Preface xix

PART 1: ACCOUNTING FOR DECISION MAKING 1

1. Decision making and the role of accounting 2
Learning objectives 3
Decisions in everyday life 5
Steps in decision making 5
Economic decisions 6
The nature of accounting 7
Accounting defined 7
Users of accounting information 9
Using information in economic decisions 11
Accounting information and decisions 12
Management and financial accounting 13
What is management accounting? 13
What is financial accounting? 13
Management accounting versus financial accounting 14
Accounting as a profession 15
Public accounting 15
Accountants in commerce and industry 17
Not-for-profit accounting 19
Ethics and accounting 19
Ethics in business 19
Ethics and professional accounting bodies 19
Ethics in practice 20
Glossary 22
Discussion questions 22
Exercises 23
Decision case 24
Critical thinking case 25
Communication/group activity 26
Ethical issues 26
Financial reporting case 26

2. Financial reports for decision making 28
Concepts for review 28
Learning objectives 29
Types of business entities 30
Management functions 31
Role of management 31
Basic financial reports 32
The statement of financial position (or balance sheet) 34
The statement of financial performance (or profit and loss statement) 36
The statement of owner's equity 37
The statement of cash flows 39
Some underlying assumptions of accounting reports 40
The accounting entity assumption 40
The cost assumption 40
The going concern assumption 41
The period assumption 41
Relevance 41
Reliability 42
Materiality 42
Economic substance 42
The effects of transactions on the accounting equation and financial reports 43
Glossary 49
Discussion questions 50
Exercises 50
Problems 53
Decision case 58
Critical thinking case 59
Communication/group activity 60
Ethical issues 60
Financial reporting case 61

PART 2: ACCOUNTING SYSTEMS AND PROCESSES 63

3. Recording transactions 64
Concepts for review 64
Learning objectives 65
Transactions 66
Types of transactions 66
Transactions of a business entity 67
Source documents 67
The accounting cycle 68
The ledger account 69
Account formats 70
Accounts commonly used 71
Accounts: statement of financial position 71
Accounts: statement of financial performance 74
General ledger 74
Chart of accounts 74
Double-entry accounting 77
Debit and credit rules 77
Normal account balances 79
Expanded accounting cycle 80
General journal 80
Recording transactions in a journal 81
Posting from journal to ledger 82
Illustration of transactions analysis 84
Trial balance 102
Limitations of the trial balance 102
Correcting errors 103
Use of dollar signs and decimal points 104
Glossary 104
Discussion questions 105
Exercises 105
Problems 109
Decision case 115
Critical thinking case 117
Communication/group activity 117
Ethical issues 118
Financial reporting case 118
Appendix: Introduction to the goods and services tax 119
The GST in practice 120
Accounting for the GST 120
Accounts for recording GST 121

4. Adjusting the accounts and preparing financial statements 122
Concepts for review 122
Learning objectives 123
Measurement of net profit 124
Cash basis 124
Accrual basis 124
The accounting cycle - further expansion 126
Adjusting entries 126
Classification of adjusting entries 127
Prepaid expenses 129
Precollected or unearned revenue 134
Accrued or unrecorded expenses 136
Unrecorded or accrued revenue 139
Adjusted trial balance 141
Preparation of financial statements 144
Statement of financial performance 144
Statement of financial position 144
Preparing financial statements from the worksheet 149
Preparation of the worksheet 150
Preparation of financial statements 155
Financial statements and decision making 156
Glossary 157
Discussion questions 158
Exercises 159
Problems 162
Decision case 171
Critical thinking case 172
Communication/group activity 173
Ethical issues 173
Financial reporting case 173

5. Completing the accounting cycle 174
Concepts for review 174
Learning objectives 175
The complete accounting cycle 176
Closing temporary accounts 177
Using the worksheet 177
Recording adjusting entries 178
The closing process 181
Closing the revenue accounts 183
Closing the expense accounts 184
Closing the Profit and Loss Summary account 187
Closing the Drawings account 188
Account balances after the closing process 188
The post-closing trial balance 199
Accrual entries in subsequent periods 199
Reversing entries 200
Reversal of accrual entries 200
Reversal of deferral entries 204
Accounting procedures applicable to a partnership or a company 205
Accounting for a partnership 205
Accounting for a company 206
Glossary 208
Discussion questions 208
Exercises 208
Problems 212
Decision case 219
Critical thinking case 220
Communication/group activity 221
Ethical issues 221
Financial reporting case 221

6. Accounting for retailing 222
Concepts for review 222
Learning objectives 223
Inventory 224
Retail business operations 224
Condensed statement of financial performance 225
Retailing and the goods and services tax 225
Tax invoices 226
Adjustment notes 227
Accounting for sales transactions 229
Sales returns and allowances 229
Cash (settlement) discounts 230
Trade discounts 232
Freight outwards 233
Accounting for purchases and cost of goods sold 233
Perpetual inventory system 233
Illustration of a perpetual inventory system 234
Periodic inventory system 240
Illustration of a periodic inventory system 240
Perpetual and periodic inventory systems contrasted 243
End of period processes 246
Illustration of worksheets in retail businesses 246
Perpetual inventory system 248
Periodic inventory system 248
Detailed statement of financial performance 249
Trading statement and performance statement 250
Profitability analysis for decision making 251
Gross profit ratio 251
Profit margin 251
Expenses to sales ratio 252
Inventory turnover 252
Ratios illustrated 253
Glossary 253
Discussion questions 254
Exercises 255
Problems 258
Decision case 265
Critical thinking case 266
Communication/group activity 266
Ethical issues 267
Financial reporting case 267

7. Accounting systems 268
Concepts for review 268
Learning objectives 269
Operation of an accounting system 270
Converting data to information 270
Manual accounting systems - subsidiary ledgers 271
Control accounts and subsidiary ledgers 271
Manual accounting systems - special journals 273
Sales journal 274
Advantages of a sales journal 274
Purchases journal 276
Cash receipts journal 279
Cash payments journal 283
Use of the general journal 286
Abnormal balances in subsidiary ledgers 287
Account set-offs 288
Demonstration problem 289
Computerised accounting systems 296
MYOB Accounting - an overview 297
Introduction to MYOB Accounting 297
Accounts receivable using MYOB Accounting 302
QuickBooks - an overview 308
An introduction to QuickBooks Pro 308
Comparison of MYOB and QuickBooks Pro 309
Computerised accounting - advantages and disadvantages 310
Advantages 310
Disadvantages 310
Accounting cycle - manual and computerised 310
Glossary 311
Discussion questions 312
Exercises 312
Problems 316
Decision case 327
Critical thinking case 327
Communication/group activity 328
Ethical issues 328
Financial reporting case 329

PART 3: OWNERS' EQUITY IN BUSINESS 331

8. Partnerships: formation, operation and reporting 332
Concepts for review 332
Learning objectives 333
Partnership defined 334
Advantages and characteristics of a partnership 334
Characteristics of a partnership 335
Partnership agreement 336
Accounting for a partnership 337
Method 1: Capital accounts reflecting profits and losses 337
Method 2: Fixed capital balances 338
Accounting for the formation of a partnership 338
Allocation of partnership profits and losses 340
Fixed ratio 341
Ratio based on capital balances 342
Fixed ratio after allowing for interest and salaries 342
Drawings and loans made by partners 346
Drawings 346
Loans or advances by partners 348
Financial statements for a partnership 348
Glossary 350
Discussion questions 350
Exercises 351
Problems 354
Decision case 361
Critical thinking case 362
Communication/group activity 362
Ethical issues 363
Financial reporting case 363

9. Partnerships: admission, retirement and dissolution 364
Concepts for review 364
Learning objectives 365
Valuation of net assets 366
Goodwill recorded 366
Arguments against recording goodwill 367
Valuation adjustment summary account 367
Admission of a new partner 368
Purchasing an interest from existing partner(s) 369
Purchasing an interest by contributing assets 369
Retirement of a partner 372
Selling partnership interest 372
Transfer of partnership assets to retiring partner 372
Death of a partner 375
Partnership dissolution 376
Sale of non-cash assets 377
Partner takes over assets and liabilities 378
Sale of partnership to a company 379
Partner with a debit capital balance 380
Unrecorded expenses and gains on dissolution 382
Glossary 382
Discussion questions 383
Exercises 383
Problems 386
Decision case 395
Critical thinking case 395
Communication/group activity 396
Ethical issues 396
Financial reporting case 397

10. Companies: formation and operations 398
Concepts for review 398
Learning objectives 399
Types of companies 400
Advantages and disadvantages of the corporate entity 402
Advantages 402
Disadvantages 403
Forming a company 404
Replaceable rules and constitution 404
The certificate of registration 405
The prospectus 405
Formation costs and share issue costs 406
Administering a company 406
Owners' equity in a company 407
Share capital 407
Reserves 408
Retained profits 408
Accounting for share issues 408
Share issue to private individuals 409
Share issue by a public company, payable in full on application 409
Share issue by a public company, payable in instalments 410
Undersubscription and oversubscription 414
Preference shares 415
Dividends 416
Cash dividends 417
Preference dividends 418
Share dividends 419
Share splits 421
Comparison of share dividends and share splits 421
Reserves 422
Creation of reserves 423
Disposal of reserves 423
Income tax 423
Preparing the financial statements 424
Illustrative example: Preparation of financial statements 424
Glossary 431
Discussion questions 432
Exercises 432
Problems 434
Decision case 440
Critical thinking case 441
Communication/group activity 442
Ethical issues 442
Financial reporting case 443

PART 4: ACCOUNTING REGULATION OF ASSETS AND LIABILITIES 445

11. Regulation and the conceptual framework 446
Concepts for review 446
Learning objectives 447
Regulation and development of accounting standards 448
Brief history of regulation 448
Financial Reporting Council 449
Australian Accounting Standards Board 450
Urgent Issues Group 451
Australian Securities and Investments Commission 452
Australian Accounting Research Foundation 452
Australian Stock Exchange 453
International influences 453
The conceptual framework 455
Development of the conceptual framework 456
The reporting entity 458
Objectives of general-purpose financial reporting 458
Qualitative characteristics of financial information 459
Relevance 460
Reliability 460
Test of materiality 460
Comparability 461
Understandability 462
Constraints on relevant and reliable financial information 462
Definitions of elements in financial statements 462
Assets 463
Liabilities 463
Equity 464
Revenues 464
Expenses 464
Recognition of the elements 465
Asset recognition 465
Liability recognition 465
Revenue recognition 466
Expense recognition 469
Assumptions underlying financial reports 470
The accounting entity assumption 470
The going concern or continuity assumption 470
The period assumption 471
The monetary assumption 471
Measurement 472
Glossary 473
Discussion questions 474
Exercises 475
Problems 477
Decision case 483
Critical thinking case 483
Communication/group activity 484
Ethical issues 484
Financial reporting case 485

12. Cash management and control 486
Concepts for review 486
Learning objectives 487
Cash defined 488
Internal control 489
Internal control systems defined 489
Principles of internal control systems 489
Limitations of internal control systems 491
Control of cash 492
Control of cash receipts 492
Control of cash payments 494
Bank accounts and reconciliation 495
Cheque accounts 495
Use of electronic funds transfer 497
The bank statement 497
Bank reconciliation 499
The petty cash fund 504
Establishing the fund 505
Making payments from the fund 505
Reimbursing the fund 505
Cash budgeting 507
Need for cash budgeting 507
Preparation of a cash budget 508
Cash management 511
Principles of cash management 511
Analysing adequacy of cash flows 512
Glossary 512
Discussion questions 513
Exercises 513
Problems 517
Decision case 525
Critical thinking case 525
Communication/group activity 526
Ethical issues 527
Financial reporting case 527

13. Receivables 528
Concepts for review 528
Learning objectives 529
Types of receivables 530
Accounts receivable 530
Bills receivable 530
Other receivables 531
Accounts receivable (trade debtors) 531
Recognition of accounts receivable 531
Valuation of accounts receivable 532
Bad and doubtful debts 532
Allowance method of accounting for bad debts 532
Estimating doubtful debts 534
Writing off bad debts 536
Recovery of an account written off 538
Direct write-off method 538
Management and control of accounts receivable 539
Credit policies 540
Monitoring credit policies 540
Internal control of accounts receivable 542
Disposal of accounts receivable 543
Bills receivable 545
Trade bills 545
Promissory notes 546
Determining due date 547
Calculating interest on bills and notes 547
Accounting for receipt and collection of bills
receivable 548
Discounting bills receivable 549
End-of-period adjustments for interest revenue 550
Demonstration problem 551
Glossary 553
Discussion questions 554
Exercises 554
Problems 557
Decision case 563
Critical thinking case 564
Communication/group activity 564
Ethical issues 565
Financial reporting case 565

14. Inventories 566
Concepts for review 566
Learning objectives 567
Determining inventory on hand 568
Transfer of ownership 569
Goods on consignment 570
Determining cost of inventory 570
Assignment of cost to ending inventory and cost
of goods sold - periodic system 570
Specific identification method - periodic 572
First-in, first-out (FIFO) method - periodic 573
Last-in, first-out (LIFO) method - periodic 574
Weighted average method - periodic 574
Comparison of costing methods 575
Consistency in using a costing method 577
Costing methods in the perpetual inventory system 578
First-in, first-out method 580
Last-in, first-out method 580
Moving average method 580
Comparison of inventory systems 580
The lower of cost and market rule 582
Sales returns and purchases returns 584
Returns using the first-in, first-out method 585
Returns using the last-in, first-out method 586
Returns using the moving average method 586
Inventory errors 586
Estimating inventories 588
Retail inventory method 588
Gross profit method 590
Presentation in financial reports 591
Effect of costing methods on decision making 592
Glossary 593
Discussion questions 594
Exercises 594
Problems 598
Decision case 603
Critical thinking case 604
Communication/group activity 604
Ethical issues 605
Financial reporting case 605

15. Non-currrent assets: acquisition and depreciation 606
Concepts for review 606
Learning objectives 607
Determining the cost of property, plant and equipment 608
Apportioning the cost of a lump-sum acquisition 610
Assets acquired under a lease agreement 611
Depreciation 612
The nature of depreciation 612
Determining the amount of depreciation 613
Depreciation methods 613
Comparison of depreciation methods 618
Revision of depreciation rates and methods 620
Accumulated depreciation does not represent cash 620
Subsequent costs 621
Ordinary repairs and maintenance 622
Major overhauls and replacement of major components 622
Leasehold improvements 623
Spare parts 623
Property and plant records 624
Disclosure of property, plant and equipment 626
Analysis, interpretation and management decisions 626
Analysis and interpretation 626
Management decisions 627
Glossary 628
Discussion questions 629
Exercises 630
Problems 633
Decision case 638
Critical thinking case 639
Communication/group activity 639
Ethical issues 640
Financial reporting case 640

16. Non-currrent assets: revaluation, disposal and other aspects 642
Concepts for review 642
Learning objectives 643
Revaluation of non-current assets 644
Revaluation increments 644
Revaluation decrements 646
Offsets and reversals of increments and decrements 647
The cost basis and the impairment test 648
Adopting the cost basis 648
The impairment test 648
Disposal of non-current assets 650
Scrapping non-current assets 650
Sale of non-current assets 651
Disposal of revalued assets 653
Exchanging non-current assets 653
Exchanging dissimilar assets 654
Composite-rate depreciation 655
Natural resources 656
Amortisation (depletion) 657
Depreciation of related non-current assets 657
Self-generating and regenerating assets 658
Intangible assets 659
Amortisation 660
Patents and research and development costs 660
Copyrights 662
Trademarks and brand names 662
Franchises 663
Goodwill 663
Discount on acquisition 664
Glossary 665
Discussion questions 666
Exercises 667
Problems 669
Decision case 675
Critical thinking case 676
Communication/group activity 676
Ethical issues 677
Financial reporting case 677

17. Liabilities 678
Concepts for review 678
Learning objectives 679
Liabilities defined 680
Recognition of liabilities 681
Provisions and contingent liabilities 682
Nature of provisions 682
Items excluded from provisions 683
Contingent liabilities 683
Classification of liabilities 685
Need for classification 685
Basis of classification 685
Categories 685
Current liabilities 685
Accounts payable (trade creditors) 686
Bills payable 686
Employee benefits 688
Warranties 693
GST collections 694
Non-current liabilities 695
The types of non-current liabilities 695
Debentures 696
Other non-current liabilities 699
Why finance through long-term debt? 701
Analysing liabilities for decision making 703
Liquidity ratios 703
Financial stability ratios 704
Illustration of ratios 705
Glossary 706
Discussion questions 707
Exercises 708
Problems 710
Decision case 715
Critical thinking case 715
Communication/group activity 716
Ethical issues 716
Financial reporting case 717

PART 5: EXTERNAL REPORTING AND PERFORMANCE EVALUATION 719

18. Statements of financial performance and position 720
Concepts for review 720
Learning objectives 721
External reporting requirements 722
Annual financial report 722
Concise report 723
Half-year financial report 724
General requirements 724
Statement of financial performance 725
Disclosure of revenues and expenses 727
Ordinary activities and extraordinary items 728
Statement of financial position 729
Demonstration problem 732
Revisions of accounting estimates 734
Errors 736
Glossary 738
Discussion questions 738
Exercises 739
Problems 741
Decision case 748
Critical thinking case 749
Communication/group activity 750
Ethical issues 750
Financial reporting case 751

19. Statement of cash flows 752
Concepts for review 752
Learning objectives 753
Purpose of the statement of cash flows 754
General format of statement of cash flows 754
Concept of cash 756
Classification of cash flow activities 757
Cash flows from operating activities 757
Cash flows from investing activities 758
Cash flows from financing activities 758
Preparing the statement of cash flows 760
Analysis of cash and other records 760
Analysis of financial statements 761
Illustrative example 761
Notes to the statement 770
Advanced issues 774
Impact of the GST 774
Bad and doubtful debts 776
Discount allowed 778
Discount received on accounts payable 778
Non-trade receivables and payables 779
Bills receivable and bills payable 779
Short-term investments 780
Dividends 780
Income tax payments 781
Extraordinary items 784
Demonstration problem (company) 785
Solution to demonstration problem 787
Analysing the statement of cash flows 792
Limitations of the statement of cash flows 793
Glossary 794
Discussion questions 795
Exercises 796
Problems 801
Decision case 812
Critical thinking case 813
Communication/group activity 813
Ethical issues 813
Financial reporting case 814

20. Analysis and interpretation of financial statements 816
Concepts for review 816
Learning objectives 817
Sources of financial information 818
The need for analytical techniques 818
Percentage analysis 821
Horizontal analysis 821
Trend analysis 821
Vertical analysis 822
Ratio analysis 822
Profitability ratios 823
Liquidity ratios 827
Financial stability ratios 830
Some important relationships 832
Analysis using cash flows 832
Cash sufficiency ratios 834
Cash flow efficiency ratios 836
Limitations of financial analysis 838
Glossary 842
Discussion questions 842
Exercises 843
Problems 847
Decision case 857
Critical thinking case 858
Communication/group activity 858
Ethical issues 858
Financial reporting case 859
Appendix 861

Index 871