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PRINCIPLES OF ACCOUNTING
AND FINANCE STUDY GUIDE





Financial Management
Association of Australia
(FMAA) Monash

Important Notice:




Notes prepared by: Kevin Liu and haris !oh
"ub#ect: AF $%%%


&he follo'ing notes have been prepared and provided as a
s(eleton (s(etch) of the course for this unit)


It is the responsibility of the student to ma(e note of any changes in course content)


&hese notes may e*clude some topics and therefore be inconsistent 'ith current faculty
teaching)


&hese notes should not be solely relied upon)


&hese notes should only be used to provide a basis from 'hich students can create an
individual e*tensive set of notes in preparation for unit assessments


&hese notes should not be replicated+ either in part or in full+ during assessments)

AccounLlng ls an lnformaLlon sysLem LhaL ldenLlfles, records and communlcaLes Lhe
economlc evenLs of an enLlLy Lo lnLeresLed users. ln oLher words, lL ls a flnanclal recordlng
sysLem whlch helps Lhe publlc or managemenL undersLand Lhe economlc acLlvlLy LhaL ls
happenlng wlLhln Lhe company.

!"#$ "& '((")*+,*-
AccounLlng measures buslness acLlvlLy and allows Lhls Lo be communlcaLed Lo boLh lnLernal
and exLernal users. lnLernal users are people who are lnvolved ln Lhe company, such as
managers, supervlsors and oLher employees. LxLernal users are lnvesLors (such as
shareholders) and credlLors (suppllers and bankers). CovernmenL and regulaLory bodles also
use Lhe lnformaLlon Lo make sure LhaL companles are complylng wlLh rules and regulaLlons.
1he lnformaLlon provlded ln accounLlng reporLs should asslsL users Lo undersLand Lhe
enLlLy's pasL performance, currenL flnanclal poslLlon and lLs fuLure prospecLs. lor
lnformaLlon Lo be helpful, lL musL be rellable, undersLandable, relevanL and able Lo be
compared from year Lo year.

./'+ ,0 ' !$1"!+,*- $*+,+23
SAC 1 deflnes a '8eporLlng LnLlLy' as any enLlLy ln whlch lL ls reasonable Lo expecL Lhe
exlsLence of users who depend on general-purpose flnanclal sLaLemenLs for lnformaLlon Lo
enable Lhem Lo make economlc declslons. 1o esLabllsh lf Lhe enLlLy ls a reporLlng enLlLy, we
need ask ourselves a few quesLlons:
Who are Lhe users of Lhe lnformaLlon?
Who has Lhe power Lo obLaln Lhe lnformaLlon?
uo Lhey need Lhe lnformaLlon?

$#$4$*+0 "& &,*'*(,'# 0+'+$4$*+0
AsseLs = LlablllLles + Cwner's equlLy
AsseLs are resources owned and conLrolled by Lhe enLlLy as a resulL of a pasL LransacLlon.
LlablllLles are exLernal clalms on Lhe asseLs - presenL obllgaLlons arlslng from pasL evenLs.
Cwner's equlLy ls Lhe owner's clalm on LoLal asseLs. lncome ls an lnflow of economlc
beneflLs whlch elLher lncreases asseLs or decreases llablllLles resulLlng ln an lncrease ln
equlLy. Lxpenses are decreases ln economlc beneflLs whlch elLher depleLe asseLs or lncur
llablllLles resulLlng ln a decrease ln equlLy.
0)0+',*'5,#,+2 !$1"!+,*-
non-flnanclal performance measures whlch help users undersLand how Lhe company ls
lmpacLlng socleLy aL large. We use Lhe Lrlple boLLom llne measure:
Soclal - employee worklng condlLlons, safeLy and securlLy, conLrlbuLlons Lo
communlLy servlces.
LnvlronmenLal - how does Lhe operaLlons of Lhe enLlLy lmpacL Lhe envlronmenL?
Lconomlc - Lhe reporLlng of buslness sLraLegy
("!1"!'+$ -"6$!*'*($
lL ls a sysLem ln whlch enLlLles are dlrecLed or conLrolled, managed and admlnlsLered. 1he
maln ob[ecLlve of corporaLe governance ls Lo ensure LhaL Lhe declslons made by
managemenL are allgned wlLh Lhose of shareholders. 1hls requlres Lhe enLlLy Lo provlde
./'+ ,0 '((")*+,*-3
beLLer quallLy accounLlng lnformaLlon, monlLor lLs rlsk whlch wlll encourage lmprovemenL ln
Lhe overall performance of Lhe company.


Cash-basls accounLlng records LransacLlons only when Lhe cash has been recelved or pald.
1hls meLhod can become a problem lf Lhere are advanced or delayed paymenLs and Lhe
LransacLlons are recorded ln a dlfferenL Llme perlod ln whlch Lhey do noL maLch.
Accrual-basls accounLlng records revenues and expenses when Lhey have been earned or
lncurred, regardless of wheLher Lhe cash been pald or recelved. 1hls beLLer reflecLs Lhe
performance of Lhe company durlng a speclflc perlod. MosL enLlLles prefer Lhe accrual
meLhod as lL ls more relevanL ln descrlblng Lhe buslness performance of Lhe enLlLy.
Lach buslness LransacLlon musL have a dual effecL on Lhe accounLlng equaLlon:
AsseLs = LlablllLles + Cwner's equlLy
A decrease ln an asseL should have a reclprocaLlng lncrease ln anoLher asseL, or decrease ln
a llablllLy or decrease ln owner's equlLy.
789:;< =>? (@8?:;<
ueblLlng happens on Lhe lefL slde of Lhe accounL. CredlLlng happens on Lhe rlghL slde of Lhe
accounL. AsseLs, expenses and drawlngs are lncreased by deblLs and decreased by credlLs.
LlablllLles, revenue and owner's caplLal are lncreased by credlLs and decreased by deblLs.

+A8 !8BC@?:>D 1@CB8<<
! ldenLlfy Lhe LransacLlon from source documenLs
- Pow would you classlfy Lhe lLem ln Lhe LransacLlon? ls lL an asseL or llablllLy or
expense or revenue eLc? ls lL relevanL Lo Lhe buslness?
! Analyse each LransacLlon ln Lerms of lLs effecLs on Lhe accounLs
- ls lL a credlL or a deblL?
! LnLer Lhe LransacLlon lnformaLlon ln a [ournal
- !ournallslng ls slmply Lhe process of recordlng LransacLlons ln a chronologlcal
order whlch help prevenL or locaLe errors ln Lhe deblL and credlL amounLs.
! 1ransfer Lhe [ournal lnformaLlon Lo Lhe approprlaLe accounLs ln Lhe ledger - Lhls ls
called posLlng.
- 1he ledger ls a group of accounLs malnLalned by Lhe buslness and conLalns all
Lhe lnformaLlon abouL changes ln accounL balances.
LasLly, we have Lhe Lrlal balance whlch ls a compllaLlon of a llsL of accounLs and Lhelr
balances aL a speclflc polnL ln Llme. 1he maln alm of Lhls ls Lo prove deblLs equal credlLs ln
ledgers. lf Lhey do noL balance, Lhen Lhe Lrlal balance can be used Lo correcL any errors LhaL
occurred durlng Lhe process of [ournallslng and posLlng.


Servlce enLlLles and Lradlng/reLall enLlLles dlffer ln Lhe way Lhey derlve Lhelr revenues whlch
affecL Lhe way expenses are belng recorded. 8eLall flrms requlre more deLalled recordlng
Lhan servlce flrms as Lhey have Lo accounL for Lhelr lnvenLory. 1hls dlvldes Lhelr expenses
+!'*0'(+,"* '*'#20,0 '*7 +/$ !$("!7,*- 1!"($00
!$6,0,+,*- +/$ !$("!7,*- 1!"($00
lnLo Lwo caLegorles: llrsL, Lhe cosL of sales and second, oLher expenses. 1hus, a reLaller wlll
have Lo choose beLween a perpeLual lnvenLory sysLem and a perlodlc sysLem.
18@E8;F=G :>H8>;C@I <I<;8J
lor purchases:
1he lnvenLory accounL ls deblLed for all purchases of lnvenLory (as lL lndlcaLes an lncrease ln
sLock on hand), and lL ls credlLed for purchase reLurns and allowances (as lL reflecLs a
reducLlon ln Lhe asseL on hand).
lor sales revenue - Lwo [ournal enLrles are made for each sale:
When lnvenLory ls sold, AccounLs 8ecelvable (or Cash) ls deblLed, and Sales ls credlLed for
Lhe selllng prlce of Lhe lnvenLory. AL Lhe same Llme, CosL of Sales ls deblLed, and lnvenLory ls
credlLed for Lhe cosL of Lhe lnvenLory lLems sold.
ln Lhe evenL of a sales reLurn or allowance, AccounLs 8ecelvable (or Cash) ls credlLed, and
Sales reLurns and allowances ls deblLed aL Lhe selllng prlce. AL Lhe same Llme, CosL of Sales ls
credlLed (Lo remove Lhe expense prevlously recorded), and lnvenLory ls deblLed aL Lhe cosL
prlce.

-CC?< =>? 08@H:B8< +=K L-0+M N 6=GF8 '??8? +=K L6'+M
1hls Lax ls placed on goods and servlces whenever value ls added aL a sLage of producLlon
and aL flnal sale. CS1 ln AusLralla ls usually aL a raLe of 10 and applles Lo mosL sales of
goods and provlslon of servlces. 1he consumer bears Lhe cosL of CS1 and Lhe suppller
merely acLs as a collecLor of CS1 on behalf of Lhe LaxaLlon auLhorlLy.

1he dlfference beLween Lhe LoLal amounL of CS1 Lhe buslness collecLs on sales and Lhe LoLal
lL pays on purchases wlll deLermlne wheLher or noL lL wlll have a CS1 llablllLy.
lf CS1 collecLed > CS1 pald, Lhen a llablllLy has been lncurred. 1he buslness musL pass on Lhe
Lax collecLed Lo Lhe CovernmenL. lf CS1 pald > CS1 collecLed, Lhen Lhls amounL presenLs an
asseL Lhe buslness can clalm from Lhe CovernmenL,
1he Llme perlod assumpLlon
1he economlc llfe of a buslness can be dlvlded lnLo arLlflclal Llme perlods
1he @8H8>F8 & 8KE8><8 recognlLlon prlnclples
8evenue recognlLlon prlnclple " revenue should be recognlsed ln Lhe accounLlng perlod when lL ls earned
Lxpense recognlLlon prlnclple " expenses should be recognlsed ln Lhe accounLlng perlod when lL ls lncurred
Ad[usLlng enLrles
Ad[usLlng enLrles are made aL Lhe end of an accounLlng perlod and Lhey ensure LhaL revenue and expenses are
recognlsed ln Lhe accounLlng perlod LhaL Lhey are earned and lncurred

+IE8 CO =?PF<;J8>; !8=<C> OC@ =?PF<;J8>; 'BBCF>;< 98OC@8
=?PF<;J8>;
'?PF<;:>D 8>;@I
1. repald expenses repald expenses orlglnally
recorded ln asseL accounLs
have been used

AsseLs oversLaLed
Lxpenses undersLaLed
ur Lxpenses
Cr AsseLs

2. unearned revenue unearned revenue lnlLlally
recorded ln llablllLy
accounLs have been
earned

LlablllLles oversLaLed
8evenue undersLaLed
ur LlablllLles
Cr 8evenue
3. Accrued revenue 8evenue has been earned
buL noL yeL recelved ln
cash or recorded

AsseLs undersLaLed
8evenue undersLaLed
ur AsseLs
Cr 8evenue
4. Accrued expenses Lxpenses have been
lncurred buL noL yeL pald
ln cash or recorded

Lxpenses undersLaLed
LlablllLles undersLaLed
ur Lxpenses
Cr LlablllLles
1he ad[usLed Lrlal balance shows Lhe balances of all accounLs afLer all ad[usLmenLs have been made


reparlng a worksheeL:
(1) repare a Lrlal balance
(2) LnLer ad[usLmenLs lnLo ad[usLmenL columns
(3) LnLer ad[usLed balances ln Lhe ad[usLed Lrlal balance
(4) LnLer ad[usLed Lrlal balance amounLs Lo approprlaLe flnanclal sLaLemenL columns
8alance sheeL " SLaLemenL of cash flows " lncome sLaLemenL
(3) 1oLal Lhe sLaLemenL columns and calculaLe proflL (or loss)

Closlng Lhe books
Closlng Lhe books occurs aL Lhe end of an accounLlng perlod. Cnly Lemporary accounLs are closed (accounLs ln
Lhe lncome sLaLemenL, revenue, expenses and owner's drawlngs)
Lxpenses and revenue accounLs " closed Lo 1@CO:; Q #C<< 0FJJ=@I
roflL & Loss Summary and urawlng's accounLs closed Lo Lhe owner's (=E:;=G accounL
'7R)0+,*- +/$ '((")*+0
1!$1'!,*- &,*'*(,'# 0+'+$4$*+0
1he posL-closlng Lrlal balance conLalns balances ln permanenL accounLs carrled forward Lo Lhe nexL accounLlng
perlod, lLs purpose ls Lo prove equallLy of Lhese balances

1he accounLlng cycle



noLe: uslng a worksheeL, flnanclal sLaLemenLs can be prepared before ad[usLlng enLrles are [ournallsed and
posLed
















(1) Analyse
buslnes
Lransacuons
(2) !ournallse
Lransacuons
(3) osL Lo
ledger
accounLs
(4) repare a
Lrlal balance
(3) !ournallse
and posL
ad[usung
enLrles
(6) repare
an ad[usLed
Lrlal balance
(7) repare
nanclal
sLaLemenLs
(8) !ournallse
and posL
closlng
enLrles
(9) repare
posL-closlng
Lrlal balance
Classlfled 8alance SheeL


Classlfled lncome sLaLemenL for a reLall organlsaLlon
!8H8>F8

Sales revenue
Sales
Less: Sales reLurns and allowances
neL Sales
Less: CosL of sales
Cross roflL
CLher revenue
[ . ]

$KE8><8<
Selllng expenses
[ . ]
1oLal selllng expenses
AdmlnlsLraLlve expenses
[ . ]
'<<8;<

(F@@8>; '<<8;<
Cash and cash equlvalenLs
1rade and oLher recelvables
lnvenLorles
CLher currenL asseLs
1oLal CurrenL AsseLs

*C>SBF@@8>; '<<8;<
lnvesLmenLs
roperLy, planL and equlpmenL
Coodwlll
CLher lnLanglble asseLs
CLher non-currenL asseLs
1oLal non-currenL AsseLs
+C;=G '<<8;<

#:=9:G:;:8<

(F@@8>; #:=9:G:;:8<
1rade and oLher payables
ShorL-Lerm borrowlngs
CurrenL Lax payable
CurrenL porLlon of long-Lerm borrowlngs
CLher currenL llablllLles
1oLal CurrenL LlablllLles

*C>SBF@@8>; #:=9:G:;:8<
Long-Lerm borrowlngs
Long-Lerm provlslons
CLher non-currenL llablllLles
1oLal non-currenL LlablllLles
+C;=G #:=9:G:;:8<

*8; '<<8;< (1oLal AsseLs - 1oLal LlablllLles)

"T>8@U< $VF:;I
Share caplLal
CLher reserves
8eLalned earnlngs
+C;=G $VF:;I

1oLal admlnlsLraLlve expenses
llnance expenses
[ . ]
1oLal flnance expenses
1oLal expenses

1@CO:;

noLe: gross proflL represenLs Lhe Lradlng proflL of a buslness

1he sLaLemenL of cash flows
1he sLaLemenL of cash flows conLalns lnformaLlon regardlng cash recelpLs and paymenLs of a company durlng
a speclflc perlod. lL classlfled Lhe ln and ouLflows of cash lnLo Lhree maln caLegorles:
CperaLlng acLlvlLles " cash flows relaLlng Lo Lhe normal acLlvlLles of Lhe enLlLy, lncludlng cash relaLed Lo
revenue and expenses
lnvesLlng acLlvlLles " cash flows relaLlng Lo Lhe acqulslLlon and/or dlsposal of non-currenL asseLs
llnanclng acLlvlLles " cash flows relaLlng Lo Lhe changes ln non-currenL llablllLles and equlLy
1he sLaLemenL of cash flows helps lnvesLors, credlLors and managemenL of an enLlLy assess Lhe enLlLy's ablllLy
Lo generaLe fuLure cash flows, pay dlvldends, and meeL obllgaLlons





























Comparlsons beLween Lhe flnanclal sLaLemenLs of a company musL be made before any concluslons can be
drawn abouL Lhelr llquldlLy, proflLablllLy and solvency. 1here are 3 bases of comparlson:
(1) lnLra-enLlLy " compares lLems of flnanclal relaLlonshlp wlLhln an enLlLy across dlfferenL years
(2) lnLer-enLlLy " compares lLems of flnanclal relaLlonshlp of one enLlLy wlLh Lhe same lLem of one or more
compeLlng enLlLles
(3) lndusLry " compares lLems of flnanclal relaLlonshlp of an enLlLy wlLh lndusLry averages
llnanclal sLaLemenLs can be analysed horlzonLally (year Lo year) or uslng raLlos

1he G:J:;=;:C>< of flnanclal sLaLemenL analysls lnclude esLlmaLes belng used, cosL (lnflaLlon and deflaLlon noL
belng consldered), aLyplcal daLa (end of year daLa noL represenLaLlve of an enLlLy's performance LhroughouL
Lhe year) and Lhe dlverslflcaLlon of enLlLles (enLlLles cannoL be classlfled lnLo slngle lndusLrles someLlmes)

normal earnlngs
normal earnlngs refers Lo an enLlLy's ablllLy Lo susLaln lLs proflLs from operaLlons. lrregular lLems such as
dlsconLlnued operaLlons are presenLed below revenue from conLlnulng operaLlons Lo hlghllghL Lhelr unusual
naLure. ln Lhe lncome sLaLemenL, a 'normallsed' proflL excludes lrregular lLems of revenue or expendlLure noL
assoclaLed wlLh Lhe normal operaLlons of Lhe buslness


!=;:C &C@JFG= 1F@EC<8 C@ F<8

#:VF:?:;I

Measures how qulckly an enLlLy can converL currenL asseLs lnLo cash, lL represenLs Lhe
shorL-Lerm ablllLy of an enLlLy Lo pay lLs obllgaLlons and Lo meeL unexpecLed needs for cash.



(1) CurrenL raLlo


!"##$%& !""#$"
!"##$%& !"!"#$#%#&'



Measures shorL-Lerm debL-paylng ablllLy. lL ls
sLaLlc, meanlng lL glves no lndlcaLlon of Lhe
Llmlng of Lhe cash flows.



(2) Acld-LesL (Culck) raLlo

!"#! ! !!!"# !"#$ !"#$%&'$"&%
! !"#"$%"&'(")
!!""#$% !"#$"!"%"&'




Measures lmmedlaLe shorL-Lerm llquldlLy.
ls also sLaLlc.

(3) 8ecelvables Lurnover

!"# !"#$%& !"#$!
!"#$!%# !"#"$%&'(")



Measures llquldlLy of recelvables.

(4) lnvenLory Lurnover

!"#$ !" !"#$!
!"#$!%# !"#$"%&'(



Measures llquldlLy of lnvenLory.

(3) CredlLors Lurnover

!"# !"#$%& !"#$!!"#"
!"#$!%# !"#$% !"#$%&'"(



Measures Llme lL Lakes Lo make paymenL
followlng a credlL purchase.

&,*'*(,'# 0+'+$4$*+ '*'#20,0

0CGH8>BI

Measures ablllLy of an enLlLy Lo survlve over a long perlod of Llme
(hlgher solvency = hlgher chance of survlvlng long Lerm).


(6) uebL Lo LoLal asseLs raLlo
(gearlng)

!"!#$ !"#$
!"!#$ !""#$"



Measures of LoLal asseLs provlded by credlLors.


(7) lnLeresL coverage raLlo

!"#$%& !"#$%" !"#$%& !"#
!"# !"#$%$&# !"#!$%!
!"#$%$&# !"#!$%!




Measures ablllLy Lo meeL lnLeresL paymenLs
as Lhey fall due.

(8) Cash debL coverage

!"#! !"#$% !"#$%&'& !"
!"#$%&'() !"#$%$#$&'
!"#$!%# !"#$"!"%"&'



Measures cash flows from operaLlng
acLlvlLles per dollar of llablllLles.




1@CO:;=9:G:;I





Measures proflL or operaLlng success of an enLlLy for a glven Llme perlod.

(9) 8eLurn on owner's equlLy
(8CL)

!"#$%&
!"#$!%# !"#$!
!
! !"#$%&



Measures proflLablllLy of owner's lnvesLmenL.

(10) ayouL raLlo

!"#$%&'( !"# !"#"!$%!&
!"#$%&



Measures of earnlngs dlsLrlbuLed Lo owners.

(11) 8eLurn on asseLs (8CA)

!"#$%&
!"#$!%# !""#$"



Measures overall proflLablllLy of asseLs.

(12) roflL margln
(reLurn on sales)


!"#$%&
!"# !"#$!



Measures proflL generaLed by each dollar of
sales.

(13) AsseL Lurnover


!"# !"#$!
!"#$!%# !""#$"



Measures how efflclenLly asseLs are used Lo
generaLe sales.


(14) Cross proflL margln


!"!"" !"#$%&
!"# !"#$!



Measures gross proflL generaLed by each dollar
of sales.

(13) Lxpense raLlo


!"#!$%!%
!"# !"#$!


Measures Lhe expenses lncurred for each dollar
of sales.


(16) Cash reLurn on sales

!"#! !"#$%&'& !"#$
!"#$%&'() !"#$%$#$&'
!"# !"#$!



Measures cash from operaLlng acLlvlLles
generaLed per dollar of sales.

uu onL's 1heorem
8eLurn on AsseLs (8CA) ! !"#$!% !" !"#$! !!""#$ !"#$%&'# !
!"# !"#$%&
!"!#$ !"#$!
!
!"!#$ !"#$!
!"#$!%# !""#"$"




llnanclal accounLlng ls concerned wlLh Lhe recordlng of pasL LransacLlons wlLh Lhe purpose
of produclng flnanclal reporLs prlmarlly for parLles who are exLernal Lo Lhe buslness. 1he
flnanclal sLaLemenLs are produced annually, consolldaLed Lo Lhe whole enLlLy level and ls
audlLed by an exLernal regulaLory body.
ManagemenL accounLlng however seeks Lo produce reporLs conLalnlng boLh flnanclal and
non-flnanclal lnformaLlon LhaL are sulLed Lo Lhe needs of lnLernal managemenL. 1he reporLs
are noL sub[ecL Lo audlL and can be produced as ofLen as necessary. 8aLher Lhan slmply
descrlblng hlsLorlcal lnformaLlon, reporLs produced ln managemenL accounLlng also lnclude
relevanL lnformaLlon Lo asslsL managers ln maklng fuLure pro[ecLlons abouL Lhe flrm.

+A8 5=G=>B8? 0BC@8B=@?
1he balanced scorecard conslsLs of performance measures on four perspecLlves:
llnanclal perspecLlve - concerned wlLh Lhe value of Lhe flrm. Measures lnclude
proflL, 8Cl and oLher flnanclal raLlos.
CusLomer perspecLlve - Measures lnclude cusLomer reLenLlon, cusLomer saLlsfacLlon
eLc.
8uslness process perspecLlve - concerned wlLh buslness processes LhaL wlll affecL
cusLomer saLlsfacLlon and flnanclal performance. Measures lnclude producL quallLy
and labour producLlvlLy.
lnnovaLlons / lmprovemenL perspecLlve - we're focusslng on conLlnuous and long-
Lerm lmprovemenL. Measures lnclude lnvesLmenL ln employee Lralnlng and 8 & u.

48;AC?< CO ?:H:<:C>=G E8@OC@J=>B8 J8=<F@8J8>;
AbsoluLe proflL
1he slmple calculaLlon of proflL uslng absoluLe values whlch Lells us Lhe LoLal proflL
earned durlng a speclflc perlod. 1hls doesn'L conslder how much proflL Lhe flrm has
made relaLlve Lo Lhe amounL of caplLal lnvesLed. 1he proflL margln could dlffer
greaLly buL Lhe absoluLe dollars would sLlll be Lhe same.

8eLurn on lnvesLmenL (8Cl) = roflL / lnvesLmenL
Measures Lhe amounL of reLurn on a company's caplLal by uslng proflL as a
percenLage of Lhe company's lnvesLmenLs.
AdvanLages: Lasy Lo undersLand, llnks proflL wlLh Lhe lnvesLmenL base, provldes a
connecLlon beLween asseLs (balance sheeL) and proflL (lncome sLaLemenL).
ulsadvanLages: ls a percenLage measure, only approprlaLe for dlvlslons of Lhe slmllar
slze and Lype, could be mlsused Lo dlsplay hlgher proflLs ln Lhe shorL Lerm and Lhus
noL accuraLely reflecLlng performance of flrm ln Lhe long Lerm.

8esldual lncome (8l) = roflL before Lax - (8equlred raLe of reLurn x lnvesLmenL)
1he remalnlng proflL afLer Lhe cosL of caplLal of Lhe lnvesLmenL has been deducLed.
1hls ls Lhe resldual lncome LhaL shareholders are enLlLled Lo.
AdvanLages: Mlnlmlses subopLlmal declslon maklng, cosL of caplLal can be varled
across dlvlslons.
ulsadvanLages: Could sLlll encourage shorL Lerm declslon-maklng, cosL of caplLal ls
hard Lo deLermlne.
4'*'-$4$*+ '((")*+,*- '*7 1$!&"!4'*($ 4$'0)!$4$*+
Whlch ls beLLer? 1hls ls dlfflculL Lo [udge and depends on whlch crlLerla are belng used for
evaluaLlon.


Why are buslnesses concerned wlLh cosLs? 8uslnesses wanL Lo know whlch process or whlch
producL ls cosLlng more or less, how Lo conLrol such cosLs wheLher Lo lncrease sales or ln Lhe
evenL of falllng sales, whlch producLs or servlce are maklng Lhe mosL proflL eLc.
CosLs can be classlfled lnLo 3 caLegorles:
1) roducL and perlod cosLs
roducL cosLs ls Lhe cosL of provldlng a servlce or purchaslng sLock. lL ls Lhe cosL of
goods sold and ls used Lo deLermlne gross proflL. roducL cosLs lnclude flxed and
varlable cosLs whlch wlll be dlscussed below ln 2).
erlod cosLs are expenses are maLched wlLh lncome of a speclflc perlod. lL ls used Lo
deLermlne neL proflL. Lxamples lnclude selllng and admlnlsLraLlve expenses.

2) llxed and varlable cosLs
llxed cosLs remaln consLanL desplLe changes ln volume of producLlon. 1hese cosLs
are only flxed wlLhln a relevanL range (l.e. a lecLure LheaLre ls hlred and can only slL
max 300 sLudenLs. lf Lhere are more sLudenLs, Lhen anoLher lecLure LheaLre wlll have
Lo be hlred Lhus lncreaslng flxed cosLs.)
varlable cosLs vary ln proporLlon Lo changes ln volume of producLlon. ConLrlbuLlon ls
sales less varlable cosLs. Cross proflL comes afLerwards - lL ls Lhe resulLlng proflL
when boLh flxed and varlable cosLs are deducLed.
- Plgh-Low meLhod:
varlable cosL per unlL = Change ln LoLal cosLs / Change ln acLlvlLy
- Cv graph - look aL Lhe LexLbook or slldes and know how Lo draw and label
Lhe graph. 8emember LhaL Lhe varlable cosLs gradlenL ls parallel Lo Lhe LoLal
cosLs gradlenL. Where 'revenue' and 'LoLal cosLs' cross, glves us our
breakeven polnL.
)>:; BC>;@:9F;:C> = selllng prlce per unlL - varlable cosL per unlL
5@8=W8H8> <=G8< L:> F>:;<M = llxed cosLs / unlL conLrlbuLlon
(C>;@:9F;:C> J=@D:> @=;:C = unlL conLrlbuLlon / Selllng prlce per unlL
5@8=W8H8> <=G8< L:> XM = llxed cosLs / ConLrlbuLlon margln raLlo
*lor Lo flnd Lhe breakeven flgure for a LargeL proflL, [usL add Lhe LargeL proflL
Lo Lhe flxed cosLs of Lhe breakeven formulas.

3) ulrecL and lndlrecL cosLs
ulrecL cosLs - readlly Lraceable (usually varlable)
lndlrecL / Cverhead cosLs - noL readlly Lraceable (usually a mlx of varlable and flxed)
hence Lhe need for meLhods of overhead allocaLlon:
AbsorpLlon cosLlng vs. AcLlvlLy-based cosLlng (A8C)
under absorpLlon cosLlng, overheads are allocaLed uslng arblLrary measures
such as hours of labour, number of unlLs of sold eLc. AlLhough Lhls ls slmple Lo
use lL can easlly resulL ln over-cosLlng and under-cosLlng as lL doesn'L
("0+ '*7 ("0+,*-
conslder Lhe real causes of Lhe acLlvlLles whlch are aLLracLlng cosL. lL assumes
LhaL overhead can be averaged over all producLs and servlces.
A8C addresses Lhls lssue, lL looks aL Lhe buslness processes and ldenLlfles Lhe
causes of Lhose processes (cosL drlvers). roducLs and servlces LhaL requlre
more processes wlll lncur a hlgher proporLlon of overhead.


SLraLeglc managemenL accounLlng llnks LradlLlonal accounLlng wlLh buslness sLraLegy. lL
seeks Lo lmprove Lhe compeLlLlve poslLlon of Lhe company by looklng beyond Lhe
boundarles of Lhe organlsaLlon and conslderlng Lhe performance of Lhe whole supply chaln
(suppllers and cusLomers) LogeLher wlLh Lhe buslness.
lurLhermore, lL ls noL resLrlcLed Lo an accounLlng perlod buL raLher looks ahead of Lhe llfe
cycle of producLs and servlces and deLermlnes Lhelr proflLablllLy ln Lhe fuLure.

1argeL cosLlng happens before producLlon durlng Lhe plannlng phase of Lhe producL.
kalzen cosLlng happens durlng Lhe producLlon phase when lL ls no longer posslble Lo make
large lmprovemenLs or changes.

5)7-$+,*- '*7 !$01"*0,5,#,+2 '((")*+,*-
1he prlmary purpose of budgeLlng ls Lo provlde a plan on whlch flnanclal pro[ecLlons can be
made Lo asslsL ln achlevlng Lhe buslness sLraLegy. 1he beneflLs of budgeLlng lnclude:
o SeLLlng goals and plannlng ahead.
o 1argeLs can be used Lo [udge acLual performance Lhus moLlvaLlng managers Lo
perform beLLer.
o Lnabllng Lhe coordlnaLlon of buslness acLlvlLles because Lhere ls a common plan.
o CorrecLlve measures can be Laken when acLual performance doesn'L meeL wlLh
expecLaLlons.
8udgeLs can cause behavloural problems as lL seLs a sLandard whlch ls requlred of managers
ln Lhe flrm Lo achleve. Slack and blas behavlour may arlse when managers deslre Lo be
performlng beLLer Lhan Lhe budgeL ln order Lo recelve rewards llnked wlLh aLLalnlng Lhose
LargeLs. ollLlcs may also be lnvolved ln Lhe process especlally wlLh accounLanLs who are
responslble for seLLlng a budgeL.













0+!'+$-,( 4'*'-$4$*+ '((")*+,*-

llnance ls Lhe sLudy of Lhe J=>=D8J8>; CO JC>8I
As lL ls a soclal sclence, lL ls concerned wlLh human behavlour, ln whlch lnherenLly conLalns a large amounL of
uncerLalnLy
Lconomlcs " concerned wlLh Lhe allocaLlon of scarce resources
llnance " concerned wlLh Lhe allocaLlon of scarce resources CH8@ ;:J8
1he four maln characLerlsLlcs of flnanclal LransacLlons:
+:J8 )>B8@;=:>;I "E;:C>< ,>OC@J=;:C>
Money now Lraded for money
ln Lhe fuLure
1he amounL and Llmlng of
money Lransferred ln Lhe
fuLure ls uncerLaln

arLles may have Lhe opLlon Lo
make a declslon whlch affecLs
Lhe subsequenL Lransfer of
money

lnformaLlon abouL Lhe fuLure can
reduce uncerLalnLy
llnance can be 9@C=?GI caLegorlsed lnLo Lwo areas:
(1) lnvesLmenLs: looks aL flnance from an lndlvldual lnvesLor's polnL of vlew
(2) CorporaLe flnance: looks aL flnance from Lhe company's polnL of vlew
(CLher areas of flnance do lnclude: banklng, derlvaLlves, lnLernaLlonal flnance, flnanclal analysls & valuaLlon)



1he Llme value of money " $1 Loday ls worLh more Lhan $1 Lomorrow, why?
Money can be lnvesLed and lnLeresL earned on lnvesLmenL, hence JC>8I A=< ;:J8 H=GF8 (and you cannoL add
money amounLs aL dlfferenL polnLs ln Llme). Money musL be added aL Lhe same polnL ln Llme
Slmple lnLeresL " lnLeresL compounded C>B8 over Lhe enLlre lnvesLmenL
Compound lnLeresL " lnLeresL compounded JC@8 ;A=> C>B8 over Lhe enLlre lnvesLmenL

Compound lnLeresL means LhaL you earn lnLeresL upon lnLeresL upon lnLeresL. 1he lnLeresL componenL ls
added and lnLeresL upon Lhe new prlnclpal amounL ls earned
WlLh conLlnuously compounded lnLeresL, lnLeresL ls compounded so frequenLly LhaL Lhe Llme beLween
compoundlng perlods approaches zero (ln effecL, lnLeresL ls compounded every lnsLanL)
lmpllcaLlons of changlng Lhe frequency of compoundlng
1he more frequenLly lnLeresL ls compounded, Lhe more lnLeresL ls earned upon lnLeresL, hence leadlng Lo a
greaLer fuLure wealLh from an lnvesLmenL
Poldlng all else consLanL: <:JEG8 :>;8@8<; generaLes Lhe lowesL fuLure wealLh and BC>;:>FCF<GI BCJECF>?8?
:>;8@8<; generaLes Lhe hlghesL fuLure wealLh
,*+!"7)(+,"* +" &,*'*($
,*+!"7)(+,"* +" &,*'*(,'# 4'+/$4'+,(0

Slmple lnLeresL
!" ! !"!! !!"!
Compound lnLeresL (only when
frequency of compoundlng ls
once per year)
!" ! !" ! !!
!

Compound lnLeresL (when
frequency of
compoundlng ls noL once
per year)
!" ! !" ! !
!
!
!"


LffecLlve lnLeresL raLes
! ! ! !
!
!
!
!!
!" ! !"#"$% !"#$% !" ! !"#$#%& !"#$% ! ! !"#$%$&# !"#$ ! ! !"#$%& !" !"#$%&' ! ! !"#$!%& !"#$%$&# !"#$
! ! !"#$%#&'( !" !"#$"%&'(&) !" !"# !"#$%&

1he effecLlve annual lnLeresL raLe
1he effecLlve annual lnLeresL raLe ls an lnLeresL raLe sLaLed on an annual basls compounded once per year, lL ls
used ln order Lo faclllLaLe a comparlson beLween dlfferenL lnLeresL raLes
*C;8: lnLeresL raLes can only be compared when Lhey are compounded aL Lhe same frequency


An lnvesLmenL ls a commlLmenL of funds Lo an asseL LhaL wlll be held for a perlod of Llme. eople lnvesL Lo
lncrease Lhelr fuLure wealLh, consequenLly lncreaslng Lhelr fuLure consumpLlon and uLlllLy
1he lnvesLmenL declslon
1here are Lwo key aspecLs ln Lhe lnvesLmenL declslon
(1) SecurlLy analysls " valuaLlon and analysls of lnvesLable asseLs. SecurlLy analysls focuses on each asseL ln
lsolaLlon
(2) orLfollo managemenL " selecLlon and managemenL of a group of asseLs. orLfollo analysls focuses on all
asseLs ln Lhe porLfollo and Lhelr relaLlonshlps
1ypes of lnvesLors
lndlvldual " lnvesL on Lhelr own behalf
lnsLlLuLlonal " lnvesL on Lhe behalf of oLhers (usually Lrade ln larger amounLs and are usually more skllled
Lhan lndlvldual lnvesLors)
1ypes of flnanclal securlLles
A flnanclal securlLy ls an asseL Lraded ln Lhe flnanclal markeLs, Lhere are Lwo ma[or Lypes
789; <8BF@:;:8< $VF:;I <8BF@:;:8<
SecurlLles Lraded ln boLh JC>8I and B=E:;=G markeLs

uebL securlLles can have shorL or long maLurlLles
SecurlLles Lraded ln only Lhe B=E:;=G markeLs

LqulLy securlLles have usually no maLurlLy (Lhey are
assumed Lo exlsL lndeflnlLely)


4C>8I 4=@W8; 08BF@:;:8< (=E:;=G 4=@W8; 08BF@:;:8<
Cnly ?89; securlLles are Lraded ln Lhe money markeL

1he money markeL ls a markeL for shorL-Lerm
securlLles


+@8=<F@I >C;8<
# ShorL-Lerm loan made by buyer of noLe Lo
governmenL
# lssued by Lhe federal governmenL
# unsecured (no collaLeral)

1@CJ:<<C@I >C;8<
# Same as Lreasury noLes, only lssued by
companles
# Cnly larger companles wlLh good credlL
SLandlng can lssue Lhese
8oLh ?89; and 8VF:;I securlLles are Lraded ln Lhe
caplLal markeL

1he caplLal markeL ls a markeL for long-Lerm
securlLles

+@8=<F@I 9C>?<
# Same as a Lreasury noLe, buL long-Lerm and
lssues 'coupons' (perlodlc lnLeresL paymenLs)
# unsecured (no collaLeral)

(C@EC@=;8 9C>?<
# Same as Lreasury bonds, only lssued by
companles
# Also pays coupons
# More expenslve Lhan governmenL bonds Lo
lssue
,*6$0+4$*+0

5=>WS=BB8E;8? 5:GG L5'5M
# Slmllar Lo promlssory noLes, buL accepLed by
Lhe bank
# 8ank pays blll-holder lf Lhe company ls unable
Lo, Lhe company ls charged a fee

# 8ecomes rlskler due Lo chance of Lhe company
uefaulLlng

7898>;F@8<
# Same as corporaLe bonds, however Lhey are
Secured (requlre collaLeral)
# Cheaper for companles Lo lssue


lundamenLal prlnclple of flnance
1he relaLlonshlp beLween rlsk and reLurn ls LhaL Lhere ls an expecLaLlon LhaL wlLh hlgher rlsk also comes hlgher
reLurn
!:<W ls Lhe measure of varlablllLy ln reLurns. 1here are many Lypes of rlsks:
MarkeL rlsk " arlses from flucLuaLlons ln Lhe reLurn of Lhe overall share markeL
lnLeresL raLe rlsk "resulLs from changes ln Lhe level of lnLeresL raLes
8uslness rlsk " assoclaLed wlLh unlque clrcumsLances of a company
llnanclal rlsk " assoclaLed wlLh a company's use of debL flnanclng
uefaulL rlsk " rlsk of company defaulLlng on lLs debL paymenLs and ulLlmaLely golng bankrupL
LlquldlLy rlsk " rlsk assoclaLed wlLh Lradlng any securlLy ln a secondary markeL
-8>8@=GGI @:<W:8@
(hence over Llme, earn a hlgher reLurn)
-8>8@=GGI G8<< @:<WI
(hence over Llme, earn a lower reLurn)
LqulLy uebL
Long Lerm debL ShorL Lerm debL
Small sLocks Large sLocks
CorporaLe bonds CovernmenL bonds

Crdlnary shares
A company can ralse long-Lerm equlLy fundlng by lssulng ordlnary shares. Shareholders become resldual
clalmanLs of Lhe company and may recelve a cuL of Lhe proflLs of Lhe company (dlvldends)
rlmary markeL " Lhe markeL for Lhe new lssuance of securlLles (lCs)
Secondary markeL " Lhe markeL where lnvesLors Lrade exlsLlng securlLles (ASx)
1here are Lwo ways of lncreaslng wealLh from share lnvesLmenL:
(1) caplLal galn: an lncrease ln share prlce
(2) dlvldend yleld: paymenL of dlvldends
1here are Lwo ways of valulng ordlnary shares:
(1) dlscounLed cash flow approach: dlscounL all Lhe fuLure dlvldends LhaL Lhe lnvesLor wlll recleve Lo Lhe
presenL value


(2) relaLlve valuaLlon approach: analyslng Lhe Lrend ln raLlos, or comparlng Lhe raLlos of slmllar companles
(such as LS or /L)


Cordon CrowLh Model
!
!
!
!
!
! !!

!
!
! !!!"# !"#$% !"#$% !
!
! !"#"!$%! !" !"# !"#$%!
!
! !"#$
! ! !"#$%&'( !"#$ !" !!! !"#!!"#$% ! ! !"#!$%!& !"#!"! !"#$ !" !"#"!$%!&
Larnlngs per share
!"# !
!"#$%$&' !!"#$%&!
!"#$%& !" !""#$% !!!"#$

rlce Lo Larnlngs
!!! !
!!!"# !"#$%
!"#$%$&' !"# !!!"#

CalculaLlng reLurns

CalculaLlng reLurns: 8aslc deflnlLlons
8eLurn " Lhe galn or loss on an lnvesLmenL over a perlod
8eallsed reLurn " acLual reLurn on an lnvesLmenL over a prlor perlod
LxpecLed reLurn " reLurn expecLed on an lnvesLmenL over a fuLure perlod
8lsk " Lhe chance LhaL acLual reLurn on an lnvesLmenL dlffers from Lhe expecLed reLurn, lL ls a measure of
varlablllLy ln reLurns

CalculaLlng porLfollo reLurns
1here are Lwo dlfferenL meLhods:
(1) equally welghLed porLfollo reLurn
Assumes LhaL an equal amounL ls lnvesLed ln each company aL Lhe beglnnlng of Lhe year
(2) value welghLed porLfollo reLurn
A meLhod used Lo calculaLe porLfollo reLurns by welghLlng each company's reLurn by lLs proporLlonal value of
Lhe markeL










!
!
!
!
!
!!
!!!
!
!!!

!
!
! !"#$!% !"#$ ! ! ! !" ! !
!
! !"#$% !"#$% !
!!!
! !"#$% !" !! ! !!

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