Self Help

Accounting for non-accounting students - John R. Dyson & Ellie Franklin

Author Photo

Matheus Puppe

· 107 min read

“If you liked the book, you can purchase it using the links in the description below. By buying through these links, you contribute to the blog without paying any extra, as we receive a small commission. This helps us bring more quality content to you!”



Here is a summary of the key points about the book “Accounting for non-accounting students Ninth Edition”:

  • The book provides a comprehensive yet accessible introduction to accounting concepts for readers without an accounting background. It uses clear language, examples, and questions to explain accounting principles.

  • Some key features include real-world news articles at the start of chapters, examples and key points sections, and self-assessment questions throughout.

  • The ninth edition has been updated with current terminology, financial statement formats, and new contemporary articles and examples. It also covers new topics like fraud.

  • Accounting ratios coverage has been simplified. All company examples use the same company for continuity.

  • The companion website provides additional learning resources for students.

  • The authors have accounting and teaching experience. John Dyson was formerly Director of Studies of the Heriot-Watt University Management Programme. Ellie Franklin is a Chartered Accountant and accounting lecturer.

  • The book covers both financial and management accounting, with case studies included. It aims to equip non-accounting students with essential accounting knowledge.

Here is a summary of the key objectives from the chapters:

Chapter 1:

  • Gain knowledge of basic accounting concepts and principles
  • Understand the purpose of accounting and why accounting standards and rules exist
  • Develop an awareness of the accounting cycle and process

Chapter 2:

  • Learn how to prepare basic financial statements (income statement, balance sheet, statement of changes in equity)
  • Understand year-end adjustments and how they affect financial statements

Chapter 3:

  • Know the roles and responsibilities of accounting standard-setting bodies in the UK
  • Be aware of the key accounting standards and regulations that companies must comply with

Chapter 4:

  • Recognize the different types of entities that exist and how their accounts may differ
  • Grasp the purpose and components of different financial statements

Chapter 5:

  • Understand the structure and contents of company accounts prepared under UK law
  • Be able to analyze and interpret a set of company accounts

Chapter 6:

  • Appreciate how accounts are prepared for different types of entities like manufacturing, services, non-profits, governments

Chapter 7:

  • Learn what a statement of cash flows is and how to prepare one
  • Comprehend the purpose and importance of the cash flow statement

The remaining chapters focus on objectives related to management accounting concepts like budgeting, decision-making, costing methods, investment analysis, and emerging issues. The overall aim is to provide knowledge of both financial and management accounting principles.

  • The book aims to provide non-accounting students with an adequate understanding of accounting to effectively communicate with accountants and do their jobs more effectively, without overly technical details.

  • The book is divided into four parts covering an introduction to accounting, financial accounting, financial reporting, and management accounting.

  • Double-entry bookkeeping is included but can be skipped if not part of the course syllabus.

  • Recent editions have updated chapters on accounting rules/regulations, statements of cash flows, and interpreting financial statements.

  • Contemporary and emerging issues chapters were substantially revised to include the most recent developments.

  • Financial statements discussed use IAS terminology given EU listed company requirements to use IFRS.

  • Students are advised to read chapters multiple times, do in-text activities, and attempt questions to ensure understanding before looking at answers.

  • Studying independently requires dividing topics over available time, repeated reading/practice until fully comprehending each point before moving on.

  • Accounting involves analytical thinking and problem-solving rather than just memorization. Students should focus on understanding principles.

urton Lt made op

erating cash receipts (sales on credit) o

f £300,

000 in 2016.

  • More than simply being good at arithmetic, accounting involves a considerable amount of personal judgment, which means there is an element of subjectivity in decisions.

4 T

  • The examples in the book illustrate real-world issues that are complex and not easily solved. People should therefore treat the suggested answers with caution and question the methodology used.

he comp

any paid £40,

000 for repairs an

d maintenance, £100,

000 for raw material

s, £60,

000 for wages, £10,

000 for advertisin

g and £20,

000 for other overheads.

  • When presented with accounting information in their job, people should subject it to a great deal of questioning, as accounting problems often have no single correct solution.

5 T

he comp

any received a £20,

000 insurance payout after a fire in the warehouse.

6 D

urton Lt bought new m

achinery costing £80,

000 paying £60,

000 in cash and the balance on cre


7 T

he comp

any paid £40,

000 to redeem debentures.

8 D

urton Lt paid £8,000

in interest on the loan from Barclays Bank.

9 T

he comp

any paid a dividend o

f £10,000 to its share


Here is a summary of the key information provided:

ining of this chapter? Test your me

  • Pennine Heating Systems Limited is a sole trader business located in Dewsbury, West

mory by answering these questions:

Yorkshire. It installs central heating systems in residential properties.

  • The business currently uses an absorption costing approach to prepare quotations for
  1. What industry does the new sto


ry relate to?

  • The management is considering whether to adopt a marginal costing approach instead to help win more contracts.
  1. Which countries’ banks are lik

ely to be most impacted by the ne

  • Other factors such as competition and the state of the local housing market also need to w accounting rules?

be taken into account when preparing a quotation.

  1. When do the new rules officia

lly come into force?

This summarizes the key details provided in the case study about the company, Pennine

Heating Systems, and the issues it is considering regarding its costing approach and

  1. What potential action could ba

nks take to soften the impact?

preparing customer quotations. The learning objectives are also outlined.

Here are the key points from the news story:

  • Pennine Heating Systems Ltd is a small heating and ventilation company located in Dewsbury, UK.

  • It provides custom-designed heating and ventilation systems for small businesses. Each system is designed, manufactured and installed separately.

  • The company has expanded rapidly in recent years but overhead costs have continued to rise as well.

  • The managing director, Ali Shah, had always priced contracts based on full absorption costing. This was not an issue when demand was high.

  • Recently, demand has slowed, competitors have emerged, and the economy is in recession. Customers are more price conscious.

  • Pennine still has a good reputation but needs to be sensitive about prices to avoid losing business.

  • Ali asked the production manager, Hugh Rodgers, to cost and price a new quote request using the company’s existing method.

  • This news story provides a brief overview of the company and situation but does not go into many details about standard costing itself. It presents standard costing as a potential strategy for Pennine to consider for pricing contracts in the current economic environment, but does not explain the concept in depth. More information would be needed to fully understand standard costing and determine if it is applicable here.

Here are the key points about the nature and purpose of accounting:

  • Accounting is the process of recording, classifying, summarizing, reporting and interpreting financial transactions and other financial information about a business or other entity.

  • The main purpose of accounting is to provide useful financial information to decision-makers both inside and outside the business. These include managers, investors, tax authorities, creditors, etc.

  • Accounting provides quantitative (numerical) information in the form of financial statements like the income statement, balance sheet, cash flow statement.

  • Financial statements aim to provide an accurate and truthful picture of the organization’s financial position, performance and cash flows.

  • Accounting standards and regulations aim to ensure consistency, comparability and transparency of financial reporting across entities.

  • In summary, accounting exists to measure and report on the financial activities and position of a business in a systematic, standardized way so that informed decisions can be made.

  • Accounting began simply as people counting their assets like farm animals to track their wealth over time.

  • Double-entry bookkeeping was developed in the 12th century to more formally track financial information for traders. By the 15th century it was widely used.

  • Double-entry bookkeeping provided accurate records of financial performance and helped owners and managers operate businesses more effectively by answering questions about profit, liabilities, and assets.

  • During the Industrial Revolution, businesses grew larger and needed to track more detailed cost information for managers as well as financial performance for owners. This led to separate accounting systems for owners and managers that eventually merged using common data.

  • Accounting continues to develop more sophisticated systems to meet the complex information needs of modern large businesses, governments, and other organizations. But it remains grounded in the core principles of double-entry bookkeeping established centuries ago.

  • Accounting has evolved over time to include several branches beyond just financial accounting and cost accounting. There are now considered to be six main branches - financial accounting, management accounting, auditing, taxation, financial management, and insolvency.

  • Financial accounting involves classifying, recording, and presenting financial transactions and balances in financial statements according to accounting standards. It provides information to external users.

  • Management accounting applies accounting principles to support managers in creating and preserving value. It provides internal information for functions like planning, control, and decision making.

  • Bookkeeping is the foundation, involving the mechanical recording of financial data in account books. This allows financial statements to be prepared.

  • Auditing is the examination of an entity’s records, systems, and controls to assess if its financial statements represent a true and fair view. There are external auditors who are independent, and internal auditors who are employed by the entity.

  • Other branches that have developed include taxation, financial management, and dealing with insolvency/bankruptcy situations. Accounting now caters to more users beyond just owners/managers.

  • External auditors examine more than just financial accounts, such as entity’s planning, control procedures, and value-for-money tests.

  • External and internal auditors work closely together but have separate roles. Internal auditors are employees of the entity so may not be fully independent and could be subject to pressures like job security. This casts doubt on the rigor of their work.

  • External auditors also are not completely independent as directors recommend auditor appointments to shareholders, and shareholders usually accept the directors’ recommendations.

  • Taxation accounting is complex and involves calculating tax payable for businesses and individuals. Accountants search for legal means of minimizing tax in a process called tax avoidance, while hiding income sources is illegal tax evasion.

  • Financial management is a newer field involving setting objectives, planning, obtaining finance, and safeguarding resources. It draws on diverse disciplines and uses qualitative data.

  • Insolvency accounting deals with bankruptcies and liquidations, which involve formal legal procedures to protect individuals and wind up companies’ affairs in financial difficulties.

  • The trading sector includes businesses like retailers and wholesalers that buy goods and sell them without major production work. This includes shops, supermarkets, builders’ merchants, etc.

  • The service sector provides intangible services like hairdressing, legal services, TV channels, advertising agencies, hotels, restaurants.

  • Manufacturing involves physical production of goods in a factory.

  • Accounting systems vary slightly between sectors but are based on similar principles. Manufacturing has the most complex accounts.

  • Businesses can be sole traders, partnerships, or companies. Sole traders have unlimited liability while partnerships and companies provide limited liability.

  • Not-for-profit entities like government, charities, social organizations provide services rather than generating profit.

  • Government is divided into central government, local government, and quasi-governmental bodies like the BBC.

  • All entities need accounting for taxes, profits, assets/liabilities, and decision making. Accountants ensure proper accounting practices.

Here is a summary of the key points from the reading passage:

  • It is important for non-accountants working in any organization to have an understanding and appreciation of financial and accounting information. This is because accounting information can benefit both the individual and the organization.

  • Even if someone is not directly involved in accounting functions, they will likely interact with accountants and accounting information in their role. Understanding more about accounting helps these interactions and makes work easier.

  • Some general questions non-accountants could ask their organization’s accountants to gain a better understanding include: How many accountants are employed? What are their different roles and responsibilities? How is the accounting function organized? What information do they need and when? How can managers and accountants work better together?

  • The main purpose of accounting is to provide useful financial information to parties that need it like owners, managers, investors, tax authorities etc. As a non-accountant, having an interest in understanding rather than dismissing accounting information can help work be done better.

  • It is important for non-accounting professionals and managers to have a basic understanding of accounting concepts and financial reports so they can make informed decisions for the organization and appreciate the accountant’s perspective.

Here are some potential rules and regulations that different types of businesses may have to comply with, and the purposes they serve:


  • Health and safety regulations (e.g. regarding food handling, maintenance of equipment, etc.) to protect customers and employees.
  • Accounting standards to ensure accurate financial reporting.
  • Tax rules to properly calculate and pay applicable taxes.
  • Employment laws regarding hiring, wages, benefits, discrimination, etc. to protect employee rights.


  • Financial regulations set by the financial regulatory body (e.g. banking rules, capital requirements, anti-money laundering policies) to maintain stability and integrity of the financial system.
  • Privacy and data protection laws to safeguard customer information and accounts.
  • Accounting standards to ensure transparency of financial position.
  • Tax laws as applicable to the organization.


  • Aviation safety standards set by aviation authorities worldwide to ensure airworthiness of aircraft and infrastructure.
  • Consumer protection laws regarding passenger rights, pricing transparency, refund policies etc.
  • Environmental regulations to reduce pollution and emissions.
  • Competition laws to prevent anti-competitive practices.
  • Labor laws as applicable for employee matters.

In general, rules and regulations aim to: ensure fairness, transparency and accountability in business dealings; protect stakeholders (customers, employees, investors etc); maintain integrity and stability of critical industries; and comply with broader societal expectations on ethical, social and environmental issues. Compliance helps build trust in the organization and long term sustainability of operations.

Accounting rules and regulations serve a few key purposes:

  1. Promote consistency and comparability. By having standardized accounting principles and financial reporting requirements, financial statements are prepared and presented in a consistent manner across companies. This allows for meaningful comparisons between companies.

  2. Protect investors and other stakeholders. Regulatory oversight and enforcement helps ensure accurate and reliable financial reporting. This protects stakeholders who rely on financial reports.

  3. Foster trust and integrity in financial markets. Upholding accounting standards and regulations promotes transparency, ethical behavior, and trust in the financial reporting system. This supports the functioning of capital markets.

Accounting rules and regulations are more prescriptive than accounting principles (like GAAP). Rules lay out very specific requirements and guidelines that must be followed, whereas principles provide broad standards open to some interpretation. Non-compliance with accounting rules can result in regulatory sanctions, whereas principles allow for more professional judgment in application. Overall, both rules and principles aim to achieve the objectives of consistency, comparability, transparency and protection of stakeholders.

  • The Companies Act 2006 is the key piece of legislation governing accounting requirements for limited liability companies in the UK.

  • It classifies companies as small, medium, or large based on turnover, assets, and employee counts.

  • Companies must keep adequate accounting records to show transactions and financial position. This includes daily money records and asset/liability records.

  • Publicly traded companies (PLC) must use International Accounting Standards (IAS) when preparing consolidated accounts.

  • Non-publicly traded UK companies can choose IAS or the Companies Act 2006 plus UK Accounting Standards.

  • The Act gives some flexibility in form, content and terminology compared to earlier acts, leaving some details to the Secretary of State.

  • It covers formation, management, operations including accounting requirements, and financial reporting for limited liability companies. Accounting is in Part 15 but a relatively small section of the large and complex Act overall.

  • Secondary legislation (SIs) allow the Secretary of State to make changes to primary/existing legislation without needing to introduce new bills to Parliament. This enables non-controversial changes to be made more efficiently when circumstances change.

  • The Financial Reporting Council (FRC) is the prescribed body that issues accounting standards in the UK. It was established in 2012 and aims to develop high-quality accounting standards and financial reporting frameworks.

  • The FRC previously issued Financial Reporting Standards (FRSs) but some older Statements of Standard Accounting Practice (SSAPs) still apply to specific topics until replaced.

  • International Accounting Standards are issued by the International Accounting Standards Board (IASB, previously the IASC) to improve global comparability of financial statements.

  • The IASB works closely with national standard setters like the FRC. It issues International Financial Reporting Standards (IFRSs) that over 120 countries now apply or permit.

  • Until 2005, UK standards took priority over IASs/IFRSs but the two bodies worked closely together to improve financial reporting frameworks.

  • The ASB in the UK used to set domestic accounting standards but adopted IFRS in 2005 when the EU mandated them.

  • UK and IFRS standards sometimes addressed different accounting issues and their solutions sometimes differed in level of generality, with IFRS tending to be more principles-based.

  • Both the ASB and IASB took a reactive, issue-by-issue approach rather than having an underlying conceptual framework until developing such frameworks in the late 90s/early 2000s.

  • The frameworks outlined objectives of providing useful financial information to users for decision making, key users, the reporting entity concept, and qualitative characteristics like relevance, reliability, comparability and understandability.

  • They also covered recognition of elements like assets/liabilities and measurement approaches like historical cost.

  • While the frameworks provided structure, they were still principles-based and vague, leaving room for inconsistent application without more prescriptive rules. However, a rules-based approach could incentivize working around rigid rules.

  • This contributed to the difference in the UK/EU favoring principles-based IFRS and the US preferring rules-based standards. Consistent application of principles remains a challenge across diverse regions and cultures.

Here is a summary of the key points regarding immaterial items or errors in financial statements:

  • An immaterial item or error is one that is not significant or relevant enough to impact the understanding or decisions of the intended users of the financial statements.

  • Materiality is determined based on both quantitative and qualitative factors. Quantitatively, an item is immaterial if it is small relative to various financial statement items and metrics. Qualitatively, an item is immaterial if omitting or misstating it would not influence or change the decisions made by financial statement users.

  • Accounting standards provide guidance on materiality but do not establish rigid quantitative thresholds due to the need to consider both quantitative and qualitative factors. Judgments on materiality involve professional expertise and experience.

  • Immaterial items and errors need not be disclosed or corrected in the financial statements. This is because making such disclosures or corrections could overburden the statements with unnecessary information and obscure more important material disclosures.

  • The concept of materiality allows for flexibility in financial reporting by not requiring excessive precision. It recognizes that financial statements are approximations of a business’s financial position and performance. Perfect accuracy is not achievable and not necessary for fair presentation as long as any misstatements are immaterial.

  • Neutrality in financial reporting is important but is balanced against the need for prudence. Prudence gives precedence in situations where neutrality could allow for intentional or unintentional misstatement of financial results. However, prudence should not be used as a justification to override material facts or intentionally misapply accounting policies.

In summary, immateriality allows for flexibility and a balanced perspective in financial reporting, while materiality judgments consider both quantitative size and qualitative importance from the user’s perspective. Neutrality is balanced against the need for prudent financial reporting, especially regarding potentially material misstatements.

Here are the key points about recording data in accounting:

  • Double-entry bookkeeping is the system accountants use to record financial transactions. It recognizes that every transaction has two effects.

  • The accounting equation states that Assets = Liabilities + Equity. It represents the financial position of an entity.

  • Debit means a left-hand entry that increases assets or expenses and decreases liabilities, equity, income. Credit means a right-hand entry that increases liabilities, equity, income and decreases assets or expenses.

  • Ledger accounts are used to record transactions for each item in the accounting equation (assets, liabilities, equity, income and expenses). They have debit and credit columns.

  • A trial balance is prepared by listing all ledger account balances to check that total debits equal total credits. It does not detect all errors.

  • Six types of errors not revealed in a trial balance are: transposition errors, missing accounts, wrong posting references, wrong amounts, including canceled checks/debit notes as expenses.wrong account classification.

  • Understanding accounting concepts and terminology helps non-accountants interpret financial reports, discuss issues with accountants, and assess reliability of information presented.

  • Double-entry bookkeeping has been used for accounting for over 600 years and is now used globally.

  • Three important accounting terms are defined: Assets (resources owned), Capital (amount owners invested), and Liabilities (amounts owed to others).

  • The accounting equation represents the relationship between assets, capital, and liabilities: Assets = Capital + Liabilities. It shows that resources come from either owners’ investments or borrowings.

  • Transactions are recorded twice in a double-entry system to follow the accounting equation. One account is debited and another is credited to show the dual effects.

  • Accounts are kept in ledgers and can be debited or credited. Debit means to receive and credit means to give.

  • Common account types are discussed like capital, cash, purchases, sales, expenses etc. which are all interlinked.

  • Transactions are entered on the debit or credit side of the relevant accounts to increase or decrease the balance. Balances can be debit or credit.

  • At the end of the period, balances are carried forward to start the next period.

Yes, there is something wrong with the abbreviated bank account.

The interest received entry is incorrect. Since the bank account is receiving interest, it should be credited, not debited.

The correct entries should be:






Wages paid



Bank account


When money or a value is received by an account, that account should be credited. In this case, the bank account is receiving interest, so it should be credited for $500, not debited.

Here are the summaries:

(a) cash paid to a supplier - The supplier account would be debited (receives money) and the cash account would be credited (pays money).

(b) office rent paid by cheque - The rent expense account would be debited (spending on rent) and the cash account would be credited (paying with cash).

(c) cash sales - The cash account would be debited (receives money from sales) and the sales revenue account would be credited (earning revenue from sales).

(d) dividend received by electronic bank transfer - The cash account would be credited (receiving money from dividend) and the dividend revenue account would be debited (earning dividend revenue).

So in summary: Debit accounts that receive money or record expenses/assets. Credit accounts that pay out money or record income/revenues/equity.

Here is a summary of the key points from the textbook passage:

  • The passage provides an example trial balance for a business on January 31, 2017. It includes transactions recorded in various ledger accounts throughout January.

  • A trial balance is prepared that lists all the ledger accounts with their debit and credit balances to ensure the accounting equation balances. This confirms the correct recording of transactions.

  • However, a trial balance does not detect all possible errors, such as complete omissions, reversals, entries in the wrong account, compensating errors, etc. These types of errors could still remain undetected.

  • Most businesses now use computerized accounting software rather than manual systems, though the double-entry principles remain the same. Cloud accounting, where records are hosted online, is also gaining popularity.

  • As a non-accountant manager, you do not need detailed accounting knowledge but should understand basic concepts and ensure accurate records are kept to allow for financial statement preparation and meet legal requirements.

  • Key questions for managers to ask about the accounting system and trial balance are identified to verify its integrity and reliability for managerial decision making.

  • N is the carrying out and performance of a particular business activity or event.

  • Double-entry bookkeeping records the two-fold effect of all transactions. For every debit there must be an equal and offsetting credit. This is the basic rule.

  • An account is a record of increases and decreases to a particular item or head like capital, expenses etc.

  • A debit means a transaction is received into an account. A credit means a transaction is given by an account.

  • Debits are entered on the left side and credits on the right side of accounts.

  • Accounts are balanced periodically by preparing a trial balance to check the accuracy of bookkeeping. However, some errors may not be detected by the trial balance.

  • The accounting equation is Assets = Liabilities + Equity/Capital. It must always balance according to the double-entry principle.

Let me know if you need any clarification or have additional questions!

Here are some key points about why this chapter is important for non-accountants:

  • It helps distinguish between capital and revenue items, which is important for correctly reporting profit. This distinction involves judgement that non-accountants should be involved in.

  • It shows how subjective accounting judgements around items like inventory, depreciation, accruals/prepayments, and bad debts can significantly impact reported profit. Non-accountants need to understand these judgements.

  • Cash and profit are not the same - you can make an accounting profit without increasing your cash balance. Adjustments are made to match expenses to the period they relate to rather than when cash is paid. Non-accountants need to understand this difference to avoid cash flow issues.

  • Historical cost accounting has limitations that non-accountants should be aware of, such as not reflecting current values. This impacts how well the accounts represent the true financial position.

  • Preparing and understanding financial statements is important for non-accountants to properly manage finances, make investment decisions, obtain financing, comply with tax obligations, and monitor performance of the business.

So in summary, this chapter provides important context for non-accountants on how and why profit is measured, the subjective elements involved, and why cash and profit differ - which are all critical considerations for managing a business.

  • Profit is not simply the difference between cash received and cash paid. Accountants arrive at profit by making adjustments to the cash position.

  • Capital expenditure provides benefits for more than one accounting period, unlike revenue expenditure which benefits only the current period.

  • The key financial statements prepared are:

  1. Statement of profit or loss (shows income and expenses to calculate net profit)

  2. Statement of retained earnings (shows profit from statement of profit or loss, less drawings, to calculate retained earnings)

  3. Statement of financial position (shows assets, equity and liabilities at a point in time to demonstrate the sources of funding for assets)

  • Adjustments may need to be made to the trial balance before preparing the financial statements, such as distinguishing between capital and revenue items.

  • Retained earnings from the statement of retained earnings need to be included in the statement of financial position to balance it.

  • 4000 is a source of debt funding or borrowing for a business. This refers to long-term loans that are due for repayment more than 12 months in the future.

  • Current liabilities are amounts owed to various parties that will be due for payment within the next 12 months. This includes short-term loans, payables, accrued expenses etc.

  • In a more detailed financial statement, expense items would be grouped (e.g. administrative expenses) and assets/liabilities would be ordered from longest to shortest term. Long-term assets come before current assets. Long-term liabilities before current liabilities. Equity comes last.

  • For the order of balances given in the activity, the order should be: property, plant and machinery, land, furniture and fittings for non-current assets. Cash comes first for current assets, followed by other receivables, trade receivables, inventory, insurance prepaid. For current liabilities, bank overdraft comes first, followed by other payables, trade payables, electricity owed.

  • Year-end adjustments involve allowing for opening/closing inventory, depreciation, adjusting receivables/payables, and provisions for bad debts. Depreciation charges the cost of non-current assets over their useful life using methods like straight-line or reducing balance. This matches the cost to the periods benefiting from the asset.

  • Depreciation is charged equally over the asset’s useful life under the straight-line method, resulting in the same depreciation expense each year.

  • With the reducing balance method, depreciation is higher in earlier years as it is calculated on the reducing net book value (cost minus accumulated depreciation). This results in a higher percentage of the asset being depreciated each year.

  • Non-current assets are shown on the statement of financial position at their original cost (gross book value), minus accumulated depreciation (to get to the net book value).

  • Accruals are amounts owed for expenses incurred in the accounting period but not yet paid. Prepayments are amounts paid for expenses relating to future accounting periods. Both need to be adjusted at the year-end.

  • Bad debts are written off against the statement of profit or loss when deemed irrecoverable. An allowance for doubtful debts is estimated to account for likely future bad debts not yet known.

Here is a summary of the key points from the given information:

  • Trade receivables as at 31 March 2016 were £20,000.

  • Trade receivables as at 31 March 2017 were £33,000.

  • Allowance for doubtful debts as at 1 April 2016 was £1,000.

  • One receivable of £3,000 has been declared bankrupt and will not be recovered.

  • Allowance for doubtful debts is maintained at 5% of year-end trade receivables.

(a) To calculate the required increase in allowance for doubtful debts:

  • Trade receivables at 31 March 2017: £33,000
  • Less specific bad debt of £3,000 = £30,000
  • Allowance required at 5% of £30,000 is £1,500 (5% of £30,000 is 0.05 x £30,000 = £1,500)
  • Less allowance at 1 April 2016 of £1,000
  • Required increase is £500

(b) Statement of financial position extract at 31 March 2017: Trade receivables: £33,000
Less: Allowance for doubtful debts: £1,500 Net trade receivables: £31,500

  • Accounting profit calculated using historic cost accounting is an arbitrary number that does not accurately reflect a company’s economic reality or value. It is subject to significant criticisms.

  • Issues include arbitrary reductions for doubtful debts, no adjustment for inflation so historic costs are not comparable to current values, ability to manipulate depreciation rates and charges.

  • While there are defects in historic cost accounting, no better alternative has been found yet. For now it provides a roughly right number even if not precisely accurate.

  • A key point is that accounting profit does not equal an increase in cash. Non-cash expenses/revenues and capital expenditures are included/excluded from profit calculations.

  • As a non-accountant, it is important to understand the assumptions and judgments that go into profit calculations and not take the reported number at face value. You should critically examine accounting policies and estimates.

So in summary, the passage discusses the highly questionable nature of profit calculations under historic cost accounting and emphasizes the need for non-accountants to scrutinize the inputs and not rely blindly on the final profit number.

Marion’s Statement of Profit or Loss and Statement of Retained Earnings for the year ended 28 February 2017:

Statement of Profit or Loss for the year ended 28 February 2017

Sales £400,000 Less: Cost of Sales Opening Inventory £0 Add: Purchases £200,000 Less: Closing Inventory £0 Cost of Sales £200,000 Gross Profit £200,000 Less: Expenses Heat and light £10,000 Wages and salaries £98,000 Miscellaneous expenses £25,000 Total Expenses £133,000 Net Profit £67,000

Statement of Retained Earnings for the year ended 28 February 2017

Retained Earnings b/f £0 Add: Net Profit for the year £67,000 Less: Drawings £55,000 Retained Earnings c/f £12,000

Statement of Financial Position as at 28 February 2017

Assets Cash at Bank £4,000 Cash in Hand £2,000 Total Assets £6,000

Equity and Liabilities Capital £50,000 Retained Earnings £12,000 Total Equity £62,000 Payables £24,000 Total Equity and Liabilities £86,000

  • This chapter focuses on preparing financial statements for a company, building on the sole trader accounts covered in Chapter 4. Company accounts have more complexity due to limited liability and various types of companies.

  • The two most common types of companies are private limited liability companies and public limited liability companies. All companies must prepare annual accounts and file them with the Registrar of Companies, with more detail required for larger companies.

  • This chapter explains how to prepare basic internal management accounts for a company. These are similar to external statutory accounts but often more detailed. There are no legal requirements for internal accounts.

  • Learning objectives are to understand limited liability, distinguish private and public companies, describe company organization, and prepare basic financial statements for a company.

  • The chapter is important because many non-accountants work for companies and need to understand company accounting information to assess performance versus competitors. Knowledge of where data comes from and what it means is necessary to use accounting information effectively.

So in summary, this chapter builds on the previous sole trader content to explain key company accounting concepts and demonstrate preparation of basic financial statements for a company. Understanding this topic is important for non-accountants working in a company environment.

Here is a summary of the key points about limited liability companies from the passage:

  • Limited liability companies are a legal structure that limits the personal financial risk of owners/shareholders in the event the company fails or goes into debt. This encourages business formation by reducing personal risk.

  • The concept emerged in the 19th century to encourage investment in large projects like railways that required substantial capital. It is now the dominant legal structure for businesses.

  • A company is a separate legal entity from its owners/shareholders. Owners’ liability is limited to their investment in the company through shares.

  • Companies must disclose certain information publicly through filing with the Registrar of Companies to warn creditors and others of the limited liability structure. They must also include “Limited” or “PLC” in their names.

  • There are private and public companies. Public have stricter requirements like a minimum capital level but private companies still have reporting obligations.

  • Equity capital comes from shareholder investments in ordinary or preference shares. Profits can be returned to shareholders as dividends or retained in the business.

  • Companies can also take on debt through loans, bonds, debentures or preference shares held by creditors.

In terms of deficiencies, the passage provides a balanced overview but does not deeply analyze limitations or critiques of the limited liability model. Some potential issues not discussed include:

  • Creditor protection - creditors accept higher risk without recourse to owners’ personal assets if company fails. Is disclosure enough?

  • Moral hazard - limited liability could encourage greater risk-taking knowing losses are limited. More oversight may be needed.

  • Wealth inequality - limited liability enables concentration of wealth in capital-owning classes. Alternatives could consider broader stakeholder interests.

  • Transparency - disclosure rules may not catch all relevant information, especially for private companies. More comprehensive reporting could improve understanding of risks.

So in summary, while limited liability clearly provides economic benefits, the model is not without critique and some argue additional safeguards could improve outcomes for all stakeholders over reliance on disclosure alone. A balanced assessment would weigh these issues.

  • Bonds and debentures are debt instruments that are issued by companies to raise funds for a certain period of time at a specified interest rate.

  • A debenture loan may be secured against the company’s specific assets, general assets, or unsecured. If secured and the company defaults, debenture holders can sell the secured assets to recover what is owed.

  • Bonds and debentures can be freely bought and sold on the stock exchange. The closer to the redemption/repayment date, the closer the market price will be to the nominal/face value.

  • Debt holders are not shareholders - they do not have voting rights.

  • For companies, interest paid on debt is tax deductible as a business expense unlike dividends.

  • Companies must disclose minimum financial information to members/shareholders annually but shareholders do not have unlimited access rights to company information or premises.

  • Companies must be managed by directors who are responsible for day-to-day operations but answerable to shareholders. Remuneration of directors is a business expense.

  • Profits can be distributed to shareholders as dividends which are recommended by directors and approved by shareholders. Interim and final dividends may be paid.

  • Companies pay corporation tax on profits instead of the owners paying personal income tax like sole proprietors. Corporation tax is treated as a current liability.

Here is a summary of the key statements:

  • The statement of profit or loss (also called income statement) shows the revenues, expenses, and net profit or loss for a period of time. It includes items like sales, cost of goods sold, operating expenses, profit/loss before/after tax.

  • The statement of retained earnings tracks the changes in retained earnings balance over time. It shows the opening balance, net income/loss, dividends, and closing balance.

  • The statement of financial position (balance sheet) provides a snapshot of the company’s financial position at a point in time. It lists assets, liabilities, and equity. Assets are broken into current and non-current. Liabilities and equity are also broken into current and non-current. Equity includes share capital and retained earnings.

  • The statement of changes in equity tracks the changes in share capital and retained earnings over time from income/expense, issuance/retirement of shares, and dividends.

  • Together these statements provide information on the company’s performance and financial position over a period of time.

(1) A company pays tax on its profits, known as corporation tax. The tax due at the year-end is shown as a current liability in the statement of financial position.

(2) A company’s net profit after tax can be paid out to shareholders as dividends. Dividends declared but not yet paid are shown as a current liability.

(3) Retained profits not paid out as dividends are carried forward in the statement of retained earnings or statement of changes in equity.

(4) The financial statements of a company include a statement of profit or loss, statement of financial position, and statement of retained earnings (or statement of changes in equity for large companies).

(5) The statement of financial position shows the company’s assets, liabilities, and capital/reserves. Assets include non-current assets like land, vehicles, and investments. Current assets include inventory, receivables, and cash.

(6) Liabilities include non-current liabilities like long-term loans as well as current liabilities like trade payables, tax payable, and dividends payable.

(7) Capital/reserves include share capital, share premium, revaluation reserves, and retained profits/earnings. Shareholders’ funds represent the total capital employed in the business.

(8) Depreciation is charged on non-current assets, accumulated depreciation is deducted from cost to arrive at the net book value shown in the statement of financial position.

  • The National Audit Office (NAO) examines how government departments spend taxpayers’ money.

  • Accounting Officers, usually the Permanent Secretary, are tasked with safeguarding value for taxpayers’ money within their department.

  • However, the incentives for Accounting Officers to do this are weak compared to just doing their day-to-day jobs running the department.

  • There needs to be more transparency around decision-making within departments to truly hold them accountable for spending taxpayers’ money effectively, according to the NAO.

  • Overall the NAO concludes the current system does not robustly or accountably safeguard taxpayers’ money as well as it could. More transparency is needed.

  • The key issue is there does not seem to be strong enough incentives or accountability for heads of departments to prioritize value for taxpayers’ money over other departmental goals and priorities.

So in summary, the passage discusses the National Audit Office’s view that government departments are not held strongly enough to account for how they spend taxpayers’ money, and more transparency is needed to improve accountability.

Here is a summary of the manufacturing account:

  • A manufacturing account is used by manufacturing entities to calculate the manufacturing cost of goods produced. It shows the direct and indirect costs of converting raw materials into finished goods.

  • Direct costs such as direct materials, direct labour, and other direct expenses can be easily identified with specific products. They make up the prime cost.

  • Indirect or overhead costs such as indirect materials, indirect labour, and other indirect expenses cannot be easily identified with specific products. They are added to the prime cost.

  • Total manufacturing costs include direct and indirect costs. Adjustments are made for changes in work-in-progress to arrive at the manufacturing cost of goods produced.

  • The manufacturing cost of goods produced is transferred to the trading account. The difference between this cost and the market value of goods produced gives the manufacturing profit or loss.

  • The manufacturing account is part of the double entry system and included in periodic financial statements to calculate the cost of converting raw materials into finished goods for manufacturing entities.

  • Direct material cost includes the cost of raw materials purchased plus the closing inventory of raw materials minus the opening inventory of raw materials. This is also sometimes referred to as materials consumed.

  • Direct labor includes all employment costs that can be directly identified with specific products.

  • Other direct expenses are expenses other than direct materials and labor that can be directly identified with specific products, such as machine rental costs. These are relatively rare.

  • Prime cost is the total of direct material costs, direct labor costs, and other direct expenses.

  • Manufacturing overhead refers to all indirect costs that cannot be directly identified with specific products, such as indirect material, labor, and other expenses.

  • Total manufacturing overhead incurred is the sum of indirect material, labor, and other expenses.

  • Total manufacturing costs incurred is the sum of prime cost and total manufacturing overhead incurred.

  • Work-in-progress is the estimated cost of incomplete products not yet transferred to finished inventory, with opening and closing balances.

  • Manufacturing cost of goods produced is the total manufacturing costs plus/minus the change in work-in-progress.

  • Manufacturing profit can sometimes be added to the manufacturing cost before transferring to finished goods inventory/trading account. This allows comparison to external prices.

  • Market value of goods produced is the amount transferred to the trading account, which can be the manufacturing cost or cost plus manufacturing profit.

  • Income and expenditure for a not-for-profit entity like a charity or social club are shown in a statement of financial activities rather than a statement of profit or loss.

  • This accounts for income and expenses separately for unrestricted, restricted, and endowment funds.

  • It shows the “net income/expenditure” rather than profit/loss as the objective is not to generate profit.

  • Accounting treatment is otherwise similar to a trading entity with accruals/prepayments and classification of assets/liabilities.

  • The accumulated fund account tracks the balance of funds over time, equivalent to capital/retained earnings for a trading entity.

  • Example 6.5 shows statements of financial activities and financial position for a social club, illustrating the format and accounting principles for a not-for-profit entity.

Here are the key points about the club’s financial year based on the information provided:

  • The club transferred a balance of £8,000 from its statement of financial activities. This suggests it had a surplus or profit of £8,000 for the financial year.

  • Its accumulated fund balance at the end of the financial year was £9,000. The accumulated fund represents retained earnings/profits brought forward from prior years plus the net increase/decrease during the current year.

  • So it appears the club had an accumulated fund balance of £1,000 at the start of the year, made a surplus of £8,000 during the year, resulting in an accumulated fund of £9,000 at the end of the year.

  • Overall, the club’s financial performance during the year appears satisfactory as it generated a surplus/profit and increased its accumulated fund balance. This suggests its revenue exceeded its expenditures, allowing it to grow its reserves balance.

In summary, the key information indicates the club had a profitable financial year, with a £8,000 surplus transferred from its statement of financial activities to increase its accumulated fund balance. Its financial performance for the year ended 31 March 2017 seems satisfactory.

Here is a summary of the key points about statements of cash flows:

  • A statement of cash flows reports the cash receipts and cash payments of a business over a period of time, usually a financial year.

  • It shows how changes in balance sheet accounts affect cash and cash equivalents, and consists of three main sections - operating, investing and financing activities.

  • The purpose is to provide useful information about the cash generation of a business and its ability to pay debts. It helps evaluate the liquidity, solvency and financial flexibility of a company.

  • Preparation of the statement of cash flows is governed by IAS 7 for UK listed companies and those that have adopted IFRS. For other UK companies it is set out by FRS 102.

  • Understanding cash flows is important for non-accountant managers as no business can survive without taking in more cash than it pays out over the long run. Cash flow monitoring helps assess liquidity and financial health.

  • Key causes of changes in cash flows include changes in revenue, expenses, assets, liabilities, investments and financing activities like share issues or debt repayment.

The key item that explains the unfavorable change in cash flow is the purchase of non-current assets for £150,000. This large cash outflow drained the company’s cash balance and led to the £400,000 overdraft.

Dear Managing Director,

Thank you for bringing your concern to me. Let me explain why the figures suggest there was no fraud of £15,000 as you thought.

While Durton Ltd reported a profit of £40,000 for the year, not all of this profit was received in cash. Some items like depreciation expense do not involve any cash outflow.

More importantly, the statement of cash flows shows us that £100,000 was received by taking out a new loan, but £150,000 was spent on purchasing new non-current assets.

These non-operating cash flows are what explain the difference between the profit and the actual increase in cash balance. The loan proceeds came in as cash, but most of it went out immediately to acquire long-term assets for the business.

I hope this helps explain why the accounts do not indicate any missing funds due to fraud. A statement of cash flows is important precisely because it reconciles net income to the change in cash balance, accounting for all cash ins and outs throughout the period. Please let me know if any part of the explanation requires more clarity.

Regards, [Your Name]

Here is a summary of the very close relationship between the statement of profit or loss, the statement of retained earnings, the statement of financial position and the statement of cash flows (SCF):

  • The SCF shows cash inflows and outflows from operating, investing and financing activities. Operating activities relate to items in the statement of profit or loss.

  • Cash flows from operating activities reconcile profit/loss for the period to the net cash flows from operating activities. This involves adjustments for non-cash items like depreciation and changes in working capital.

  • Investing activities relate to cash flows from purchasing/selling non-current assets, which are presented on the statement of financial position.

  • Financing activities relate to cash flows from equity/debt financing activities, which impact the statement of retained earnings and statement of financial position.

  • The opening and closing cash balances presented in the SCF must agree to the cash balances presented on the statement of financial position.

  • Changes in retained earnings presented in the statement of retained earnings are driven by profit/loss for the period and dividends, which tie back to the statement of profit or loss and statement of cash flows.

  • In summary, the statements are interconnected and must tie together to provide a complete picture of the company’s financial performance and position for a period from a cash flow perspective. The SCF brings together inputs from the other primary statements.

  • The statement of cash flows summarizes the increases or decreases in opening and closing balances of current assets (receivables, prepayments, inventory) and current liabilities (payables, accruals) between the start and end of the reporting period.

  • If the closing balance of a current asset is greater than the opening balance, it represents an increase which is deducted from operating profit as it means less cash has been received.

  • If the closing balance of a current asset is less than the opening balance, it represents a decrease which is added to operating profit as it means more cash has been received.

  • For current liabilities, the logic is reversed. If the closing balance is greater than the opening balance, it represents an increase which is added to operating profit as it means less cash has been paid out.

  • If the closing balance of a current liability is less than the opening balance, it represents a decrease which is deducted from operating profit as it means more cash has been paid out.

  • The statement of cash flows reconciles the profit reported in the income statement to the actual cash generated or used during the period by adjusting for non-cash items and changes in working capital balances.

Here are the key points about presenting a statement of cash flows with more detail:

  • A statement of cash flows provides important additional information beyond what is in the income statement and balance sheet by showing the actual cash generated or used during a period.

  • It is possible for a company to be profitable without having sufficient cash to fund operations or growth. Cash flow analysis helps identify potential liquidity issues.

  • Strict cash management and monitoring cash flows is essential for a company to continue as a going concern, especially in times of economic uncertainty or distress.

  • The statement of cash flows breaks down where cash came from and where it went during the period. It categorizes cash flows from operating, investing, and financing activities.

  • Operating activities involve cash effects of transactions entered into by a company as part of its normal business operations, such as cash sales, purchases, payroll, etc.

  • Investing activities include cash used to acquire or improve long-term assets as well as cash generated from asset sales.

  • Financing activities report cash flows involving debt and equity instruments, such as issuing shares, paying dividends, obtaining loans, repaying debt principal.

  • Presenting detailed cash flow information is important for managers and investors to understand a company’s short-term cash needs and long-term cash generation ability. It helps evaluate liquidity, debt management, profitability, and investment decisions.

  • Additional line items, subcategories or notes can provide further transparency into sources and uses of cash beyond the standard statement of cash flows format. This allows for a more comprehensive cash flow analysis.

Here is a summary of the key points from the case study:

  • Accounting policies refer to the principles, conventions, rules and procedures that a company adopts in preparing and presenting its financial statements. They affect how transactions and other events are reflected in the financial statements.

  • The main accounting policies covered in the case study are:

  1. Basis of accounting - the cash basis simply records cash receipts and payments. The accruals basis recognizes income when earned and expenses when incurred, even if no cash has changed hands yet. This gives a truer picture of financial performance.

  2. Inventory valuation - the main methods are cost and net realizable value. Cost attributes the full cost of inventory to the period in which it is purchased. Net realizable value writes down inventory if the expected selling price falls below cost.

  3. Depreciation - this allocates the cost of non-current assets over their useful lives. The main methods are straight line and reducing balance. Straight line gives a constant annual charge. Reducing balance gives a higher charge in early years that declines over time.

  4. Revenue recognition - when is income considered earned and recognized in the accounts. For consulting services it’s typically when the service is provided. For long term construction projects it may be on a percentage of completion basis as the work progresses.

  5. Provisions - amounts set aside in the accounts for liabilities that are uncertain in terms of timing or amount. Common examples are warranty costs and bad debts.

In summary, the choice of accounting policies can significantly impact reported profit figures from period to period. Consistent application of policies provides comparability, while disclosure enables users to understand influences on performance.

Here is a summary of the key points in the case study:

  • Edgar Glennie is a recently retired aircraft engineer who has moved to Sidmouth. He is worried about his pension and investments following turmoil in the financial markets.

  • Prior to retirement, Edgar invested some of his savings in various companies. However, the market collapse has reduced the value of his shareholdings.

  • As a shareholder, Edgar receives annual reports but rarely opened or read them in the past. Recently he has pledged to pay closer attention to company performance.

  • One report he received was for Acorn Technology plc. As a non-accountant, Edgar finds the reports difficult to understand.

  • Edgar meets his friend James Arbuthnot, a retired chartered accountant, while out playing golf. He asks James to help explain Acorn’s annual report, particularly the statement of cash flows.

  • James agrees to review the report with Edgar and help him understand the key financial statements, with a focus on the statement of cash flows and what it reveals about Acorn’s liquidity and financial position.

The key learning objectives are for Edgar to gain an understanding of:

  • The main components of a statement of cash flows
  • How to evaluate changes in a company’s cash position based on its cash flow statement

Here is a summary of the key points about Liko plc’s annual report:

  • Liko plc is a leading global provider of mobile power solutions and operates in around 100 countries worldwide.

  • Edgar, a shareholder in Liko, was trying to understand the company’s annual report but found it difficult as he lacks accounting knowledge.

  • The annual report included financial statements like the income statement, balance sheet, and cash flow statement. It was over 100 pages long.

  • Edgar had trouble finding details on the company’s profit and dividend. The income statement showed a profit of £162 million but he didn’t see the dividend.

  • The cash flow statement showed an increase in cash of £14 million but the balance sheet showed higher cash balances, so Edgar was confused.

  • He asked his friend James, a retired accountant, to help explain the financial statements.

  • As an accountant, James would be able to reconcile the differences between the profit reported, the changes in cash per the cash flow statement, and the ending cash balances on the balance sheet. He could also explain where the profit ultimately went if it did not result in higher cash balances.

  • This chapter covers annual reports and provides necessary background information to understand a company’s annual report and accounts.

  • It will discuss reports separately from accounts, which are covered in Chapter 9.

  • The chapter focuses on public limited companies and refers to examples from published reports.

  • By the end of the chapter, the reader should be able to identify and explain the different sections and reports typically found in an annual report.

  • These include introductory material, corporate reports like the Chairman’s report, and shareholder information.

  • Introductory material usually includes highlights, a financial summary, promotional content, and the Chairman’s statement.

  • Corporate reports provide information like on corporate governance, business reviews, and details in the Director’s report.

  • The chapter is important for non-accountants to understand annual reports as they may need to analyze them for work or investments. Understanding the structure and content will help readers interpret these documents.

  • Some companies include corporate governance information in a statutory directors’ report, while others present it separately as its own section.

  • Corporate governance refers to how companies and other entities are controlled and managed.

  • Since the early 1990s, committees like the Cadbury Committee have examined corporate governance best practices and issued reports and recommendations.

  • Corporate governance disclosure provides shareholders assurance that directors are properly running companies on their behalf. However, Parliament has largely let the business/financial sector determine standards rather than legislate them.

  • Typical corporate governance disclosures cover items like board membership and structure, internal controls, risk management, auditor relationships, remuneration policies, and shareholder/stakeholder engagement.

So in summary, the corporate governance section provides transparency around a company’s leadership, oversight, controls, and shareholder accountability based on evolving voluntary governance codes and recommendations.

  • The UK Corporate Governance Code lays out detailed corporate governance disclosure requirements for listed companies in their annual reports. It deals with board structure and operations, board evaluation, shareholder engagement, committee work, directors’ duties, and more.

  • Disclosure requirements are also specified in the Financial Conduct Authority’s Transparency Rules and Listing Rules.

  • Some of the main disclosures required include application of the Code’s principles, board member details, chairman’s comments, board and director evaluation, shareholder engagement, nomination and remuneration committee descriptions, going concern statement, and internal controls review.

  • Additional information is required on companies’ websites regarding nomination, remuneration, and audit committees as well as non-executive director appointments.

  • Directors’ reports contain statutory information like director names and future developments. They must include disclosure on auditor reporting responsibilities.

  • Strategic reports provide a business review with key indicators, principal risks, and environmental/social policies.

  • Nomination, audit, and remuneration committee reports summarize the committees’ membership, remit, and any significant issues discussed.

  • Directors’ remuneration reports disclose aggregate director pay, which is an important corporate governance issue for shareholders.

  • Directors run companies on behalf of shareholders and determine their own pay, which is an expense that reduces company profits and shareholder dividends.

  • The purpose of the directors’ remuneration report is to inform shareholders about what the company is paying directors to act on their behalf.

  • Total director pay packages are usually complex and can be very large, including salaries, bonuses, pensions, share options, etc.

  • For listed companies, remuneration reports have additional legal requirements including splitting reports into historical and policy sections, with the policy section requiring shareholder approval every three years.

  • Reports aim to provide transparency around director pay and performance but can be lengthy and use complex language. Shareholder revolts suggest some feel pay is not always appropriately linked to performance.

So in summary, directors determine their own pay which impacts shareholders, so remuneration reports aim to provide transparency around sometimes large and complex pay packages to the shareholders who ultimately own the company. Requirements aim to give shareholders a say, but there is ongoing debate around aligning pay with performance.

Here are three sample columns listing the titles of accounts that may be included based on the three annual reports reviewed:

Company 1 Company 2 Company 3

Statement of profit or loss and other comprehensive income

Income statement Statement of profit or loss and other comprehensive income

Statement of changes in equity

Statement of changes in equity

Statement of changes in equity

Statement of financial position

Balance sheet Statement of financial position

Statement of cash flows Cash flow statement Statement of cash flows

Notes to the accounts Notes to the accounts Notes to the accounts

Independent auditor’s report

Independent auditor’s report Independent auditor’s report

  • The passage assumes the company being discussed is incorporated in the UK but most points also apply to companies in other EU countries.

  • UK companies must follow IAS accounting standards under the Companies Act 2006, which incorporates EU law. Other EU countries have similar requirements.

  • This means listed companies across the EU must adopt IAS standards for consolidated financial reporting.

  • Key IAS standards covered are IAS 1, IAS 7, IAS 28, IAS 34, IFRS 3, and IFRS 10 related to financial statement presentation, cash flows, associates/joint ventures, interim reporting, business combinations, and consolidated statements.

  • IAS 1 outlines requirements for financial statement presentation including comparative figures.

  • Published accounts are usually for a group of companies rather than a single entity.

  • It discusses consolidated financial statements and what they entail for a group.

  • It provides an example consolidated statement of profit/loss and other comprehensive income to illustrate the format and terminology.

So in summary, it outlines the EU/UK regulatory context for financial reporting, key IAS standards, and what to expect in terms of presentation in consolidated group financial statements.

Here is a summary of activity 9.2:

The activity instructs students to analyze the consolidated statement of profit or loss (income statement) for three sets of annual accounts. Students are told to read through each statement line-by-line and compare them to Example 9.1. They should list any significant differences between the statements in their three accounts and the example.

The key aspects of the activity are:

  • Analyze the consolidated statement of profit or loss for 3 sets of annual accounts
  • Read each statement line-by-line
  • Compare to Example 9.1 and list any significant differences
  • Focus on comparing statement formatting, terminology and types of items reported

The goal is for students to gain experience evaluating and comparing the profit/loss statements reported in different companies’ annual reports. By noting differences, they can better understand variations in financial statement presentation conventions.

  • The notes to the financial statements provide additional details and information to supplement what is presented on the face of the statements themselves. They avoid over-crowding the statements and allow for additional explanatory information.

  • IASB requirements determine what information must be disclosed on the statements versus in the notes.

  • The auditor’s independent report is found before the financial statements. It reports on the audit work conducted and whether the statements provide a true and fair view.

  • A periodic summary is often included and provides financial data over a longer period like the past 5-10 years. This can provide more context than just the 2 years required by law.

  • The components that make up the accounts section are the statement of profit/loss, statement of changes in equity, statement of financial position, statement of cash flows, notes, auditor’s report, and sometimes a periodic summary.

  • As EU listed companies, UK groups must prepare financial statements according to IASB standards, including IAS 1 which specifies statement formats.

So in summary, it outlines the typical contents and components of the accounts section of an annual report, including notes, auditor’s report, and periodic summary, and notes the IASB requirements for EU listed companies.

Here are the key points from the passage:

  • Interpretation of accounts means to explain in detail the financial performance of an entity by using data and other quantitative and qualitative information extracted from internal and external sources.

  • Company annual reports and financial statements can contain a huge amount of information, for example Sainsbury’s annual reports span over 100 pages in recent years.

  • While there is a large volume of information, the numbers and disclosures only tell part of the story. Reading between the lines and understanding the hidden meaning requires interpreting the relationships between numbers.

  • Interpretation involves detective work - looking for evidence in the accounts, analyzing it, and forming a conclusion or verdict. Ratio analysis is a common method used to interpret accounts.

  • Understanding a business’ financial performance in context is important for making informed decisions. Relating numbers to something else, like profit compared to investments, is needed to avoid being misled by headlines.

  • Non-accountants may rely entirely on accountants for financial information, but interpreting accounts allows them to understand the information better and not take figures at face value. This is a vital skill for effective management.

Here is a summary of the key information provided in the passage:

(a) How many pages is the length of the document?

Ordinarily, an annual report and financial statements for a listed company like Sainsbury’s will be around 100-150 pages long. It will include:

  • Statement of directors’ responsibilities (1 page)
  • Independent auditors’ report (1-3 pages)
  • Primary financial statements (6-7 pages)
  • Notes to the financial statements (50-60 pages)
  • Other information like strategy, CSR, board details (50-100 pages)

(b) What is included in it?

The annual report and financial statements will include the key financial statements like the income statement, balance sheet, cash flow statement. It will also include notes to the financial statements providing additional details and explanations. Other non-financial information about the company’s strategy, operations, corporate social responsibility initiatives, board of directors etc. are also typically included.

  • Ratio analysis is an important technique for interpreting financial statements and putting the numbers into context. It allows comparisons over time and between companies.

  • Ratios can be grouped into liquidity, profitability, efficiency, investor, and gearing categories depending on what aspect of a company’s performance they assess.

  • Liquidity ratios measure a company’s ability to meet short-term obligations. Profitability ratios gauge return on resources. Efficiency ratios evaluate resource management. Investor ratios interest shareholders. Gearing ratios assess debt repayment ability.

  • Only a select number of key ratios should be analyzed to avoid too much information. The passage focuses on 7 core ratios across the main categories.

  • Calculating ratios involves direct number comparisons or expressing one figure as a percentage of another. Trend analysis also converts figures to index numbers for easier comparison over time.

  • Interpreting ratios provides insights into a company’s performance, prospects, strengths, and weaknesses to holistically evaluate its position and make recommendations. A written report should clearly communicate the analysis and conclusions.

So in summary, ratio analysis is a critical tool for evaluating financial statements by establishing meaningful relationships between key metrics both over time and against peers through various calculation techniques.

  • Dragons (investors) on the TV show Dragons’ Den evaluate start-up business proposals to decide whether to invest.

  • They ask questions to understand the market size/demand, revenue, costs, cashflows, patents/IP to evaluate the business ideas.

  • Specifically, they calculate financial metrics like revenue, cost of goods sold, gross profit to understand profitability.

  • This allows them to calculate ratios like profit margin (gross profit/revenue) and return on capital employed (profit/capital invested) to evaluate the business’s performance and efficiency.

  • Higher ratios are more favorable as they indicate greater profitability and returns for a given level of investment/risk.

  • Ratios are important analysis tools for investors as they allow comparison of performance across businesses and over time.

So in summary, the Dragons use financial questioning and ratio analysis to understand start-ups and make informed investment decisions on whether to back potential entrepreneurs on the show.

Based on the information provided,

  • Tal employed 100 employees as of the financial statements date.

  • The passage discusses several key liquidity, profitability and gearing ratios that can be used to assess the overall financial health and performance of a business. Specifically, it focuses on:

  1. Operating cash flow to operating profit ratio - Indicates how much cash is being collected relative to reported profits. A higher ratio is better.

  2. Current ratio - Measures a company’s ability to pay short-term debts with its current assets. A ratio above 1 indicates it can cover current liabilities.

  3. Debt to equity ratio - Compares amount of debt to equity, showing how well funded the company is. Too much debt can increase risk.

  4. Return on capital employed - Measures profits earned relative to capital used, showing efficient use of resources.

  5. Earnings per share - Shows amount of profit allocated to each share, important for shareholders.

  • It provides an example of analyzing financial statements for a company called Marks and Spencer to assess its financial health and make a decision on providing a £10 million loan over 5 years.

So in summary, the passage discusses key financial ratios that can be used to evaluate the overall financial position and performance of a business, using Marks and Spencer as a case example.

  • Ratio analysis is a useful way to interpret financial accounts, but ratios have limitations as they only look at past historic data and depend on how accurate the underlying accounting numbers are.

  • Key questions to ask when interpreting ratios and financial statements include checking reliability of accounting information, consistency of accounting policies, impact of unusual items or inflation.

  • Important to understand what lines in the financial statements were used to calculate the ratios and which formulas were applied.

  • Other analysis like horizontal, trend and vertical analysis can also be used alongside ratio analysis to better understand a company’s financial performance and prospects.

  • Key financial ratios can be grouped into liquidity, profitability, efficiency, investment and gearing ratios to assess different aspects of a business.

  • Ratios only provide evidence, the interpreter needs to use judgment to come to conclusions about a company’s past and future based on the financial analysis.

In summary, ratio analysis is a useful tool but has limitations, so it needs to be used carefully alongside other analysis and accounting expertise to properly interpret financial statements. Key is understanding what the numbers represent and any adjustments or unusual items that impact comparability.

Here is a summary of the key points related to interpretation of accounts:

  1. Interpretation of accounts involves analyzing the absolute data shown in financial statements to gain a deeper understanding of an entity’s performance and financial position. Raw numbers need context and interpretation as they may be impacted by non-recurring items or external factors.

  2. Reasons why interpretation is needed include accounting policies, non-recurring items, comparability between entities, and changes over time that impact absolute figures.

  3. Users of accounts include managers, investors, creditors, analysts, and tax authorities. Each may require different types of information such as profitability, financial health, dividend prospects, compliance with debt covenants.

  4. Horizontal analysis involves comparison over time within an entity. Trend analysis identifies trends and patterns over multiple periods.

  5. Vertical analysis expresses each financial statement item as a percentage of a base amount like total assets or revenues to analyze structure and relationships.

  6. Ratios are financial metrics calculated using numbers from financial statements. Ratio analysis involves interpretation of various financial ratios to evaluate aspects like performance, position, risks.

  7. Key ratios help analyze profitability, liquidity, efficiency, leverage. ROCE measures return on capital employed. Gross and operating profit ratios differ in treatment of operating expenses. Net profit margin comparisons need to factor in differences in businesses and economies. Liquidity and related ratios assess ability to meet short-term obligations.

  8. EPS measures profit attributable to each ordinary share. It is calculated by dividing profit after tax by number of ordinary shares and found in published annual reports.

  9. Capital gearing relates debt to equity and shows extent to which operations are financed by debt versus equity. Higher gearing indicates greater financial risk.

  10. Linkages exist between different types of ratios as they shine light on company from different perspectives. Interpretation of overall ratios picture is important.

  11. Key steps to appraise financial performance using annual report include calculating/comparing key ratios over time, against industry norms, assessing non-financial indicators, and overall evaluation of trends, risks and outlook.

Here are some additional details about two accounting scandals:


  • Enron hid billions in debt through off-balance sheet entities referred to as special purpose entities or vehicles.
  • Senior management inflated profits through fraudulent accounting tricks which made the company appear more profitable and successful than it actually was.
  • This misleading profit information was used to manipulate Enron’s stock price.
  • Motive was likely to inflate the company’s stock price to benefit senior executives and investors. Bonuses and stock options were tied to stock performance.


  • Worldcom falsified over $7 billion in expenses by improperly categorizing line costs (basic operational costs of running the telephone network) as capital expenditures.
  • This falsely increased Worldcom’s reported profits. The capital expenditures were spread out over many years, keeping profits high.
  • Motive was likely to meet Wall Street earnings targets so that stock price would stay high and benefit senior executives and investors. The CEO’s salary, bonus and stock sales were tied to stock performance.

In both cases, senior management were motivated by profit and stock performance targets to engage in fraudulent accounting practices that misled investors about the true financial position and performance of the companies. This allowed them to benefit while the companies were inflating profits and before the truth was discovered.

Accounting fraud, also known as false accounting fraud, refers to intentionally misrepresenting a company’s financial records to mislead stakeholders. It involves overstating assets, understating liabilities, falsifying accounting records, or creating two sets of books. This is done to obtain loans, boost share prices, hide losses, or achieve performance bonuses.

To prevent accounting fraud, companies should thoroughly vet employees, implement whistleblowing policies, restrict access to financial systems, enforce segregation of duties, regularly audit processes, and promote a culture of fraud awareness. However, fraud is often difficult for auditors to detect since perpetrators work hard to cover it up.

Concerns over auditor independence have also been raised. Auditors may become too close to company directors over many years of working together. They may also conduct non-audit services or later take jobs at the audited company. New EU regulations require audit tendering every 10 years and rotation every 20 years to improve independence. However, the public also has unrealistic expectations of auditors, expecting them to detect all fraud when their main role is confirming accurate financial reporting.

The summary is:

The passage discusses recent and pending changes to accounting standards by standard-setting boards like the International Accounting Standards Board (IASB) and the UK’s Financial Reporting Council (FRC). It summarizes some major projects currently underway by the IASB, including new standards for leases, insurance contracts, and the conceptual framework. It also outlines new financial reporting standards recently issued by the FRC for UK entities. The passage concludes by suggesting questions accountants should consider regarding changes to accounting practices and standards.

Here are the key points from the passage:

  1. The IASB and the FRC are the two main standard-setting bodies that establish accounting standards and guidance. The IASB focuses on international standards, while the FRC does so for the UK.

  2. Both organizations have active development programs that should result in new standards being issued over the next 5 years. However, most of their projects deal with technical issues that are not immediately relevant to non-accountants.

  3. Some of the major projects that could impact financial reporting in the coming years include standards on revenue recognition, leases, insurance contracts, and financial instruments.

  4. The relationship between companies and their external auditors can be challenging as auditors have to balance being independent while also maintaining a good relationship with company management.

  5. Auditor independence is considered important for audits. However, auditors also don’t want to damage their relationship with company directors, and they face difficult decisions in supporting directors’ accounting judgments. This is one reason why auditor rotation rules are being introduced.

  6. Rotation of auditors is meant to improve independence. However, there are also disadvantages such as loss of institutional knowledge and increased costs as new auditors get up to speed.

  7. In summary, the passage highlights the ongoing work of standard-setters that will impact reporting, as well as some of the challenges auditors face in maintaining independence balanced with healthy company relationships.

Here is a summary of the key points in the text:

  • Management accounting traces its origins to the Industrial Revolution when businesses grew larger and more complex, requiring specialized management and financial reporting.

  • Early management accounting was informal since most businesses were small and owner-managed.

  • Industrialization led to larger corporations financed by investors rather than families. This separated ownership from management.

  • Corporations needed to attract specialized managers from outside the owner’s family. They also had reporting obligations to shareholders.

  • Over time, management accounting systems became more formalized to plan, control operations, and report internally to managers as businesses scaled up during industrialization.

  • Modern management accounting aims to provide both financial and non-financial information to managers within companies to aid decision-making and value creation. It has more flexibility than external financial reporting.

  • The new industrial enterprises of the 19th century required more detailed and timely managerial control than could be provided by annual statutory accounts.

  • Cost accounting systems evolved between 1850-1900 to provide more detailed recording and reporting of costs. Their main purposes were stock valuation, work-in-progress costs, and product costing.

  • Initially, financial and cost accounting ran in parallel but eventually merged as they used similar data.

  • Major developments in management accounting occurred in the US in the early 20th century. By 1925, most modern practices had been established.

  • New ideas continued to be developed through the late 20th century, mainly by large companies.

  • Management accounting progressed more slowly in Britain, with smaller companies relying more on informal methods.

  • As industries shifted to services, traditional manufacturing-focused techniques like standard costing became less significant. However, the basic functions of management accounting have continued to be relevant.

In summary, the passage describes the historical evolution of management accounting from informal early systems to the formalized cost accounting and management reporting systems used widely today, beginning with19th century industrialization and progressing most rapidly in the early 20th century US.

  • The passage discusses the role and responsibilities of management accountants in decision-making.

  • While management accountants collect and analyze financial data, the ultimate decisions should be taken by management/leadership, not the accountants themselves.

  • Accountants can and should make valuable contributions to strategic decision-making by providing expert analysis and insights. However, they should not be the primary decision-makers.

  • Businesses that do not fully utilize their management accountants’ expertise tend to have less clear business strategies compared to those that do.

  • In summary, the passage argues that management accountants are advisors and should inform decision-making, but the final decisions (and accountability) should rest with management/leadership, not the accounting team.

Here is a summary of the key points about financial accounting systems used at the time when more detailed information was needed for stock control and for production costing purposes:

  • In the 19th century, as the Industrial Revolution progressed, businesses grew larger and more complex. Detailed information about production costs was needed for setting selling prices and controlling inventories.

  • The financial accounting systems at that time could not provide the detailed cost information that managers required for planning and control purposes related to stock levels and production costs.

  • This led to the development of a separate branch of accounting called cost accounting, which focused specifically on collecting and reporting detailed cost data about products, services, and production processes.

  • Cost accounting systems allowed costs to be traced and allocated to specific products and production orders. This provided managers with visibility into actual costs versus planned or standard costs.

  • Key purposes for which more detailed cost information was needed included setting product prices based on actual costs of production, controlling and reducing inventory levels, and monitoring production efficiency and product profitability.

  • By tracking costs more precisely through cost accounting, managers aimed to gain better control over resources and production processes, as well as enhance decision making related to pricing, inventory management, and operational improvements.

  • There are two main types of cost centers: production cost centers where products are manufactured or processed, and service cost centers where a service is provided to other cost centers. Cost centers can take various forms like departments, production lines, machines, products or sales areas.

  • Profit centers are similar to cost centers except that both costs and revenues are charged to them, allowing the calculation of profit or loss.

  • Investment centers are like profit centers but are also responsible for major investment decisions related to the center.

  • By identifying segments, it’s possible to isolate costs and revenues for each segment. Segment managers can then be responsible for planning, budgeting, controlling activities, and decisions affecting the segment.

  • Costs are classified as direct, easily identifiable with a segment, or indirect, more difficult to relate to specific units.

  • Costs have elements like materials, labor, expenses that need to be broken down.

  • Direct materials consist of raw materials and component parts incorporated into production. There can be issues with identifying direct material costs due to size, timing and purchasing practices. Appropriate pricing methods need to be determined.

  • There are three main methods for pricing direct materials: FIFO, average cost, and standard cost.

  • FIFO stands for first-in, first-out. It uses the oldest price first when issuing materials to production. It aims to match the physical flow of materials.

  • Average cost calculates a weighted average price by dividing the total value of materials by the total quantity. The continuous weighted average (CWA) method recalculates the average price when new purchases are made.

  • Standard cost uses estimated future costs rather than actual purchase prices. It is part of a standard costing system.

  • FIFO is logical but cumbersome, while average/CWA is easier to calculate but prices may lag.

  • Direct labor costs involve charging employee salaries, wages, bonuses and employer costs like insurance to specific production units based on hours worked. Employees record hours spent on each unit.

Here is a summary of the key points around direct labor cost to production:

  • Direct labor refers to labor costs that can be easily traced or attributed to specific products or production orders.

  • An example given is of two employees, Alex and Will, working on Unit X. Their time spent on Unit X is recorded.

  • Alex spent 10 hours at a rate of £10 per hour. Will spent 20 hours at a rate of £5 per hour.

  • Their direct wages are calculated: Alex 10 hrs x £10/hr = £100. Will 20 hrs x £5/hr = £100. Total direct wages = £100 + £100 = £200.

  • The employer estimates additional costs of 20% on top of wages for national insurance, pension, holiday pay etc. 20% of £200 is 0.2 x £200 = £40.

  • The total direct labor cost of producing Unit X is therefore the direct wages (£200) plus the employer’s additional costs (£40), which is £200 + £40 = £240.

  • Accuracy of labor time recording is important for accurate costing. Management should emphasize importance of this to employees.

  • Labor costs can be a major cost driver so tight control is needed, especially for tender pricing purposes.

So in summary, direct labor cost is calculated based on employee time spent on a production order at their hourly pay rate, plus an estimated percentage for additional employer costs. Accurate time recording is crucial.

Here is a summary of the key points about indirect costs from the chapter:

  • Indirect costs (also called overheads) are costs that cannot be easily traced to a specific product or service. They include things like utilities, rent, insurance, salaries of managers, etc.

  • Absorption costing is the traditional method used to allocate indirect costs to products/services. It has three stages:

  1. Allocation of all costs to specific cost centers

  2. Sharing out of costs of production service cost centers to other cost centers

  3. Absorption of all production overhead costs into the cost of units produced

  • Under absorption costing, unit costs are calculated by adding direct costs and an allocated share of indirect costs. This allows for setting of prices and valuation of inventory.

  • Activity-based costing is an alternative method that assigns indirect costs to products/services based on their use of organizational resources or activities, providing a more accurate view of costs.

  • ABC is argued to provide better information for decision making but it is more complex to implement than absorption costing.

Here are the key points about charging overhead costs between service cost centers and to production cost centers:

  • Service cost centers provide support services to production cost centers and other service cost centers. Their costs need to be allocated to the beneficiaries of their services.

  • Two main methods are used - charging individual costs directly or charging total costs through apportionment. A combination is usually adopted.

  • Common quantitative factors used for apportionment include number of employees, floor area, level of activity.

  • A problem arises when service cost centers provide services to each other, creating a circular relationship in charging costs.

  • Three main approaches to dealing with reciprocal service costs are: 1) ignore interdepartmental service costs, 2) specify an order to close off cost centers, 3) use mathematical apportionment to gradually allocate all costs.

  • In practice, ignoring reciprocal service costs is usually adopted to avoid complicated calculations based on estimates of benefit between cost centers.

  • The aim is to ultimately allocate all indirect costs to production cost centers so they can be added to the cost of specific units passing through those centers.

  • The passage discusses different methods that can be used to absorb overhead costs into the cost of production, including direct labor cost method, prime cost method, direct labor hours method, and machine hours method.

  • It notes that the direct labor cost method may not be appropriate if labor hours are low and labor rates are high, as the cost will not closely relate to time spent in production.

  • The prime cost method is unlikely to have a close relationship between overhead costs and either direct materials or direct labor.

  • The direct labor hours method and machine hours method are considered highly acceptable, especially for labor-intensive and machine-intensive cost centers respectively, as overhead tends to move with time spent in production.

  • Example 14.2 illustrates how to calculate absorption rates using each of the different methods based on information provided for an assembling department.

  • The passage concludes that the most appropriate absorption method depends on individual circumstances, and labor-intensive cost centers should generally use direct labor hours while machine-intensive centers use machine hours.

  • Traditionally, overhead costs are allocated to products based on a common cost driver like direct labor hours. However, this may not allocate costs accurately since it doesn’t account for different resource consumption between products.

  • Activity-based costing (ABC) seeks to allocate overhead more accurately by identifying the activities that drive overhead costs and tracing costs to products based on each product’s actual consumption of each activity.

  • The example shows two products, Unit A and Unit B, being produced in a cost center with $1,000 total overhead from machine set-up costs of $800 and inspection costs of $200.

  • Using traditional absorption, Unit A is allocated $750 of overhead and Unit B is allocated $250 based on their direct labor hours.

  • However, ABC allocation shows Unit A only consumes $180 of overhead (1 set-up x $80 + 2 inspections x $10) while Unit B consumes $820 of overhead (9 set-ups x $80 + 2 inspections x $10), a more accurate reflection of their actual resource usage.

  • ABC aims to allocate overhead costs more precisely by tracing costs to activities and activities to cost objects, providing more accurate product costs than traditional absorption methods.

Here is a summary of the relevant parts of the passage for B):

  • Jasmine Limited uses two methods to absorb overhead costs - the traditional method and activity-based costing (ABC).

  • Under the traditional method, Unit A is allocated £750 of overhead costs and Unit B is allocated £250.

  • Under ABC, Unit A is allocated £180 of overhead costs (set-up of £80 and inspections of £100) and Unit B is allocated £820 of overhead costs (set-up of £720 and inspections of £100).

  • ABC allocates overhead costs based on the activities each unit requires, like set-ups and inspections. The traditional method unevenly allocates overhead costs.

  • ABC is considered a fairer method for allocating overhead costs between different production units. It aims to avoid inflating or deflating unit costs.

So in summary, part B compares the overhead costs allocated to each unit under the traditional method vs the activity-based costing (ABC) method, showing ABC achieves a fairer allocation of overhead costs.

  • Service cost centers’ costs may be allocated separately or apportioned in total to production cost centers.

  • There is an element of cross-charging when service centers provide services to each other. This can be resolved by ignoring cross-charging, apportioning service center costs in a specified order, or using mathematical apportionment.

  • Once production cost centers receive their share of service center costs, absorption rates are calculated for each production cost center by dividing its indirect costs by its actual/planned direct labor hours or machine hours.

  • Absorption rates are used to charge units passing through each production cost center a share of production overhead.

  • Total production cost equals direct materials + direct labor + direct expenses + share of production overhead.

  • Absorbing non-production overhead is not normally recommended except for pricing.

  • Absorption rates are usually predetermined based on planned costs and activity levels.

  • Under-/over-absorption of overhead is written off to profit/loss in the period incurred.

  • Activity-based costing involves charging overheads to cost pools, identifying cost drivers, and calculating driver rates to charge units their share of pool costs. It differs from traditional absorption costing.

Here is a summary of the key points about contracts in the period discussed:

  • There were two contracts, Contract 1 and Contract 2.

  • Each contract involved direct labour hours and machine hours in different departments (L, M, N, O).

  • For Contract 1: Department L had 60 direct labour hours and 30 machine hours. Department M had 10 direct labour hours and 10 machine hours. Department N had no hours.

  • For Contract 2: Department L had 20 direct labour hours and 10 machine hours. Department M had 10 direct labour hours and 10 machine hours. Department N had 10 direct labour hours. Department O had 60 direct labour hours.

  • The direct labour cost per hour in all departments was £3.00.

  • The questions asked to calculate the overhead absorbed by each contract using (a) the direct labour cost method and (b) a machine hour rate for each department.

A production manager is responsible for overseeing the production process and meeting production goals and objectives. Key responsibilities include:

  • Planning and coordinating production schedules and workflows
  • Ensuring production meets quality standards
  • Managing staffing/resource allocation for production
  • Monitoring productivity and efficiency
  • Overseeing maintenance of production equipment/facilities
  • Tracking production metrics like output, costs, waste etc.
  • Inventory management and ensuring adequate supply of materials
  • Compliance with health, safety and environmental regulations
  • Liaising with other departments like procurement, logistics etc.
  • Budgeting and cost control for the production department
  • Reporting on production performance and issues

In summary, a production manager is accountable for efficiently managing all aspects of the production process to meet output targets while ensuring quality, safety, cost control and regulatory compliance. They help coordinate production activities across departments to maximize productivity.

Here is a summary of the key points from the budgeting information provided:

  • A sales budget is prepared for Product EC2 projecting sales of 10,000 units at a price of £100 per unit, for total sales of £1,000,000. All sales are on credit terms.

  • EC2 requires raw materials E (5 units per EC2) and C (10 units per EC2). Raw material E costs £3 per unit and C costs £4 per unit. All raw materials are purchased on credit terms.

  • Two departments, Machining and Assembly, are involved in producing EC2. Direct labor hours and rates per unit are provided.

  • Finished production overhead is budgeted at £100,000.

  • Opening stocks of finished EC2, raw materials E and C and their values are provided. Closing stocks are budgeted to be 10% higher than opening stocks.

  • Administration, selling and distribution overhead is budgeted at £150,000.

  • Additional information is provided on opening and closing trade debtors and creditors, other expenses, asset/liability accounts, proposed dividend, and capital expenditures.

  • All relevant budgets are to be prepared from the information provided, including sales, production, materials, labor, overhead, costs of goods sold, cash, profit and loss, and balance sheet.

  • Flexible budgeting allows budgets to be adjusted based on actual activity levels, as some costs vary with activity while others remain fixed.

  • When actual activity differs from the budgeted level, flexing the budget provides a fairer comparison than just comparing to the original fixed budget.

  • An example is provided to demonstrate how to flex a budget based on actual activity levels being higher than originally budgeted.

  • Behavioral factors are important for budgeting systems to work effectively. Managers need to be consulted, educated, involved in budget preparation, and budgets should not be used purely for disciplinary purposes.

  • If managers feel the system works against them rather than for them, it can lead to dysfunctional behavior like building in slack, short-term decision making, or unnecessary spending up to budget limits.

  • Involving managers in budget preparation and not imposing budgets from above helps gain their acceptance and commitment to the budgeting system.

  • Budgetary control involves comparing actual results to a budget/plan on a frequent basis to identify any deviations and take corrective action.

  • It is more valuable if budgetary control is also used as a form of behavioral/performance control to monitor managers and hold them accountable for achieving budgets.

  • Comparing actual results only to a fixed budget may not be that helpful if actual activity levels differ significantly from what was budgeted. A flexed budget that adjusts for different activity levels is preferable.

  • Accurately estimating activity levels is important as budgets for other functional areas are based on the activity level budget. Significant errors in estimating activity can affect budgets and company performance.

  • Managers may resent tight budgetary control systems and react in ways that are not in the best interests of the organization, such as under-reporting or exercising slack. This needs to be monitored.

Here is a summary of the key points about standard costing overhead:

  • Standard costing involves estimating future sales revenue and product costs in detail, breaking costs down into elements like direct materials, direct labor, variable overhead and fixed overhead.

  • Actual costs are compared to standard costs, and any differences are variances. Variances are usually analyzed into volume and price variances.

  • Overhead includes administration overhead, selling and distribution overhead, and production/factory overhead. Standard overhead rates are set for these.

  • Actual overhead costs are compared to standard overhead rates to calculate overhead variances. Significant variances are investigated to identify reasons for differences from standard.

  • The standard costing system provides information to help set prices, measure performance against objectives, and identify inefficiencies for corrective action through variance analysis.

  • It is commonly used in manufacturing where processes are repetitive, to facilitate budgeting, cost control and decision making. Periodic adjustment of standards may be needed due to changing costs or conditions.

  • An ideal standard makes no allowance for normal losses or inefficiencies and can only be achieved under perfect conditions. An attainable standard accounts for some reasonable level of losses and inefficiencies.

  • As a cost center manager, if my standards were based on ideal levels that can’t be achieved realistically, I would be unhappy with variance reports showing unfavorable variances.

  • To address unfavorable variances due to unrealistic standards, I would need to work with senior management to revise the standards to make them more attainable and reasonable. This could involve accounting for typical levels of downtime, waste or other inefficiencies in setting the new standards.

  • Standard costing requires collecting cost data on direct materials, direct labor, variable overhead and fixed overhead. Standard costs are built up using quantities, prices, rates and absorption levels for each of these cost elements.

  • Key performance measures that can be calculated from standard costing data include efficiency ratio, capacity ratio and production volume ratio. These help evaluate performance against budgets and standards.

  • The management of Frost Production company will need to investigate why only 90 units were produced instead of the expected 100 units in the budget. Producing fewer units than budgeted is unfavorable to meeting production and profitability targets.

  • Standard cost variances can be calculated to compare actual costs to standard costs set in the budget. Variances may be favorable (lower actual cost than standard) or unfavorable (higher actual cost than standard).

  • Calculating variances for each cost element (direct materials, direct labor, overhead) helps identify areas where costs differ significantly from budget and where further analysis is needed. Looking at price, usage, rate, efficiency and expenditure sub-variances provides even more detail.

  • Achievable and motivational production targets set through the standard costing system can help control costs, identify inefficient areas, and reward managers who meet standards. This in turn contributes to increased production and profitability.

  • A favorable direct materials price variance can be offset by an adverse direct materials usage variance because lower purchase prices may result in greater wastage of materials if inferior quality materials are used.

  • An adverse direct labor rate variance may be offset by a favorable direct labor efficiency variance because higher paid labor may work more efficiently to make up for the higher rates. Paying more per hour could potentially motivate workers to improve productivity and work more efficiently.

So in both cases, an adverse cost variance in one area can potentially be offset by a favorable variance in another related area, resulting in the variances offsetting each other to some degree. The overall impact on profit depends on the magnitude of the favorable versus unfavorable variances.

  • LP management will need to decide which variances to investigate based on company policy. Only significant or “exceptional” variances are typically investigated due to time and resource constraints.

  • What constitutes an “exceptional” variance would need to be defined based on the company’s tolerance levels. Very large or unusual variances compared to expectations would warrant investigation.

  • The purpose of investigating variances is to understand the root causes and determine if corrective actions are needed to improve future performance. Both favorable and unfavorable variances should be probed to ensure standards are accurate.

  • Managers supplied the standard cost statements should include operations managers, department heads, and others who can act on the variance information. Senior executives may only need a high-level summary unless involved in specific investigations.

  • Key questions to ask in an investigation include accuracy of standards/activity levels, any unusual events, reliability of measures, linkages between variances, and factors not considered in setting standards. The goal is to learn from variances, not to assign blame.

Some key points on marginal costing and absorption costing:

  • Absorption costing aims to allocate all costs (both variable and fixed) to units produced. It is appropriate for inventory valuation and income measurement.

  • Marginal costing only includes variable costs in its analysis. Fixed costs are ignored as they are not impacted by short-term decisions.

  • Marginal costing is more appropriate than absorption costing for short-term decision making like make or buy, normal or special order, product addition/deletion etc. as it focuses on relevant costs.

  • Absorption costing may lead to sub-optimal decisions in such cases as it includes fixed costs which are irrelevant for short-run decisions.

  • Variable costs per unit are the same under both costing methods. Difference lies in treatment of fixed costs.

  • Absorption costing allocates fixed costs to units based on some allocation metric like machine hours. Marginal costing ignores fixed costs altogether for short-term decision making.

So in summary, while absorption costing is suitable for inventory valuation and income measurement, marginal costing approach which ignores fixed costs is more appropriate for short-term decision making as it considers only relevant variable costs.

The principal’s requirement to add a 25% loading to the course fee to go towards the college’s general running costs may be inappropriate for the following reasons:

  • The proposed evening class lectures are extra classes being run in addition to the college’s normal daytime courses. They are intended to cover their own specific costs only.

  • The course fee has been calculated based only on the direct costs incurred as a result of running the extra evening classes - lecturer fees, heating, lighting etc. It is not meant to subsidize the college’s general costs.

  • Adding a 25% loading would make the course fee higher than necessary to cover the direct costs of the evening classes. This could make the course uneconomical or unaffordable for students.

  • It does not follow the college’s normal costing procedure of calculating fees based only on direct costs for a particular course. The principal is insisting on a departure from normal procedure.

  • The evening classes may be generating additional revenue for the college. A loading could discourage participation and reduce that additional revenue.

So in summary, adding a general loading is inappropriate as it would make the evening course fees higher than their direct costs and gotoards day-to-day costs unrelated to the courses, contrary to normal costing practice.

  • The examples show changes in profit at different levels of activity (units sold). They illustrate that profits increase as activity increases beyond the break-even point, as the additional contribution from extra sales exceeds the fixed costs.

  • It is assumed that variable costs remain proportional to activity and fixed costs do not change as activity levels change. This allows calculation of contribution and profits at different activity levels.

  • Contribution analysis involves looking at sales revenue, variable costs, contribution, fixed costs and profit. It is useful for managerial decision making when activity levels may fluctuate.

  • Break-even charts, contribution graphs and profit-volume charts can help visually illustrate the relationships between sales, costs and profits at different activity levels based on the assumptions used in contribution analysis. They provide an overview to support management decision making.

The key point is that contribution analysis assumes variable costs and fixed costs behave linearly as activity changes, allowing calculation of profits across a relevant range of activity levels to aid planning and decision making. Graphs can help present this analysis visually.

Here are the key reservations about marginal costing and contribution analysis outlined in the passage:

  1. Cost classification - It can be difficult to cleanly separate costs into fixed and variable categories. In reality, many costs have both fixed and variable elements.

  2. Variable costs - They may not actually vary directly with activity or sales. For example, material costs could change if supplies are limited.

  3. Fixed costs - They are unlikely to remain truly fixed over a wide range of activity and may change in “steps” above or below certain activity levels.

In my view, these issues around the assumptions of strict fixed vs variable cost classification and behavior are the most significant weaknesses since they undermine the underlying model that marginal costing/contribution analysis is based on. Issues like time period of analysis and non-quantitative factors are also important limitations but the cost classification issues strike at the core of the technique.

  • The company’s budget is to break even at 15,000 units or make a profit target at 25,000 units.

  • To break even with the current budget, unit sales would need to increase by 50% to 15,000 units or 150% to 25,000 units to meet the profit target.

  • Reducing the selling price by 10% would require a 200% increase in units to break even or 400% increase to meet the profit target.

  • Increasing the selling price by 10% would allow breaking even at the original budgeted level, but units would still need to increase 66.7% to meet the profit target.

  • Improving the product at a higher variable cost of £1.50 per unit would require a 500% increase in units to break even or 900% increase to meet the profit target.

  • Increasing the selling price by 10% is concluded to be the most practical short-term solution, as it allows breaking even at the original level and has the best chance of meeting the profit target with increased sales over time.

  • Key factors or limiting factors need to be considered if production resources are constrained, and the option maximizing contribution per limiting factor unit should be chosen.

Here is a summary of the key points in the passage:

  • Fixed costs cannot be ignored in decision making, even though contribution analysis focuses on marginal/variable costs. Fixed costs still need to be considered.

  • Decision making refers to specific decisions that management needs to make, such as whether to continue producing a product, expand production, shut down a plant, etc. These types of specific decisions require more information than just contribution margins.

  • Incremental costing looks at the additional or extra costs associated with a specific decision or event.

  • Contribution analysis and break-even charts are useful tools, but they simplify reality and may not provide all the relevant information needed for complex management decisions. Fixed costs are still relevant.

  • Contribution is defined as revenue minus variable costs. It is the amount each product or segment contributes to the coverage of fixed costs.

  • Marginal cost is the additional or incremental cost of producing one more unit. It includes only variable costs.

  • A break-even chart graphs total revenue and total costs to show the break-even point. It can help identify the margin of safety but does not consider all relevant factors for decision making.

So in summary, the key point is that while contribution analysis and marginal costing are useful tools, fixed costs cannot be entirely ignored when making specific management decisions, as they simplify reality and may omit important cost factors.

  • Deciding whether we supply or make our own materials and components involves determining whether to procure materials from external suppliers or manufacture them internally. This decision considers factors like relative costs, quality control, reliability of supply, etc.

  • Those that involve determining what price to charge for goods and services refer to setting the selling prices for products and services. Pricing decisions need to consider factors like customers’ willingness and ability to pay, competition, costs, desired profit levels, etc.

  • Those that involve deciding what price to charge for one-off or special orders refer to setting prices for custom or non-standard orders that are outside regular product offerings. These types of orders may require consideration of additional customer-specific specifications, volumes, timelines and costs compared to standard products.

  • Classification of costs is important for decision making. Key classifications discussed are fixed vs variable costs, relevant vs non-relevant costs, sunk vs avoidable costs, opportunity costs, committed costs, etc. Understanding which costs change with activity levels helps identify relevant factors for different types of decisions.

Here are the key points about relevant and non-relevant costs in decision making:

  • Relevant costs are future costs that will be affected by the decision. They are important to consider in decision making.

  • Non-relevant costs are costs that will not be affected by the decision. They can be ignored in the analysis because the decision will not impact them. Examples include fixed costs.

  • Avoidable costs are costs that can be saved or avoided by choosing one option over another. Non-avoidable costs will be incurred regardless of the decision. Avoidable costs are similar to relevant costs.

  • Sunk costs have already been incurred from a previous decision and cannot be recovered, so they should not be considered in future decision making. They are examples of non-relevant costs.

  • Committed costs arise from a previous decision that has not fully materialized yet. Once incurred they become sunk costs. Like sunk costs, committed costs are not relevant to future decisions.

  • Opportunity costs refer to the potential benefits lost from choosing one alternative over another. They are difficult to quantify but should be considered when assessing different options.

  • Local government housing departments face the decision of whether to employ their own joiners to do necessary work, or contract outside firms (known as outsourcing).

  • The theory behind make-or-buy decisions is that entities should focus on their core objectives and outsource peripheral activities. However, cost is not the only consideration - factors like quality, reliability and control are also important.

  • A simple example is presented of a company deciding whether to make an important component internally or buy it from an external supplier. Based on the estimated costs, it would be cheaper to outsource in this case.

  • However, more information would be needed to make a conclusive decision, such as ensuring cost data is accurate, considering variability in demand, supplier reliability, ability to switch back if needed, etc.

  • Pricing decisions also require consideration of whether to base prices on market rates or costs. Market-based pricing depends on demand elasticity, while cost-based methods include pricing at variable cost, total cost, or cost-plus for profitability.

  • Transfer pricing is also an issue when one part of an organization sells to another, requiring an internal price to be set.

  • It matters what prices are charged for internal transfers between segments because segments are often given autonomy and may purchase from external suppliers if they offer better prices or service.

  • Transfer prices should encourage internal trade and discourage external purchasing. Various methods can be used like market price, adjusted market price, cost-plus, variable cost plus.

  • For special orders beyond normal capacity, the minimum acceptable price would be the incremental/extra cost. Variable cost could be accepted to get the work but contributes nothing to fixed costs. Higher prices are preferred if capacity allows.

  • When considering a special order, the extra contribution is compared to the loss of normal contribution from switching resources. Non-quantitative factors like future orders and availability of alternative work should also be considered.

  • Management accountants provide cost data but the final decision weighs various quantitative and qualitative factors, not just costs. Key questions relate to data reliability, assumptions, relevant costs, probabilities, and non-financial factors.

Here is a summary of the key points from M18 Accounting for Non-Accounting 28979.indd 419:

  • Management accountants assist managers in decision making by providing financial and non-financial information. Their role is to help managers make more effective decisions.

  • Decision making often involves future events so information provided contains estimates and speculation. Judgment is required to collect accurate and relevant data.

  • Only relevant costs and revenues should be included, along with opportunity costs estimates. Probability testing of data is recommended.

  • Key cost classifications include fixed/variable, relevant/non-relevant, avoidable/non-avoidable, sunk, committed, and opportunity costs.

  • Closure/shutdown decisions compare contribution of the segment to closure/shutdown costs.

  • Internal production is usually preferable if variable cost is lower than external price.

  • Pricing determines if goods/services are sold externally, based on market price or cost depending on conditions.

  • Internal transfers based on market or adjusted market price, or at/above variable cost if prices not possible. Opportunity cost should be included.

  • Special orders priced to cover variable cost ideally, but below is sometimes accepted short-term. Above variable cost helps cover fixed costs.

  • Non-financial factors also important in decisions alongside cost/financial factors.

The summary highlights the main points around the role of management accountants in decision making and key cost considerations and pricing approaches discussed in the chapter. Let me know if you need any clarification or have additional questions.

  • Conoco Phillips, a major US oil and gas producer, announced a 25% cut to its 2016 capital spending budget vs 2015, reducing it to $7.7 billion. This is less than half of what it spent in 2014.

  • The cut is aimed at protecting the company’s dividend, which it prioritizes as the highest use of its cash. However, two other energy companies have cut their dividends this year.

  • Weak oil and gas prices are forcing companies to cut investment and production growth forecasts. Conoco now expects 1-3% growth vs 3-5% growth projected in mid-2014 before prices slumped.

  • The cuts will help reduce excess crude supplies in the market and support a market rebalancing as fewer new volumes are added.

  • The CEO said the dividend level is a long-term decision and they have only been in the low price environment for a short time so far. Spending could increase if prices improve, but increases would be disciplined even in an upturn.

So in summary, the contract is making deep cuts to capital spending to maintain its dividend for shareholders, recognizing the need to adapt to weak prices while also supporting a market rebalancing through reduced future production volumes.

This passage summarizes several capital investment appraisal techniques used by accountants, with a focus on profit-making entities.

It introduces the payback period method, which estimates how long it will take for a project’s cash receipts to pay back its upfront costs. It then discusses the discounted payback method, which accounts for the time value of money by discounting future cash flows.

Two examples are provided to illustrate how to calculate payback period and discounted payback period for a sample project. Advantages and disadvantages of each method are outlined.

The key techniques discussed are payback period, discounted payback period, internal rate of return, accounting rate of return, and net present value. The passage focuses on explaining payback period and discounted payback period in detail with examples. The overall context is capital investment appraisal for profit-seeking businesses.

Here is a summary of the key techniques discussed in the passage:

  • Accounting Rate of Return (ARR) - Compares the average annual profit of a project to the capital invested. Can be calculated using either the original capital invested or the average capital employed over the project life. Does not consider the time value of money.

  • Net Present Value (NPV) - Discounts the expected annual cash flows of a project using a discount rate (cost of capital) and sums them to arrive at a present value. A project is accepted if NPV is positive. Considers the time value of money but requires estimates of cash flows and discount rate.

  • Internal Rate of Return (IRR) - Similar to NPV but estimates the discount rate that sets the NPV equal to zero rather than using a predetermined rate. A project is accepted if IRR exceeds the cost of capital. Considers time value of money but also requires estimates.

  • Advantages of NPV and IRR are they consider time value of money. Disadvantages are difficulty estimating cash flows and discount/required rates of return. ARR is simpler but does not consider time value of money. NPV is generally considered the most robust method.

  • The internal rate of return (IRR) method was used to calculate the rate of return for the new project.

  • Step 1 involved selecting two discount rates (10% and 15%) and calculating the net present value (NPV) of the project cash flows using each rate. This showed an NPV of £2,978 using 10% and an NPV of -£2,426 using 15%.

  • Step 2 calculated the specific break-even rate of return using interpolation between the 10% and 15% rates. The formula shown gave an IRR of 12.76%.

  • This means the project will be profitable if the required rate of return is below 12.76%. The company can accept the project as long as its required rate is not above 13%.

  • The IRR method gives an indicative rate of return for the project but requires estimating two suitable discount rates and does not provide an exact rate.

  • In summary, the IRR method was used to calculate the maximum rate of return that would give a positive NPV for the new project, indicating it should be accepted.

  • When a fixed asset is purchased in a given year, the amount of corporation tax payable for that year will be low as depreciation allowances can be claimed. However, in later years when fewer allowances are available, tax payments will likely be higher. Forecasting future tax liability is difficult due to potential changes in tax laws and rates.

  • Sources of finance include short-term options like trade credit, bank overdrafts, factoring, bills of exchange, and commercial paper. Medium-term options are bank loans, credit sales, hire purchase, and leasing. Long-term options are debentures, loan capital, unsecured loan stock, convertible unsecured loan stock, eurobonds, and issuing new shares.

  • Choosing a financing method for a capital investment project is an important decision that managers should get expert advice on. Key questions to ask accountants include what appraisal method they used, allowance made for inflation/taxation, the rate of return used, qualitative factors considered, and how to value those qualitative factors monetarily. Capital investment appraisal is complex and managers from different departments may have biased views, so questioning the financial analysis is important.

  • A processing manager may be convinced that a new high-powered computer is essential for their operations. This could be one potential capital expenditure project the company is considering.

  • Accountants play an important role in the capital budgeting process by assessing potential projects’ costs and comparing them to possible benefits. This helps management choose between competing investment options.

  • Once a choice is made, accountants ensure the necessary finance is available to fund the project.

  • Capital investment appraisal techniques like net present value analysis should not be used to block new projects altogether. They are decision support tools for management, not final determinants.

  • Management is ultimately responsible for considering other non-financial factors and making the final investment decision. Accountants provide information and guidance, but management bears responsibility for the decision.

So in summary, the passage discusses the accountant’s role in objectively assessing costs and benefits of potential capital projects using tools like NPV, while also noting their analysis should not preclude projects on its own - management still needs to make the final call based on both financial and non-financial factors. The accountant aims to inform rather than dictate the investment decision.

  • The business environment has changed significantly over the last 40 years due to factors like globalization, new technologies, and economic shifts.

  • Developments pioneered by Japanese companies like advanced manufacturing technology (AMT), just-in-time (JIT) production, and total quality management (TQM) emphasized flexibility, quality, and efficiency. These were later adopted globally.

  • Traditional UK industries like mining, steel, and manufacturing declined as service industries like finance, tourism, and information grew. Organizations also changed, becoming less hierarchical and more team-based.

  • These changes impacted traditional management accounting practices, which were rooted in the 19th century. Practices needed to become more flexible, focus on quality, and provide relevant information to support new approaches like JIT.

  • As a result, emerging developments in management accounting aimed to address these needs through approaches like activity-based costing, balanced scorecard, life-cycle costing, and strategic management accounting.

So in summary, changes to the business environment drove the need for new management accounting practices to support more modern, flexible, customer-focused approaches to business.

  • In recent years, both profit-seeking and not-for-profit entities have increasingly adopted outsourcing and privatization. This allows them to focus on core activities while outsourcing non-core functions.

  • Production processes and back-office administration have become highly automated and computerized. Employees now have access to vast internal and external data via personal computers.

  • Key changes in management accounting include greater use of computers for data collection, analysis and reporting. Inventory and overhead accounting will be less important due to JIT and automation. Budgeting, costing and decision-making tools will be more sophisticated and flexible.

  • Management accountants will transition to become more like business analysts focusing on financial decision making using a wide range of internal and external data. Their role will be less about recording past financial data and more about informed decision-making for the future.

  • A number of emerging management accounting techniques were summarized, including activity-based management, balanced scorecard, benchmarking, target costing, etc. Future changes in management accounting practices are expected to be evolutionary rather than revolutionary.

  • The M system (Activity-Based Management) is difficult to reduce activities to a practical level and determine precise activity boundaries. It also causes resentment by cutting across departmental structures. It’s not clear who is in charge of activities. As a result, ABM has not been widely adopted despite discussion.

  • The balanced scorecard aims to link objectives and performance. It has 4 perspectives - financial, internal processes, innovation/learning, customer. Each perspective has objectives, measures, targets and initiatives. It provides a flexible framework but risks information overload if too many are added.

  • Benchmarking compares performance to targets, internally and externally. The 4 types are internal, functional, competitive, and strategic. It can encourage improvement when benchmarks show underperformance vs competitors.

  • Issues with traditional budgeting include being unrelated to strategy, outdated quickly, departmentally organized, based on past budgets, inefficient, focusing on finances not operations, and costly.

  • Better budgeting proposals include rolling budgets, zero-based budgets, and activity-based budgets. But these still have weaknesses.

  • Beyond budgeting recognizes changes in the business environment. It proposes relating budgets to strategy, shorter forecast periods, rolling forecasts on outcomes, focusing on activities/processes not departments, and flexible discretionary costs. But a full replacement model for budgeting has not been developed yet.

  • Marketing, research and training costs from short-term forecasts should be excluded from comprehensive budgets, as they focus more on long-term planning.

  • Budgets should include both financial and non-financial data to provide a more holistic view of performance.

  • Data on competitors should also be included to aid strategic decision making.

  • Managers should have more autonomy when preparing their budgets to encourage ownership and accountability.

  • Staff should receive bonuses for meeting targets set in budgets to motivate performance.

  • The requirements outlined would represent an evolution from incremental budgeting to a more comprehensive strategic planning model, though change may take time to implement fully. Environmental, social and governance issues are increasingly important considerations for budgets and planning.

  • The passage discusses product life cycle costing, which seeks to account for the costs of a product across its entire lifespan - from development through growth, maturity, and decline stages.

  • Traditional costing only accounts for costs when incurred, undercharging products. Product life cycle costing aims to give a more accurate picture of true product profitability.

  • It accounts for all costs from initial R&D through disposal. This helps minimize loss-making products and pushes emphasis to lifetime impact and disposal costs.

  • While intended to improve cost estimation, it faces challenges in estimating costs and timelines for new products as well as determining typical growth curves.

  • Adoption in practice has been limited despite theoretical benefits. Estimating lifetime costs remains difficult but comparing objectives to results still provides valuable insights for cost control.

  • Target costing determines the maximum amount that can be spent on manufacturing, marketing, selling, and distributing goods based on the difference between the desired selling price and profit. This becomes the target cost.

  • It can be expressed as an equation: Target selling price - desired profit = target cost. Traditional absorption costing uses a more complex equation.

  • Target costing requires re-evaluating all costs if the target price and profit can’t be achieved due to competitive prices. All aspects of the product life cycle are analyzed to reduce costs.

  • It aims to have all employees work together to ensure total costs don’t exceed the target cost. This enhances cooperation and continuous improvement.

  • Potential issues include accurately assessing markets, forecasting technology changes, understanding customer needs, and determining acceptable profit margins.

  • Success depends on customers being willing to pay the target price. Costs may need to be cut if the price is still too high for the market.

  • Throughput accounting focuses on direct materials throughput by treating it as a key performance indicator. It classifies all other costs as fixed.

  • This simplifies the accounting process and highlights direct materials and constraints/bottlenecks. But it may overlook some variable production costs.

Here is a summary of the key disadvantages of throughput accounting discussed in the passage:

  • Emphasis on increasing material input to maximize throughput may result in overproduction. Focusing solely on throughput contribution could incentivize producing excess quantities without regard for demand.

  • Less attention may be given to controlling operating expenses. Throughput accounting concentrates on materials as the only direct costs, which could lead to neglecting efforts to reduce other variable and fixed operating costs.

  • Concentrating only on throughput contribution may draw attention away from overall profitability. Looking just at throughput metrics does not provide the full picture of revenues, costs and overall profits/losses. Important non-material costs are excluded from the analysis.

So in summary, the key disadvantages are that throughput accounting could encourage overproduction, neglect of operating expense control, and a narrow focus that fails to consider overall profitability by overlooking non-material costs. The emphasis on throughput may distort production and cost management decisions if not balanced with other financial perspectives.

Here is a summary of the key points regarding the standard cost operating statement case study:

  • The case study introduces Amber Textiles, a textile processing company that is struggling with competition and looking to tightly control costs.

  • It has introduced an “information for management” (IFM) system using standard costs and budgets for control.

  • Ted Finch, the managing director, is struggling to understand all the reports being produced by the new system.

  • The case provides a standard cost operating statement comparing budgeted and actual figures, along with favorable and unfavorable variances.

  • Ted studied the statement but was still puzzled, so reviewed the manual provided by the consultants.

  • After reviewing the manual section on standard costing operating statements, Ted still wanted advice, so asked the chief accountant to prepare a written report explaining the statement and variances.

  • The key issues are introducing standard costing for control, Ted’s lack of accounting knowledge, needing guidance to understand the new reports, and seeking an explanation of the operating statement and variances.

Activity 1.2: There is no single right answer here. Accept any answer that provides a reasonable example of different categories of animals that could add up to 10 and assigns them to groups.

Activity 1.3: Here is a possible table of answers:

Type of entity



Sole trader

  • Easy to set up and operate

  • sole control

  • profits taxed at individual’s rate

  • Unlimited liability

  • Difficult to raise large amounts of capital


  • More capital can be raised

  • Shared workload

  • Potential disputes between partners

  • Unlimited liability

Private limited company

  • Limited liability

  • Perceived greater status and prestige

  • Separate legal identity

  • More complex legal structure

  • Higher set up and ongoing costs

Public limited company

  • Easy to raise large amounts of capital by issuing shares

  • Shares can be widely held

  • Subject to more regulation

  • Loss of control by owners


  • Shared control by members

  • Profits distributed to members

  • Constraints on raising capital

  • More complex governance


  • Tax exemption on profits

  • Potential access to grants

  • Constraints on purpose and activities

  • Subject to charity regulation

Chapter 2

2.1 Business transactions are exchanges that can be measured in money terms. They involve the transfer of something of value (goods, services, money etc.). Examples are:

  • Buying supplies
  • Selling goods
  • Obtaining a bank loan
  • Paying wages

2.2 Records should be:

  1. Accurate - record the actual transaction details correctly
  2. Complete - include all necessary details of each transaction
  3. Timely - record transactions at the time they occur or very soon after
  4. Consistent - use consistent classifications and measurement rules
  5. Preserve original documentation - keep prime documents like invoices for reference
  6. Systematic - categorise transactions logically using accounting ledgers and journals
  7. Restricted access - only authorised personnel should be able to amend records.

2.3 Double entry means that for every transaction there are two equal and opposite entries recording different aspects of it. So for example, if goods are purchased:

Debit entry - supplies (asset)
Credit entry - accounts payable (liability)

This ensures the accounting equation (assets = liabilities + equity) remains in balance.

Chapter 3

3.2 Examples of source documents:

  • Invoice - records a sale or purchase transaction
  • Receipt - records cash received
  • Payment voucher - records cash paid out
  • Bank statement - records cash/cheques into and out of the bank
  • Wage/salary record - records wages/salaries paid
  • Petty cash voucher - records small cash payments

3.3 Prime (or primary) documents are original source documents from external parties that record details of business transactions such as invoices, receipts and bank statements. These provide evidence of the transactions.

Supporting documents are internal records, such as purchase orders, delivery notes and payment vouchers that provide additional information to substantiate the prime documents.

3.4 Steps in the accounting cycle:

  1. Identify and analyse transactions and record in journals.

  2. Post from journals to ledger accounts.

  3. Extract a trial balance from the ledger accounts.

  4. Prepare the financial statements - income statement and statement of financial position.

  5. Analyse and interpret financial statements.

  6. Record closing entries to transfer profit/loss to equity.

  7. Prepare adjusted trial balance after closing.

Chapter 4

4.1 Rules for double entry bookkeeping:

  1. Every transaction has a minimum of two entries - one in the debit column and one in the credit column.

  2. The total debits must equal the total credits.

  3. Debits are recorded on the left side of accounts and credits on the right.

  4. Assets and expenses are increased by debits and decreased by credits.

  5. Liabilities, capital and revenues are increased by credits and decreased by debits.

  6. The accounting equation must always balance:

    Assets = Liabilities + Equity

4.2 Examples of ledger account titles:


  • Cash
  • Inventory
  • Plant and equipment


  • Accounts payable
  • Bank overdraft
  • Loans payable


  • Capital
  • Dividends
  • Net income/loss


  • Sales
  • Service fees


  • Rent
  • Utilities
  • Wages

4.3 Answers will vary but should include:

  • Name and purpose of account
  • Explanation of normal balance (debit or credit)
  • Entries for a sample transaction (date, narrative, debit amount, credit amount)
  • Running balance after entries posted

Here are the summarized answers:

a) Sole trader - the owner has total control of the business and can make autonomous decisions but it may be difficult to obtain sufficient finance due to unlimited liability.

b) Partnership - partners can pool funds to start up and share the workload but have unlimited liability for debts of the business unless it is an LLP.

c) Limited liability company - owners/shareholders have limited liability and are not liable for business debts beyond their investment. However, there is a bigger administrative burden of submission of accounts/returns.

Jim Limited’s accounts:

Jim Limited Statement of profit or loss for the year to 31 March 2016

Sales £270,000 Less: Cost of goods sold: £126,000 Gross profit £144,000 Less: Expenses: £32,000 Net profit £112,000

Jim Limited Statement of financial position as at 31 March 2016

Non-current assets £47,000 Current assets £85,000 Less: Current liabilities £28,000 Net current assets £57,000 Total assets less current liabilities £104,000 Less: Non-current liabilities £20,000 Capital and reserves £84,000

Here is a summary of the key points in the information provided:

  • Jim Limited reported a net profit after tax of £56,000 for the year ended 31 March 2016.

  • Its statement of financial position as of 31 March 2016 showed total equity of £134,000.

  • However, this value is misleading as it simply represents the balances left in the double entry bookkeeping system and can be adjusted through depreciation methods or inventory valuation.

  • When liquidated, all assets and liabilities may not realize their book values and there will be additional costs of liquidation.

  • Megg Manufacturing account showed a manufacturing cost of goods produced of £149,000 for the year ended 31 January 2017.

  • Moor Manufacturing account showed a manufacturing cost of goods produced of £204,800 for the year ended 28 February 2017.

  • Dennis Limited’s statement of cash flows for the year ended 31 January 2016 showed a net cash inflow from operating activities of £4,000 and net cash used in investing activities of £100,000 which was offset by a net cash from financing activities of £100,000 from a share issue.

  • Frank Limited’s statement of cash flows for the year ended 28 February 2017 showed a net cash from operating activities of £70,000, net cash used in investing activities of £100,000 offset by a net cash from financing activities of £60,000 from long term borrowings.

  • The key accounting functions are collecting quantifiable data, translating it to monetary terms, storing the information and extracting/summarizing it for users. Financial accounting focuses on external users while management accounting focuses on internal users.

  • A management accountant employed by a large manufacturing entity will be involved in collecting and storing financial and operational data, and providing information and advice to management for planning, control, and decision-making purposes.

  • At more senior levels, the management accountant’s role involves advising on the financial impact of a wide variety of managerial decisions, such as whether to close a product line or set the price of a new product.

  • The management accountant works as an integral member of the entity’s management team, responsible for providing advice on all financial matters.

  • Tasks may range from routine data processing and cost calculations to higher-level advisory work supporting the entity’s directors and managers in their decision-making.

The passage discusses whether it would be profitable for Temple Limited to accept two new contract offers (Contracts 1 and 2) given resource constraints of direct materials and direct labour hours.

It first calculates the contribution per unit of the limiting factors (direct materials and direct labour hours) for normal work and each contract. It then calculates the total maximum contribution that could be achieved if each contract was accepted.

For Contract 1, the maximum number of normal jobs that could be done is 450, contributing £900,000. Contract 1 contribution is £300,000, so total maximum is £1,200,000.

For Contract 2, the maximum normal jobs is 375, contributing £750,000. Contract 2 contribution is £500,000, so total maximum is £1,250,000.

Therefore, the decision should be to accept Contract 2, as it results in the higher total maximum contribution of £1,250,000 compared to £1,200,000 for Contract 1.

A careful assessment of more profitable alternative work that could be displaced is also recommended before accepting a contract.

  • Behavioural considerations are important in management accounting, such as how budgets can affect employee behaviour.

  • Capital investment involves long-term spending on assets like machinery. Methods to appraise investments include net cash flow, internal rate of return and payback period. Sources of finance include retained earnings, loans and share issues.

  • Consolidated or group accounts combine the financial statements of a parent company and all its subsidiaries.

  • Cost accounting classifies and tracks manufacturing and operating costs. It is used for standard costing, absorption costing, marginal costing and activity-based costing.

  • Decision making in management accounting involves cost classification, information gathering and choosing between options like make vs buy or closure.

  • Double-entry bookkeeping records transactions with equal debits and credits to maintain the accounting equation. Ledger accounts track increases and decreases in asset, liability and equity accounts.

  • Interpretation of financial statements involves ratio analysis of liquidity, activity, profitability, gearing and investment. It aids decision making.

  • Indirect costs like manufacturing overheads are allocated to cost objects using predetermined absorption rates or activity-based costing.

  • Budgeting involves preparing fixed, flexible and master budgets for revenues, costs and activities to aid planning and control. Variances highlight differences from budgets.

  • Sources of finance for companies include retained profits, share issues, loans and leases. Groups prepare consolidated accounts to show total performance.

This chapter discusses accounting rules and regulations that provide the framework for preparing accounting information. Some key points include:

  • Regulations seek to provide consistency, transparency and fairness to help users of accounts. The main sources of authority are the Companies Act 2006, UK accounting standards, and international standards like IFRS.

  • The Companies Act governs company financial reporting. It requires companies to prepare accounts annually and have them audited.

  • UK accounting standards are issued by the Financial Reporting Council and provide detailed guidance. The main standards are FRS 100-102, which are based on IFRS.

  • International Accounting Standards (IAS and IFRS) are set by the International Accounting Standards Board. Listed UK companies must comply with IFRS adopted by the EU.

  • Together these sources create a framework that accounting must conform to in order to be considered acceptable. They provide rules on recognition, measurement, presentation and disclosure of financial information.

  • Key questions for users of accounts are about compliance with regulations, objectivity, transparency and whether the accounts provide a true and fair view. Adhering to regulations helps achieve these qualities.

So in summary, the chapter establishes that accounting regulations exist to help standardize and govern the preparation of accounts, making the information more reliable and useful for stakeholders. Compliance with these rules is important for accountants.

Here is a summary of key points about asic financial statements:

  • Year-end adjustments - Adjustments made at the end of the accounting period to accurately reflect income and expenses in the appropriate period, such as accruals and prepayments.

  • Inventory - Valuing the stock/inventory held at the end of the period, determining costs and valuation method.

  • Depreciation - Allocating the cost of fixed assets such as property, plant and equipment over their useful lives.

  • Accruals and prepayments - Recognizing revenues and expenses in the period they are earned/incurred rather than when cash is received or paid.

  • Bad and doubtful debts - Making provisions for debts that may not be collected by estimating expected credit losses.

  • A comprehensive example - Walks through a full set of sample financial statements including all required elements and notes.

  • Accounting defects - Common errors or omissions that could occur in financial statements and things to watch out for.

  • Questions you should ask - Key things to consider and discuss with accountants about the financial statements.

  • Conclusion - Recap of main takeaways and ensuring statements provide accurate picture of financial position.

  • Key points - Bullets highlighting the most important elements covered.

  • Check your learning - Self-test questions to assess understanding.

So in summary, it covers the key accounting adjustments, elements, and issues to consider when preparing and analyzing asic financial statements.

Author Photo

About Matheus Puppe