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Financial Accounting for Decision Makers Peter Atrill Eddie McLaney

‘The book is written in a very friendly way, from which students will benefit.’

Paulo Alves, University of Lancaster

A comprehensive and accessible introduction to the subject, Financial Accounting for Decision Makers focuses on the ways in which financial statements and information can be used to improve the quality of decision making.

By introducing topics gradually and explaining technical terminology in a clear, friendly style, the authors cater both for accounting students, and for those studying entry-level accounting within another field. A practical emphasis throughout the book ensures that the material is always relevant and suitable to the decision makers of the future.

Financial Accounting for Decision Makers offers: • Interactive ‘open-learning’ style, ideal for self-study, encourages you to check your progress continually.

• NEW chapter examining supplementary financial reports prepared by businesses.

• Interactive ‘open-learning’ style, ideal for self-study, encourages you to check your progress continually.

• Fully integrated coverage of International Financial Reporting Standards (IFRS).

• NEW sections dealing with key standards and standard-setting issues.

• Numerous activities and exercises enable you to constantly test your understanding and reinforce learning.

• Updated and expanded chapter on corporate governance outlines the issues and potential problems inherent to the separation of ownership of a company from day-to-day control.

• Colourful and relevant examples from the real world, including company reports and survey data, demonstrate the practical application and value of concepts and techniques learnt.

• Key terms, glossary and bulleted summaries providing excellent revision aids.

Visit the student companion website at www.pearsoned.co.uk/atrillmclaney to access a host of student study resources including multiple choice questions and links to useful websites.

Authors Peter Atrill is a freelance academic and author working with leading institutions in the UK, Europe and SE Asia.

He was previously Head of Business and Management and Head of Accounting and Law at the University of Plymouth Business School.

Eddie McLaney is Visiting Fellow in Accounting and Finance at the University of Plymouth.

Front cover image: © Getty Images

CVR_ATRI0391_06_SE_CVR.indd 1

Sixth Edition

Financial Accounting for Decision Makers Peter Atrill Eddie McLaney

Sixth Edition

Atrill & McLaney

Audience Suitable for all those studying an introductory course in financial accounting, who are seeking an understanding of basic principles and underlying concepts without detailed technical knowledge.

Financial Accounting for Decision Makers

Sixth Edition

www.pearson-books.com

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Contents

Guided tour of the book Guided tour of the Companion Website Preface How to use this book Acknowledgements

1

xiv xvi xviii xx xxii

Introduction to accounting

1

Introduction Learning outcomes

1 1

What is accounting?

Who are the users of accounting information?

The conflicting interests of users How useful is accounting information?

Providing a service But . . . is it material?

Weighing up the costs and benefits Accounting as an information system Management accounting and financial accounting Scope of this book Has accounting become too interesting?

The changing face of accounting What kinds of business ownership exist?

How are businesses organised?

What is the financial objective of a business?

Balancing risk and return Not-for-profit organisations

2 2 4 4 6 7 8 10 12 13 14 16 17 19 20 23 24

Summary Key terms Reference Further reading Review questions

25 27 27 28 29

2 Measuring and reporting financial position

30

Introduction Learning outcomes

30 30

Making financial decisions The major financial statements – an overview

31 31

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CONTENTS

The statement of financial position The effect of trading transactions Classifying assets Classifying claims Statement layouts Capturing a moment in time The role of accounting conventions Money measurement Valuing assets Meeting user needs

36 42 45 47 48 50 51 54 58 62

Summary Key terms Further reading Review questions Exercises

63 65 65 66 66

3 Measuring and reporting financial performance Introduction Learning outcomes

69 69 69

What does it mean?

The income statement Different roles Income statement layout Further issues Recognising revenue Recognising expenses Depreciation Costing inventories Trade receivables problems Uses and usefulness of the income statement

70 70 72 73 74 77 81 86 96 101 105

Summary Key terms Further reading Review questions Exercises

106 108 108 109 109

4 Accounting for limited companies (1)

114

Introduction Learning outcomes

114 114

Why limited companies?

The main features of limited companies Legal safeguards Public and private companies Taxation Transferring share ownership: the role of the Stock Exchange

115 115 119 119 121 122

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CONTENTS

Managing a company Financing limited companies Share capital Reserves Bonus shares Share capital jargon Raising share capital Borrowings Withdrawing equity The main financial statements Dividends

123 123 124 126 128 130 131 131 133 136 139

Summary Key terms Further reading Review questions Exercises

140 142 142 143 143

5 Accounting for limited companies (2)

149

Introduction Learning outcomes

149 149

The directors’ duty to account The need for accounting rules Sources of accounting rules Presenting the financial statements Selected financial reporting standards The framework of principles Problems with standards Accounting rules or accounting choice?

The auditors’ role Directors’ report Summary financial statements Creative accounting

150 150 153 156 162 166 168 170 171 172 173 173

Summary Key terms Further reading Review questions Exercises

180 182 182 183 183

6 Measuring and reporting cash flows

186

Introduction Learning outcomes

186 186

The statement of cash flows Why is cash so important?

The main features of the statement of cash flows A definition of cash and cash equivalents

187 188 189 189

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The relationship between the main financial statements The form of the statement of cash flows Preparing the statement of cash flows What does the statement of cash flows tell us?

Problems with IAS 7

190 191 195 202 204

Summary Key terms Reference Further reading Review questions Exercises

206 207 207 207 208 208

7 Analysing and interpreting financial statements (1)

217

Introduction Learning outcomes

217 217

Financial ratios Financial ratio classifications The need for comparison Calculating the ratios Profitability Efficiency Relationship between profitability and efficiency Liquidity Operating cash cycle Financial gearing

218 219 220 221 225 231 237 239 242 244

Summary Key terms Further reading Review questions Exercises

251 252 252 253 253

8 Analysing and interpreting financial statements (2)

261

Introduction Learning outcomes

261 261

Investment ratios Financial ratios and the problem of overtrading Trend analysis Common-sized financial statements Using ratios to predict financial failure Limitations of ratio analysis

262 270 271 273 277 283

Summary Key terms References Further reading Review questions Exercises

285 286 286 286 287 287

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CONTENTS

9 Reporting the financial results of groups

of companies

295

Introduction Learning outcomes

295 295

What is a group of companies?

Why do groups exist?

Types of group relationship Preparation of a group statement of financial position Goodwill arising on consolidation and asset carrying amounts Inter-company assets and claims Preparation of a group income statement The statement of comprehensive income Inter-company trading Group statement of cash flows Accounting for less than a controlling interest – associate companies The argument against consolidation

296 296 303 305 326 333 334 336 336 336 338 341

Summary Key terms Further reading Review questions Exercises

342 344 344 345 345

10 Increasing the scope of financial reporting

352

Introduction Learning outcomes

352 352

The development of financial reporting From stewardship to decision making Segmental financial reports Business review Interim financial statements The value added statement Inflation accounting and reporting

353 354 354 358 363 366 375

Summary Key terms References Further reading Review questions Exercises

384 386 386 386 387 387

11 Governing a company

390

Introduction Learning outcomes

390 390

Corporate governance The board of directors The UK Corporate Governance Code Tasks of the board

391 392 393 397

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Chairing the board The role of non-executive directors The audit process Assessing board performance Remunerating directors Setting performance targets Total shareholder return Economic value added (EVAŽ) Earnings per share Directors’ share options Deciding on a target measure The rise of shareholder activism

397 403 406 414 416 421 421 424 426 427 431 432

Summary Key terms References Further reading Review questions Exercises

437 439 439 440 441 441

Appendix A Recording financial transactions

442

Introduction Learning outcomes

442 442

The basics of double-entry bookkeeping Recording trading transactions Balancing accounts and the trial balance Preparing the financial statements (final accounts) The ledger and its division

443 445 448 452 455

Summary Key terms Further reading Exercises

456 457 457 458

Appendix B Appendix C Appendix D Appendix E

461 472 481 491

Index

Glossary of key terms Solutions to self-assessment questions Solutions to review questions Solutions to selected exercises

528