Sources of Accounting Information
Definitions
Data – Raw facts and figures.
Information – Data that has been processed to have meaning.
Accountants within business organisations prepare information for both external users and internal users.
External information is produced by a company mainly for its shareholders, although reports may be intended for and used by other stakeholders. Internal information is prepared for use by management within the organisation.
Information can be defined as processed data, providing its recipient with some facts or understanding. In business, different types of information will have varying purposes.
Information may be provided or obtained in two ways:
on demand, whenever the user needs it, or
in the form of routine or regular reports.
Data for preparing financial statements and reports are primarily obtained from the organisation’s financial accounting (bookkeeping) system.
If they exist, information about costs can be obtained from costing records maintained separately from the financial (bookkeeping) accounts.
Information for including in statements or reports is often obtained from previous statements and reports.
For example, financial statements include comparative figures for the previous accounting period. Reports on previous performance may be used as a basis for making forecasts for the future.
Although most accounting information is obtained from sources within the organisation, some may be obtained from external sources.
For example, a company may compare its financial performance with a similar company in the same industry by using the information in the published financial statements of the other company.
Role of Accountants in Providing Information
Initially, the company’s financial accountants prepared financial statements and reports.
In many organisations, their responsibility has extended to responsibility for various non-financial reports, such as sustainability reports or integrated reports.
Statement of Profit or Loss (SOPL)
A statement of profit or loss reports the organisation’s financial results for a given period, typically a financial year.
It is included in the annual financial statements of a company for its shareholders, but it is also used by management and other stakeholders for assessing the company’s profitability.
Example 1
This example shows the statement of profit or loss (SPOL) for a sole trader business and for a company.
Sole Trader Statement of Profit or Loss
Company Statement of Profit or Loss
$
Sales
X
Revenue
Less: Sales returns
(X)
Cost of sales
Gross profit
Cost of goods sold:
Other operating income
Opening inventory
Selling expenses
Purchases
Research and development expenses
Less: Purchase returns
General and administrative expenses
Other operating expenses
Less: Closing inventory
Operating profit
Dividend income
Interest income
Other income
Profit before interest expense and income taxes
Less Expenses:
Interest expense
Profit before income taxes
Income tax expense
Profit
· Sales/revenue – Sales/revenue is the income generated from the trading activities of a business. This could be selling goods or providing a service. The recognition of revenue is the same for both sole traders and companies, but a sole trader may highlight sales returns separately in its SPL.
· Cost of sales – For a sole trader, the components of this balance are presented on the SPL itself.
A company’s SPLOCI will not only show the cost of sales figure, but it includes all expenses relating to the cost of goods sold and can include such things as the depreciation of plant and machinery.
· Gross profit – gross profit is the revenue surplus after deducting the cost of sales. This represents the profit on the trading activities of the entity.
· Other income/other operating income – This is income generated by a business from anything other than its normal trading activities. For a sole trader, other income can include any interest earned or rental income. For a company, an example of other operating income is rental income relating to spare capacity in their premises e.g. an unused area of the company’s warehouse which is let for storage.
· Expenses – These are costs incurred in the day-to-day running of the business. A sole trader will list every business expense incurred separately in the SPL, including any interest paid on borrowings.
For a company, the expenses are categorised as selling, research and development, general and administrative, or other operating expenses. Selling expenses include all costs to sell, advertise and deliver goods sold. General and administrative expenses represent those costs that do not fall into either cost of sales or distribution, such as accountancy fees.
· Operating profit – this subtotal applies for a company and is the profit achieved on the company’s operations.
· Profit before interest expenses and income taxes – this subtotal applies for a company and is the profit achieved on the company’s operations and investments before the deduction of interest expenses and income tax. For companies without investing activity, this figure will be the same as operating profit.
· Interest expense – this applies for a company and includes interest payable on borrowing, dividends on redeemable preference shares; and interest expenses on liabilities e.g. trade payables or lease liabilities.
· Profit before Income Taxes – this subtotal applies for a company and is the profit achieved on the company’s operations and investments after the deduction of interest expenses but before the deduction of income tax.
· Income Tax Expense – This is the tax charged on the entity’s profit for the year. The tax rate will be based on the rules of the local tax authority. Income tax expense will not be included in the sole trader’s SPL. Income tax expense is classified in the income taxes category for a company.
· Profit – is the excess income for the year after all business expenses have been deducted. The profit amount is transferred to the ‘Profit for the Year’ section of the Statement of Financial Position, thus increasing capital. (If a loss is made, a negative amount is transferred to the SFP, thus reducing the business’s capital).
Purpose of the SOPL to Stakeholders
The SOPL provides information about the profit or loss made by the company in the period under review.
Shareholders can use this information to assess the company’s performance.
Profits made in the past may be a valuable source of information for estimating profitability in the future, although this should be done with caution.
Dividends paid by the company during the financial period are not shown in the statement, but the size of the company’s profits may guide the dividend it can afford.
A SOPL includes comparative figures for the previous financial period, so it is possible to assess the reasons for changes in profit between the most recent and prior periods.
If a company has large amounts of interest-paying debt, such as bank loans, it is helpful to compare the finance charges with the operating profit.
Statement of Financial Position (SOFP)
A statement of financial position is often called a balance sheet. It is a statement of the company’s financial position, showing its assets, liabilities, and equity capital at the end of its financial period.
Figures for the end of the previous year are also included for comparison.
The SOFP illustrates the accounting equation:
Assets are items that the company possesses or owns. They are divided into two broad types.
Long-term assets (non-current) held for more than 12 months,
Short-term assets (current) are held for less than 12 months.
Includes cash inventory and money owed by customers.
Liabilities are items that the company owes.
In the same way as assets, liabilities are divided into non-current (long-term) and current (short-term).
Current liabilities are payable within one year.
Liabilities include loans and other sources of borrowing, as well as money owed to suppliers.
Equity capital is the capital contributed to the company by its shareholders.
It includes profits made in the past by the company and retained within the company instead of being paid out as dividends.
So assets are financed by a combination of equity capital and other sources of financing.
Total assets always equal the company’s liabilities plus its equity capital.
A simple statement of financial position is illustrated below:
Statement of financial position (SOFP)
Non-current assets
Equity capital
+
Current assets
Non-current liabilities
current liabilities
Total assets
Total liabilities + Equity capital
Total assets = Total liabilities + Equity capital
Information from the SOFP
Statement of Cash Flows (SOCF)
As its name indicates, a company’s statement of cash flows presents a view of the cash flows in and out of the company during the financial year.
Components of a SOCF
A typical cash flow statement is as follows:
Cash flows from operating activities
Cash flows from investing activities
Cash flows from financing activities
Net cash flows for the period
Opening cash balance for the period
Closing cash balance for the period
Component
Description
Cash flows from trading.
This should typically be a positive amount, with more cash coming in than being paid out.
The company is probably in financial difficulty if there is a negative cash flow from operating activities.
Cash flows from buying or selling of non-current assets and investments.
These include cash spent to purchase investments, such as machinery and other long-term assets.
They also include cash received from the disposal of similar assets when they are no longer required.
The net cash flow from investing activities could be either positive or negative.
If the company grows in size, the net cash flows are likely to be negative because the company will be investing in longterm assets.
Cashflows from financing activities
Cash flows related to how the company is financed (debt or equity)
It includes amounts borrowed, loans repaid, and dividends paid out to shareholders.
The net cash flow from financing activities could be either positive or negative.
Information from the SOCF
Cash is essential for a business. Suppose a company runs out of cash to pay the money it owes and cannot obtain cash from any source, including borrowing. In that case, it will have severe financial difficulty and may go out of business.
Other insights include:
Activity 1
Determine which financial statement provides the information:
Statement of profit or loss (SOPL)
Statement of cash flows (SOCF)
Information
Statement
(SOPL, SOFP, or SOCF)
Valuation of non-current assets (NCA)
Shareholders’ equity
Bank loans repaid in the period
Amount spent on new non-current assets in the period
Taxation on profit for the period
The amount of the company’s short-term bank borrowings
Purpose of Sustainability Reports
A sustainable business can sustain its operations into the foreseeable, long-term future.
To survive over the long term, a business needs to consider its non-financial performance, as well as its financial performance.
Sustainability reports clarify to users how the business is attaining these goals.
Sustainability reports are additional reports companies produce for a given period, usually the company’s financial year. They are voluntary reports and are generally only published by big companies.
The purpose of sustainability reports is to provide information that is not found in the financial statements. Shareholders can use them, but they are often intended for a much wider audience and other stakeholders in the business, including the general public.
Since they are voluntary, they do not have standardised content or presentation, although there are currently some international initiatives to achieve standardisation.
Content of Sustainability Reports
Sustainability reports report three aspects of a company’s performance and operations: economic, social, and environmental.
This is also known as triple-bottom-line reporting on the 3Ps: profit, people, and the planet.
Non-financial performance, in the context of environmental reports, means performance concerning social and environmental issues.
For example, a company may not be able to sustain its business over the long term if it damages the environment in which it operates.
Ideally, reports should be prepared in the same format every year, including comparable information from one year to the next and for comparison with similar companies.
Social Aspect of Sustainability Reports
Some examples of the social aspect of a sustainability report are:
Subject
Content
Employees
Information about the company’s performance concerning its employees on matters such as:
Health and safety,
Recruitment and training,
Recognition of trade unions, and
Reported incidents of discrimination at work.
Customers
Information about the company’s relationships with its customers, such as:
Product safety (customer complaints),
Protection of customers’ data
Product labelling.
Local community
The company’s contribution to the community or communities in which it operates, such as money contributed or employee days contributed to community activities, like local schools or nursery centres.
Society in general
The company’s contribution to human rights in society, such as its policies on using child labour or slave labour (by itself or by its suppliers).
Activity 2
Determine which social group the performance measurement relates to:
Performance measure
Social group
The number of suppliers audited for compliance with employment legislation.
Work days idle due to injuries at work.
Average hours of training in the year for accounting staff
Number of justified customer complaints about service standards
The number of work days employees were given paid time off for voluntary work.
Environmental Aspect of Sustainability Reports
The information in the environmental section of a sustainability report will differ substantially between companies, depending on the industry or commercial sector they are in. A company producing chemicals will affect the natural environment differently than a bank.
Some examples of the environmental aspect of a sustainability report include:
Pollution created
A company may report on the quantity of pollution its activities have created during the period.
Pollution can be measured by the quantities of toxic items discharged into the air, rivers, seas or land.
For example, a sewerage company may report on the number of incidents when there have been accidental sewage spillages into the natural environment.
Waste created
A company may report on the amount of waste it creates and disposes of and the effects of its waste reduction measures over time.
For example, a supermarket may report the amount of unsold food that goes to waste.
Waste recycling
A company may report on the quantity of waste it has been able to recycle and reuse.
For example, an office-based company may report on how much waste paper has been recycled and reused by the company.
Use of scarce resources
All companies should be able to report, to some extent at least, their use of scarce resources. These include energy and water.
For some companies, other scarce resources may be consumed, such as rare minerals, limited stocks of fish, or quantities of timber from forests.
Sustainable Business Development
Sustainable business development has been defined as ‘development that meets the need of the present without compromising the ability of future generations to meet their own needs’ (Brundtland Report, 1987).
It may be tempting to think of sustainability as protecting the environment and preventing environmental deterioration. The social aspects of sustainability should also be remembered. Companies cannot survive long-term without support from employees, customers, local communities, or society.
Integrated Reports
The initiative for non-financial reporting originates from the International Integrated Reporting Council (IIRC).
The IIRC has developed a framework for integrated reporting that is primarily nonfinancial, with a forward-looking element in addition to historical performance.
Several large companies have already adopted integrated reporting as a voluntary form of reporting. These reports may be included as a separate section in a company’s annual report.
There are places (for example, Malaysia) where prominent stock market companies will be expected or required to publish an integrated report annually.
Content of an Integrated Report
An overview of the company and its external environment
The company’s corporate governance structure and how it supports the company’s efforts to create value
A description of the company’s business model – in other words, how it intends to compete successfully against its competitors
Details of risks and opportunities in the company’s business and industry environment
Performance: to what extent has the company achieved its strategic performance targets? This will be explained in more detail later
The Six Capitals
The IIRC does not set rules about measuring performance and reporting in an integrated report. Still, it recommends that performance be reported in terms of ‘six capitals’.
This topic was first introduced in Chapter 8.
International <IR> Framework, January 2021
Capital
Financial capital
Financial capital is the pool of funds available to the organisation. It includes both owners’ capital and borrowed capital.
Financial capital is the source of funds applied to acquire manufactured and other forms of capital.
Manufactured capital
Manufactured capital includes the company’s manufactured or constructed assets, such as buildings, machinery and other equipment.
It also consists of items constructed for the benefit of society, such as road networks, railways, bridges and water treatment plants, which are available to the organisation.
Intellectual capital
Intellectual capital is a crucial element for the future of the organisation.
It includes intellectual property owned by the company, such as the value of its patents, copyrights and brand names.
It also includes the organisation’s investment in research and development (R & D) and innovation.
Human capital
This is the value of the company’s workforce, in terms not just of numbers but also of their skills and abilities.
This type of capital derives from the formal education of the organisation’s employees and managers, training, experience and talent.
Social and relationship capital
Social and relationship capital refers to the relationship between the organisation and its external stakeholders.
It includes the value of its business contacts and the strength of its supply chain relationships, customer loyalty, relationships with the government, and also acceptance by the community.
The International Integrated Reporting Council has said: ‘It is only by building relationships that an organisation can retain its social licence to operate.
Natural capital
This refers to the natural environment.
Performance, and sustainability, should also be measured in terms of the company’s impact on the natural environment.
Activity 3
Match the item with the type of capital it represents:
Financial
Manufactured
Intellectual
Human
Social and relationship
Natural
Item
Capital type
The effect of a company’s polluting activities on the land
A company’s investment in research and development
A company’s fleet of delivery trucks
The loyalty of employees to a company
A company’s amount of equity capital
A company’s close relationship with a significant customer
An important feature of integrated reports is that they show different aspects of a company’s performance, position and prospects.
They combine historical information with forward-looking information, non-financial information, such as risk and strategy, and sustainability with financial information.
In these respects, integrated reports are more useful for users than traditional financial statements.
Cost Schedules
Management accounting is the provision of accounting information for management within the organisation.
A simple form of report is a cost schedule (or cost card). This is simply a list of the individual items in the overall cost of a product.
The example below shows the cost schedule for Job 1234. Note that includes different cost objects like materials, labour, expenses and overheads.
Uses of a Cost Schedule
A cost schedule may be used to:
Budget
A budget is a planning document expressed mainly in financial terms. It is usual for companies to prepare a budget for each financial year before the year begins. The budget then becomes the officially-accepted plan for the year.
A budget can also cover more than one year, with decreasing levels of certainty as it goes further into the future, and be part of the company’s overall strategic plan. Some companies may have a three-year, rolling budget.
The budget can also be used to compare actual performance to planned performance via variance reports (discussed later)
Features of Budgets
The features of budgets and the budgeting process can be remembered with the mnemonic PRIME:
Aspect
Planning
A budget provides a plan for the financial year.
An overall master budget is built up from a series of component budgets.
For example, in a manufacturing company, there is a budget for sales but also budgets for:
material costs
labour costs in production
departmental costs.
The sales and cost budgets are combined to produce an overall budget for the organisation, with a budgeted profit for the year.
The budget for capital expenditure on new machinery and equipment will likely cover more than a year.
A detailed budget of cash flows (a cash budget) for a year ahead is likely broken down into quarters or months.
Responsibility
When approved by senior management, a budget is used to communicate to managers throughout the organisation their planning targets for the year.
Therefore, the budget allows senior managers to allocate responsibility to other managers.
Integration
Because a budget plan covers the entire organisation, it should help the different departments within the organisation to coordinate their activities.
They should all know how their activities integrate and fit into the overall business plan, and they should therefore work towards the same goal.
Motivation
Sometimes a budget plan can be used to incentivise managers by rewarding managers (say, with a cash bonus at the end of the year) if the operations under their control have performed better than budgeted.
Therefore, the budget plan can be a source of motivation.
Evaluation
A budget is used for control reporting, so the overall financial year is divided into smaller reporting periods. Similarly, the budget plan is divided into plans for each control period. Each control period may be for a month or a quarter (three months).
Actual performance can be compared to the budget plan to evaluate whether performance has met expectations.
Variance Reports
Budgets are a valuable source of information to management because they are a plan for what should be done at a middle management (tactical) level. They provide a practical framework for reporting on actual performance by comparing actual performance with the budget.
Budgeting, then using budgets for control reporting purposes, is known as budgetary control.
Variance Reporting
Variance reporting can be applied to sales revenue or costs.
All variances can be broken down into price and quantity to assist management and focus their attention on why the variance may have happened.
For sales revenue, a variance report compares budgeted and actual sales revenue in a control period.
The difference is the variance between budgeted and actual sales revenue. This can be converted into a profit variance by applying a profit percentage to the revenue figure.
For costs, a variance report compares expected and actual costs, and the differences are cost variances.
Managers responsible for the sales or cost variances must investigate why they happened and take necessary control measures.Application of Management Reports
Below are some examples of how management reports are used:
Management Report
Example
(clothes manufacturer)
Cost schedules
Reports are produced to show the actual or expected cost of something.
Use cost schedules to determine the expenses involved in making a clothing item.
Budgets
Reports are produced as financial plans or forecasts. Budgets are an essential annual financial plan in many organisations.
Use budgets to estimate and plan the cost of producing clothing items and the revenues from selling these items in the coming period.
Variance reports
Control reports show the difference between revenues, costs and profits compared to what was expected.
The differences, or variances, provide management with information for management to investigate the reasons and take control measures if needed.
Compare what was estimated in the budget with the actual results from making and selling clothing items.
