of goods sold under a periodic
system.
Recall that under a periodic inventory system, purchases are recorded in a temporary account called
Purchases. When sales are made, the resulting revenue is recorded, but the cost of goods sold are
not
A periodic system uses the following four temporary accounts to capture inventory costs:
- Purchases accumulates the cost of all purchases
- Transportation-in accumulates the transportation costs of obtaining the inventory
- Purchases returns and allowances accumulates the cost of all inventory returned to vendors
as well as the cost reductions from vendor allowances
- Purchase discounts accumulate the cost reductions generated from vendor discounts
granted for prompt payments
Purchases 20000
Accounts payable 20000
Transportation-in 300
Cash 300

Purchase returns and allowances 1000

Purchase discounts 190
Cash 18810
With this preceding information, net purchases can be calculated:

Purchases 20000
Add: transportation-in 300
Less: Purchase returns and allowances (1000)
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Purchase discounts (190)

Net purchases $19110
Costing:
1. Count the inventory on hand at the end of the period
2. Use an inventory costing method to assign a cost to the ending inventory
Specific identification
Determine the cost of ending inventory based on the actual cost of the units on hand
FIFO
Assume that the first units of inventory purchased the first units sold
LIFO
Assume that the last units of inventory purchased are the first units sold
Weighted average
Assume that the cost of each unit in ending inventory is the average cost of all units
available for sale during the period
'".# "? <"";. $0$/%$6%+ ?"* .$%+
50+*$<+ 2-/# '".# =
2-/#. $0$/%$6%+ ?"* .$%+
3. Calculate cost of goods sold using the cost of goods sold model
'".# "? <"";. ."%; = '".# "? <"";. $0$/%$6%+ ?"* .$%+ − +-;/-< /-0+-#"*9
@".#. "? <"";. $0$/%$6%+ ?"* .$%+ = 6+</--/-< /-0+-#"*9 + )2*'ℎ$.+.

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Module 8 – Introduction to management accounting and costing

Module 8.1 – Introduction to managerial accounting
Data refers to reports such as financial statements, customer lists and inventory records
Information is data that has been organised, processed and summarised
Knowledge is information that is shared and exploited so that it adds value to an organisation
Objective 1 Describe the contemporary view of accounting information systems and describe and
give examples of financial and non-financial accounting information.
Accounting information systems are transaction-processing systems that capture financial data
resulting from accounting transactions within a company
Traditionally, non-financial information has been captured by separate information systems,

however having many systems is costly and compatibility is an issue
- Additionally, metrics such as customer satisfaction and timeliness of the delivery of items
may not be captured at all and therefore won’t be factored into decision making
- Enterprise resource planning systems aim to remedy this, they integrate traditional AIS
systems with other information systems to capture qualitative and quantitative data into
useful information, they also help to transform this information into knowledge that can be
communicated throughout an organisation
Financial information
- Assets
- Liabilities
- Revenues
- Gross margin
- Operating expenses
Non-financial information
- Quantitative
- Percentage of defects
- Number of customer complaints
- Warranty claims
- Units in inventory
- Budgeted hours
- Qualitative
- Customer satisfaction
- Employee satisfaction
- Product or service quality
- Reputation
Objective 2 Compare and contrast managerial accounting with financial accounting and
distinguish between the information needs of external and internal users.
Financial accounting is primarily concerned with the preparation of general-use financial statements
for creditors, investors and other users outside the company (external users), whereas managerial
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accounting is primarily concerned with generating financial and non-financial information for use by
managers in their decision-making roles within a company (internal users)
A stakeholder is any person or group that either affects or is affected by the company’s actions and
decisions, can be an external or internal user of information
External users
- Shareholders, potential investors, creditors, government bodies, regulators, suppliers and
customers
- They want information to analyse the current and future profitability of an organisation, e.g.
annual reports, registration statements, prospectuses
- The information they receive in these statements is governed by the AASB and ASIC
- Generally financial information, but may include non-financial information such as units
shipped and market share
- Qualitative information can typically be found in the ‘management’s discussion and analysis’
section of annual reports
- The need for information will differ across firms, e.g. stakeholders in a closely held firm or a
non-profit will have different desires to those in a major financial institution
- Much of this information is fairly inflexible, with the content being dictated by the users
Internal users
- Individual employees, teams, departments, regions, top management and others inside the
company, often called managers
- Managers are involved in three primary activities:
o Planning activities involve the development of short-term (operational) and long-
term (strategic) objectives and goals for an organisation and the identification of the
resources needed to achieve them. Operational planning is typically for objectives
and goals to be achieved in less than a year, e.g. planning the raw material and
production needs over the next annual period. Strategic planning addresses long-
term questions of how an organisation positions and distinguishes itself from
competitors. For example, where to locate plants and other facilities, whether to
enter new markets, create new products or purchase new production equipment.
It’s all about determining long-term performance and profitability measures, such as
market share, sales growth and share price
o Operating activities encompass what managers must do to run the business on a
day-to-day basis. E.g. assigning tasks to individual employees, choosing whether to
advertise and choosing whether to hire full-time employees or to outsource
o Controlling activities involve the motivation and monitoring of employees and the
evaluation of people and other resources used in the organisation’s operations. The
purpose is to make sure that goals of the organisation are being attained and
includes using incentives and other rewards to motivate employees to accomplish
and organisation’s goals and using mechanisms to detect and correct deviations
from those goals. They often involve the comparison of actual outcomes with
desired outcomes as stated in the organisation’s operating and strategic plans.
Control decisions include questions of how to evaluate performance, what measures
to use and what types of incentives to implement, e.g. a company that emphasises
high-quality products and excellent customer service may evaluate and reward
production workers who have exceeded goals based on these virtues
The functional areas of management

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- The operations and production function produces the products or services that an
organisation sells to its customers
o Managers in this area are concerned with providing quality products and services
that can compete in a global marketplace
o Accounting information is needed to make planning decisions affecting how and
when products are produced and services are provided, e.g. the costs of producing
and storing products in order to decide how much inventory to keep on hand
o Influenced by information provided by marketing managers, such as the expected
customer reaction if products are not available when orders are placed
- The marketing function is involved with the process of developing, pricing, promoting and
distributing goods and services sold to customers
o Marketing managers need to know much a product costs in order to help establish a
reasonable selling price
o They need to know how a given advertising campaign and its resulting impact on the
number of units sold is expected to affect income, and so on
o These decisions require accounting information
- The finance function is responsible for managing the financial resources of the organisation
o Finance managers make decisions about how to raise capital as well as where and
how to invest it
o Accounting information is needed to do this
- The human resource function is concerned with the utilisation of human resources to help
an organisation reach its goals
o Although note that all managers who supervise, motivate and evaluate other
employees are technically human resource managers
o Human resource managers support other functions and managers by recruiting and
staffing, designing compensation and benefit packages, ensuring the safety and
overall health of personal and providing training and development opportunities for
employees
o Require input from all other functional areas, e.g. hiring new employees will have
budget constraints, ensuring safety may involve a redesign of manufacturing
processes
The information needs of internal and external users

- Due to the varying needs of internal users, managerial accounting is more flexible than
financial accounting
- Financial reporting is geared towards the preparation of financial statements and other
reports according to the GAAP and other rules, whereas managerial accounting can be
customised to a specific company or segment of a company
- As a consequence of internal managers being decision makers, managerial accounting
information must focus on the future rather than the past
o They require very up-to-date information, this can result in less precision or
estimates being made
The role of the managerial accountant

- Automation of traditional accounting functions has shifted the role of the managerial
accountant
- They often are responsible for analysing information and creating knowledge from it rather
than collecting data
- Decision-support specialists who see their role as interpreting information, putting it into a
useful format for other managers and facilitating management decision making
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Objective 3 Recognise the role of relevant factors in decision making.
Decision making is the process of identifying different courses of action and selecting one
appropriate to a given situation
- With the information available at a point in time, the best decision is the decision that
broadly encompasses all factors reasonably, the actual correctness of a decision may not be
fully realised until some time in the future as a range of factors may only become apparent
post-decision
- All decisions require judgement, which refers to the extent to which we take a logical,
rational approach to making decisions rather than making decisions impulsively
Relevant costs are those that differ among alternatives

- E.g. If you were purchasing a car and two options had features (aircon, cameras etc) at the
same price, they are not relevant because they do not differ between the two cars. On the
other hand, if one car has aircon and the other doesn’t then it is a relevant cost
Sunk costs are costs that have already been incurred, they cannot be avoided and thus are not
relevant in the decision
- E.g. Imagine you spent $10,000 on a welding cost and were offered a $70,000 job in welding
and a $75,000 job in sales – it makes more sense to go for the sales job despite a desire to
justify the $10,000 spent on welding
Opportunity costs are benefits forgone by choosing one alternative over another and are relevant
costs for decision-making purposes
- E.g. choosing to go to university will result in you forgoing a salary you could receive by
working full time
- Can be difficult to quantify, e.g. choosing to study instead of hanging with mates
Relevant costs
Future costs that differ among alternatives Opportunity costs
Irrelevant costs
Future costs that don’t differ among Sunk costs
alternatives
Objective 4 Understand sources of ethical issues in business and the importance of maintaining an
ethical business environment.
Business ethics results from the interaction of personal morals and the processes and objectives of
business
Ethics programs are company programs or policies created for the express purpose of establishing
and maintaining an ethical business environment
- Common elements include written codes of conduct, employee hotlines and ethics call
centres, ethics training, processes to register anonymous complaints about wrongdoing and
ethics offices
Corporate wrongdoing involves unethical actions in corporations

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Despite not being Australian legislation, the Sarbanes-Oxley Act 2002 may apply to Australian
organisations that are subsidiaries of US parent companies
- Requires management to assess whether internal controls over financial reporting (ICFR) are
effective
- The company’s external financial statement auditor is required to audit ICFR and assess
whether those controls are effective in preventing and detecting financial misstatements
- Companies are required to establish procedures to allow employees to make complaints
about accounting and auditing matters directly to members of the audit committee
o Companies must ensure that employees who make such complaints are not
harassed or otherwise discriminated by others within the organisation
Accounting Professional and Ethical Standards Board (APESB)

- The major professional accounting bodies in Australia jointly subscribe to the guidelines of
the APESB
- They broadly define the ethical obligations of accountants in practice
- The APES state that the accountant’s obligation is to both the firm to which they are
employed and (more importantly) the public interest
o The ‘public interest’ is defined as the collective wellbeing of the community of
people and institutions that an accountant serves
- What is ethically expected of an accountant? According to the APESB:
o Integrity – being straightforward and honest, implying fair dealing and truthfulness
o Objectivity – not compromising judgement owing to bias, conflict of interest or
undue influence
o Professional competence and due care – continuing awareness and understanding
of relevant technical, professional and business developments
o Confidentiality – disclosing information relating to the firm that is otherwise private
(unless there is a legal obligation to disclose), or using private information for
personal gain is unethical
o Professional behaviour – complying with relevant laws and regulations and avoiding
any action or omission that may bring discredit to the profession
- Members found to have breached these standards of behaviour risk their professional
membership being revoked and possible further legal action by disadvantaged internal or
external stakeholders
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Module 8.2 – Introduction to management accounting and costing
Objective 1 Describe basic production processes used by manufacturing companies.
Manufacturing companies purchase raw materials from other companies and transform them into a
finish product. This transformation typically requires labour and the incurring of other costs, such as
utilities, the depreciation of factory equipment and supplies
- Some are capital intensive, some are labour intensive, some are low-cost, some are high-
cost – processes will vary greatly based on factors such as these
Manufacturing in a traditional environment

- Traditional manufacturing saw factories organised with similar machines grouped together
- It was normal to accumulate raw materials inventory and finished-goods inventory to serve
as buffers in case of unexpected demand for products or unexpected problems in
production, it was also normal to accumulate inventories of partially completed products
(called work in process inventory or WIP)
Objective 2 Identify the key characteristics and benefits of lean production and JIT manufacturing
One of the biggest changes of the past 20-25 years has been the adoption of lean production
systems and just-in-time (JIT) manufacturing
- Lean production systems focus on eliminating waste associated with holding more inventory
than required, making more product than is needed, over-processing a product (doing more
than a customer values), moving products and people further than required and
experiencing downtime caused by people waiting for work to do and products waiting in
mid-assembly
o Key aspect is to manage inventory such that only that which is needed in the
mediate future is carried
§ Less inventory à lower storage costs
§ Also, it has been found that the earlier mentioned buffers lead workers to
pay less attention to detail and to work less efficiently
- JIT systems see materials purchased and product made ‘just in time’ to meet consumer
demand
o The process beings with a customer order, and products are pulled through the
manufacturing process
o In ideal conditions, a JIT environment results in reduced inventories of raw materials
and for WIP and finished goods inventories to near-zero levels or even zero
o E.g. years ago Dell held a 30-day of hard drives, processors and other components
on hand, but now just holds a few days of supplies
o With only a small buffer of extra finished goods and raw materials, firms using JIT
must be able to procure supplies and raw materials on a timely basis, resulting in a
need for companies to work with suppliers that can deliver goods on time and free
of defects
§ As a result, JIT companies rely on only a few supplies that have been proven
to be highly reliable
§ E.g. for Dell, they require that suppliers hold 8 to 10 days of inventory and to
be able to deliver parts to Dell in 90 minutes
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There are some risks that arise in satisfying customer demand when lower inventory stocks are held,
the less stock on hand you have the more you need suppliers to guarantee availability and quick
delivery should demand spikes occur
In order to implement these systems, companies must be able to manufacture very quickly
- This often results in the restructuring of factories, rather than grouping similar machines
together, factories in a JIT environment are typically organised so that all the machinery and
equipment needed to make a product are available in one area
o These groupings of machines are called manufacturing cells, and they minimise the
handling and moving of products. They also reduce or eliminate setup time (the
time needed to switch production from one product to another)
o Sometimes, workers are trained to operate all the machinery in a manufacturing
cell, increasing speed and efficiency further
Lean production and JIT offer benefits beyond inventory management:

- Reduced waste and scrap
- Improved product quality
- Lower overall production costs (although the costs of raw materials may increase in some
cases)
- Lower labour costs
- Reduced inventory
- Reduced processing time, and
- Increasing manufacturing flexibility
The main disadvantage is that disruptions in supply are particularly harmful as buffer stocks are
either not held or are minimal
Objective 3 Distinguish manufacturing costs from non-manufacturing costs and classify

manufacturing costs as direct materials, direct labour or overhead.
Regardless of the size of the company involved, the number of products made or the type of
manufacturing system used, manufacturing companies must know how much their products cost
- Direct costs are costs that are directly attached to the finished product and can be
conveniently traced to that product
- Indirect costs are costs that are attached to the product but cannot be conveniently traced
to each separate product
- Manufacturing costs are costs incurred in the factory or plant to produce a product, consists
of:
o Direct materials: materials that can be directly and conveniently traced to a
particular product or other cost object and that can become an integral part of the
finished product
§ The key test for differentiating between a direct and indirect cost is ‘can the
cost be economically feasibly linked to a cost object?’ If so, then it may be
classed as a direct cost, otherwise, it is indirect
o Direct labour is the labour cost (including fringe benefits) of all production
employees who work directly on the product being made or the service being
provided
§ Sometimes called touch labour to reflect the hands-on relationship between
the employee and the product or service
§ Assembly-line workers are an example of direct labour
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o Manufacturing overhead includes both indirect materials and indirect labour

§ Materials that we know are used in the manufacture of products but cannot
be measured with reasonable accuracy and easily and conveniently traced
to a particular product are called indirect materials
§ Certain labour costs not directly associated with production are classified as
indirect labour, e.g. a janitor
§ Also includes utilities, depreciation of factory equipment and buildings, rent,
repairs and maintenance, insurance and other factory costs
§ Because of the indirect nature of most overhead costs and the inability of
companies to directly measure the amount of overhead included in products
or to trace manufacturing overheard to products, accountants have come
up with a few methods of allocating inventory overheads to products, these
will be covered later
o Also called product costs or inventoriable costs because they attach to products as
they go through the manufacturing process, direct material, direct labour and
overheard costs remain with the product until it is sold, when the product is sold
these costs are expensed on the income statement as cost of goods sold
- Non-manufacturing costs consist of costs that are incurred outside the plant or factory and
typically are categorised as selling and administrative costs
o a rule of thumb is to imagine the product not being produced, if a particular cost
would occur, it is probably a non-manufacturing cost
o e.g. advertising costs, commissions paid to salespersons etc
o Also includes rent, insurance, taxes, utilities and depreciation of equipment when
used in selling and administrative activities
o Also known as period costs
o Expensed on the income statement in the period occurred
o Whether something is a production or non-production cost is based on the way the
cost is used
§ E.g. costs related to factory activities are production costs whilst those
related to sales staff, office, human resources and so on are non-production
costs
Objective 4 Diagram the flow of costs in manufacturing, merchandising and service companies
and calculate the cost of manufacturing or selling goods and services.
The process of calculating the income or loss from selling a product is complicated by the fact that
many firms will sell multiple products and won’t sell all materials and finish or sell all goods,
consequently, companies must trace or allocate manufacturing costs to each individual product as it
is being produced and then follow those costs through various inventory accounts as the product
progresses towards its eventual completion and sale
- At sale, the cost of goods sold must be matched with the sales price to compute a profit or
loss on the sale (gross profit)
- Subtracting non-manufacturing costs from the gross margin provides a measure of
profitability for the company as a whole
The cost-of-goods-sold model for a traditional manufacturing company with inventory

- Actual costing is a product costing system in which actual overhead costs are entered
directly into work in process
- Costs flow from the raw materials storeroom to WIP inventory to finished goods inventory
to cost of goods sold
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- Normal costing is a system in which estimated or predetermined overhead rates are used to
apply overheard to work in process
Cost flows in a manufacturing company – JIT environment

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- Cost flows are much more streamlined in a JIT environment, direct materials, direct labour
and overhead costs can essentially be accumulated directly in cost of goods sold account
o E.g. since raw materials are immediately put into production when purchased, there
is no need to record their purchase in a separate raw materials inventory account,
likewise since all goods are typically finished and shipped out immediately there is
no need to keep track of a WIP or finish goods inventory
Merchandising companies and the cost of products

- Wholesalers and retailers purchase merchandise in finished form from other companies,
with the exception of packaging and other minor changes, they offer the products for resale
to other companies (wholesalers) or to the ultimate consumer (retailers)
o thus, the cost is the simply the purchase price of the merchandise
- A single ‘merchandise inventory’ account is used on the balance sheet
- But what if merchandise is purchased and not sold in the period? What if merchandise
purchased in another period is sold now? COGS must be adjusted
- Take this hypothetical COGS calculation:
Beginning inventory 15000
+ Cost of goods purchased 63000
= Cost of goods available for sale 78000
- Ending inventory 18000
= Cost of goods sold 60000
Service companies and the cost of services

- Service providers must calculate the costs associated with the revenue earned by the
company from selling its services, income statements will typically refer to the cost of
services as the ‘cost of revenue’
- Includes direct materials, direct labour and overhead, similarly to product costs – however
the proportions are way different with materials much lower and labour higher
- Service companies tend to incur significant indirect costs, e.g. in a movie studio, costumes
and props are direct materials and the salaries of actors and directors are direct labour.
Overhead would include the costs of the studio itself and all the recording and production
equipment. Camera operators and other support people would be classified as indirect
labour because they likely work on more than one file at a time
Objective 5 Evaluate the impact of product costs and period costs on a company’s income
statement and balance sheet.
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Until the sale of the product, the costs of manufacturing are included in one of three inventory
accounts: raw materials, work in process and finished goods
- They appear on the balance sheet along with other assets and liabilities, it is only when a
product is sold that manufacturing costs are expensed as costs of goods sold on the income
statement
- On the other hand, non-manufacturing costs or period costs are expensed immediately on
the income statement in the period they are incurred
- For external financial reporting, information on the COGS (or cost of sales) and the amount
of inventory owned by a company is provided in financial statements and included in the
company’s annual report
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Module 9 – Cost volume profit analysis

Module 9.1 – Cost behaviour
Objective 1 Describe the nature and behaviour of fixed and variable costs.
Fixed costs are costs that remain the same irrespective of production volume
- As a result, fixed cost per unit always decreases when production volume increases
- E.g. if the cost to rent a factory building is $10,000 per year, the rent cost per unit of product
will be $2 if 5000 units are produced and $4 if 25000 are produced
Variable costs vary in direct proportion to changes in production volume

- They are constant when expressed in per unit amounts
- E.g. if the production of a desk requires $20 of direct materials, the total direct material
costs incurred will increase or decrease proportionately with changes in production volume.
- Direct labour can be variable if paid per unit of output
The trend of automation in manufacturing has had the effect of increasing fixed costs (depreciation)
and decreasing variable costs (direct labour)
When a cost varies in direct proportion to changes in volume, there is a linear relationship between
the two variables
- In reality costs may behave in a curvilinear relationship, average costs or costs per unit may
increase or decrease as production increases
- Managerial accountants attempt to circumvent this complication by assuming that the
relationship between cost and volume is linear within a relevant range of production, the
relevant range is the normal range of production that can be expected for a particular
product and company
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o It can also be viewed as the volume of production for which the fixed cost stays the
same and the variable rate per unit remains unchanged
As can be seen above, a linear function can approximate a curvilinear function within a
range
Step-costs are costs that vary with activity in steps and may look like and be treated as either
variable or fixed costs; they are not technically fixed costs but may be treated as such if they remain
constant within a relevant range of production
- E.g. imagine you hire a cleaner to clean 7500 desks for $25,000, the cost is fixed as long as
production remains below 7500 units, but if desk production exceeds you may need to hire a
new cleaner at another $25,000
o The cost is basically fixed from 1-7500 desks ($25,000), 7501-15000 ($50,000) and so
on
Relevant costs are also known as differential or incremental costs

- Generally, they are relevant in production decisions because they vary with the level of
production whereas fixed costs are generally not relevant because they typically do not
change as production changes
- However, there are cases when variable costs remain the same between two alternatives
and where fixed costs vary between alternatives
o E.g. the direct material cost of a product may be the same for two competing
designs, making it irrelevant
o Additionally, consider rent paid for a facility to store inventory, despite rent being a
fixed cost, it is relevant to a decision to reduce inventory storage costs through JIT
production techniques if the cost of rent can be avoided by choosing one alternative
over another
o Firms can produce outside their relevant range, resulting in fixed costs changing,
making them relevant
The cost equation:

9 = $ + 64, where y=total direct material costs and x=units produced
9 = $$ + $04 would be fixed, 9 = $$ + $64 (where 6 ≠ 0) would be variable

22107 James Burns
Objective 2 Define and analyse mixed costs using regression analysis and the high/low method.
Mixed costs exhibit characteristics of both fixed and variable costs

- They increase at a constant rate (Like a variable cost) but do not vary in proportion with
production volumes and their costs per unit decrease as more units are produced (Like a
fixed cost)
- As a result, it is a challenge to predict the behaviour of a mixed cost as production first
without first disaggregating it into its fixed and variable costs
Once we know that a cost is mixed, we can separate it into its components through the use of
regression analysis, which I’m pretty sure we don’t need to know yet J
Objective 3 Illustrate the impact of income taxes on costs and decision making.
Objective 4 Identify the difference between variable costing and absorption costing.
Objective 5 Identify the impact on the income statement of variable costing and absorption
costing.
Objective 6 Recognise the benefits of using variable costing for decision making.
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Module 9.2 – Cost-volume-profit analysis
Objective 1 Use the contribution margin in its various forms to determine the impact of changes in
sales on profit.
Since COGS includes both fixed and variable costs, its behaviour (and thus gross profit’s behaviour) is
difficult to predict when production changes
The contribution margin profit and loss statement is structured by behaviour rather than by
function as the traditional statement does
*S, G & A means selling, general and administrative
@"-#*/62#/"- ($*</- = .$%+. *+0+-2+. − 0$*/$6%+ '".#.
The margin is useful for managers to understand much is left over from sales revenues to cover fixed
costs
- This is important since fixed costs can have a substantial impact on net income since no
matter how badly or how well the firm does they’ll stay the same, whereas the variable
costs will go down if business is slow and go up if it’s booming
The contribution margin per unit is the sales price per unit of product less all variable costs to
produce and sell the unit of product, it is used to calculate the change in contribution margin
resulting from a change in unit sales
'"-#*/62#/"- ($*</-
@"-#*/62#/"- ($*</- ()+* 2-/#) =
2-/#. ."%;
The contribution margin ratio is calculated by dividing the contribution margin in dollars by sales
dollars
'"-#*/62#/"- ($*</-
@"-#*/62#/"- ($*</- *$#/" =
.$%+.
It can be viewed as the amount of each sales dollar contributing to the payment of fixed costs and
increasing net profit
- Allows us to quickly see the impact of a change in sales on contribution margin and net
profit
Objective 2 Analyse what-if decisions using CVP analysis

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Look at the impact of changes to cost, price and volume

- In particular the impact on net income is observed
Objective 3 Compute a company’s break-even point in single and multi-product environments
Note: if the break-even units is a decimal, ALWAYS round up, otherwise you’ll incur a small loss
The break-even point is the level of sales at which contribution margin just covers fixed costs and,
consequently, net profit is equal to zero
- Really just a variation of CVP analysis in which volume is altered in an effort to find the point
at which net profit is equal to zero
Given that, e$%+. − (S$*/$6%+ '".#. + ?/4+; '".#.) = -+# )*"?/#, we want e$%+. −
(S$*/$6%+ '".#. + ?/4+; '".#.) = 0, or more formally: eC(4) − S@(4) − f@ = 0,
*SP=sales price per unit, VC=variable costs per unit, FC=fixed costs, x=number of units sold
gh
Rearranging it gives this: 4 = hi
`PkNE JFXVX
Or, 6*+$j +0+- (2-/#.) = JFLVIPRUVPFL lHIMPL ONI ULPV
So essentially the break-even (units) measure is the number of units needed to be sold to cover fixed
costs (the total contribution margin will equal fixed costs)
We can also work out the number of sales dollars to break even:
?/4+; '".#.
6*+$j +0+- ($) =
'"-#*/62#/"- ($*</- *$#/"
22107 James Burns
In a multiproduct environment, a manager calculating the break-even point is less concerned with
the unit sales or the dollar sales of a single product but with the total sales necessary to break even
- This requires the calculation of an average contribution margin for all the products
produced and sold
- This requires an estimate of the sales mix – the relative percentage of total units or total
sales dollars expected from each product (although customers will not always behave as we
predict, so models aren’t perfect)
- We find the average contribution margin by weighting the contribution margin per unit for
the products by the relative sales mix and then summing the products
- E.g. imagine you have two products, one with a per unit contribution margin of $2 and
another with $2.50, they take up 40% and 60% of sales respectively:
Do this:
0.4 x 2 = 0.8
0.6 x 2.5 = 1.5
The weighted-average contribution margin would be 1.5+0.8=$2.3
This amount can also be obtained by dividing the total contribution margin earned by selling
the products by the total number of units sold
- The break-even formula for a company with multiple products is 6*+$j +0+- (2-/#.) =
`PkNE JFXVX
mNPMKVNE HZNIHMN JFLVIPRUVPFL lHIMPL ONI ULPV
- You can then multiply this figure by the predicted percentages in your sales to work out how
many units of each item you need (e.g. if a product is expected to take up x% of sales you
need to sell break even (units) * x% of them to breakeven. This breakeven point is only valid
for the sales mix used to calculate it
Objective 4 Analyse target profit before and after the impact of income tax
Breaking even is cool but have you ever tried making a profit?
We use target profit analysis for that, the formula is as such:

eC(4) − S@(4) − f@ = !C
Where, SP=sales price per unit, VC=variable costs per unit, FC=total fixed costs, TP=Target profit
(before tax), x=number of units sold
Rearranging it gives:
e$%+. 0"%2(+ (#" *+$'ℎ $ #$*<+# )*"?/# 6+?"*+ #$4)
?/4+; '".#. + #$*<+# )*"?/# (6+?"*+ #$4)
=
'"-#*/62#+; ($*</-
We can also modify the multiple-product break-even formula to reach a target profit:
(?/4+; '".#. + #$*<+# )*"?/#)
.$%+. 0"%2(+ (#" *+$'ℎ $ #$*<+# )*"?/#) =
A+/<ℎ#+; $0+*$<+ '"-#*/62#/"- ($*</- )+* 2-/#
22107 James Burns
Taxes must be considered though, if we set a target of $100,000 and reach it that doesn’t mean we’ll
have $100,000 in cash flow to distribute
$?#+* #$4 )*"?/#

n+?"*+ #$4 )*"?/# =
(1 − #$4 *$#+)
Objective 5 Compute a company’s operating leverage and understand its relationship to cost
structure
Cost structure refers to the relative proportion of fixed and variable costs in a company
- Highly automated manufacturers would be predominately fixed costs, while labour-intensive
firms would have many variable costs
Cost structure impacts the sensitivity of the company’s profits to changes in sales volumes, generally
the greater the proportion of fixed costs in your cost structure the more sensitive your profits are to
changes in sales volume
Operating leverage is a measure of the proportion of fixed costs in a company’s cost structure and is
used as an indicator of how sensitive profit is to changes in sales volume
- A high operating leverage means that a company has a high level of fixed costs relative to
variable costs, meaning net profit will be very sensitive to changes in sales volume
- In other words, a small percentage increase in sales dollars will result in a large percentage
increase in net profit
'"-#*/62#/"- ($*</-
p)+*$#/-< %+0+*$<+ =
-+# /-'"(+
An operating leverage of 2.0 means that the profit of a firm change by 2 times the change in sales
(e.g. a 10% increase in sales will increase profit by 20%)
As a company gets closer and closer to the break-even point, operating leverage will continue to
increase and profit will be very sensitive to changes in sales
22107 James Burns
Module 10 – Part 1: Budgeting
Budgets are the financial quantification of plans dealing with the acquisition and use of resources
over a specified time period
Managers use budgets to go about planning (developing objectives and goals for the organisation
and actual preparation of budgets), operating (day-to-day decision making, which is often facilitated
by budgeting) and control (ensuring that objectives and goals developed by the organisation are
being attained, often involves a comparison of budgets to actual performance and the use of
budgets for performance-evaluation purposes)
Objective 1 Describe the budget development process, behavioural implications of budgeting,

advantages of budgeting and the master budget.
More and more companies are using enterprise resource planning systems as a key budgeting tools
rather than just spreadsheets (Spreadsheets are still dominant though)
- They link data across areas of the business, ensuring that the same assumptions are used
throughout different budgets and speeding up the budgeting process
Some companies start their budget based on last year’s numbers, whereas others use zero-based
budgeting, which requires managers to build budgets from the ground up each year rather than just
add a percentage increase to previous numbers
- This means that they must justify all items in the budget rather than just changes from last
year’s budget
- Very consuming when done on an annual basis, though, some companies will only do it
every few years or rotate among departments the requirement that budgets be justified in
full
Companies frequently use monthly budgets and rolling 12-month budgets to provide a mechanism
for adjusting items in response to unforeseen circumstances
Participation in the budget development process

- Budgeting is traditionally a bottom-up process, with departmental managers providing a
detailed plan for the upcoming month, quarter or year
- A system of participatory budgeting starts with departmental managers and then flows up
through middle management and ultimately to top management
o At each level, estimates are prepared and then submitted to the next level for
review and negotiation
- Regardless of the specific process employed, development must be guided by a strategic
plan that focuses attention on the company as a whole and integrates individual budgets
o This allows managers to focus more on the important aspects of the budget and less
worried about irrelevant details
o In order to motivate managers and other employees to meet the objectives and
goals provided in budgets, companies should structure bonuses, merit pay, and
other tangible and intangible rewards in ways that link these rewards to measurable
goals outlined in the budgets
Behavioural implications of budgeting

22107 James Burns
- When budgets are used for planning and control purposes conflicts will arise
- If managers are evaluated and compensated based upon budget outcomes, they may have
incentives to make targets easier to reach, this is known as budget gaming
o E.g. if a manager expects to be paid extra if costs are lowered, they may pad out the
budget to forecast higher costs than will actually occur in order to make it easy to
accomplish this
- Such gaming can impact accounting information, e.g. if a manager is behind on their sales
target for this period and expects sales at the start of the next period, they may record those
sales in advance, meaning the revenue will be incorrectly recorded, impacting the income
statement by increasing this period’s profit and understating it next period
- Solve this by evaluating managers with other methods such as with customer satisfaction
surveys
Advantages of budgeting
- Compels communication to occur within the organisation
- Forces management to focus on the future and not be distracted by daily crises in the
organisation
- The process can help management identify and deal with potential bottlenecks or
constraints before they become major problems
- Can increase the coordination of organisational activities and help facilitate goal congruence
(this means making sure that the personal goals of the managers are closely aligned with the
goals of the organisation)
- The process can define specific goals and objectives that become benchmarks for evaluating
future performance
The master budget consists of an interrelated set of budgets prepared by a business
Objective 2 Explain how managers develop a sales forecast and demonstrate the preparation of a
sales budget.
The sales budget is used in planning the cash needs for manufacturing, merchandising and service
companies
The sales forecast combines with the sales budget to form the starting points in the preparation of
production budgets for manufacturing companies, purchases budgets for merchandising companies
and labour budgets for service companies
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Information uses in sales forecasting are as follows:

- Last year’s sales
- Historical data for the company, competitors and the industry
- General economic trends
- Regional and local factors
- Anticipated price changes in both purchasing costs and sales prices
- Anticipated marketing or advertising plans
- The impact of new products or changes in the product mix on the entire product line
- Technology or process changes in an industry
- Other factors such as political and legal events
Different organisations will attach differing levels of significance to each factor, e.g. a Thredbo Ski
Resort would consider weather as a significant factor in sales forecasting
Operating budgets are used by companies to plan for the short term (usually a year or less)
All the remaining budgets and the decisions that are made on the basis of their forecasts are
dependent upon sales estimates, consequently an accurate sales budget is very important
Objective 3 Prepare a production budget and recognise how it relates to the material purchases,
direct labour and manufacturing overhead budgets.
The production budget is used to forecast how many units of product to produce in order to meet
sales projections
- Able to be made after the sales volume has been projected
- Traditional manufacturing companies will generally choose to hold an established minimum
level of finish-goods inventory (as well as direct materials inventory) to serve as buffers in
case of unexpected demand for products or unexpected problems in production
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e$%+. ?"*+'$.# (/- 2-/#.) + ;+./*+; +-;/-< /-0+-#"*9 "? ?/-/.ℎ+; <"";.
= #"#$% 62;<+#+; )*";2'#/"- -++;.
#"#$% 62;<+#. )*";2'#/"- -++;. − 6+</--/-< /-0+-#"*9 "? ?/-/.ℎ+; <"";.

= *+82/*+; )*";2'#/"-
:+82/*+; )*";2'#/"- = 62;<+#+; .$%+. + 'ℎ$-<+ /- ?/-/.ℎ+; <"";. /-0+-#"*9
e.g. if the budgeted sales are 250,000 units and inventories are projected to increase by 7,500 units
we have a required production of 257,000
Objective 4 Prepare budgets for material purchases, direct labour, manufacturing overhead, and
selling and administrative expenses.
The material purchases budget is used to project the dollar amount of raw materials purchased for
production
- Many traditional companies desire to keep materials on hand at all times in order to plan for
unforeseen changes in demand, as a result the desired ending inventory for materials must
be added to the projected production needs for materials to arrive at the total expected
needs for materials, an adjustment is then made for any raw materials on hand at the
beginning of the month
The first step in preparation of the direct material purchases budget is to compute the raw materials
needed based on the projected production form the production budget
The direct labour budget is used to project the dollar amount of direct labour cost needed for
production
- Prepared by multiplying the units to be produced by the number of direct labour hours
required to produce each unit
The manufacturing overhead budget is used to project the dollar amount of manufacturing
overhead needed for production
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- Can be done with predetermined overhead rates or activity-based costing

- May wish to separate variable and fixed overheads due to their differing behaviours
o Fixed costs will be known, but you can calculate a predetermined overhead rate for
the variables
The abovementioned budgets are summarised in a total manufacturing cost budget
A selling and administrative budget includes variable expenses such as commissions, shipping costs
and supplies, as well as fixed costs such as rent, insurance, salaries and advertising
- E.g. commissions may be forecasted as a function of projected sales
Objective 5 Explain the importance of budgeting for cash and prepare a cash receipts budget, a
cash disbursements budget and a summary cash budget.
Cash is what pays the bills so it’s very important
The timing of cash flows is critical to the planning process, if cash inflows are delayed, such as due to
extension of credit to buyers, there may not be sufficient cash to pay suppliers, creditors and
employee wages
- Cash budgeting forces manages to focus on cash flow and to plan for the purchase of
materials, the payment of creditors and the payment of salaries
The cash receipts budget is the first cash budget that must be prepared, it shows cash receipts that
are generated from operating activities (cash sales of inventory or services and customer payments
on account), other cash receipts are included in the summary cash budget
- Counter intuitively, businesses that are growing rapidly are often short of cash due to the lag
between sales and the collection of cash
The cash disbursements budget includes cash outflows resulting from operating activities (payments
to suppliers for materials, cash outflows for salaries and other labour costs, and cash outflows for
overhead expenditures)
- Disbursements for selling and administrative costs are also included, but other outflows such
as for payment of dividends or equipment purchases are not included, these non-operating
disbursements are included in the summary cash budget
- Complicated by how purchases are often made on account, resulting in lags between the
date items are purchased and the outflow of cash
- The manufacturing overhead budget also includes non-cash items such as depreciation that
must be adjusted as well
The summary cash budget has three sections: cash flows from operating, investing (property, plant,
equipment and interest and dividends earned on investment assets), and financing (payments for
the retirement of any debt issued by the company, payment of dividends, repayments of long-term
liabilities) activities
Objective 6 Prepare budgeted income statements and balance sheets and evaluate the
importance of budgeted financial statements for decision making.
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Objective 7 Contrast budgeting in a manufacturing company with budgeting in a merchandising

company and a service company.
Objective 8 Differentiate static budgets from flexible budgets.
Objective 9 Explain and understand the concept of rolling budgets in modern organisations.
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Module 10 – Part 2: Activity based costing
Objective 1 Classify overhead costs as unit, batch, product or facility level.
Unit-level costs are incurred each time a unit is produced

Batch-level costs are incurred each time a batch of goods is produced
Product-level costs are incurred as needed to support the production of each type of product
Facility-level costs are incurred to sustain the overall manufacturing process
Traditional overhead allocation methods utilise volume-based cost drivers to assign overhead costs
to products – this can provide misleading product-cost information in heavily automated
manufacturing environments in which companies make a variety of diverse products
Objective 2 Describe ABC and recognise typical activities and cost drivers in an ABC system.
Activity-based costing is a system of allocating overhead costs that assumes that activities, not the
volume of production, cause overhead costs to be incurred
Activities are procedures or processes that cause work to be accomplished
Stage 1 – identification of activities

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-
- Some typical activities can be seen above
- Overhead costs can be traced to more than one activity sometimes, e.g. utilities may be
related to purchasing, engineering and machining activities
Stage 2 – identification of cost drivers

- Cost drivers should cause, or drive, the incurrence of costs, e.g. the costs of purchasing
might be driven by the number of purchase orders processed, whereas engineering costs
might be driven by the number of parts used in a product
- E.g. the costs of purchasing might be driven by the number of purchase orders processed,
whereas engineering costs might be driven by the number of parts used in a product
- Unit, batch and product-level activities are assigned to products by using cost drivers that
capture the underlying behaviour of the costs that are being assigned. Facility-level costs,
however, are usually not allocated to products or are allocated to products in an arbitrary
manner e.g. plant occupancy is a facility-level activity that would include costs such as plant
managers’ salaries, depreciation of the building, rent, taxes and insurance
22107 James Burns
ABC systems in non-manufacturing environments

- Can be challenging to implement as non-manufacturing companies, especially services
businesses, tend to undergo activities that are non-repetitive
- Additionally, service-oriented companies are likely to have proportionately more facility-
level costs than manufacturing companies, and those costs are allocated arbitrarily to goods
and services
- ABC can also be used to determine the cost of providing a particular non-manufacturing
activity
Objective 3 Calculate the cost of a product using ABC and compare traditional volume-based
costing to ABC.
Stage 1 – identification of activities
Objective 4 Evaluate the benefits and limitations of ABC systems.

22107 James Burns
ABC systems provide more and more accurate cost information that focuses managers on
opportunities for continuous improvement
- ABC systems provide information that informs planning, operating and control activities
One of the biggest advantages of ABC is the increased accuracy of cost information it provides for
day-to-day decision making by managers (operating decisions)
- They use ABC information to make better decisions related to adding or dropping products,
making or buying components used in the manufacturing process, marketing and pricing
strategies, and so forth
- It also provides benefits related to the control function of managers, costs that appear to be
indirect using volume-based costing systems now are traced to specific activities using cost
drivers
o This allows managers to better see what causes costs to be incurred, leading to
better control
However, it does have drawbacks: accumulating, tracking and assigning costs to products and
services using ABC requires the use of multiple activity pools and cost drivers
- High measurement costs associated with ABC systems are a significant limitation, with some
companies determining that the measurement costs associated with implementing ABC
systems are greater than the benefit from having more accurate cost information
Companies that have a high potential for cost distortions are more likely to benefit from ABC
- Cost distortions are likely when companies make diverse products that consume resources
differently, products that vary a great deal in complexity are typically diverse, but minor
differences such as colour can cause differences in product costs consumed
o E.g. a company may sell a black shirt and a gold shirt, the dye for the gold dye may
be more expensive than the black dye, causing the gold shirt to be more costly
despite the production processes involved being identical otherwise
- Companies that have a large proportion of non-unit-level costs are likely to benefit from ABC
o This is because unit-level costs vary with the number of units produced and can be
allocated with reasonable accuracy using volume-based cost systems and drivers
such as direct labour hours and machine hours
- Companies with relatively high proportions of overhead compared to direct materials and
direct labour are likely to benefit from ABC as well
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22107 James Burns
Module 11 – Part 1: Relevant costing
Objective 1 Analyse the pricing of a special order.
Special-order decisions are short-run pricing decisions in which management must decide which
sales price is appropriate when customers place orders that are different from those placed in the
regular course of business
- These decisions are affected by whether the company has excess production capacity and
can produce additional units with existing machinery, labour and facilities
- A special order would almost never be accepted if a company does not have excess capacity
o However, if the selling price offered is high enough a company may turn away
customers to free up capacity
- Even if excess capacity exists, qualitative factors must be considered before deciding to
accept a special order, particularly if the special-order price is below the price offered to
regular customers
o In these situations, care must be taken so that regular customers do not feel they
have been treated unfairly
Final costs can be relevant to a special-order decision when they change depending on the option
chosen
Objective 2 Analyse a decision involving the outsourcing of labour or making or buying a

component.
Make-or-buy decisions are short-term decisions to outsource labour or to purchase components

used in manufacturing from another company rather than to provide services or produce
components internally
Vertical integration is accomplished when a company is involved in multiple steps of the value chain
- E.g. a company might own a gold mine, a manufacturing facility to produce gold jewellery
and a retail jewellery store and a retail jewellery store
- All elements of the value chain must be considered for decisions about making or buying
components needed for production of the final product
- There are advantages to making components internally instead of buying them from an
outside supplier, vertically integrated companies are not dependent on suppliers for timely
delivery of services or components needed in the production process or for the quality of
those services and components. However, external suppliers may be able to provide a
higher-quality part for less cost
Objective 3 Analyse a decision dealing with adding or dropping a product, product line or service.
The decision hinges on the relevant costs and qualitative factors affecting the decision
Objective 4 Analyse a decision dealing with scarce or limited resources.

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A company faces a constraint when the capacity to manufacture a product or to provide a service is
limited in some manner. A resource utilisation decision requires an analysis of how best to use a
resource that is available in limited supply
- They are typically short-term decisions, such resources involved e.g. machine time, labour
hours and shelf space are fixed and cannot be increased, however, in the long run, new
machines can be purchased, new workers can be hired and stores can be expanded
When focused on short-run constraints, managers must focus on the contribution margin per unit of
limited resource rather than on the profitability of each product
- Qualitative factors must also be considered
Objective 5 Describe the theory of constraints and explain the importance of identifying
bottlenecks in the production process.
The theory of constraints is a management tool for dealing with constraints, it identifies bottlenecks
in the production process, which are production-process steps that limit throughput or the number
of finished products that go through the production process
The key is the identification and management of bottlenecks, once a bottleneck has been identified,
management must focus time and resources on relieving it
- Increasing resource allocation to a non-bottleneck operation will rarely provide significant
improvement to throughput, so finding bottlenecks is important in encouraging allocative
efficiency
Objective 6 Analyse a decision dealing with selling a product or processing it further.

22107 James Burns
The decision whether to sell a product as is or to process it further to generate additional revenue is
another common management decision
- The key in deciding whether to sell or process further is that all costs that are incurred up to
the point where the decision is made are sunk costs and therefore not relevant
- The relevant costs are incremental or additional processing costs
o Managers should compare additional sales revenue that can be earned from
processing the product further against the additional processing costs
o If additional revenue is greater than the costs, the product should be processed
further
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Module 11 – Part 2: Long-term decision making
Objective 1 Evaluate capital investment decisions using the NPV method.
Capital investment decisions are long-term decisions involving the purchase or lease of new
machinery and equipment and the acquisition or expansion of facilities used in a business
- One of the main factors to consider is the return of the investment and the return on the
investment
- Since capital investments involve large sums of money and last for many years, a
quantitative analysis of the costs and benefits of capital investment decisions must consider
the time value of money, the focus of the time value of money is on cash, flow, not
accounting net income, which is based on the accrual of income and expenses rather than
on the receipt and payment of cash
The net present value method requires the choice of a discount rate to be used in the analysis,
many companies choose to use the cost of capital, which represents what the firm would have to
pay to borrow (issue bonds) or to raise funds through equity (issue stock) in the financial
marketplace
- The discount rate serves as a minimum required rate of return, or a hurdle rate – the return
that the company feels must be earned in order for any potential investment to be
profitable
- The discount rate is often adjusted to reflect the risk and the uncertainty of cash flows
expected to occur many years in the future
Computing net present value requires comparing the net present value of all cash inflows associated
with a project with the present value of all cash outflows
- If the present value of the inflows is greater than or equal to the present value of the
outflows (the NPV is greater than or equal to zero), the investment provides a return at least
equal to the discount rate
CS5 = :(Df5L,I )
PVA=present value of an annuity, R=annual cash inflow, n=number of periods, r=interest rate
Objective 2 Evaluate capital investment decisions using the IRR method.
The internal rate of return is the actual yield, or return, earned by an investment
One way of calculating the IRR is as the discount rate that equates the present value of all cash
inflows to the present value of all cash outflows
- Aka, the IRR is the discount rate that makes the NPV=0
The problem of uneven cash flows

- Calculation of NPV and IRR get more difficult when cash inflows and outflows are more
numerous and cash flows are uneven
22107 James Burns
Key assumptions of discounted cash flow analysis

- In both NPV and IRR, two simplifying assumptions are made when discounting cash flows to
their present value
o Firstly, all cash flows are assumed to occur at the end of each period
o Secondly, all cash inflows are immediately reinvested in another project or
investment (this is analogous to the immediate reinvesting of dividends in a stock
investment)
- The rate of return assumed to be earned on the reinvested amounts depends on whether
the NPV or the IRR method is used. Under the NPV method, cash inflows are assumed to be
reinvested at the discount rate used in the analysis, whereas under the IRR method, cash
inflows are assumed ot be reinvested at the internal rate of return of the original investment
The importance of qualitative factors

- Investments in automated and computerised design and manufacturing equipment and
robots tend to be very large, although many of the benefits may be indirect and intangible
(or at least difficult to quantify), e.g. increased quality resulting in fewer warranty expenses
o It is difficult to evaluate investments based purely upon quantitative data, and thus
qualitative factors must be included in analysis
Objective 3 Distinguish between screening and preference decisions and use the profitability index
to evaluate preference decisions.
Capital investment decisions typically fall into one of two categories:

- Screening decisions involve deciding whether an investment meets a predetermined
company standard
- Preference decisions involve choosing among alternatives
Typical problems addressed in capital investment decisions are as follows:

- Should old equipment be replaced with new equipment that promises to be more cost
efficient?
- Should a new delivery vehicle be purchased or leased?
- Should a manufacturing plant be expanded?
- Should a new retail store be opened?
Once the problem is defined, the next step is to identify objectives

- Objectives include both quantitative factors (increase production, increase sales, reduce
costs) and qualitative factors (make a higher-quality product, provide better customer
service)
NPV and IRR can be used as screening tools, they allow a manger to identify and eliminate
undesirable projects
- Although the methods accomplish the same objective, it is important to remember that they
are used in different ways
- With net present value, the cost of capital is typically used as the discount rate to compute
the net present value of each proposed investment
22107 James Burns
o Any project that has a negative net present value should be rejected unless
qualitative reasons exist for considering the project further
- With the internal rate of return, the cost of capital or other measure of a company’s
minimum required rate of return is compared to the computed internal rate of return
o If the internal rate of return is equal to or greater than the minimum required rate
of return, the investment is acceptable unless qualitative reasons exist for rejecting
the project
- The NPV method has some advantages over the IRR method for screening decisions:
adjusting the discount rate to take into account the increased risk and the uncertainty of
cash flows expected to occur many years in the future is possible using NPV, when using the
IRR method, users have to modify cash flows directly to adjust for risk
- However, NPV (without adjustment) cannot be used to compare investments (make
preference decisions) unless the competing investments are of similar magnitude
The NPV analysis can be modified slightly through the calculation of a profitability index to better
allow the comparison of investments of different size, the profitability index is calculated by dividing
the present value of the cash inflows (netted with the present value of any cash outflows occurring
after the project starts) by the initial investment (netted with any other cash flows occurring on the
project start date)
- An index greater than 1.0 means the NPV is positive (The PV of inflows is greater than the
initial investment), and the project is acceptable
- When comparing the index of competing projects, the project with the highest PI is
preferred
Objective 4 Evaluate the impact of taxes on capital investment decisions.
Taxes are a major source of cash outflows for many companies
$?#+* #$4 )*"?/#

n+?"*+ #$4 )*"?/# =
(1 − #$4 *$#+)
22107 James Burns
The disposal of assets will have tax consequences, when an asset is sold or otherwise disposed of,
the gain or loss is calculated on the excess of sales price over book value (usually original cost less
accumulated depreciation), and vice versa for a loss on sale
- The after-tax cash flow associated with the sale of an asset at a gain on sale is therefore
found by multiplying the difference between selling price and salvage value by (1-tax rate)
The depreciation tax shield

- Depreciation is a tax-deductible expense that does not involve a direct payment of cash
- Despite depreciation not resulting in a direct cash flow, it creates an indirect cash inflow
owing to the impact of depreciation on income taxes paid
- The tax savings from depreciation, the depreciation tax shield, can easily be found my
multiplying the depreciation expense by the tax rate
Objective 5 Evaluate capital investment decisions using the payback method and discuss the
limitations of the method.
The payback period is the length of time needed for a long-term project to recapture the initial
investment
"*/</-$% /-0+.#(+-#
C$96$'j )+*/"; =
-+# $--2$% '$.ℎ /-?%"A.
The payback method ignores the time value of money, and thus must be used with caution
- E.g. Imagine you have Project A and Project B, both require an initial investment of $20000,
A promises inflows of $12,500 per year for two years, whereas B promises cash inflows of
$5000 per year for six years
- The payback method would show A being better, but it doesn’t consider the cash flow
received after the initial investment is paid for
- The method is very useful if cash flow is a serious concern and management wants to
eliminate projects that would have adverse cash flow consequences
22107 James Burns
Case studies
Module 2 Describe the role of forensic accounting. Identify the potential stakeholders that benefit
from forensic accounting.
Describe:
The use of accounting skills to investigate fraud or embezzlement and to analyse financial
information for use in legal proceedings
Identify:
- Shareholders
o Forensic accounting can prove that a company has intentionally engaged in illegal
accounting activities, in doing so shareholders may be able to seek damages in the
event that a firm they invest in has had its share value drop after a scandal
associated with the aforementioned illegal accounting activities, it may even be able
to catch issues prior to such a drop in value occurring, further buffering shareholders
from losses
o Moreover, the very existence of forensic accounting may act as a deterrence from
improper activities in the first place
- Companies that abide by accounting regulation
o Forensic accounting can result in firms that practice improper accounting methods
being penalised whereas those companies that are seen as legitimate can generate
goodwill for their practices
- Consumers
o The existence of forensic accounting may deter firms from exploiting consumers in
the first place
- The government
o Forensic accounting may uncover measures taken to illegally avoid tax, enabling the
government to collect taxation revenue that is owed to them
Module 4 Define the practice of earnings management and explain why it occurs. Identify and
contrast the legal and ethical issues associated with earnings management.
Define:
The use of accounting techniques to produce financial reports the present an overly positive view of
a company’s business and financial position
Two categories of creative accounting are:
- Macro-manipulation: when preparers attempt to bring about an alternative depiction of
economic reality that is more favourable to them in efforts to lobby accounting regulators to
alter proposals or current rules that are disadvantageous to them
- Micro-manipulation: occurs at the level of an individual entity and involves preparers
altering accounting disclosures so as to create the view of reality that they wish to have
communicated to users of financial statements
Identify and contrast:

Ethical issues:
- Lobbying is an abuse of market power in some cases
- ‘Morally reprehensible’ according to Gowthorpe and Amat
- Undermines the regulatory system
- May result in reduced tax being paid
- When firms are subjected to penalties incurred as a consequence of illegal creative
accounting this may harm employees who were in no way involved or aware or these
practices
22107 James Burns
Legal issues:
- Falsification of accounting information
- Macro-manipulation can result in the legal framework surrounding accounting being
degraded
- Misleading shareholders
- To what extent should personal interpretation of complex accounting regulation provide
flexibility? Is the law robust enough provide a black and white view of when earnings
management is actually an exploitation of accounting regulation versus a consequence of an
individual’s personal comprehension of said regulations
Module 5 Identify accrual components in which the paper examines the effect on future cash
flows. Briefly discuss the findings regarding the effect of changes in accrual components on future
cash flows.
Identify
Change in accounts receivable, change in accounts payable, change in inventory, depreciation,
amortization, and other accruals
Discuss
The disaggregation of earnings into accrual components enhances the predictive ability of
accounting information on future cash flows.
Accounts receivable: 0.59

Accounts payable: -0.56
Changes in inventory: 0.35
Depreciation: 0.42
Amortization: 0.47
Other: 0.15
Module 10 – Part 1: Budgeting Discuss the relationship the paper expects to find between
budgetary slack creation, managerial short-term orientation and budgetary control style. What
are the two other variables the paper identifies as possibly impacting on these three factors? Are
the findings consistent with the predictions (hypotheses) proposed in the paper?
Discuss
A rigid budgetary control style is one in which managers are evaluated primarily on whether or not
they achieved their budget. The rigidity of budgetary control is measured by the emphasis placed on
meeting the budget
Budget slack exists if the business unit managers have intentionally set their budget targets lower
than their best guess forecast about the future so that the budget becomes easier to achieve
- Business managers may create slack by exploiting the informational asymmetry between
themselves and corporate management about their segment of the business in order to get
performance targets that are deliberately lower than their best guess forecast about the
future
- Slack provides protection from unseen contingencies and improves the probability that a
budget target will be met, thus increasing the likelihood of receiving a favourable evaluation
- It may seem intuitive to think that slack will be greatest when budget emphasis is high, but
this has been found to not be the case, it is partly because higher levels of management will
often be aware of these attempts to create slack and thus they’ll be critical of budget
forecasts
22107 James Burns
The paper posits the following hypotheses:

H1: Rigid budgetary controls are:
a. Negatively related to budgetary slack
b. Positively related to managerial short-term orientation
o Managerial short-term orientation is when managers focus more on short-term
profit maximisation at the expense of long-run profitability in order to meet budget
targets
H2: Budgetary slack and managerial short-term orientation are negatively related
H3: Relative to cost leadership strategies, differentiation strategies are:

a. Negatively associated with rigid budgetary controls;
b. Positively associated with budgetary slack
H4: Past business unit performance is

a. Negatively related to rigid budgetary controls;
b. Positively related to budgetary slack; and,
c. Negatively related to managerial short-term orientation
The paper also finds that competitive strategy and past performance impact these factors
Competitive strategy:
- Organisation theory suggests that some level of slack may be needed to successfully pursue
strategies that require a high degree of flexibility to respond effectively to changes in the
environment
- One of the main factors is whether a firm is a cost leader/defender (narrow product range
and undertake little product or market development, focuses primarily on achieving a low
cost position relative to competitors and therefore pursue cost reduction, exploit economies
of scale, standardise the task environment, and produce standard, undifferentiated
products) or a differentiator/prospector (actively engage in market and product
development in order to create something perceived as unique by pursuing superior product
features, innovation, customer service, brand image, etc)
- Differentiators face uncertainty because they have broad product lines, engage in product
innovation, deal with products that have not yet crystallized, whereas cost leaders face
relative certainty since they keep their essentially undifferentiated product offerings
relatively stable over time
o Slack is a mechanism by which firms can hedge against uncertainty, thus,
differentiators may opt to increase budget slack to pursue the critical success factors
on which their strategies are built
Past performance:
22107 James Burns
- Managers who have demonstrated good performance over an extended period enjoy larger
amounts of budgetary slack
- Business units that have been more profitable may be less affected by rigid budgetary
controls and enjoy more flexibility in the expenditures they make
- An urgent need for immediate profits is an important reason for managers to reduce slack,
even if it comes with short-term management actions that may be harmful in the long-run
Findings
- The paper found that there is a significant negative relationship between budget rigidity and
budget slack (H1a confirmed)
- The relationship between budget rigidity and managerial short-term time-orientation is
insignificant (H1b disproven)
- Budget slack and managerial short-term time-orientation are significantly and negatively
related (H2 proven)
- “These correlations suggest that rigid budgetary controls reduce budget slack. Reduced slack
makes short-term budget targets more difficult to achieve, which may drive managers to
become concerned primarily about actions that affect short-term results. Put differently,
may be a necessary condition for managers to think long term”
- A strategy of differentiation is associated with less rigid budgetary control (H3a confirmed)
and more slack (H3b confirmed)
- Past performance is negatively related to rigid budgetary control (H4a confirmed) and is
positively related to slack (H4b confirmed) and negatively related to time-orientation (H4c
confirmed)
- “In summary, the correlations seem to be in line with the relationships formulated in H1ab,
H2, H3ab and, H4abc at conventional levels of significance, except H1b”
- These are only correlations though, path analysis is utilised to test whether the one-to-one
correlations hold significant in the presence of other intervening variables
-
- The bb column shows the nature of the relationship between the two variables in the path
analysis, note that CONTROL and TIME have an insignificant relationship, suggesting an
indirect relationship
22107 James Burns
Fundamentals of Business Law

Module 1, Chapter 4 – Business Organisations
The sole trader:
- Business is owned and operated by one person
- The owner retains all profits and bears any loss
- No need to incur expense in creating a legal entity, however there may be a need to register
a business name if the name to be used is different from the name of the operator
Advantages:
- Formation is simple
- Complete control
- Profits go to the owner
- Taxation generally low (if profits are low as well)
- Dissolution a simple process
Disadvantages:
- Big workload for the owner
- Sole traders are limited to the expertise they possess
- Limited options to raise capital
- A trader has unlimited liability, personal assets may need to be used to meet business debts
since the trader and the business are regarded as a single entity
- If the sole trader dies the business ends (unless they have set up a will)
- If profits are large then tax is high, whereas in a partnership taxable income can be divided
amongst several people to reduce tax payable
The partnership:
- Can be created by written or verbal agreement or even by the actions of partners
- Rights and duties of each partner cannot be altered unless all partners consent
- Actual and implied authority is held, a partner will bind the partnership if the partner acts
within the scope of their actual or apparent authority, if they choose to act outside this
authority they will be personally liable
Advantages:
- Easy to form
- Management is more flexible as people can stand in for each other if for example an owner
wishes to go on holiday
- Partners are not restricted in terms of the nature of the business they carry on, if all partners
agree the nature of the business conducted can be altered
- Profits and taxes can be divided amongst partners in order to reduce tax
Disadvantages:
- Also unlimited liability
- No existence separate from partners; if they all die the business goes
o withdrawal of a single partner will end the partnership and require a new
partnership to be constituted
- The maximum number of partners is twenty
- Capital is largely limited to the savings of the partners
Companies:
- A company is an incorporated body created by a process called ‘incorporation’
22107 James Burns
- Seen as a separate legal entity from the owners

o ‘veil of incorporation’: the veil protects those who operate the company from
liability for company obligations (to a certain extent)
Proprietary companies:
- Most common type of company in Australia
- Cannot raise funds from the public
o Minimum of one and maximum of fifty shareholders
- Only needs one director but can have more
- Broken into small and large proprietary company
o Large companies are required to prepare annual financial accounts and to disclose
financial information to ASIC
Characteristics:
- May incorporate with only one member (the director)
- Directors must be 18+
- No need to hold an annual general meeting
- A proprietary company with more than one member may circulate a resolution, which if all
the members entitled to vote sign in favour, will be passed without members needing to
meet
- A single-member company can pass a resolution by a statement in writing instead of holding
a meeting
- The name must include the word ‘proprietary’ or the abbreviation ‘Pty’
Public companies
- May raise funding directly from the public by selling shares or debentures through a
prospectus
- May be listed on the securities exchange
Characteristics:
- May incorporate with only member, no maximum
- No restrictions on the transfer of shares or raising money by way of a share or debenture
issue
- A minimum of three directors are required, two of which must reside in Australia
- The name must include the word ‘limited’ or the abbreviation ‘Ltd’
Advantages:
- Companies are a separate entity, it will continue to exist until it is wound up
- Capable of operating a business separate from its shareholders, contracts can be signed by
the company itself, binding the company but not the individual shareholders
- The company has the power to acquire, hold and dispose of property
- Fundraising capacity
Disadvantages:
- Relatively high establishment and compliance costs
- Possible for control to fall into the hands of someone other than the party who established it
Module 3, Chapter 18 – Principal and Agent

An agency is a relationship that exists whereby one person authorises another person to act on their
behalf to bring them into a legal relationship with a third party
22107 James Burns
- Created through expression or implication
Types of agent:
- Special agent: appointed to carry out a particular task
- General agent: has to authority to act for a principal on all matters in relation to a particular
trade or business, or to do an act that is in the ordinary course of the agent’s business
o e.g. an accountant who is appointed as an agent has the power to perform actions
within the ordinary course of business of an accountant
- Universal agent: one who has the authority to do all acts a principal is permitted to do
o Requires power of attorney
Duties:
- Follow principal’s instructions
- Act personally
- Exercise reasonable skill and diligence
- Act in the principal’s best interest
- Not to make a secret profit
- Not to divulge confidential information
- Keep proper accounts
Rights:
- Remuneration
- Indemnity and reimbursement
- Lien
- Stoppage in transit
Liabilities:
- Liable to the principle if the agent fails to follow instructions and a loss is incurred
- May be liable to third parties if they are contracted with them
o if an agent contracts a third party and discloses the principal’s name e.g. ‘On behalf
of John Smith’ they will not be liable, the same goes if they just disclose that the
principal exists
o An agent who does not disclose that they are acting on behalf of a principal will be
personally liable on the contract
Termination of agency:
- By the acts of the parties
o Performance of the agency will end the contract
o Agreement of both parties can terminate the agency
o A principle can revoke an agent authority
- By the operation of the law
o If performance becomes impossible by frustration of contract
§ E.g. if an agent is hired to sell a house but the house is destroyed by a fire
o Death of either the agent or the principal terminates the agency, if an agent
contracts with a third party not knowing of the principal’s death, then the agent will
be personally liable on the contract
o Bankruptcy of the principal will terminate the agency, the same goes for the agent if
the bankruptcy affects the ability of the agent to contract
o Insanity of the principle or agent will terminate the agency
22107 James Burns
Module 7, Chapter 12 – Sale of goods

Rights of an unpaid seller against the buyer:
- Suing for damages
- Suing for the price of the goods

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22107 James Burns

Accounting for Business Decisions A

Module 1 – Accounting in the world of business

The purpose of an income statement (technically known as a statement of comprehensive income

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Example cash flow statement (Note that outflows are in brackets):

Understandability refers to the ability of accounting information to be comprehensible to those who

Comparability refers to the ability of information to be weighed against or contrasted to the

Objective 7 Study the conceptual framework of accounting.

Terms used to identify and describe economic information

Terms used to identify and describe economic information

Principles used to measure economic information

Assumptions made when communicating economic information

Qualitative characteristics that make accounting information useful

Financial statements used to communicate economic information

Financial statements used to communicate economic information

Module 2 – Financial statements

Objective 1 Explore the three major forms of business.

A company or corporation is a separate legal entity established by registering with ASIC

Public companies must follow the GAAP

A fair presentation requires entities to:

Assets are grouped into two main categories on a balance sheet:

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Liabilities are also generally classified into two main categories:

Equity is generated from two main sources:

Objective 4 Describe the main subtotals of income on an income statement.

Companies will generally one of two types of income statement:

Operating (other) expenses

Profits before income tax expense

Other comprehensive income

Horizontal analysis is a method of analysing a company’s account balances over time

Vertical analysis is a method of comparing account balances within one year

Objective 6 Explain the purpose of a statement of changes in equity.

Three basic types of notes to the financial statements:

Notes to the financial statements

Management’s discussion and analysis

Module 3 – Recording accounting transactions

Objective 1 Describe the purpose of an accounting information system.

Objective 2 Analyse the effect of accounting transactions on the accounting equation.

Accounts can be represented as above (this is known as a T-account)

Journals are a chronological record of transactions

A ledger is a collection of accounts and their balances

Module 4 – Accrual accounting and adjusting entries

The adjusting entry after one month would be:

This subsequent transaction is made (NOT an adjustment because it includes cash)

Objective 5 Describe the steps of the accounting cycle.

Module 5 – Cash and internal controls

Objective 1 Identify the role of internal control in a business.

Objective 2 Describe the five components of internal control.

Objective 4 Outline the reporting of cash.

Cash is reported as a current asset on the statement of financial position

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Objective 1 Describe the recording and reporting of receivables.

Recording accounts receivable:

n/30=net balance paid in 30 days

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