Accounting: Decision making by the numbers

Chapter 8

Suzaan Hughes
 Planning ahead - Learning Outcomes

• Define accounting and describe how accounting information is used by a variety of

stakeholders both in and outside the organisation
• Identify the purposes and goals of generally accepted accounting principles
• Describe the key elements of the major financial statements
• Describe several methods stakeholders can use to obtain useful insights from a
company’s financial statements
• Explain how the budget process can help managers plan, motivate, and evaluate their
organisation’s performance
• Explain the role of managerial accounting and describe the various cost concepts
identified by managerial accountants

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 Chapter 8 Outline
1. Accounting
a) Who does it
b) Who uses its
c) Financial Accounting
d) Ethics in Accounting
2. Financial Statements
a) The Balance Sheet
b) The Income Statement
c) Statement of Cash Flows
d) Interpreting Financial Statements

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 Chapter 8 Outline

3. Budgeting
a) Preparing the budget
b) Developing the key budget components
c) Static vs Flexible budgets
4. The role of Managerial Accounting
a) Cost concepts
b) Assigning costs to products

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Accounting
Accounting is the “language of business”
Accounting*: A system for recognizing, organizing, analyzing, and
reporting information about the financial transactions that affect an
organization
Accounting’s goal: To provide users with relevant, timely information
that can help them make better economic decisions

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Users of Accounting Information

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Accounting: Who does it?

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Financial Accounting
Financial accounting*: The branch of accounting that prepares financial
statements for use by owners, creditors, suppliers, and other external
stakeholders
◦ Stakeholders need this information to analyze the financial condition of
the firm through a period of time
◦ Investors compare a company’s financial results to other firms in the same
industry
◦ The major output of financial accounting—balance sheets, income
statements, and cash flows—provides fundamental information about a
company’s past and future financial performance

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 Financial Accounting
Role of the Financial Accounting Standards Board
Generally accepted accounting principles (GAAP)*: A set of accounting
standards that is used in the preparation of financial statements
Financial Accounting Standards Board (FASB)*: The private board that
establishes the generally accepted accounting principles used in the practice
of financial accounting
International Financial Reporting Standards (IFRS)
Used in SA
◦ Standards issued by the IFRS foundation and the International Accounting
Standards Board (IASB), to ensure that company accounts are
understandable and comparable across international boundaries

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Accounting Standards Board
• Aims to ensure that financial statements are:
• Relevant
• Reliable
• Consistent
• Comparable

In SA the Financial Reporting Standards Council (FRSC) suggest use of either

• IFRS
• South African GAAP
Ethics in Accounting
Because of accounting improprieties and scandals, accounting boards include ethics-
related requirements
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Ethics in Accounting
• Clear and well-established accounting principles will
not result in accurate and reliable information if
managers and accountants do not use them
• Consider that many corporate scandals in recent
years were related to accounting improprieties
• Consequences: financial difficulties; reputational
damage
• Several scandals have served as a wake-up call to the
accounting profession that their ethical training and
standards need to improve

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Financial Statements: Read All About Us
Three basic financial statements: balance sheet, income statement, and statement of
cash flows
◦ Provide external stakeholders with a view of an organization’s financial condition
◦ Must appear in publicly traded (listed) companies’ annual report
◦ Part of companies’ quarterly and annual filings with relevant oversight bodies
 Financial Statements –
Balance Sheet
The Balance Sheet: What We Own and How We Got It
Balance sheet*: A financial statement that reports the
financial position of a firm by identifying and reporting the
value of the firm’s assets, liabilities, and owners’ equity
Accounting equation*: Assets = Liabilities + Owners’ Equity
◦ Assets*: Resources owned by a firm
◦ Liabilities*: Claims that outsiders have against a firm’s
assets
◦ Owners’ equity*: The claims a firm’s owners have
against their company’s assets (often called
“stockholders’ equity” on balance sheets of
corporations)

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Exhibit 8.2 The Balance Sheet for McDonald’s Corporation

Kelly/Williams, BUSN 12th Edition. © 2023 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly
accessible website, in whole or in part. 14
 Financial Statements –
Income Statement
The Income Statement: So, How Did We Do?
Income statement*: The financial statement that reports the
revenues, expenses, and net income that resulted from a firm’s
operations over an accounting period
◦ Revenue*: Increases in a firm’s assets that result from the sale
of goods, provision of services, or other activities intended to
earn income
◦ Expenses*: Resources that are used up as the result of business
operations
◦ Net income*: The difference between the revenue a firm earns
and the expenses it incurs in a given time period
◦ Reflects the equation, Revenue − Expenses = Net income
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Exhibit 8.3 Income Statement for McDonald’s
 Financial Statements –
Statement of Cash Flows
Statement of cash flows*: The financial statement that identifies a firm’s
sources and uses of cash in a given accounting period

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Exhibit 8.4 McDonald’s Statement of Cash Flows
 Financial Statements - Other Statements
Other Statements: What Happened to the Owners’ Stake?
Statement of retained earnings
◦ Shows how retained earnings have changed from one
accounting period to the next
Stockholders’ equity statement
◦ Shows how net income and dividends affect retained
earnings
◦ Shows changes in stockholders’ equity, such as changes that
arise from the issuance of additional shares of stock

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 Interpreting Financial Statements:
Digging Beneath the Surface
Checking independent auditor’s report
Checking notes to financial statements
Looking for trends in comparative statements
• Horizontal analysis: Compares account values reported
on the financial statements over two or more years to
identify changes and trends

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The Independent Auditor’s Report:
Getting a Stamp of Approval
Prepared after conducting an annual external audit of
the financial statements
Purpose - To verify if financial statements:
◦ Are prepared in accordance with the generally
accepted accounting principles
◦ Fairly present the financial condition of the firm
Included in the annual report that a firm sends to its
stockholders

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 Notes to Financial Statements
Disclose additional information about a firm’s operations,
accounting practices, and special conditions

Explain the specific accounting methods used to recognize

revenue, value inventory, and depreciate fixed assets

Disclose changes in accounting methods or any risks that a

firm may face

Checking Out the Notes to Financial Statements: What’s in the Fine Print?
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Interpreting Financial Statements
Looking for Trends in Comparative Statements
Comparative statements put the balance sheet, income statement, and
statement of cash flows of two or more years side by side
◦ Trace what happened to key assets and liabilities through several time periods
◦ Show increases or decreases in revenues or expenses

Horizontal analysis*: Analysis of financial statements that compares account

values reported on these statements through two or more years to identify
changes and trends
Budgeting: Planning for Accountability
Management tool that shows how a firm will
acquire and allocate the resources needed to
achieve its goals over a specific time period
Facilitates planning by requiring managers to:
• Translate goals into measurable quantities
• Identify the specific resources needed to
achieve goals

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Advantages of Budgeting

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Approaches to Budgeting
Top-down budgeting
• Top management prepares the budget with
little or no input from middle and supervisory
managers
Bottom-up (or participatory) budgeting
• Middle and supervisory managers are allowed
to participate actively in the creation of the
budget
• Overstatement of needs or low budget goals
create budgetary slack

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 Developing the Key Budget Components:
One Step at a Time
Operating budgets

Communicate an organisation’s sales and production goals and the

resources needed to achieve them

Financial budgets

Focus on a firm’s financial goals and identify the resources needed to

achieve them

Master budgets

A presentation of an organisation’s operational and financial budgets that

represents the firm’s overall plan of action for a specified time period
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Development of the master budget

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Budgeting: Planning for Accountability
Being Flexible: Clearing Up Problems with Static Budgets
A static budget is based on a single assumed level of sales
Problems result when real-world sales vary considerably from the forecasted
value
◦ Figures become inaccurate
◦ Can be avoided by preparing a flexible budget
A flexible budget is developed through a range of possible sales levels and
appropriate budgeted level of costs

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 Inside Intelligence: The Role
of Managerial Accounting
Managerial (or management) accounting*: The branch of accounting that
provides reports and analysis to managers to help them make informed
business decisions
◦ A firm’s performance depends on the accuracy and reliability of this
information
◦ Management accounting systems may be a source of competitive
advantage
 Comparison of Financial and Managerial
Accounting
Financial Accounting Managerial Accounting

Timing of Reports Presents financial statements on a Creates reports upon request by management
predetermined schedule rather than
(usually quarterly and annually). according to a predetermined schedule.

Adherence to Governed by a set of generally accepted Uses procedures developed internally that are
Accounting accounting principles (GAAP). not required to follow GAAP.
Standards?

Time Period Focus Summarizes past performance and its impact Provides reports dealing with past
on the firm’s present condition. performance but also involves making
projections about the future when dealing
with planning issues.

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 Comparison of Financial and Managerial
Accounting (continued)
Financial Accounting Managerial Accounting

Timing of Reports Presents financial statements on a Creates reports upon request by management
predetermined schedule rather than
(usually quarterly and annually). according to a predetermined schedule.

Adherence to Governed by a set of generally accepted Uses procedures developed internally that are
Accounting accounting principles (GAAP). not required to follow GAAP.
Standards?

Time Period Focus Summarizes past performance and its impact Provides reports dealing with past
on the firm’s present condition. performance but also involves making
projections about the future when dealing
with planning issues.

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Cost Concepts
Cost*: The value of what is given up in exchange for
something
◦ Out-of-pocket cost*: A cost that involves the payment of
money or other resources
◦ Implicit cost*: The opportunity cost that arises when a firm
uses owner-supplied resources
◦ Fixed costs*: Costs that remain the same when the level of
production changes within some relevant range
◦ Variable costs*: Costs that vary directly with the level of
production

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 Assigning Costs to Products
Direct cost: Incurred directly as a result of some
specific cost object
Indirect cost: Result of a firm’s general
operations and is not directly tied to any specific
cost object
Activity-based costing (ABC)
◦ Technique to assign product costs based on
links between activities that drive costs and
the production of specific products

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 Tutorial Discussion forum question
Read the article at this link in preparation to complete the tutorial discussion forum:
https://www.news24.com/news24/bi-archive/the-top-south-african-business-scandals-the-past-decade-2020-1

In light of the article;

• Describe why the Accounting function is important in businesses (consider different users of the information).
• Elaborate on the value of the balance sheet, income statement and cash flow statement for managers when accurately
prepared and the danger of incorrect statements.
• Discuss the value of adhering to accounting standards versus the cost of not adhering to accounting standards (Consider the
financial position/reputation of companies, countries as investment destinations and the accounting profession)

Criteria for your discussion: In each instance you have to outline the reason for your conclusion and link to theory
discussed in this chapter, making sure to mention at least two theories. Make sure that your opinion is based on a sound
understanding of the theory, 500-600 words in length. Please reference the sources used in formulating your opinion
using APA referencing.

Expectations: Please post your answer by Friday 23 August 23:59