UNIT

1
REAL-WORLD ACCOUNTING
Introduction
In this first unit you will be introduced to accounting and study its functions and roles. Keeping accounting
records and learning how to interpret them is an important part of operating any business or similar
organisation. You will see how accounting provides information for decision making and helps evaluate
performance, allowing businesses to operate efficiently and profitably. Indeed, accounting is now so important
in our business lives that parts of its terminology have become common in our everyday language. Accounting
is thus sometimes called ‘the language of business’. But it is much more than this. You will also see that it
can assist all types of organisations, as well as governments and individuals, to manage their financial affairs
efficiently.
After studying this unit you will understand the environment in which accounting operates; what is
published in public company financial reports; the basic rules of accounting; how information is recorded and
processed; how accounting reports are prepared, analysed and interpreted; and how technology can assist in
processing data and information, and making decisions.

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1 THE ACCOUNTING ENVIRONMENT

LEARNING OBJECTIVES
When you are competent in the work covered by this chapter you should be able to:
• describe the nature and objectives of accounting
• describe the main forms of business organisations that use accounting
• describe where people can invest their money and the main financial statements used in
accounting
• explain why investments are made in businesses and how accounting information is used to
communicate information to those investors
• analyse the relationships between the main elements of a company’s financial statements
• explain the role of the auditor
• explain the nature and role of the accounting profession.

The accounting environment

Accounting for business organisations • Partnerships
• Where to invest? • Companies
• Statement of Profit or Loss • Non-profit organisations
• Statement of Financial Position • Public sector organisations
• Statement of Cash Flows • Trusts
• Illustrative example highlighting financial The accounting profession in Australia
statements
• Role of the auditor
Introduction to accounting
Factors impacting accounting
• Definition of accounting
• Historical development
Objectives of accounting • Legal factors
• Information for decision making • Economic factors
• Discharging accountability • Technology trends
• Evaluating performance • Ethical considerations and business conduct
• Demand for diversity of accounting services
Forms of business organisations
Review and reflect
• Sole traders (sole proprietors)

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Accounting for business organisations

Where to invest?
Imagine you have some money to invest. You may have saved $50 000 or inherited or borrowed it. You
basically have a number of alternatives. Some of these include:
• putting the money in the bank
• putting the money into fixed deposits
• buying a share of a house with a friend
• buying shares in a company
• setting up your own business.
What factors will influence your choice about what to do with the money? Some of the factors you
would consider include:
• The return each year you will get on your money. This will be in the form of interest, rent, dividends
or profit.
• How much capital gain you will achieve on each alternative. This is the difference between the initial
investment amount and the amount you will receive for the item when you sell it.
• How much time will be required in monitoring the investment and ongoing effort on a daily basis.
• Which investments meet your own personal goals. For example, you might only like to invest in
businesses in certain industries such as renewable energy.
Only you can decide which of these factors are important to you and therefore which investment to
make. You might decide to run your own business because you see you may get a greater return, and you
may be able to control the activities of the business through your own hard work. Whatever you decide,
you will still need to know that your money will give you a return, otherwise you will be wasting it.
If you decide to invest your money in a business as an owner, you will require financial information
about that business so that you can monitor your investment. Accounting performs that role of providing
financial information to its investors, its owners/shareholders and other stakeholders interested in its
progress. This is done through financial statements. There are three common financial statements that
provide information to assist their users’ decision making.

Statement of Profit or Loss

The aim of the Statement of Profit or Loss is to show how the business has performed during the period of time
(month, year) that the report covers. To do this the report shows the revenues a business receives and the expenses
it incurs in order to earn those revenues. The resulting net figure is either a profit or a loss during the period.

Statement of Financial Position

The aim of the Statement of Financial Position is to present a snapshot at a point in time of what the
business owns/controls (assets), the amounts it owes (liabilities) and the owner’s investment (owners’
equity). This statement is always at a particular date.

Statement of Cash Flows

The aim of the Statement of Cash Flows is to show where the business obtained cash during the period
and how that cash was received. There are three sources and uses for cash during the period.
• Operating activities. The revenues from the operating activities are the receipts the business receives for
performing its services. If we are using the example of an accounting practice, then the receipts would be
the monies received for doing the accounting for the clients of the business. The payments for the operating
activities are the expenses the business needs to pay for to earn those revenues. Typical examples are the
cash paid for the wages and salaries of its employees, and other business expenses such as electricity.
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• Investing activities. Investing activities involve the cash used to purchase the resources (assets) the
business needs to operate. Typical examples are the purchase of equipment and office furniture.
• Financing activities. The business needs to have access to resources if it is to be able to operate.
The business can obtain those resources either from owner cash inflows or loans from parties outside
the business. Likewise, the business may use cash to make payments to those owners in the form of
dividends if it is a company or to repay loans to outside parties.

Illustrative example highlighting financial statements

In order to introduce you to the features of these simplified statements, consider the following
information for an accounting practice – Vogel Pty Ltd.

Vogel Pty Ltd

Statement of Profit or Loss for the year ended 30 June 2019
$ $
Service revenue 254 400
Expenses
Salaries and wages expense 61 080
Rent expense 37 000
Other expenses 19 000
Interest expense 1 000 118 080
Profit before income tax 136 320
Income tax expense     76 320
Profit after income tax $60 000

Vogel Pty Ltd

Statement of Financial Position as at 30 June 2019
$ $ $
Assets
Cash 10 000
Accounts receivable 4 000
Office equipment 81 000
Total Assets 95 000
Liabilities
Accounts payable 1 900
Interest payable 100
Bank loan 11 000
Total Liabilities     13 000
Net assets $82 000
Equity
Share capital 40 000
Retained earnings 1/7/2018 0
Add profit after tax 60 000
Dividends paid (18 000)
Retained earnings 30/6/2019     42 000
Total Equity $82 000

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Vogel Pty Ltd

Statement of Cash Flows for the year ended 30 June 2019
$ $
Cash flows from operating activities
Inflows
Cash receipts from operating activities 250 400
Outflows
Cash payments for operating activities 192 400
Net cash from operating activities 58 000
Cash flows from investing activities
Outflows
Office equipment purchases 81 000
Net cash used in investing activities (81 000)
Cash flows from financing activities
Inflows
Issue of shares 40 000
Proceeds from bank loan 11 000
Outflows
Payment of dividend (18 000)
Net cash from financing activities 33 000
Net increase in cash 10 000
Cash at beginning of year    0
Cash at end of year $10 000

Statement of Profit or Loss

The purpose of the Statement of Profit or Loss is to report how successful Vogel Pty Ltd has been during
the year. A perusal of the report reveals:
• The statement covers the financial year ending 30 June 2019.
• It shows an after-tax profit of $60 000 for the year. This is often called the bottom line of the business.
The company itself must pay tax on its profits.
• The profit has occurred because the revenues of $254 400 are greater than the total expenses
(including tax) of $194 400.
• Outside investors and the owners would look at this statement before deciding whether to invest any
more money into the business.

Statement of Financial Position

The purpose of the Statement of Financial Position is to report the assets and liabilities and the net worth
of the business at a point in time.
• The statement shows the position at close of business on 30 June 2019.
• It shows total assets of $95 000 and total liabilities of $13 000, with the difference of $82 000 being
called net assets.

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• Net assets will always equal the equity in the business. This occurs because the funds represented by
the net assets will have been contributed by the owners of the business.
• The equity of $82 000 is what the business is worth to the owners – or, putting it another way, the
owners’ investment in the business.
• The assets the business owns comprise cash in the bank ($10 000); amounts owing to it on 30 June by
its customers – called accounts receivable ($4000); and office equipment that has been purchased in
order to assist the business to operate ($81 000).
• The liabilities the business owes are comprised of amounts owing to its suppliers at 30 June ($1900);
interest payable on the loan of $100; and the principal value of the loan at 30 June ($11 000).
• The equity, the investment of the owners in the business, can be seen as comprising two elements:
share capital (the value of shares issued) and the retained earnings.
• Total share capital at 30 June was $40 000. This is the amount the shareholders/owners have invested
in the business.
• The retained earnings at 30 June 2019 are $42 000. Note that there were no retained earnings at the
beginning of the year (1 July 2018), but this was increased through the profit made during the year
of $60 000 and the dividends paid of $18 000, giving a figure for retained earnings at 30 June 2019 of
$42 000. The dividends are the return paid to the shareholders for investing in the company.
• The retained earnings of a company will increase or decrease over time depending on what was
available in the prior year, and the profits made and dividends paid during the year.

Statement of Cash Flows

The main purpose of the Statement of Cash Flows is to report the cash receipts and cash payments the
business made during the reporting period.
• The statement has three sections: cash inflows and outflows from operating activities; cash inflows
and outflows from investing activities; cash inflows and outflows from financing activities.
• The Statement of Cash Flows reconciles to the cash at bank figure from the Statement of Financial
Position; that is, $10 000.
• Operating flows: the statement shows operating cash receipts of $250 400. This is primarily cash
received from providing services to customers. The statement shows operating payments of
$192 400. This is primarily cash paid for the expenses necessary to earn the revenues.
• Investing flows: the statement shows an outflow of $81 000 because the business purchased
equipment.
• Financing flows: the statement shows an inflow of $40 000 cash from the owners because shares were
issued, and an inflow from the bank because a loan was taken out for $11 000. During the period a
financing cash outflow occurred because dividends of $18 000 were paid out to the owners.

Interrelationships between the statements

The three main reports are interrelated and it is important that these interrelationships are understood
when analysing the results of a business for a period of time.
• The profit figure from the Statement of Profit or Loss appears in the Statement of Financial Position
as an increase to the equity figure.
• The revenues and expenses from the Statement of Profit or Loss form the basis for the operating
section of the Statement of Cash Flows, but are not exactly the same because the Statement of Cash
Flows shows flows of cash only. You will see in your further study of accounting that profit is not
cash. A business can make big profits but have little cash to pay its debts. This is why there is a
separate statement devoted to the flows of cash.
• The final figure in the Statement of Cash Flows should be the balance of the Cash account listed in
the asset section of the Statement of Financial Position.
• The dividends shown in the Statement of Financial Position appear in the financing section of the
Statement of Cash Flows.

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1.1
What is the purpose of the:
a Statement of Profit or Loss
b Statement of Financial Position
c Statement of Cash Flows?

1.2
On NelsonNet, you will find links to the 2017 annual reports for Woolworths Limited and JB Hi-Fi.
Both of these are trading companies; that is, they buy and sell goods for a profit.
Answer the following questions for both companies. Weblink
Woolworths
HINT: you may need to move into the Notes to the Financial Reports to answer some of the Limited annual
questions. reports
JB Hi-Fi annual
a What is the after-tax profit for each company?
reports
b How has this after-tax profit been calculated?
c What are the total assets, liabilities and net assets for each company?
d What is the total equity for each company?
e What are the different categories of assets each company has?
f What are the different categories of liabilities each company has?
g What are the components of equity at the end of the financial year?
h What was the amount of cash reported as an asset?
i What was the amount of net cash from operating activities?
j What was the amount of net cash used in investing activities?
k What was the amount of net cash from financing activities?
l How much did the company pay in repayment of borrowings?
m How much did the company receive from customers?
n In 2016, how much did the company receive from customers?

1.3
On NelsonNet, you will find links to the 2017 annual reports for Qantas Airways and Flight Centre.
Both of these are service companies, that is, they earn revenues from providing services rather than Weblink
Qantas Airways
selling goods. Answer the questions in 1.2 for both of these companies. annual reports
Flight Centre
annual reports

Introduction to accounting
Accounting affects the lives of everyone in a modern society. Most people need some simple form of
accounting to deal with their personal financial matters: budgeting, paying taxes and so on. Business
firms need accounting systems to enable them to operate efficiently. Indeed, inadequate accounting
records or an inability to interpret and use records are a major cause of many business failures.
Governments need accounting systems to allow them to account for the very large amounts of money
they receive and spend.
In this book we are mainly concerned with the use of accounting by business firms. However, all the
principles, and most of the skills to be learnt, can also be applied to personal finances. Similarly, they apply
to organisations of any type, no matter how data are processed.

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Definition of accounting
To the person in the street, accounting may mean anything from ‘the best way to run your business affairs’
to ‘the only way of presenting a true and fair view of business affairs’. The accountant may be seen as ‘a
colossal bore’ or as ‘a wizard with figures’. None of these views is entirely true. Accounting is a very
complex process and is therefore difficult to define. However, one useful definition is:

Accounting is a discipline that measures, records and processes financial and other information
about an entity, and reports and interprets that information to interested parties to enable them
to make appropriate decisions.

Figure 1.1 shows how data are processed to provide information to interested parties for use in their
decision making.

Input of data Processing of Output of Decision-

(from transactions data accounting making process
and other sources) • manipulation of information • define
Recording

• measured in data into useful (timely and problem/goals

Interpreting
information accurate) • identify alternatives
Recording

monetary terms
Reporting

• relevance (including • make decisions

materiality)
• faithful representation
• comparability
• verifiability
• timeliness
• understandability

Feedback

Figure 1.1 How interested parties use accounting information to make decisions

Language and communication

Definitions
A definition is a description or explanation of a word or thing, using its attributes, properties or
relationships to distinguish it from other things. Therefore, a definition should include:
• the word or phrase being defined
• the place of the item in a broader group to which it is related
• enough information to describe this particular item and to differentiate it from others in the
broad group
• an example of the item, or other information about its use.
For example, this definition of accounting highlights the following:
• Accounting is a discipline or body of knowledge. It is an extremely important discipline
to the wellbeing of any entity – from the individual to the largest organisation. Inadequate
accounting records can cause personal hardship and, in the case of business, failure of the
enterprise.

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• Accounting provides information by recording, processing and then reporting and

­interpreting business transactions and events. This information is generally measured
and expressed in monetary terms.
• Accounting communicates information to interested parties such as owners and managers.
Such information can be derived from past records or future forecasts. Using this information,
decisions can be made and action taken that is considered necessary. The important aspect
here is the communication of the information provided by accounting. Once this information
has been communicated to individuals in their personal capacity, or to individuals working in
­business, appropriate decisions can be made. For example, information on cash balances means
that appropriate decisions on purchases or investment can be made. As a society, though, we
should encourage businesses in their decision making to balance the goal of financial success
with social responsibilities.

Objectives of accounting
The main aim of accounting is to assist in the governance of an organisation. Organisational governance
(or corporate governance) is a broad term that refers to the overall management and operational controls
in existence within an organisation.
To assist corporate or organisational governance, accounting communicates business and economic
information to various interested parties. These interested parties who wish to use accounting information
can be classified into two groups: internal users and external users.
• Internal users include all levels of management and other governing bodies of an organisation.
–– Management and other governing bodies, such as executives of clubs and boards of directors,
are continually making decisions on various aspects of the operation of the organisation, such as
financing, personnel, production and marketing.
• External users include investors and other resource providers, and government departments and
other parties performing a review or oversight function.
–– Investors and other resource providers, such as creditors, lenders, employees and suppliers, are
particularly interested in the organisation’s performance and financial position. They wish to evaluate
how efficiently and profitably management and the organisation have used the resources entrusted to
them. They will be interested in such things as financial stability and returns on investments.
–– Governments and other parties performing a review or oversight function, such as the Australian
Taxation Office and the Australian Bureau of Statistics. Labour unions, the media and special
interest groups (including environmental and consumer groups) are also interested in information
from the organisation, to see if it is complying with external requirements and meeting social
obligations.
The form the communication takes depends on the information to be conveyed and the type of user
of the information. Internal users may receive information in the form of emails, memorandums, letters,
dashboards, short specific-purpose reports, or more formal accounting reports such as Statements of
Profit or Loss and Statements of Financial Position. External users usually receive formal accounting
reports, especially Statements of Profit or Loss, Statements of Financial Position and Statements of
Cash Flow. These are referred to as general purpose financial reports. Most accounting reports are
comprised of columns of figures. However, accountants now usually add written sections, graphs,
tables, photographs or illustrations and so on to make them more readable. Even so, most accounting
reports are quite difficult to read and interpret properly, and require some knowledge of accounting and
business. Summarising is a useful technique that assists interpretation (see page 11).

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What accountants are trying to do in terms of the governance of an organisation can be expressed in
three main objectives or functions:
• to provide information for decision making
• to assist in discharging accountability
• to help evaluate performance.
To achieve these three objectives, information must be provided to users to allow judgements to be
made concerning matters such as:
• performance in using resources efficiently
• the financial position or condition of the reporting entity
• financing and investing activities undertaken
• compliance with external requirements, such as the law and government regulations.

Information for decision making

As we can see above, decisions concerning the efficient acquisition and allocation of economic
resources will be made by all levels in business organisations, and by many individuals and groups in
society. Each of these will face varying degrees of uncertainty. Relevant, reliable, cost-efficient and timely
information will help to reduce that uncertainty, and allow better decisions to be made.
General purpose reports, such as Statements of Profit or Loss, Statements of Financial Position and
Statements of Cash Flow, allow decisions to be made by management and by external users, such as
potential investors, who will make decisions about investing their resources in an organisation based on their
estimation of its continued profitability, financial stability and ability to pay good returns on money invested.
Special purpose reports, such as an analysis of sales by product, might point to poorly performing
products that could be deleted from a product list, or to high performers that warrant expenditure on more
production and marketing resources.

Discharging accountability
The second main function of accounting is to assist in discharging accountability. Accountability in general
means being held responsible to another (usually higher) authority for actions carried out. For accountants,
this is translated to mean responsibility to provide information to enable users to make informed judgements
about the performance, financial position, investment activities and compliance of the reporting entity.
In practice, this concept refers mainly to the accountability of the management or other governing
body in meeting their responsibilities to owners in terms of performance, organisational control and
other governance issues. Accountability also refers to employees and to the organisation as a whole. All
employees are accountable to management. They have responsibilities to do their jobs efficiently and
honestly. The organisation is accountable to governments, various other bodies, and even society as a
whole. It has responsibilities for meeting legal and other expectations, and in general for having ethical
dealings with all those affected by it.
Accounting provides much of the information necessary to allow judgements to be made about
whether responsibilities have been met and accountability discharged. Thus, reports will address not
only general management accountability for using resources entrusted to them to run the organisation
profitably by, for example, making good investment decisions, but also such concerns as the health and
safety of employees and the organisation’s environmental policy. This is done either in special purpose
reports or in specific parts of general purpose reports.

Evaluating performance
General purpose reports will allow an evaluation of the performance of management in using resources
efficiently, earning profits, achieving financial stability and so on. Special purpose reports will allow the

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performance of individuals and groups within the organisation to be evaluated by management or interested
external users. For example, an analysis of sales by salesperson and product would allow the marketing or
sales manager to evaluate the performance of salespeople and teams; or an analysis of overdue amounts owing
to the organisation might allow judgements to be made about the credit manager and credit department staff.
To aid such evaluations, accounting reports often compare budgeted or planned figures with actual
results, so that exceptions and variations from expectations are highlighted. Performance can then be
judged against these expectations or targets. Reports might also be prepared on a comparative basis (that
is, by providing figures for two or more years), to allow comparisons and analysis of trends over time, and
to enhance comparisons of performance with competitors and industry averages.

Language and communication

Summarising
Purpose
A summary is a brief version in your own words of the main facts and ideas that are addressed in
detail in a piece of written or spoken material. Its purpose is to save time or space by conveying only
the chief points of the more lengthy original.
Setout
A summary would be written in complete sentences and paragraphs. Important points may be
highlighted in bold or marked with a highlighter. If it is a long piece of material, it may have section
headings.
To make a summary you would follow these steps:
• Read or listen to the material carefully, so that you understand the message being conveyed.
• Make notes of what you consider to be the important parts.
• Rewrite the main ideas and points in complete sentences in your own words.
• If necessary, redraft to ensure an appropriate length and to convey the main ideas clearly.
Example
A three-page article from a professional accounting magazine might be summarised down to three
paragraphs in the following way:

Skills needed by the modern accountant

A modern accountant must be able to do more than just work with figures. In order to carry out
the functions of communicating information to interested parties for decision making, evaluating
performance and establishing accountability, accountants must develop all aspects of their
language and communication skills.
They must be good at both collecting and presenting information. They must select appropriate
information, then carefully consider their audience and the purpose of the communication in order
to decide on an appropriate form. Sometimes, as in the case of a client–consultant situation, oral
communication skills may be necessary. In other situations, written communication in the form of
a memorandum, letter or written report may be more appropriate.
In addition, many circumstances require accountants to work as part of a team, and within
agreed timeframes, to help achieve organisational objectives. This means that modern accountants
will also need interpersonal skills, such as active listening, negotiation and persuasion, as well as
skills in time management.

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1.4
Compare the definition of accounting given here with definitions given in other accounting texts. In
what ways are they similar? In what ways are they different?

1.5
In assisting with corporate or organisational governance, modern accounting has a number of objectives
or functions. List and describe these.

1.6
It is often said that the basic objective of accounting is to provide information that will assist in decision making.
Discuss this statement with reference to the people who make decisions and the kinds of decisions made.

Forms of business organisations

Although accounting can be used by many different people and organisations, this text focuses mainly
on how it is used in business organisations. There are many ways of classifying business organisations.
One way is according to the type of activity they engage in – retail, service or manufacturing, for example.
Another useful method of classification from an accounting point of view is by ownership type. The main
types of business ownership are sole traders (sole proprietors), partnerships and companies.

Sole traders (sole proprietors)

A sole trader is a one-person business where the one owner supplies most of the funds to commence the
business, runs the business, is responsible for its debts, and takes all the profits and bears all the losses.
Although it is regarded as a separate accounting entity under the accounting entity assumption (which
states that the business is accounted for separately from the owner, see page 28), the business is not
regarded as a separate legal entity. Thus the owner’s private possessions may be sold to pay the debts of
the business, and the owner is therefore said to have unlimited liability. Sole traders may work in the
business by themselves or may employ workers.
The popularity of this type of business enterprise no doubt stems from the fact that the owner is his or
her own boss. The growth of the business is limited by the owner’s personal wealth and capacity to raise
funds and, unless this is considerable, it usually places limits on the business’s ability to grow. The type of
business conducted is limited by the following:
• Law: A sole trader cannot operate a bank, a building society or an insurance firm.
• Licence: It is necessary to obtain a licence to engage in certain types of business activities, such as
running a taxi service or a hotel.
• Qualifications: Certain professions require the possession of suitable qualifications before their
practice can be commenced, such as doctors, lawyers, dentists, pharmacists and accountants.
A further requirement is that if the owner does not operate the business under his or her own name, the
business name must be registered before the sole trader can commence operations. For example, if Giorgio
Salvatore wished to open a pizza delivery business and trade as Salvatore’s Pizza, then this business name
would need to be registered. However, if he wished to trade as Giorgio Salvatore, this would not require
registration, as it is his own name.

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Businesses not affected by the above restrictions can be commenced by a sole trader without official
permission or legal formalities. Because it is not a separate legal entity, the business is not subject to tax,
but the owner must pay tax on the business’s profits.

Partnerships
A partnership is formed when two or more people (usually not more than 20) join to operate a business.
The business formed is not regarded as a separate legal entity. Thus the owners are jointly liable for
the debts of the business, and their personal possessions may be sold to pay for such debts. Like sole
traders, each partner is said to have unlimited liability. The Partnership Act, or an agreement drawn up
between the partners, governs the way in which the partnership will operate and be managed, and how
responsibilities and profits will be shared. A partnership does not pay tax but must complete a tax return,
and the tax is paid by the individual partners.

Companies
Companies are bodies formed to overcome the disadvantages of the sole trader and partnership forms of
business organisation. In general, such organisations are controlled by the various requirements of the
Corporations Act 2001. Although they can be formed with only one shareholder, companies usually have
a larger number of owners or shareholders who, by law, are regarded as separate from the company. The
company is a separate legal body and is responsible for all its debts. The owners are said to have limited
liability because they are liable for the debts of the business only to the extent of the amounts unpaid on
their shares. This means their personal possessions are safeguarded to the extent of this limit if the company
should amass debts it is unable to meet. The shareholders are entitled to a share of profits, as a return on
money invested, called a dividend.
Two of the more common types of companies are private companies and public companies. Private (or
proprietary) companies are often family concerns and, under the Corporations Act, must be distinguished
by the words ‘Proprietary Limited (Pty Ltd)’ after their name. Public companies invite ownership, and
obtain share capital and loans, from members of the public. They thus have the potential to be very large
business organisations. They have the word ‘Limited (Ltd)’ after their name. As they are a separate legal
entity, companies pay tax in their own right at the company tax rate.

Non-profit organisations
Sole traders, partnerships and companies usually exist to make a profit. Non-profit or not-for-profit
organisations are organisations whose primary motive is to provide a focus and services for people with
common interests (e.g. religious, sporting or recreational), or to carry out charity work.

Public sector organisations

Public sector organisations do not exist for the purpose of making a profit but to provide the citizens of the
country with various services. These organisations operate at the federal, state and local levels, providing
transport, power and other public services to the community.

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Trusts
A trust is a legal arrangement whereby assets such as money and property are transferred to the control of
trustees to administer for the benefit of beneficiaries. The trustees control the assets. The beneficiaries
benefit from the assets but cannot control them. Property trusts and unit share trusts allow the pooling of
large amounts of funds for investment purposes and control by specialist managers.
In this text we concentrate mainly on accounting for sole traders, but will also touch on partnerships
and companies. We will give most attention to organisations that engage in trading and service activities.

1.7
What is the meaning of the term ‘unlimited liability’?

1.8
Discuss the main types of business ownership, mentioning the advantages and disadvantages of each type.

The accounting profession in Australia

Accountants now have a wide variety of career paths open to them. They can be employed by private
businesses, as accountants or financial controllers; or work as public accountants, providing independent
professional services to the public, as auditors, advisors, tax accountants and so on; or in government and
institutional bodies, preparing reports and ensuring that laws and regulations are followed. The role of the
accountant has changed and will continue to change because of technological advances and the emergence
of new areas of specialisation.
Some of the more common areas of specialisation are:
• cost accounting • financial planning
• government accounting • international accounting
• taxation • management advisory services
• budgeting • forensic accounting
• company accounting • auditing
• e-business • design of accounting/information systems
• insolvency • finance.
As with most professions, the accounting profession has associations that exist for its advancement
and for the benefit of its members. In Australia, the three largest associations are:
• CPA Australia
• Chartered Accountants Australia and New Zealand (CA ANZ)
• Institute of Public Accountants (IPA).
CPA Australia and CA ANZ cater primarily for members who have tertiary qualifications. The IPA
caters for accounting practitioners who are recognised for their practical and hands-on skills, although
they do also have members who have tertiary qualifications.
One of the main tasks of professional associations is to set standards of performance and ethical conduct
for their members. They also represent accountants in negotiations and consultations with other bodies.
Professional accounting associations have entry qualifications and aim to keep their members up to
date with new developments by producing journals and offering professional development seminars.
They also make pronouncements on what is considered to be good accounting practice, and accountants
who are members of these professional bodies are expected to abide by them. Consequently, these
pronouncements have had a significant effect on the development of accounting.
Pronouncements take a number of forms. The main form is Accounting Standards.

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 CHAPTER 1: The accounting environment 15

Accounting Standards are set by the Australian Accounting Standards Board (AASB), under the
oversight of the Financial Reporting Council (FRC). On 1 January 2005, Australia adopted International
Financial Reporting Standards (IFRS), which the AASB renumbered according to the Australian
numbering system. There is a view that the adoption of international accounting standards facilitates the
flow of capital across national borders, benefiting both investors and companies. Some of the common
Accounting Standards are:
• AASB 101 Presentation of Financial Statements
• AASB 102 Inventories
• AASB 107 Statement of Cash Flows
• AASB 116 Property, Plant and Equipment.
Accounting practice and reporting are also heavily influenced by requirements of the Corporations
Act 2001, the Australian Securities and Investments Commission and the Australian Stock Exchange.

Role of the auditor

An auditor is an accountant who is registered to perform company audits. There are two types of auditors
who perform different roles in organisations. One is the internal auditor and the other is the external
auditor.
An internal auditor is employed by the organisation to ensure that correct processes are being
followed within it. Most large organisations would have internal auditors.
The more common type of auditor is an external auditor.

An external auditor is an independent person who is called upon to express an opinion that a
company’s financial reports provide a ‘true and fair’ representation of its financial status.

The auditor provides a report to the company’s shareholders. The audit report:
• states the company being audited and the period for which the audit occurred
• states if the financial reports are in accordance with the Corporations Act 2001 and relevant
accounting standards
• contains an opinion that the auditor is satisfied that the financial statements present fairly the results
of operations and cash flows and the financial position
• states that the auditor has met the standards of being independent from the company being audited.
In most instances a clean audit report is the norm. The reason for this is that if the auditor has any
major concerns, he or she will usually take these matters up with the management of the organisation
before issuing their report, thus providing an opportunity for management to rectify any major issues.
The purpose of an external audit is to add credibility to the reports presented by the directors of the
company to the shareholders.

1.9
a What is the aim of an audit report?
b What does a typical audit report comment on?

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16 ACCOUNTING: AN INTRODUCTORY FRAMEWORK UNITS 1&2, 4E

1.10
Research question
It is often said that there is an ‘expectation gap’ in auditing. An expectation gap is the difference between
the roles that an auditor performs and what the shareholders expect of an auditor. Research this issue
and prepare a report on this expectation gap.

Real-world application
The ‘big four’
Public accountants work on a fee-for-service basis with a variety of clients, mainly preparing
income tax returns and providing financial and other business advice. To be a Certified Practising
Accountant (CPA) or a Chartered Accountant (CA) they must pass examinations and have the
required amounts of experience in accounting. The ‘big four’ firms in this area of public accounting
and consulting in Australia are:
• Deloitte
• Ernst & Young
• KPMG
• PricewaterhouseCoopers.
Most of these firms are established as partnerships. While partnerships in most areas of business
can have only 20 members, partnerships in areas such as accounting and banking can have up to 100
partners. In recent times there has been a movement towards mergers, amalgamations and takeovers
of accounting firms, so the biggest firms in the industry are becoming even larger and more global
in nature.

1.11
Write a short paragraph on the accounting profession. Name the main accounting bodies in Australia,
the entry qualifications required to join them and the publications they produce.

1.12
Go to the AASB website and make brief notes on current media releases, lists of standards, current
knilbeW exposure drafts, and any interesting points you find in other sections.
AASB website

1.13
Investigate the career possibilities in accounting available to graduates from high school, TAFE and
tertiary institutions. Prepare a poster to illustrate the possibilities.

1.14
Investigate the requirements for becoming a CPA or CA. What are the requirements for other
types of accountants and for joining professional accounting associations? If possible, invite a
CPA or CA (possibly from one of the ‘big four’ firms) to give a guest lecture on his or her work,
career and firm.

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 CHAPTER 1: The accounting environment 17

Language and communication

Note taking
Purpose
Notes are used to record information and relationships from written or spoken material, and from
observed data. They assist with research, aid memory, and enable quick and easy reference for later
tasks or tests.
Setout
There are two main styles of notes:
• outline notes
• mind maps or concept notes.
Outline notes are the most common type of note. They are brief, structured notes in point form,
with the main ideas or points listed closest to the left margin and related points indented below, one
to a line. They can be handwritten or prepared on a computer for easy editing and additions.
Here are some points to help you record good outline notes:
• Remember to copy down all bibliographic details of your source – author, title, place of
­publication, publisher and year of publication.
• Survey or skim read to understand the pattern of ideas and to select relevant paragraphs.
• Rule a wide margin or leave space to record page numbers or other supportive references, or to
note aspects to be explored further.
• Use the main headings in the material as your headings, then select key sentences with the
­central idea from each paragraph to become subheadings.
• Use other sentences in the paragraph to provide examples, and related points and ideas, to be
listed down the page, one idea per line.
• Use appropriate abbreviations to save time.
Mind maps, sometimes called concept maps or semantic webs, show a pattern of ideas or concepts
in chart form. They help to develop and demonstrate understanding, and to assist in memorising.
From a central main concept or idea, sets of radiating ideas or sub concepts are built up in adjacent
connected boxes or other geometric shapes.
A good idea is to put the main concept in a shape that will help you remember how many other
concepts or points surround it. If there are three subconcepts or points, a triangle would be appropriate.
A square or rectangle would indicate four subconcepts or points, a star five, and so on.
Example
A mind map of the section on the objectives of accounting could look like this:

decision making

Objectives
of accounting:
providing information for

discharging accountability evaluating performance

This mind map could be extended by linking further points or concepts to each box.

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18 ACCOUNTING: AN INTRODUCTORY FRAMEWORK UNITS 1&2, 4E

Factors impacting accounting

As accounting is used to communicate financial and other information to interested parties, it is vital that
the profession keeps pace with the needs of those it serves. Accountants and accounting do not operate in
a vacuum. The business environment is constantly changing, and accounting policies and practice must
change also.

Historical development
Accounting is a very old profession and was well known to the early civilisations of the Egyptians, Greeks
and Romans. In its earliest form, accounting performed a stewardship function; that is, it was concerned
with protecting the owner’s interests through the collection of business facts and figures. After the fall of
the Roman Empire, accounting, along with the other arts, suffered due to the decline in international trade.
However, the re-emergence of the arts and international trade during the Renaissance period, around the
fourteenth century, brought with it a major development in accounting – the double-entry bookkeeping
system. Double-entry bookkeeping is considered to date from at least 150 years prior to 1494, the year
in which Luca Pacioli, a Franciscan monk, published the first printed work on mathematics. It included
a section on double-entry bookkeeping and commercial practice in Venice at that time. The first known
use of double-entry bookkeeping appears to have been in the Genoa Commune Accounts of 1340. Some
authors report the existence of evidence that bookkeeping was known and practised prior to that date.
Financial statements made an appearance in the fifteenth century when the Medici Bank in Florence
required its branches to prepare balance sheets on an annual basis.
The Industrial Revolution, from the mid-eighteenth century, provided the impetus for far-reaching
changes that have taken place in the organisation and form of business ownership. Organisations required
more capital to finance the large amount of machinery and equipment needed for increased production,
and the form of ownership therefore changed from individual to collective.
These changes resulted in larger organisations and the advent of companies as a form of business
organisation. The increase in collective ownership meant that legislation had to be enacted to protect
investors. This led accounting to adapt and add to its stewardship function. Accountants were now
required to report information to shareholders and other parties outside the business. Such accounting,
which results in the presentation of reports to external users, is called financial accounting.
The increase in the size of organisations also made it impossible for management to keep in touch
with all that was going on – hence the ‘managerial role’ of the accountant evolved. It became extremely
important for the accountant to give management information about the firm to aid them in their decision-
making, planning and control processes. Such accounting is called managerial accounting.

Legal factors
Government agencies play a role in accounting regulation. Their influence can be seen through the
Corporations Act (administered by the Australian Securities and Investments Commission), tax law,
partnership law and other relevant legislation. Under the law, accountants must also adhere strictly to
good practices as set out in various Accounting Standards, some of which are listed on page 15.

Economic factors
We have already seen that the main purpose of accounting is to supply information to interested parties
to enable them to make economic decisions. Regardless of whether the information is being supplied to
management or to those outside the firm, the accountant must be able to interpret the information in
light of economic trends to enable wise decisions to be made. Economic factors and trends to be taken
into account include the value of the dollar, supply and demand, and government policies. For example,

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 CHAPTER 1: The accounting environment 19

an accountant in an export-oriented industry would have to consider commodity prices, exchange rates,
interest rates and other relevant items.

Technology trends
Many advances are currently being made in technology to speed up the accounting process, reduce
cost and add reliability and accuracy. In addition, technology is having a marked impact on particular
aspects of accounting. The introduction of scanners has enabled better inventory control to occur.
Computer packages and the use of other software packages, such as spreadsheets and databases, have
revolutionised the way accounting is practised. E-business has revolutionised the way many businesses
communicate and do business with each other. Further marked developments in this field will occur in
the future.

Ethical considerations and business conduct

In recent times, some businesses and entrepreneurs, both in Australia and overseas, have fallen into
disrepute for unethical conduct and practices. Such conduct and practices have sometimes resulted in an
inflation of reported profits, a reduction of taxes paid to governments, and large losses to creditors and
shareholders. The accounting profession, through its accounting and auditing standards, can play a large
part in helping to stop such practices and rid business of a largely undeserved reputation.
In addition to helping ensure the ethical conduct of business people, accountants themselves have
their own code of ethics. In all responsible professions there is a code of ethics that members are expected
to follow. Both CPA Australia and the CAANZ will expel members for breaches of their ethics. The
code of ethics includes such matters as dealing honestly with all parties, not making use of information
gained from clients for personal gain and not breaching the confidence of clients.

Real-world application
Business ethics – the case of Enron
Enron was a US energy trader that misrepresented its value to shareholders over several years.
It collapsed in December 2001 with the loss of 11 000 jobs, USD800 million in retirement funds and
USD68 billion in investments. Employees were sent to prison and its accounting firm, Arthur
Andersen, one of the world’s largest, collapsed. According to Time magazine, the price of an Enron
share fell from USD75.09 on 20 February 2001 to USD0.26 on 2 December 2001.
Watch the videos by following the weblink and consider the important role of corporate culture
to the success of businesses, employees and society at large. Weblink
Corporate
culture – Enron
Sources: Enron scandal’s victims, ABC video, 25 May 2006, <http://abcnews.go.com/Archives/video/25-2006-enron-
scandals-victims-9129255>; ‘Behind the Enron scandal: chronology of a collapse’, Time, <http://content.time.com/time/
specials/packages/article/0,28804,2021097_2023262_2023247,00.html>.

Demand for diversity of accounting services

Accountants now offer a great diversity of services to individuals, as well as small and large businesses.
They do this through direct employment, auditing and taxation work, and a range of consultancy and
advisory services. Accounting services have expanded and become better tailored to particular segments
of business and society. There are now firms that specialise in providing services to governments, retirees,
the rural sector and other specific-interest groups.

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 20 ACCOUNTING: AN INTRODUCTORY FRAMEWORK UNITS 1&2, 4E

Interesting accounting fact

Did you know?
Accountants play a prominent role in the Academy Awards
Every year since 1935, a group of CPAs from a major accounting firm count and verify by hand
the Academy Awards ballots. They are also responsible for safeguarding the ballots and keep-
ing the results top secret until the winners are announced.
The CPAs used to hand-deliver the envelopes containing the names of the winners on stage
in front of the cameras, but this is now done offstage.
What is the name of the accounting firm used by the Academy?
knilbeW
Law Newz – Source: Law Newz
Academy Awards

Language and communication

Research
Purpose
The verb ‘to research’ means to investigate or enquire in order to gather or discover data and
information to apply to some task or problem. Such a task might be to write a report or an assignment,
or to prepare for an examination.
Sometimes the research topic or question is provided for you. Sometimes you must choose your
own.
Setout
Setout will vary according to the purpose or task. This might require a formal written report to be
prepared from research notes. It might require an oral report, supported by data show slides or a
brief handout. Or it could require only outline notes to be used for later reference and examination
preparation.
These are the usual steps involved in research:
• Plan the task. Ensure that you know exactly what you need to research. Consider all possible
sources of information or data, including library materials, interviews and onsite observation,
and fact finding.
• Gather the information. This would usually take the form of notes, quotes and statistics, with
accompanying bibliographic details of sources.
• Evaluate the material collected. Judge its validity, and try to ensure that it will enable you to
answer the question or carry out the task required.
• Write a draft of your answer from your notes. This would normally be planned in outline
form, then expanded into proper sentences and paragraphs, designed to satisfy the require-
ments of the audience and purpose intended.
• Prepare a final draft. Ensure that you use appropriate setout, spelling, grammar, terminology
and so on. To enhance your presentation, include any necessary graphical material, statistics,
appendices and a bibliography.

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 CHAPTER 1: The accounting environment 21

1.15
State and briefly explain several factors that have significantly affected the development of accounting.

1.16
Research the history of accounting and write a report. Be prepared to highlight key points in a brief
verbal presentation, assisted by a handout or data show slides. Ensure your report is well set out and
properly referenced from all sources used, including the Internet.

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 22 ACCOUNTING: AN INTRODUCTORY FRAMEWORK UNITS 1&2, 4E

REVIEW AND REFLECT

This chapter introduced the discipline of accounting by examining the environment in which it operates.
It showed how the accounting profession is organised, and examined the objectives or functions of
accounting, and the factors that have impacted on its development. It also introduced the types of
business organisations that use accounting information.

1.17 Chapter summary

Complete the following questions and you will have a brief summary of the work on the accounting
environment covered in Chapter 1.
a What is accounting?
b What are the main objectives or functions of accounting?
c Name the main parties interested in accounting information.
d What are the main types of business organisations that use accounting information?
e Name the three main professional accounting bodies in Australia, and describe some of their
activities.
f List five factors affecting the development of accounting.

1.18 Financial reporting case – Woolworths Limited

In Australia there are millions of people who have invested in shares in public companies. To provide
them with information and to assist them with decisions about their investments, companies are required
to send reports to shareholders on a regular basis. On NelsonNet, you will find a link to the annual
reports section of one of Australia’s largest public companies – Woolworths Limited. Woolworths is a
leading retail company, with more than $22.9 billion in assets, more than 202 000 employees, and over
429 000 shareholders in 2017. These reports provide details concerning results for the company itself
(the accounting entity), and for the consolidated group (the company plus other companies/subsidiaries
which it controls). At the end of appropriate chapters we will provide you with some questions and
activities that will help you analyse and understand these reports.
Follow the weblink to the annual reports for Woolworths Limited.
Answer the following questions relating to Woolworths Consolidated Limited for 2017.
a How many sections are there in the annual report of Woolworths Limited? Name and describe the
contents of each section.
b For what period of time is this report presented?
c What people other than shareholders would be interested users of the information in the report?
knilbeW
Woolworths d What activities does Woolworths engage in?
Limited annual e What is the role of the Board of Directors?
reports
f What does the report have to say about ‘corporate governance’?
g Has Woolworths achieved well in the 2016–17 year? Give some examples to support your answer.

1.19 Communication case

Read the article on pages 23–24 and answer the questions that follow.

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 CHAPTER 1: The accounting environment 23

Roles and Importance of Professional Accountants in Business

Professional Accountants in Business – A Varied Profession
When asked what accountants do, responses often mention roles such as tax agents and independent
auditors. The functions performed by the vast number of professional accountants who work in
businesses are often forgotten and not well understood.
What do the independent director, the internal auditor and the chief financial officer of companies
all have in common? The individuals in these positions could all be professional accountants working in
businesses. Besides these roles, professional accountants take on a vast array of other roles in businesses of
all sorts including in the public sector, not-for-profit sector, regulatory or professional bodies, and academia.
Their wide-ranging work and experience find commonality in one aspect – their knowledge of accounting.
The importance of the role of professional accountants in business in ensuring the quality of
financial reporting cannot be overly emphasized. Professional accountants in business often find
themselves being at the frontline of safeguarding the integrity of financial reporting. Management is
responsible for the financial information produced by the company. As such, professional accountants
in businesses therefore have the task of defending the quality of financial reporting right at the source
where the numbers and figures are produced!
Like their counterparts in taxation or auditing, professional accountants in business play important
roles that contribute to the overall stability and progress of society. Without public understanding of all
these diverging roles and responsibilities of different accounting specialists working in business, public
perceptions of their value may be misinformed.

Roles of Professional Accountants in Business

A competent professional accountant in business is an invaluable asset to the company. These individuals
employ an inquiring mind to their work founded on the basis of their knowledge of the company’s
financials. Using their skills and intimate understanding of the company and the environment in which
it operates, professional accountants in business ask challenging questions. Their training in accounting
enables them to adopt a pragmatic and objective approach to solving issues. This is a valuable asset
to management, particularly in small and medium enterprises where the professional accountants are
often the only professionally qualified members of staff.
Accountancy professionals in business assist with corporate strategy, provide advice and help
businesses to reduce costs, improve their top line and mitigate risks. As board directors, professional
accountants in business represent the interest of the owners of the company (i.e., shareholders in a
public company). Their roles ordinarily include: governing the organization (such as, approving annual
budgets and accounting to the stakeholders for the company’s performance); appointing the chief
executive; and determining management’s compensation. As chief financial officers, professional
accountants have oversight over all matters relating to the company’s financial health. This includes
creating and driving the strategic direction of the business to analyzing, creating and communicating
financial information. As internal auditors, professional accountants provide independent assurance
to management that the organization’s risk management, governance and internal control processes
are operating effectively. They also offer advice on areas for enhancements. In the public sector,
professional accountants in government shape fiscal policies that have far-reaching impacts on
the lives of many. Accountants in academia are tasked with the important role of imparting the
knowledge, skills and ethical underpinnings of the profession to the next generation.

Protectors of Public Interest

A description of the multifaceted role of professional accountants in business is not complete without
discussing the duty that the profession owes to the general public. As a profession that has been

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24 ACCOUNTING: AN INTRODUCTORY FRAMEWORK UNITS 1&2, 4E

bestowed a privileged position in society, the accountancy profession as a whole deals with a wide
range of issues that have a public interest angle. In the case of professional accountants in business, not
only must they maintain high standards but they also have a key role to play in helping organizations
to act ethically.
Closely linked to the protection of public interest is the notion that public accountants need to be
trusted to provide public value. Accountants will lose their legitimacy as protectors of public interest if
there is no public trust. The accountancy profession has a wide reach in society and in global capital
markets. In the most basic way, confidence in the financial data produced by professionals in businesses
forms the core of public trust and public value.

Competing Demands
Ethical codes for professional accountants globally compels them to uphold values of integrity, objectivity,
professional competence and due care, confidentiality and professional behaviour. However, competing
pressures can put professional accountants in challenging and often times difficult situations. These
conflicts revolve around ethics, commercial pressures and the burden of regulation.
Situations may occur where professional accountants in businesses are expected to help the
organization achieve certain financial outcomes. In some of these cases, the required action may risk
compromising compliance with accounting and financial reporting rules. Professional accountants in
businesses encounter tension in these situations. As an example, accountants in organizations may face
pressures to account for inventories at higher values or select alternative accounting methods which are
more financially favorable to the company. However, these actions may be contrary to what are allowable
in the accounting standards or to what the professional accountant may feel comfortable with.

Evolving Role in an Evolving Environment

Like other professions, professional accountants are increasingly challenged to demonstrate their
relevance in the capital market and their ability to evolve and face new challenges. Public expectations
are high. The value of professional accountants will be measured by the extent to which they are
perceived to be accountable not only to their own organizations but more importantly to the public.
Professional accountants in business are a key pillar in organizations helping to create and sustain
value and growth. Their ability to continue to fulfill these roles in the face of constant environmental
changes is vital to their continued relevance. Professional accountants in business are also the front
runners when it comes to upholding the quality of financial reporting and providing the broader public
with reliable financial information.
This text is an extract from ‘Roles and Importance of Professional Accountants in Business’ of the PAIB Committee, published
by the International Federation of Accountants (IFAC) in October 2013, and is used with permission of IFAC. Such use of IFAC’s
copyrighted material in no way represents an endorsement or promotion by IFAC. Any views or opinions that may be included
in Accounting an Introductory Framework Units 1 & 2 are solely those of Cengage Learning Australia Pty Ltd and do not express
the views and opinions of IFAC or any independent standard setting board associated with IFAC.

a Name some of the different types of businesses that accountants work in.
b What is the common thing that all professional accountants find themselves doing irrespective of
which type of organisation they work in?
c List some of the ways that accountants assist their businesses.
d How do accountants protect the public interest?
e How will the public judge the value of professional accountants?

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 CHAPTER 1: The accounting environment 25

1.20 Research case

Write a brief report on any topic from this chapter by using the Internet for research.
You will find some websites on NelsonNet where you may like to start your investigation. Weblink
Research case
Using search engines such as Google and Bing, you will probably find additional useful sites to assist you
with research in many of the later chapters. Create bookmarks of useful websites so that you can refer
back to them as needed.

1.21 Group communication

There are many groups that have an interest in the financial reports of a business. Brainstorm why each
of the following groups would be interested in such financial reports:
a employees
b management
c customers
d present owners
e trade unions
f potential creditors
g Australian Bureau of Statistics
h general public
i bankers.

1.22 Group communication

Set up two teams to debate the proposition that ‘a public accountant’s primary and only duty is to serve
the interests of his or her client’.

1.23 Research and communication case

Your local area will have many examples of business organisations. Make a list of 10 of these, including
at least two non-profit organisations. Classify each organisation as service, retailing, manufacturing or
‘other’, such as mining or rural. Indicate the type of business ownership involved in each. Draw up a
chart to summarise your findings.

1.24 Research and communication case

Most businesses start off small. Coca-Cola, started by Asa Candler, McDonald’s, started by the two
McDonald brothers, and Subway, started by Fred De Luca, all managed to grow their businesses to
become large companies with branches and subsidiaries throughout the world. One common element of
growth in each of these three companies has been the use of franchising.
Research the concept of franchising. Write a report, clearly showing what is meant by franchising,
the parties involved, its advantages and disadvantages, and how it can be used to establish and grow
business organisations.

Extra questions and activities Ad

Refer to NelsonNet for extra questions on Chapter 1. These questions include multiple choice,
true/false and a selection of other questions and activities. Additional
Extra questions
resources

and activities

9780170401821