Financial Accounting and Reporting Book PDF

13th Financial Accounting & Reporting is the most up-to-date text on the market. Now fully updated in EDITION BARRY ELLIOTT AND JAMIE ELLIO...

13th Financial Accounting & Reporting is the most up-to-date text on the market. Now fully updated in EDITION BARRY ELLIOTT AND JAMIE ELLIOTT FINANCIAL its 13th edition, it includes extensive coverage of International Accounting Standards (IASs) and International Financial Reporting Standards (IFRSs). ELLIOTT AND ELLIOTT ACCOUNTING This market-leading text offers students a clear, well-structured and comprehensive treatment of the subject. Supported by illustrations and exercises, the book provides a strong balance of theoretical and conceptual coverage. Students using this book will gain the knowledge and skills AND 13th Edition to help them apply current standards, and critically appraise the underlying concepts and financial reporting methods. Key features l Combines academic rigour with an REPORTING engaging and accessible style New features for this edition l Coverage of International Financial Reporting Standards l Fully updated to May 2009 AND REPORTING FINANCIAL ACCOUNTING l Illustrations taken from real published l Updated coverage of International accounts Financial Reporting Standards l Excellent range of review questions l Substantial revisions to Analysis of l Numerous exercises, varying in level of Accounts and Accountability chapters difficulty, with solutions where applicable l Selected chapters include new additional l Extensive references questions and exercises l A section on the Analysis of Accounts l Includes more examples of extracts from l A section on Accountability – includes real financial reports Corporate Governance issues, l Fully supported by a comprehensive set Sustainability - environmental and of multiple-choice questions online, social reporting and Ethics covering all parts of the text. Barry Elliott is a training consultant. He has extensive teaching experience at undergraduate, postgraduate and professional level in China, Hong Kong, New Zealand and Singapore. He has wide experience as an external examiner both in higher education and at all levels of professional education. Jamie Elliott is a Director with Deloitte & Touche. Prior to this he has lectured at university on undergraduate degree programmes and as an assistant professor on MBA and Executive programmes at the London Business School. Cover image © alamy www.pearson-books.com CVR_ELLI3325_13_SE_CVR.indd 1 8/7/09 14:12:16 A01_ELLI3325_13_SE_FM.QXD 13/7/09 11:24 Page i Financial Accounting and Reporting A01_ELLI3325_13_SE_FM.QXD 13/7/09 11:24 Page ii We work with leading authors to develop the strongest educational materials in business and finance bringing cutting-edge thinking and best learning practice to a global market. Under a range of well-known imprints, including Financial Times Prentice Hall we craft high quality print and electronic publications which help readers to understand and apply their content, whether studying or at work. To find out more about the complete range of our publishing, please visit us on the World Wide Web at: www.pearsoned.co.uk A01_ELLI3325_13_SE_FM.QXD 13/7/09 11:24 Page iii Openmirrors.com Financial Accounting and Reporting THIRTEENTH EDITION Barry Elliott and Jamie Elliott A01_ELLI3325_13_SE_FM.QXD 13/7/09 11:24 Page iv Openmirrors.com Pearson Education Limited Edinburgh Gate Harlow Essex CM20 2JE England and Associated Companies throughout the world Visit us on the World Wide Web at: www.pearsoned.co.uk First published 1993 Second edition 1996 Third edition 1999 Fourth edition 2000 Fifth edition 2001 Sixth edition 2002 Seventh edition 2003 Eighth edition 2004 Ninth edition published 2005 Tenth edition published 2006 Eleventh edition published 2007 Twelfth edition published 2008 Thirteenth edition published 2009 © Prentice Hall International UK Limited 1993, 1999 © Pearson Education Limited 2000, 2009 The rights of Barry Elliott and Jamie Elliott to be identified as authors of this work have been asserted by them in accordance with the Copyright, Designs and Patents Act 1988. All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without either the prior written permission of the publisher or a licence permitting restricted copying in the United Kingdom issued by the Copyright Licensing Agency Ltd, Saffron House, 6–10 Kirby Street, London EC1N 8TS. All trademarks used herein are the property of their respective owners. The use of any trademark in this text does not vest in the author or publisher any trademark ownership rights in such trademarks, nor does the use of such trademarks imply any affiliation with or endorsement of this book by such owners. ISBN: 978-0-273-72332-5 British Library Cataloguing-in-Publication Data A catalogue record for this book is available from the British Library Library of Congress Cataloging-in-Publication Data 10 9 8 7 6 5 4 3 2 1 13 12 11 10 09 Typeset in 10/12 Ehrhardt MT by 35 Printed by Ashford Colour Press Ltd., Gosport The publisher’s policy is to use paper manufactured from sustainable forests. A01_ELLI3325_13_SE_FM.QXD 13/7/09 11:24 Page v Openmirrors.com Brief Contents Preface and acknowledgements xxi Guided tour of MyAccountingLab xxvi Part 1 INCOME AND ASSET VALUE MEASUREMENT SYSTEMS 1 1 Accounting and reporting on a cash flow basis 3 2 Accounting and reporting on an accrual accounting basis 22 3 Income and asset value measurement: an economist’s approach 40 4 Accounting for inflation 59 Part 2 REGULATORY FRAMEWORK – AN ATTEMPT TO ACHIEVE UNIFORMITY 99 5 Financial reporting – evolution of the regulatory framework in the UK 101 6 Financial reporting – evolution of international standards 137 7 Conceptual framework 158 8 Published accounts of companies 184 9 Preparation of published accounts 229 Part 3 STATEMENT OF FINANCIAL POSITION – EQUITY, LIABILITY AND ASSET MEASUREMENT AND DISCLOSURE 255 10 Share capital, distributable profits and reduction of capital 257 11 Off balance sheet finance 282 12 Financial instruments 317 13 Employee benefits 342 14 Taxation in company accounts 373 15 Property, plant and equipment (PPE) 402 16 Leasing 436 17 R&D; goodwill and intangible assets; brands 457 18 Inventories 498 19 Construction contracts 524 Openmirrors.com A01_ELLI3325_13_SE_FM.QXD 13/7/09 11:24 Page vi Openmirrors.com vi Brief Contents Part 4 CONSOLIDATED ACCOUNTS 543 20 Accounting for groups at the date of acquisition 545 21 Preparation of consolidated statements of financial position after the date of acquisition 562 22 Preparation of consolidated statements of comprehensive income and consolidated statements of changes in equity 575 23 Accounting for associates and joint ventures 591 24 Accounting for the effects of changes in foreign exchange rates under IAS 21 611 Part 5 INTERPRETATION 625 25 Earnings per share 627 26 Statements of cash flows 654 27 Review of financial ratio analysis 680 28 Trend analysis and multivariate analysis 724 29 An introduction to financial reporting on the Internet 770 Part 6 ACCOUNTABILITY 783 30 Corporate governance 785 31 Sustainability – environmental and social reporting 838 32 Ethics for accountants 884 Appendix: Outline solutions to selected exercises 907 Index 913 A01_ELLI3325_13_SE_FM.QXD 13/7/09 11:24 Page vii Openmirrors.com Full Contents Preface and acknowledgements xxi Guided tour of MyAccountingLab xxvi Part 1 INCOME AND ASSET VALUE MEASUREMENT SYSTEMS 1 1 Accounting and reporting on a cash flow basis 3 1.1 Introduction 3 1.2 Shareholders 3 1.3 What skills does an accountant require in respect of external reports? 4 1.4 Managers 4 1.5 What skills does an accountant require in respect of internal reports? 5 1.6 Procedural steps when reporting to internal users 5 1.7 Agency costs 8 1.8 Illustration of periodic financial statements prepared under the cash flow concept to disclose realised operating cash flows 8 1.9 Illustration of preparation of balance sheet under the cash flow concept 12 1.10 Treatment of non-current assets in the cash flow model 14 1.11 What are the characteristics of these data that make them reliable? 15 1.12 Reports to external users 16 Summary 16 Review questions 17 Exercises 18 References 21 2 Accounting and reporting on an accrual accounting basis 22 2.1 Introduction 22 2.2 Historical cost convention 23 2.3 Accrual basis of accounting 24 2.4 Mechanics of accrual accounting – adjusting cash receipts and payments 24 2.5 Subjective judgements required in accrual accounting – adjusting cash receipts in accordance with lAS 18 25 2.6 Subjective judgements required in accrual accounting – adjusting cash payments in accordance with the matching principle 27 2.7 Mechanics of accrual accounting – the statement of financial position 28 2.8 Reformatting the statement of financial position 28 2.9 Accounting for the sacrifice of non-current assets 29 A01_ELLI3325_13_SE_FM.QXD 13/7/09 11:24 Page viii Openmirrors.com viii Full Contents 2.10 Reconciliation of cash flow and accrual accounting data 32 Summary 34 Review questions 34 Exercises 35 References 38 3 Income and asset value measurement: an economist’s approach 40 3.1 Introduction 40 3.2 Role and objective of income measurement 40 3.3 Accountant’s view of income, capital and value 43 3.4 Critical comment on the accountant’s measure 46 3.5 Economist’s view of income, capital and value 47 3.6 Critical comment on the economist’s measure 53 3.7 Income, capital and changing price levels 53 Summary 55 Review questions 55 Exercises 56 References 57 Bibliography 58 4 Accounting for inflation 59 4.1 Introduction 59 4.2 Review of the problems of historical cost accounting (HCA) 59 4.3 Inflation accounting 60 4.4 The concepts in principle 60 4.5 The four models illustrated for a company with cash purchases and sales 61 4.6 Critique of each model 65 4.7 Operating capital maintenance – a comprehensive example 68 4.8 Critique of CCA statements 79 4.9 The ASB approach 81 4.10 The IASC/IASB approach 83 4.11 Future developments 84 Summary 86 Review questions 87 Exercises 88 References 97 Bibliography 97 Part 2 REGULATORY FRAMEWORK – AN ATTEMPT TO ACHIEVE UNIFORMITY 99 5 Financial reporting – evolution of the regulatory framework in the UK 101 5.1 Introduction 101 5.2 Mandatory regulations 101 5.3 Arguments in support of standards 105 5.4 Arguments against standards 106 A01_ELLI3325_13_SE_FM.QXD 13/7/09 11:24 Page ix Openmirrors.com Full Contents ix 5.5 Structure of regulatory framework 107 5.6 The Operating and Financial Review (OFR) 110 5.7 The Financial Reporting Review Panel 116 5.8 The Financial Services Authority 119 5.9 The Revised Combined Code ( June 2008) 119 5.10 Interim reports following Cadbury 122 5.11 Developments for small companies 125 5.12 Evaluation of effectiveness of mandatory regulations 132 Summary 134 Review questions 134 Exercises 135 References 135 6 Financial reporting – evolution of international standards 137 6.1 Introduction 137 6.2 National differences 137 6.3 Reasons for differences in financial reporting 138 6.4 Classification of national accounting systems 142 6.5 Attempts to reduce national differences 143 6.6 The work of international bodies in harmonising and standardising financial reporting 144 6.7 US GAAP 151 Summary 155 Review questions 155 Exercises 155 References 156 7 Conceptual framework 158 7.1 Introduction 158 7.2 Historical overview of the evolution of financial accounting theory 159 7.3 IASC Framework for the Presentation and Preparation of Financial Statements 162 7.4 ASB Statement of Principles 1999 164 7.5 FASB Statements of Financial Accounting Concepts 174 7.6 Conceptual Framework developments 177 Summary 178 Review questions 180 Exercises 181 References 182 8 Published accounts of companies 184 8.1 Introduction 184 8.2 Introduction to published accounts 184 8.3 A public company’s financial calendar 186 8.4 Criteria for information appearing in a statement of comprehensive income and statement of financial position 186 8.5 The prescribed formats – the statement of comprehensive income 187 8.6 What information is required to be disclosed in Format 1 and Format 2? 188 8.7 Cost of sales 189 A01_ELLI3325_13_SE_FM.QXD 13/7/09 11:24 Page x x Full Contents 8.8 Distribution costs 193 8.9 Administrative expenses 193 8.10 Other operating income or expense 193 8.11 What costs and income are brought into account after calculating the trading profit in order to arrive at the profit on ordinary activities before tax? 193 8.12 Does it really matter under which heading a cost is classified in the statement of comprehensive income provided it is not omitted? 194 8.13 Discontinued operations disclosure in the statement of comprehensive income 194 8.14 Items requiring separate disclosure 196 8.15 Other comprehensive income 197 8.16 The prescribed formats – the statement of financial position 198 8.17 Statement of changes in equity 201 8.18 US comprehensive income reporting 203 8.19 Segment reporting 203 8.20 The fundamental accounting principles underlying the published statement of comprehensive income and statement of financial position 205 8.21 Disclosure of accounting policies 205 8.22 Fair view treatment 210 8.23 Additional information in the annual report 213 8.24 What information do companies provide to assist comparison between companies reporting under different reporting regimes? 215 Summary 219 Review questions 219 Exercises 221 References 228 9 Preparation of published accounts 229 9.1 Introduction 229 9.2 Stage 1: preparation of the internal statement of comprehensive income from a trial balance 229 9.3 Stage 2: preparation of the statement of comprehensive income of Illustrious SpA in Format 1 style 231 9.4 Stage 3: preparation of the statement of financial position 234 9.5 Preparation of accounts in Format 1 following IAS 8 and IFRS 5 235 9.6 Additional information value of IFRS 5 239 9.7 Additional information value of IAS 24 240 Summary 242 Review questions 243 Exercises 243 References 254 Part 3 STATEMENT OF FINANCIAL POSITION – EQUITY, LIABILITY AND ASSET MEASUREMENT AND DISCLOSURE 255 10 Share capital, distributable profits and reduction of capital 257 10.1 Introduction 257 A01_ELLI3325_13_SE_FM.QXD 13/7/09 11:24 Page xi Full Contents xi 10.2 Common themes 257 10.3 Total owners’ equity: an overview 258 10.4 Total shareholders’ funds: more detailed explanation 259 10.5 Accounting entries on issue of shares 262 10.6 Creditor protection: capital maintenance concept 263 10.7 Creditor protection: why capital maintenance rules are necessary 264 10.8 Creditor protection: how to quantify the amounts available to meet creditors’ claims 264 10.9 Issued share capital: minimum share capital 265 10.10 Distributable profits: general considerations 265 10.11 Distributable profits: how to arrive at the amount using relevant accounts 267 10.12 When may capital be reduced? 267 10.13 Writing off part of capital which has already been lost and is not represented by assets 267 10.14 Repayment of part of paid-in capital to shareholders or cancellation of unpaid share capital 273 10.15 Purchase of own shares 274 Summary 276 Review questions 276 Exercises 277 References 281 11 Off balance sheet finance 282 11.1 Introduction 282 11.2 Traditional statements – conceptual changes 282 11.3 Primary financial statements: their interrelationship 283 11.4 Primary financial statements: changes in their interrelationship 283 11.5 Reasons that companies borrow 284 11.6 Capital gearing and its implications 285 11.7 Off balance sheet finance – its impact 287 11.8 Substance over form 287 11.9 Impact of converting to IFRS 291 11.10 Statement of financial position as a valuation document 293 11.11 Why companies take steps to strengthen their statements of financial position 295 11.12 Definitions cannot remove uncertainty: IAS 10 and IAS 37 296 11.13 ED IAS 37 Non-financial Liabilities 304 Summary 310 Review questions 311 Exercises 313 References 316 12 Financial instruments 317 12.1 Introduction 317 12.2 Financial instruments – the IASB’s problem child 317 12.3 IAS 32 Financial Instruments: Disclosure and Presentation 320 12.4 IAS 39 Financial Instruments: Recognition and Measurement 325 12.5 IFRS 7 Financial Statement Disclosures 335 Summary 338 Review questions 339 A01_ELLI3325_13_SE_FM.QXD 13/7/09 11:24 Page xii xii Full Contents Exercises 339 References 341 13 Employee benefits 342 13.1 Introduction 342 13.2 Greater employee interest in pensions 342 13.3 Financial reporting implications 343 13.4 Types of scheme 343 13.5 Defined contribution pension schemes 345 13.6 Defined benefit pension schemes 346 13.7 IAS 19 (revised) Employee Benefits 348 13.8 The liability for pension and other post-retirement costs 348 13.9 The statement of comprehensive income 351 13.10 Comprehensive illustration 352 13.11 Plan curtailments and settlements 354 13.12 Multi-employer plans 354 13.13 Disclosures 355 13.14 Other long-service benefits 355 13.15 Short-term benefits 356 13.16 Termination benefits 357 13.17 IFRS 2 Share-Based Payment 358 13.18 Scope of IFRS 2 359 13.19 Recognition and measurement 359 13.20 Equity-settled share-based payments 359 13.21 Cash-settled share-based payments 362 13.22 Transactions which may be settled in cash or shares 362 13.23 Transitional provisions 363 13.24 IAS 26 Accounting and Reporting by Retirement Benefit Plans 363 Summary 366 Review questions 366 Exercises 369 References 372 14 Taxation in company accounts 373 14.1 Introduction 373 14.2 Corporation tax 373 14.3 Corporation tax systems – the theoretical background 374 14.4 Corporation tax systems – avoidance and evasion 375 14.5 Corporation tax – the system from 6 April 1999 378 14.6 IFRS and taxation 379 14.7 IAS 12 – accounting for current taxation 380 14.8 Deferred tax 382 14.9 FRS 19 (the UK standard on deferred taxation) 390 14.10 A critique of deferred taxation 391 14.11 Examples of companies following IAS 12 394 14.12 Value added tax (VAT) 396 Summary 397 Review questions 397 Exercises 398 References 400 A01_ELLI3325_13_SE_FM.QXD 13/7/09 11:24 Page xiii Full Contents xiii 15 Property, plant and equipment (PPE) 402 15.1 Introduction 402 15.2 PPE – concepts and the relevant IASs and IFRSs 402 15.3 What is PPE? 403 15.4 How is the cost of PPE determined? 404 15.5 What is depreciation? 406 15.6 What are the constituents in the depreciation formula? 409 15.7 How is the useful life of an asset determined? 409 15.8 Residual value 410 15.9 Calculation of depreciation 410 15.10 Measurement subsequent to initial recognition 414 15.11 IAS 36 Impairment of Assets 416 15.12 IFRS 5 Non-Current Assets Held for Sale and Discontinued Operations 422 15.13 Disclosure requirements 422 15.14 Government grants towards the cost of PPE 423 15.15 Investment properties 425 15.16 Effect of accounting policy for PPE on the interpretation of the financial statements 426 Summary 428 Review questions 428 Exercises 429 References 435 16 Leasing 436 16.1 Introduction 436 16.2 Background to leasing 436 16.3 IAS 17 (and its national equivalents) – the controversy 438 16.4 IAS 17 – classification of a lease 440 16.5 IAS 17 – accounting for leases by lessees 442 16.6 Accounting for the lease of land and buildings 447 16.7 Leasing – a form of off statement of financial position financing 448 16.8 Accounting for leases – a new approach 449 16.9 Accounting for leases by lessors 451 Summary 452 Review questions 452 Exercises 454 References 456 17 R&D; goodwill and intangible assets; brands 457 17.1 Introduction 457 17.2 Accounting treatment for research and development 457 17.3 Research and development 459 17.4 Introduction to goodwill and intangible assets 463 17.5 Accounting for goodwill under IFRS 3 463 17.6 Is there a correct treatment for amortising goodwill? 466 17.7 Accounting for intangible assets under IAS 38 471 17.8 Disclosure of intangible assets under IAS 38 473 17.9 Brand accounting 476 17.10 Emissions trading 478 17.11 Intellectual property 480 A01_ELLI3325_13_SE_FM.QXD 13/7/09 11:24 Page xiv xiv Full Contents 17.12 Intellectual capital 483 17.13 Review of implementation of IFRS 3 484 Summary 486 Review questions 486 Exercises 488 References 496 18 Inventories 498 18.1 Introduction 498 18.2 Inventory defined 498 18.3 The controversy 499 18.4 IAS 2 Inventories 500 18.5 Inventory valuation 501 18.6 Work-in-progress 508 18.7 Inventory control 510 18.8 Creative accounting 511 18.9 Audit of the year-end physical inventory count 513 18.10 Published accounts 514 18.11 Agricultural activity 515 Summary 518 Review questions 519 Exercises 519 References 523 19 Construction contracts 524 19.1 Introduction 524 19.2 The accounting issue for construction contracts 524 19.3 Identification of contract revenue 525 19.4 Identification of contract costs 525 19.5 Recognition of contract revenue and expenses 526 19.6 Public–private partnerships (PPPs) 529 Summary 535 Review questions 535 Exercises 535 References 542 PART 4 CONSOLIDATED ACCOUNTS 543 20 Accounting for groups at the date of acquisition 545 20.1 Introduction 545 20.2 The definition of a group 545 20.3 Consolidated accounts and some reasons for their preparation 545 20.4 The definition of control 547 20.5 Alternative methods of preparing consolidated accounts 548 20.6 The treatment of positive goodwill 550 20.7 The treatment of negative goodwill 550 20.8 The comparison between an acquisition by cash and an exchange of shares 550 20.9 Non-controlling interests 550 Openmirrors.com A01_ELLI3325_13_SE_FM.QXD 13/7/09 11:24 Page xv Full Contents xv 20.10 The treatment of differences between a subsidiary’s fair value and book value 553 20.11 How to calculate fair values 554 Summary 555 Review questions 555 Exercises 556 References 561 21 Preparation of consolidated statements of financial position after the date of acquisition 562 21.1 Introduction 562 21.2 Pre- and post-acquisition profits/losses 562 21.3 Inter-company balances 565 21.4 Unrealised profit on inter-company sales 566 21.5 Provision for unrealised profit affecting a non-controlling interest 570 21.6 Uniform accounting policies and reporting dates 570 21.7 How is the investment in subsidiaries reported in the parent’s own statement of financial position? 570 Summary 571 Review questions 571 Exercises 571 References 574 22 Preparation of consolidated statements of comprehensive income and consolidated statements of changes in equity 575 22.1 Introduction 575 22.2 Preparation of a consolidated statement of comprehensive income – the Ante Group 575 22.3 The statement of changes in equity (SOCE) 578 22.4 Dividends or interest paid by the subsidiary out of pre-acquisition profits 578 22.5 A subsidiary acquired part of the way through the year 579 22.6 Published format statement of comprehensive income 581 Summary 582 Review questions 582 Exercises 582 References 590 23 Accounting for associates and joint ventures 591 23.1 Introduction 591 23.2 Definitions of associates and of significant influence 591 23.3 The treatment of associated companies in consolidated accounts 592 23.4 The Brill Group – the equity method illustrated 592 23.5 The treatment of provisions for unrealised profits 594 23.6 The acquisition of an associate part-way through the year 594 23.7 Joint ventures 596 Summary 598 Review questions 598 Exercises 599 References 610 A01_ELLI3325_13_SE_FM.QXD 13/7/09 11:24 Page xvi xvi Full Contents 24 Accounting for the effects of changes in foreign exchange rates under IAS 21 611 24.1 Introduction 611 24.2 The difference between conversion and translation and the definition of a foreign currency transaction 611 24.3 The functional currency 612 24.4 The presentation currency 612 24.5 Monetary and non-monetary items 612 24.6 The rules on the recording of foreign currency transactions carried out directly by the reporting entity 613 24.7 The treatment of exchange differences on foreign currency transactions 613 24.8 Foreign exchange transactions in the individual accounts of companies illustrated – Boil plc 613 24.9 The translation of the accounts of foreign operations where the functional currency is the same as that of the parent 615 24.10 The use of a presentation currency other than the functional currency 615 24.11 Granby Ltd illustration 616 24.12 Granby Ltd illustration continued 617 24.13 Implications of IAS 21 620 Summary 621 Review questions 621 Exercises 621 References 624 PART 5 INTERPRETATION 625 25 Earnings per share 627 25.1 Introduction 627 25.2 Why is the earnings per share figure important? 627 25.3 How is the EPS figure calculated? 628 25.4 The use to shareholders of the EPS 629 25.5 Illustration of the basic EPS calculation 630 25.6 Adjusting the number of shares used in the basic EPS calculation 631 25.7 Rights issues 633 25.8 Adjusting the earnings and number of shares used in the diluted EPS calculation 638 25.9 Procedure where there are several potential dilutions 640 25.10 Exercise of conversion rights during financial year 642 25.11 Disclosure requirements of IAS 33 642 25.12 The Improvement Project 645 25.13 Convergence project 645 Summary 645 Review questions 646 Exercises 647 References 653 26 Statements of cash flows 654 26.1 Introduction 654 Openmirrors.com A01_ELLI3325_13_SE_FM.QXD 13/7/09 11:24 Page xvii Full Contents xvii 26.2 Development of statements of cash flows 654 26.3 Applying IAS 7 (revised) Cash Flow Statements 656 26.4 IAS 7 (revised) format of cash flow statements 657 26.5 Consolidated cash flow statements 662 26.6 Analysing a cash flow statement 664 26.7 Critique of cash flow accounting 668 Summary 670 Review questions 670 Exercises 671 References 679 27 Review of financial ratio analysis 680 27.1 Introduction 680 27.2 Initial impressions 680 27.3 Accounting ratios 681 27.4 Six key ratios 682 27.5 Description of the six key ratios 684 27.6 Description of subsidiary ratios 686 27.7 Application of pyramid of ratios to JD Wetherspoon plc 695 27.8 Segmental analysis 698 27.9 Inter-firm comparisons and industry averages 705 27.10 Ensuring true inter-firm comparisons 707 27.11 Sources of company information 708 27.12 Non-financial ratios 708 27.13 Interpretation problems when using ratios and consolidated financial statements 708 Summary 711 Review questions 711 Exercises 712 References 723 28 Trend analysis and multivariate analysis 724 28.1 Introduction 724 28.2 Horizontal analysis between two periods 724 28.3 Trend analysis over a series of periods 726 28.4 Historical summaries 727 28.5 Vertical analysis – common size statements 728 28.6 Multivariate analysis – Z-scores 730 28.7 H-scores 733 28.8 A-scores 733 28.9 Combining cash flow and accrual data 735 28.10 Accounting polices 735 28.11 Balanced scorecards 736 28.12 Valuing shares of an unquoted company – quantitative process 737 28.13 Valuing shares of an unquoted company – qualitative process 740 28.14 Shareholder value analysis (SVA) 741 28.15 Measuring and reporting values in the annual report 742 28.16 Shareholder information needs 747 28.17 Professional risk assessors 750 28.18 Aggressive earnings management 755 A01_ELLI3325_13_SE_FM.QXD 13/7/09 11:24 Page xviii xviii Full Contents 28.19 Impact of differences between IFRSs and national standards on trend analysis 756 Summary 757 Review questions 757 Exercises 759 References 768 29 An introduction to financial reporting on the Internet 770 29.1 Introduction 770 29.2 The reason for the development of a business reporting language 770 29.3 Reports and the flow of information pre-XBRL 771 29.4 What are HTML, XML and XBRL? 771 29.5 Reports and the flow of information post-XBRL 773 29.6 XBRL and the IASB 774 29.7 Why should companies adopt XBRL? 774 29.8 What is needed to use XBRL for outputting information? 775 29.9 What is needed when receiving XBRL output information? 777 29.10 Progress of XBRL development for published financial statements 778 29.11 Progress of XBRL development for internal accounting 779 29.12 Further study 780 Summary 780 Review questions 781 Exercises 781 Bibliography 782 PART 6 ACCOUNTABILITY 783 30 Corporate governance 785 30.1 Introduction 785 30.2 What do we mean by corporate governance? 785 30.3 What do we mean by good corporate governance? 786 30.4 What are the constraints on good governance? 786 30.5 How to encourage directors to act in the best interest of the shareholders 786 30.6 Corporate governance in different countries 788 30.7 Corporate governance codes and guidelines 793 30.8 Codes of Hong Kong, Malaysia and Singapore 793 30.9 UK – role of non-executive directors in corporate governance 794 30.10 Review of the contribution of NEDs 798 30.11 Directors’ remuneration – Code provisions 799 30.12 Directors’ remuneration – performance criteria 800 30.13 Directors’ remuneration – illustration from the Annual Report of Diageo plc 804 30.14 Share options 808 30.15 IFRS 2 Share-Based Payment – a brief discussion of its principles 813 30.16 Directors’ remuneration – conclusion 814 30.17 Relations with shareholders 815 30.18 Institutional investors 815 30.19 The Myners Report 816 Openmirrors.com A01_ELLI3325_13_SE_FM.QXD 13/7/09 11:24 Page xix Full Contents xix 30.20 Corporate governance – directors’ remuneration summary 817 30.21 Audit committees and audit function 818 30.22 Principal qualities of an auditor 820 30.23 Current position on the auditor providing consultancy services 823 30.24 Future developments on auditors providing consultancy services 825 30.25 The Sarbanes–Oxley Act 2002 826 30.26 Review of corporate governance initiatives 827 30.27 How effective have the four pillars been in achieving good corporate governance? 828 30.28 How effective have efforts been to control directors’ remuneration? 829 Summary 830 Review questions 830 Exercises 832 References 836 31 Sustainability – environmental and social reporting 838 31.1 Introduction 838 31.2 How financial reporting has evolved to embrace sustainability reporting 838 31.3 The Triple Bottom Line (TBL) 839 31.4 The Connected Reporting Framework 840 31.5 IFAC Sustainability Framework 842 31.6 The accountant’s role in a capitalist industrial society 844 31.7 The accountant’s changing role 844 31.8 Sustainability – environmental reporting 845 31.9 Environmental information in the annual accounts 845 31.10 Background to companies’ reporting practices 846 31.11 European Commission recommendations for disclosures in annual accounts 847 31.12 Evolution of stand-alone environmental reports 848 31.13 International charters and guidelines 852 31.14 Self-regulation schemes 854 31.15 Economic consequences of environmental reporting 856 31.16 Summary on environmental reporting 857 31.17 Environmental auditing: international initiatives 858 31.18 The activities involved in an environmental audit 859 31.19 Concept of social accounting 861 31.20 Background to social accounting 863 31.21 Corporate social responsibility 866 31.22 Need for comparative data 868 31.23 International initiatives towards triple bottom line reporting 870 Summary 873 Review questions 873 Exercises 875 References 881 Bibliography 882 32 Ethics for accountants 884 32.1 Introduction 884 32.2 What do we mean by ‘ethics’? 884 A01_ELLI3325_13_SE_FM.QXD 13/7/09 11:24 Page xx xx Full Contents 32.3 The nature of business ethics 885 32.4 Ethical codes for businesses 886 32.5 The background to business ethics 889 32.6 The role of ethics in modern business 890 32.7 International Accreditation Programme 893 32.8 The role of professional accounting ethics 894 32.9 National and international regulation 896 32.10 The role of the accountant as guardian of business ethics 899 32.11 Growth of voluntary standards 900 32.12 Conflict between Codes and Targets 903 Summary 903 Review questions 904 References 906 Bibliography 906 Appendix: Outline solutions to selected exercises 907 Index 913 Openmirrors.com A01_ELLI3325_13_SE_FM.QXD 13/7/09 11:24 Page xxi Preface and acknowledgements Our objective is to provide a balanced and comprehensive framework to enable students to acquire the requisite knowledge and skills to appraise current practice critically and to evaluate proposed changes from a theoretical base. To this end, the text contains: current IASs and IFRSs, illustrations from published accounts, a range of review questions, exercises of varying difficulty, outline solutions to selected exercises in an Appendix at the end of the book, extensive references. We have assumed that readers will have an understanding of financial accounting to a foundation or first-year level, although the text and exercises have been designed on the basis that a brief revision is still helpful. Lecturers are using the text selectively to support a range of teaching programmes for second-year and final-year undergraduate and postgraduate programmes. We have therefore attempted to provide subject coverage of sufficient breadth and depth to assist selective use. The text has been adopted for financial accounting, reporting and analysis modules on: second-year undergraduate courses for Accounting, Business Studies and Combined Studies; final-year undergraduate courses for Accounting, Business Studies and Combined Studies; MBA courses; specialist MSc courses; and professional courses preparing students for professional accountancy examinations. Changes to the thirteenth edition Accounting standards UK listed companies, together with those non-listed companies that so choose, have applied international standards from January 2005. For non-listed companies that choose to continue to apply UK GAAP, the ASB has stated its commitment to progressively bringing UK GAAP into line with international standards. A01_ELLI3325_13_SE_FM.QXD 13/7/09 11:24 Page xxii xxii Preface and acknowlegements For companies currently applying FRSSE, this will continue. The IASB launched field tests of an SME Exposure draft in June 2007 with an IFRS for non-publicly accountable/ private entities due in 2009. Accounting standards – thirteenth edition updates Chapters 5 and 6 cover the evolution of the regulatory framework in the UK and the evolution of international standards. Topics and International Standards are covered as follows: Chapter 4 Accounting for inflation IAS 29 Chapter 8 Published accounts of companies IAS 1, IAS 37, IFRS 1, IFRS 5 and IRFS 8 Chapter 9 Preparation of published accounts IAS 1, IAS 8, IAS 24 and IFRS 5 Chapter 11 Off statement of financial position finance IAS 37 Chapter 12 Financial instruments IAS 32, IAS 39 and IFRS 7 Chapter 13 Employee benefits IAS 19, IAS 26 and IFRS 2 Chapter 14 Taxation in company accounts IAS 12 Chapter 15 Property, plant and equipment (PPE) IAS 16, IAS 20, IAS 23, IAS 36, IAS 40 and IFRS 5 Chapter 16 Leasing IAS 17 Chapter 17 R&D; goodwill and intangible assets; brands IAS 38 and IFRS 3 Chapter 18 Inventories IAS 2 Chapter 19 Construction contracts IAS 11 Chapters 20 to 24 Consolidation IAS 21, IAS 27, IAS 28, IAS 31 and IFRS 3 Chapter 25 Earnings per share IAS 33 Chapter 26 Statements of cash flows IAS 7 Chapter 30 Corporate governance IFRS 2 Income and asset value measurement systems Chapters 1 to 4 continue to cover accounting and reporting on a cash flow and accrual basis, the economic income approach and accounting for changing price levels. The UK regulatory framework and analysis UK listed companies will continue to be subject to national company law, and mandatory and best practice requirements such as the Operating and Financial Review and the Combined Code. UK regulatory framework and analysis – thirteenth edition changes The following chapters have been retained and updated as appropriate: Chapter 10 Share capital, distributable profits and reduction of capital Chapter 11 Off balance sheet finance Chapter 27 Review of financial ratio analysis Chapter 28 Trend analysis and multivariate analysis Chapter 29 An introduction to financial reporting on the Internet Chapter 30 Corporate governance Openmirrors.com A01_ELLI3325_13_SE_FM.QXD 13/7/09 11:24 Page xxiii Openmirrors.com Preface and acknowlegements xxiii Chapter 31 Sustainability – environmental and social reporting Chapter 32 Ethics for accountants Our emphasis has been on keeping the text current and responsive to constructive comments from reviewers. Recent developments In addition to the steps being taken towards the development of IFRSs that will receive broad consensus support, regulators have been active in developing further requirements concern- ing corporate governance. These have been prompted by the accounting scandals in the USA and, more recently, in Europe and by shareholder activism fuelled by the apparent lack of any relationship between increases in directors’ remuneration and company performance. The content of financial reports continues to be subjected to discussion with a tension between preparers, stakeholders, auditors, academics and standard setters; this is mirrored in the tension that exists between theory and practice. Preparers favour reporting transactions on a historical cost basis which is reliable but does not provide shareholders with relevant information to appraise past performance or to predict future earnings. Shareholders favour forward-looking reports relevant in estimating future dividend and capital growth and in understanding environmental and social impacts. Stakeholders favour quantified and narrative disclosure of environmental and social impacts and the steps taken to reduce negative impacts. Auditors favour reports that are verifiable so that the figures can be substantiated to avoid them being proved wrong at a later date. Academic accountants favour reports that reflect economic reality and are relevant in apprais- ing management performance and in assessing the capacity of the company to adapt. Standard setters lean towards the academic view and favour reporting according to the commercial substance of a transaction. In order to understand the tensions that exist, students need: the skill to prepare financial statements in accordance with the historical cost and current cost conventions, both of which appear in annual financial reports; an understanding of the main thrust of mandatory and voluntary standards; an understanding of the degree of flexibility available to the preparers and the impact of this on reported earnings and the figures in the statement of financial position; an understanding of the limitations of financial reports in portraying economic reality; and an exposure to source material and other published material in so far as time permits. Instructor’s Manual A separate Instructor’s Manual has been written to accompany this text. It contains fully worked solutions to all the exercises and is of a quality that allows them to be used as over- head transparencies. The Manual is available at no cost to lecturers on application to the publishers. A01_ELLI3325_13_SE_FM.QXD 13/7/09 11:24 Page xxiv xxiv Preface and acknowlegements Website An electronic version of the Manual is also available for download at www.pearsoned.co.uk/ elliott-elliott. Acknowledgements Financial reporting is a dynamic area and we see it as extremely important that the text should reflect this and be kept current. Assistance has been generously given by colleagues and many others in the preparation and review of the text and assessment material. This thirteenth edition continues to be very much a result of the authors, colleagues, reviewers and Pearson editorial and production staff working as a team and we are grateful to all concerned for their assistance in achieving this. We owe particular thanks to Ron Altshul of Leeds Metropolitan University, who has updated ‘Taxation in company accounts’ (Chapter 14); Bala Balachandran of South Bank University ‘Corporate governance’ (Chapter 30); Charles Batchelor formerly of FTC Kaplan for ‘Financial instruments’ (Chapter 12) and ‘Employee benefits’ (Chapter 13); Steve Dungworth of De Montfort University, for ‘Ethics for accountants’ (Chapter 32), which first appeared in the third edition; Ozer Erman of Kingston University, for ‘Share capital, distributable profits and reduction of capital’ (Chapter 10), which first appeared in the second edition; Paul Robins of the Financial Training Company for ‘Property, plant and equipment (PPE)’ (Chapter 15) and Consolidation chapters; Professor Garry Tibbits of the University of Western Sydney for Leasing (Chapter 16); Hendrika Tibbits of the University of Western Sydney for An introduction to financial reporting on the Internet (Chapter 29); David Towers, formerly of Keele University, for R&D; goodwill and intangible assets (Chapter 17); and Martin Howes for inputs to financial analysis. The authors are grateful for the constructive comments received from the following reviewers which have assisted us in making improvements: Iain Fleming of the University of Paisley, John Morley of the University of Brighton, John Forker of Queen’s University, Belfast, Breda Sweeney of Cork University, Patricia McCourt Larres of Queen’s University, Belfast, and Dave Knight of Leeds Metropolitan University. Thanks are owed to A.T. Benedict of the South Bank University, Keith Brown of De Montfort University, Kenneth N. Field of the University of Leeds, Sue McDermott of London Guildhall University, David Murphy of Manchester Metropolitan University, Bahadur Najak of the University of Durham, Graham Sara of Coventry University, Laura Spira of Oxford Brookes University, Ken Trunkfield, formerly of the University of Derby, and Martin Tuffy formerly of the University of Brighton. Thanks are also due to the following organisations: the Accounting Standards Board, the International Accounting Standards Board, the Association of Chartered Certified Accountants, the Association of International Accountants, the Chartered Institute of Manage- ment Accountants, the Institute of Chartered Accountants of Scotland, Chartered Institute of Public Finance and Accountancy, Chartered Institute of Bankers and the Institute of Investment Management and Research. We would also like to thank the authors of some of the end-of-chapter exercises. Some of these exercises have been inherited from a variety of institutions with which we have been associated, and we have unfortunately lost the identities of the originators of such material with the passage of time. We are sorry that we cannot acknowledge them by name and hope that they will excuse us for using their material. Openmirrors.com A01_ELLI3325_13_SE_FM.QXD 13/7/09 11:24 Page xxv Openmirrors.com Preface and acknowlegements xxv We are indebted to Matthew Smith and the editorial team at Pearson Education for active support in keeping us largely to schedule and the attractively produced and presented text.