Accounting for Business

David Harvey, Edward McLaney, Peter Atrill

• Publisher: Routledge
• Year: 2013
• ISBN:
  9781136006975
• Edition: 3
• Topic: Business
• Subtopic: Business General
• Index: Business

'Accounting for Business' is ideal for undergraduate students on business and accounting courses who need to understand the nuts and bolts of financial accounting. This popular textbook has always enjoyed a deserved reputation for accessibility and thoroughness. Now in its third edition, its contents have been fully updated and restructured to make them even easier to use. Readers will benefit from the coverage of current accounting practices and legislation, in addition to the range of worked examples and self-test activities throughout the book. 'Accounting for Business' clearly explains accounting information's role in making sound business decisions and focuses upon the aspects of accounting practice which are most relevant to the non-specialist manager. It is ideal for first year undergraduates of business studies, higher students and those pursuing professional accountancy qualifications. This third edition has been restructured, to further enhance its 'student centred' approach. The content has now been broken down into 25 roughly equivalent 'bite-sized' individual study topics. Each of these requires 6 hours of study time, enabling this book to support a full scale semester course with two topics a week, or a full year course at one topic a week. Includes a wide selection of topical case studies, with a broad spread of international examples.

Part One Introduction to Accounting

This part, which consists of two chapters, aims to provide you with an introduction to the role of accounting and to the type of accounting information typically provided for a variety of users. It gives you a broad framework within which your subsequent studies can be set.

Chapter 1 The role of accounting in business decision making

DOI: 10.4324/9780080939025-1

1.1 Introduction

This chapter is concerned with introducing the role and nature of accounting, the users of accounting information and their information needs.

1.2 Objectives

On completion of this chapter you should be able to:

• discuss the nature and purpose of accounting;
• identify the main users of accounting information and their needs

1.3 Activities and self-assessment questions

There are activities interspersed throughout this and succeeding chapters. The aim of these activities is to help you find out if you have grasped the points which have been raised and to get you to think about issues which relate to the subjects being discussed. Suggested answers to these questions are provided immediately below each activity. You will also find one or more self-assessment questions within each chapter. These questions are usually more demanding than the activities. They may cover a number of the topics or may try to extend your understanding of particular areas. Answers to the self-assessment questions are given at the end of the book. You should make a serious attempt at each activity and self-assessment question before referring to the answers provided.

1.4 The nature of business and business decisions

Most commercial activity occurs because business people (entrepreneurs) see an opportunity to make a profit, to increase their wealth. Given the nature of the free-market economy, with generally free entry and exit into markets, those ventures which yield high returns (profits) are likely to attract new entrants into the industry, thus pushing profits back down to lower levels. Entrepreneurs who find themselves in ventures which are giving low returns will tend to get out of the industry, leaving the more efficient to remain. Given the ever-changing state of the world economy, changes in technology, and a host of other factors, it is fairly apparent that business is in an ever-changing state of flux. In making decisions entrepreneurs need to be as fully aware as possible of the underlying economic situation, both in terms of general economic conditions, and in terms of the specifics of the particular venture. In order to remain profitable, businesses must be aware of the conditions in the particular market(s) in which they trade. They should be fully aware of the costs they are currently incurring, as well as the current and future prices they expect to be able to charge. Much of this information should be available if records (known as accounts) are kept of the historical transactions in which the business engages. Indeed it is difficult to see how decisions can be made effectively unless records of this sort are kept.

Business decision making usually involves choices between alternative courses of action. These alternative courses of action are often subject to constraints of various types. Alternatives are then evaluated, and the decision made. It is usual to then monitor or check the actual decision to see whether in fact the results were in line with what was expected. If not, questions need to be asked. Monitoring can provide useful insights into what went wrong and how to rectify it.

Business decisions can cover a multitude of different things. Possible decisions might include:

• how much of a product to sell
• how much to charge for a product
• whether to take over another business
• whether to close down a business
• whether to invest in a particular piece of equipment
• how much to spend on research and development

plus a host of alternatives.

In passing it is worth pointing out that, in general, it may be expected that ventures which carry higher degrees of risk will (on average) achieve higher rates of return.

1.5 The role of accounting

Accounting is concerned with the provision of economic information which will be useful to those directly (and to some extent indirectly) connected with an organization. The information provided should be useful in assessing both the performance of those who manage the organization and the performance and position of the organization itself. Once these assessments have been made by the interested parties, they will be in a position to make more informed economic decisions concerning the organization.

This view of accounting as an aid to economic decision making has achieved increasing acceptance in recent years. The American Accounting Association adopted this perspective when it defined accounting as ‘the process of identifying, measuring and communicating economic information to permit informed judgements and decisions by the users of the information’. Though this is only one of very many published definitions of accounting, it is widely quoted in accounting texts because it emphasizes the primary purpose of accounting as providing information which will help users make decisions.

This decision-making emphasis is one which you should constantly bear in mind. There seems to be a feeling held by many people, including many who work in accounting, that accounting is concerned with getting accounting statements prepared each month or each year as if that were an end in itself. While this may describe what some accountants do, it does not describe the purpose of accounting. Unfortunately, some textbooks on accounting do not really emphasize that accounting is not, or should not be, carried on for its own sake. You should never lose sight of the decision-making objective of accounting information.

1.6 Users of financial information

Having established that accounting exists in order to provide information for interested parties to make decisions, it is logical to ask: ‘Who are these interested parties?’ and ‘For what kind of decisions is accounting information required?’ Figure 1.1 shows the major groups of people who have an interest in an organization. The figure, as constructed, relates to a private sector business but minor alterations in the titles of the participants would make it equally relevant to any organization — for example, a government, a local government unit, a charity, a nationalized industry, a school or college.

Staying with the example of a private enterprise business, it is possible to identify the types of decision that each of the participants might need to make with respect to the organization and the information required. These are as follows.

Owners

Owners are concerned with making two types of decisions. These are:

• investment decisions; and
• stewardship decisions.

Investment decisions are primarily concerned with increasing the wealth of the owners. Those who own businesses normally do so with the intention of increasing their wealth. Owners will, therefore, wish to assess the extent to which the business has generated financial benefits (profits etc.) and the likely future prospects of the business. They will also wish to assess the degree of risk associated with their investment in the business. Information relating to associated risks and returns will be useful when deciding whether to hold or sell their ownership interest in the business.

Figure 1.1 Parties with an interest in the private-sector organization

In larger businesses, the owners tend not to exercise day-to-day control over the activities of the business. Instead, managers will often run the business on behalf of the owners. Although managers are expected to operate the business in the interests of the owners, they do have discretion over the way in which the resources of the business are used and there is, therefore, the potential for conflict between managers and owners. This potential conflict creates a need among owners to receive accounting information from the managers which reveals how the resources of the business have been used. The provision of information by managers to owners for this purpose is referred to as stewardship accounting. This information may be used by owners, among other things, as a basis for rewarding or dismissing managers.

Government

A government may require information from a business for a variety of reasons. These include:

• Taxation Businesses are taxed on the basis of their accounting profits (subject to certain adjustments); government (in the form of the Inland Revenue) needs information on each business in order to decide how much tax to charge.
• Regulation A government may also need information relating to a business for regulatory purposes. For example, information relating to costs and profits may be required in order to decide whether policies promoting greater competition are being adhered to or are necessary.
• Economic management Governments may also use accounting information relating to businesses to help in the general management of the economy. For example, accounting information may be useful in deciding whether to give support to businesses in a particular industry.
• Government contracts The government may award contracts on a ‘cost plus’ basis (i.e. the cost of supplying the goods or service plus an additional profit element) and therefore will be interested in the costs of goods or services supplied by the contractor. This approach is often used when awarding defence contracts. The government will also be interested to see if businesses are making excessive profits as a result of their dealings with the government.

Management

The management of the business is the user group who need most accounting information. Managers are charged with planning the activities of the business. They, therefore, require forecast information in order to assess the likely outcome of implementing particular policies in order to decide whether s...