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Accounting (Esp. Theory)

Terms in this set (149)

Planning involves working out the goals and objectives of a business and expressing how they are to be attained. It involves a series of stages:

• the development of business goals, often expressed as a mission statement or vision statement. A mission statement is a statement of purpose that serves to guide the business.
• the setting of objectives to achieved these goals. An important part of the planning process is for a business to undertake a SWOT (strengths, weaknesses, opportunities, threats) analysis of itself and its environment. From this a business can develop its objectives and priorities.
• determining strategies to meet the objectives.
• taking the operational decisions necessary to put the strategies into effect.

Business planning is important to the success of any business. Budgeting is a vital part of this process. A budget can:

• give purpose and direction
• anticipate future events and plan how to deal with them
• connect and coordinate business activity
• encourage the challenging of accepted practice
• galvanise the energy of all staff, focus their activity and give employees a sense of belonging
• improve decision-making processes and bring forth creativity
• provide a business with a competitive advantage and improved market recognition.

One of the main purposes of business planning is to reduce risk and costs. By anticipating what might occur in the future, a business can prepare itself to respond to future changes. The planning process should highlight those areas of the business that are not operating effectively or that need to improve efficiency and productivity.
Ratios are only as good as the underlying figures used in their calculation. If the accounting reports have not been prepared properly or there have been differences in accounting methods, then the ratios will also be inaccurate.

When using ratios to assess business performance and position it is important to remember the following limitations in using this approach to financial analysis:

1. Ratios may need to be calculated for a number of years before a trend becomes apparent. Like any statistical analysis, the smaller the sample size the great the standard deviation possible.
2. Ratios need to be compared to an industry-wide standard to be further evaluated. These standards are not readily available.
3. Ratios do not identify the causes of problems. A change in a particular ratio may have a number of different explanations that the external user of the report may be unable to identify.
4. Most media-reported market ratios use data from the previous year in calculating certain ratios. This can lead to incorrect interpretations of the published ratios as future profits or dividends may not be the same as the previous period.
5. The market price of listed company shares varies because of many factors not related to a specific company. This may be because of government policy, economic factors or the actions of similar companies.
6. General purpose financial reports (and the relevant ratios) are produced some time after the end of the financial period. To be useful, financial information needs to be available quickly.
7. Companies can sometimes manipulate data at the balance date (eg run down creditors to an unrealistic level) to create a false impression when the ratios are calculated.
There is a wide variety of external users of financial information. These may include:

Owners - With larger firms, especially public companies, the owners are remote from the management and usually have no wish to be involved in the day-to-day operations. The shareholders of such companies (and their advisors) need information to enable them to evaluate the performance of the business, compare it with alternative investments and identify trends that may impact on the future value of their investment.

Customers and suppliers - Those relying on a business as a market for their product or as a source of stock or components for manufacture need to know whether that business is likely to remain in existence. They will therefore have a general interest in its continuing profitability and stability.

Lenders - Both at the time of borrowing and later during the currency of the loan, lenders (banks, finance companies, etc) will rely on financial information to assess the financial viability of the borrower and its capacity to repay the loan and meet interest payment obligations.

Employees - Those working for a business obviously have an interest in the firm's future viability and thus the likelihood that they will continue to be employed.

Governments - The federal government, and to a lesser extent state governments, need financial information from businesses. Sometimes this is in the form of specific report such as a BAS. General profit reports will be used by government to assess the income tax liability.
It is a well-established principle in our society that people should be protected to some degree from exploitation from others who may be better informed or more expert than they are. In the world of business this is achieved broadly in three ways:

1. the development of an accounting conceptual framework, with associated accounting standards, which sets out principles and rules with which all producers of financial reports are encouraged and some are required by law, to comply

2. legislation governing the operations of certain forms of business entity, notably the Corporations Act 2001

3. the requirement that certain entities must have their accounting systems and reports checked by an independent expert

The group most in need of protection provided by these means are those who hold shares and other securities in public companies, so it is these forms of business entity that are required by law to comply with accounting standards.

From the start of 2005, Australia adopted the Framework for the Preparation and Presentation of Financial Reports set out by the International Accounting Standards Board (ISAB) which, together with the former SACs 1 and 2, constitutes the conceptual outline which Australian businesses must operate. That Australian Accounting Standards Board (AASB) has issued a number of Accounting Standards that deal with specific items of preparation or presentation. Generally, Standards comply with the principles contained in the Framework though, if there is a conflict, the Standard prevails.

Although compliance with Accounting Standards is not mandatory for all business financial reports, it does extend well beyond the bounds of legal requirements. For example, the professional accounting bodies in Australia expect their members to comply with standards in all reports for whose preparation they are responsible, regardless of whether their compliance is compulsory.
There are three main purposes governing internal control:

1. Accounting controls aim to detect and correct errors and deficiencies in accounting systems and to ensure that accounting records and reports are complete and accurate.

2. Administrative controls involve the review of procedures and policies in business, identification of risks and aim to improve business efficiency.

3. Internal audit used to review and improve their internal controls. The effectiveness of controls is examined and any risks and improvements are identified.


The risks that internal controls try to minimise are opportunities for fraud, theft and loss of assets and information. For example, where it may be easy to falsify records to steal assets, access information for fraud or lose source documents.

As mentioned earlier, publicly listed companies are required by law to conduct an external audit on their annual reports. It is good advice for all businesses to have their accounting systems and records assessed by an independent party.

An external auditor focuses on the reliability and accuracy of the financial statements and the accounting and business systems that can affect the statements. The external audit can highlight deficiencies in an accounting system and evaluates compliance with accounting standards and regulations.

If a business conducts internal audits and maintains good internal controls, accounting and business systems will be consistent with regulations and accounting standards. It is less likely that an external auditor will find errors and deficiencies. It is possible that an external audit may take less time and therefore the business will pay less fees to the auditor.