The Role and Limitations of Accounting

8/7/2019 The Role and Limitations of Accounting

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Homework for next weeks classes(17 & 18 November):

Read Hall et al (2009) Chapter 43The Role and Objectives of AccountingMarcous et al (2009) Chapter 58Limitations of Accounts

Answer Revision questions, Marcous p412 Q1-8


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The Role and Limitationsof Accounting


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Learning Objectives

Discuss the purpose of accounts Identify which accounting information is relevant

for particular stakeholders Distinguish between internal and external users of accounting information

Discuss the limitations of public accounts andexplain the areas that need further research whenmaking recommendations


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D efinition of Accounting

The process of recording, classifying

and summarising business transactionswith the aim of providing useful financialinformation for a range of users

(Hall et al, 2009)


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Provide information for stakeholders customers, shareholders, suppliers, etc.

Provides the opportunity for the business to monitor itsown activities

Provides transparency to enable the firm to attractinvestment

Reduces the chance for fraud not 100% successful!!

The Purpose of Accounts


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F inancial AccountingThe preparation of company accounts from business records

- G eared toward external users of accounting information- C oncerned with past performance

Management AccountingThe preparation of financial statements, reports and data for useby managers

- Aimed at internal users of accounting information- C oncerned with the future

Financial v Management Accounting


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Management- Recording- Analysis and Evaluation- C ontrol- Decision making

Employees Owners

Internal Users of Accounts

Refer Handout: Users of Accounts


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Legal Requirements- Tax authorities, Auditors, Registrar of C ompanies

Performance & Stability Requirements- B ankers, Suppliers, C ompetitors, Local

C ommunity, Media, Investors Statistical Requirements

- G overnment

External Users of Accounts


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B alance Sheet- A snap -shot of the business at a specific point- Lists assets, liabilities and capital of the business

Profit and Loss Account- Provides a summary of the years trading activities,

stating the turnover (revenue from sales), businesscosts, profit/loss and how the profit is used

C ash Flow Statement- Shows the flows of cash into and out of a business

in a trading year

Key Financial Accounting Statements


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S ample Annual Reports

http://www.tescoplc.com/annualreport09

Next plc


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Limitations of Accounts

Accounting data should be used with cautionas part of an overall picture of the business

What is not covered may be more importantthan what is


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Focus on quantitative data- take no account of important qualitative data, such as theculture of the firm, a highly skilled, motivated workforce,

customer service record etc Using profit as a performance indicator - the long -term success of a business may depend on awillingness to sacrifice profits over the short -medium term

The state of the market- accounts reflect on what has happened in the past but nobusiness environment will remain static

Limitations of Accounts


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Quality of the workforce Quality of the businesss technology Market share New product success Arrival of a new competitor Loss of a valued supplier

Examples of What Accounts Leave Out


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Land and B uildings Intangible Assets Debtors Stock Profit Quality

Problems Interpreting Accounts


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Window Dressing

Window dressing refers to attempts bybusiness to present its accounts in the best light

Has become more of a necessity as pressure toplease shareholders and the C ity increases

It is NOT illegal Deliberate deception in the accounts is fraud


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How do firms massage the accounts? Timing of reporting

B alance sheet snapshot of a business at a point in time,

therefore: Delay major payment Include large injection of cash/assets

Exploit accounting procedures often a wide range in thedefinition, e.g:

Depreciation Extraordinary items

Window Dressing


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Extraordinary Items

Large one off costs outside the normal tradingactivities of a company

e.g. C losure of a factory/business unit As an example of window dressing, somecompanies will choose to write off assets in an

accounting period when the business has donebadly anywayG etting rid of all the bad news at once is

perceived as better than continued badperformance over a number of years(Hall, p.318)


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Depreciation

To window dress their accounts, a companycould increase the potential life of machinery

E.g., take a building initially valued at 1 million If the business depreciates the building over

10yrs, the cost of depreciation each year will be100 000B ut, if it were to depreciate the building over 25years instead, then the annual depreciationcharge would be 40 000

Profit on the P&L would be 60 000 more for thefirst 10 years


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P ast P aper Questions

06-07 v3Question 6

B ecause accounts do not contain any non -numerical data the profitand loss account does not tell you all there is to know about thehealth of a company. B riefly highlight FOUR other types of information that would help with the interpretation of the accountsstatement.

[ 4 ]


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P ast P aper Questions06-07 v2Question B6

Window dressing is the term given to the legal manipulation of accounts by a business to present a financial picture which is to its

benefit.

a)Discuss how a company might report its accounts to make thecompany look good [8]

a)Explain why a company might want to window dress its accounts

and give your opinion on how normal or acceptable you think thepractice is. [12]


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Homework for tomorrows class(18 November):

(1) Read Marcous et al (2009) Chapter 58S ources of F inance

(2) Create a glossary of financial terminology,to include the following terms:


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F inancial Glossary (1)

Window D ressing

Intangible Assets

D epreciation

P rofit Quality

Income S tatement

Extraordinary Items

S hareholders

D ebtorsBalance S heet

Assets

Liquidity

Liabilities

Capital

The Role and Limitations of Accounting

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