FINANCIAL ACCOUNTING AND REPORTING

882_233797479.pdf

BARRY ELLIOTT

AND

JAMIE ELLIOTT

FINANCIALACCOUNTINGANDREPORTING

13th Edition

FINANCIAL ACCOUNTING

AND REPORTING

ELLIOTT

AND

ELLIOTT

Financial Accounting & Reporting is the most up-to-date text on the market. Now fully updated in its 13th edition, it includes extensive coverage of International Accounting Standards (IASs) and International Financial Reporting Standards (IFRSs). 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 to help them apply current standards, and critically appraise the underlying concepts and financial reporting methods.

Key features

Combines academic rigour with an engaging and accessible style Coverage of International Financial

Reporting Standards

Illustrations taken from real published accounts Excellent range of review questions Numerous exercises, varying in level of difficulty, with solutions where applicable Extensive references A section on the Analysis of Accounts A section on Accountability - includes

Corporate Governance issues,

Sustainability - environmental and

social reporting and Ethic s

New features for this edition

Fully updated to May 2009 Updated coverage of International

Financial Reporting Standards

Substantial revisions to Analysis of

Accounts and Accountability chapters

Selected chapters include new additional questions and exercises Includes more examples of extracts from real financial reports Fully supported by a comprehensive set of multiple-choice questions online, 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. 13th

EDITION

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Financial Accounting

and Reporting

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Financial Accounting

and ReportingTHIRTEENTH EDITIONBarry Elliott and Jamie ElliottA01_ELLI3325_13_SE_FM.QXD 13/7/09 11:24 Page iiiOpenmirrors.com

Pearson Education Limited

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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 identiÞed 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

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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 afÞliation 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

10987654321

13 12 11 10 09

Typeset in 10/12 Ehrhardt MT by 35

Printed by Ashford Colour Press Ltd., Gosport

The publisherÕs policy is to use paper manufactured from sustainable forests.A01_ELLI3325_13_SE_FM.QXD 13/7/09 11:24 Page ivOpenmirrors.com

Preface and acknowledgementsxxi

Guided tour of MyAccountingLabxxvi

Part 1

INCOME AND ASSET VALUE MEASUREMENT SYSTEMS1

1 Accounting and reporting on a cash ßow basis3

2 Accounting and reporting on an accrual accounting basis22

3 Income and asset value measurement: an economistÕs approach40

4 Accounting for inßation59

Part 2

REGULATORY FRAMEWORK Ð AN ATTEMPT TO ACHIEVE

UNIFORMITY99

5 Financial reporting Ð evolution of the regulatory framework in the UK 101

6 Financial reporting Ð evolution of international standards137

7 Conceptual framework158

8 Published accounts of companies184

9 Preparation of published accounts229

Part 3

STATEMENT OF FINANCIAL POSITION Ð EQUITY, LIABILITY

AND ASSET MEASUREMENT AND DISCLOSURE255

10 Share capital, distributable proÞts and reduction of capital257

11 Off balance sheet Þnance282

12 Financial instruments317

13 Employee beneÞts342

14 Taxation in company accounts373

15 Property, plant and equipment (PPE)402

16 Leasing436

17 R&D; goodwill and intangible assets; brands457

18 Inventories498

19 Construction contracts524Brief ContentsA01_ELLI3325_13_SE_FM.QXD 13/7/09 11:24 Page vOpenmirrors.com

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Part 4

CONSOLIDATED ACCOUNTS 543

20 Accounting for groups at the date of acquisition 545

21 Preparation of consolidated statements of Þnancial 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 ßows 654

27 Review of Þnancial ratio analysis 680

28 Trend analysis and multivariate analysis 724

29 An introduction to Þnancial reporting on the Internet 770

Part 6

ACCOUNTABILITY 783

30 Corporate governance 785

31 Sustainability Ð environmental and social reporting 838

32 Ethics for accountants 884

Appendix: Outline solutions to selected exercises 907

Index 913vi¥Brief ContentsA01_ELLI3325_13_SE_FM.QXD 13/7/09 11:24 Page viOpenmirrors.comOpenmirrors.com

Preface and acknowledgementsxxi

Guided tour of MyAccountingLabxxvi

Part 1

INCOME AND ASSET VALUE MEASUREMENT SYSTEMS 11 Accounting and reporting on a cash ßow basis31.1 Introduction3

1.2 Shareholders3

1.3 What skills does an accountant require in respect of external reports? 4

1.4 Managers4

1.5 What skills does an accountant require in respect of internal reports? 5

1.6 Procedural steps when reporting to internal users5

1.7 Agency costs8

1.8 Illustration of periodic Þnancial statements prepared under the cash

ßow concept to disclose realised operating cash ßows8

1.9 Illustration of preparation of balance sheet under the cash ßow concept 12

1.10 Treatment of non-current assets in the cash ßow model14

1.11 What are the characteristics of these data that make them reliable? 15

1.12 Reports to external users16

Summary16

Review questions17

Exercises18

References212 Accounting and reporting on an accrual accounting basis 222.1 Introduction22

2.2 Historical cost convention23

2.3 Accrual basis of accounting24

2.4 Mechanics of accrual accounting Ð adjusting cash receipts and payments 24

2.5 Subjective judgements required in accrual accounting Ð adjusting cash

receipts in accordance with lAS 1825

2.6 Subjective judgements required in accrual accounting Ð adjusting cash

payments in accordance with the matching principle27

2.7 Mechanics of accrual accounting Ð the statement of Þnancial position 28

2.8 Reformatting the statement of Þnancial position28

2.9 Accounting for the sacriÞce of non-current assets29Full ContentsA01_ELLI3325_13_SE_FM.QXD 13/7/09 11:24 Page viiOpenmirrors.com

2.10 Reconciliation of cash ßow and accrual accounting data32

Summary34

Review questions34

Exercises35

References383 Income and asset value measurement: an economistÕs approach 403.1 Introduction40

3.2 Role and objective of income measurement 40

3.3 AccountantÕs view of income, capital and value 43

3.4 Critical comment on the accountantÕs measure46

3.5 EconomistÕs view of income, capital and value 47

3.6 Critical comment on the economistÕs measure 53

3.7 Income, capital and changing price levels53

Summary55

Review questions55

Exercises56

References57

Bibliography584 Accounting for inßation594.1 Introduction59

4.2 Review of the problems of historical cost accounting (HCA)59

4.3 Inßation accounting60

4.4 The concepts in principle60

4.5 The four models illustrated for a company with cash purchases

and sales61

4.6 Critique of each model65

4.7 Operating capital maintenance Ð a comprehensive example68

4.8 Critique of CCA statements79

4.9 The ASB approach81

4.10 The IASC/IASB approach83

4.11 Future developments84

Summary86

Review questions87

Exercises88

References97

Bibliography97Part 2

REGULATORY FRAMEWORK Ð AN ATTEMPT TO

ACHIEVE UNIFORMITY 995 Financial reporting Ð evolution of the regulatory framework in the UK 1015.1 Introduction101

5.2 Mandatory regulations101

5.3 Arguments in support of standards105

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5.5 Structure of regulatory framework107

5.6 The Operating and Financial Review (OFR)110

5.7 The Financial Reporting Review Panel116

5.8 The Financial Services Authority119

5.9 The Revised Combined Code (June 2008)119

5.10 Interim reports following Cadbury122

5.11 Developments for small companies125

5.12 Evaluation of effectiveness of mandatory regulations132

Summary134

Review questions134

Exercises135

References1356 Financial reporting Ð evolution of international standards 1376.1 Introduction137

6.2 National differences137

6.3 Reasons for differences in Þnancial reporting138

6.4 ClassiÞcation of national accounting systems142

6.5 Attempts to reduce national differences143

6.6 The work of international bodies in harmonising and standardising

Þnancial reporting144

6.7 US GAAP151

Summary155

Review questions155

Exercises155

References1567 Conceptual framework1587.1 Introduction158

7.2 Historical overview of the evolution of Þnancial accounting theory 159

7.3 IASC Framework for the Presentation and Preparation of Financial

Statements162

7.4 ASB Statement of Principles1999164

7.5 FASB Statements of Financial Accounting Concepts 174

7.6 Conceptual Framework developments177

Summary178

Review questions180

Exercises181

References1828 Published accounts of companies1848.1 Introduction184

8.2 Introduction to published accounts184

8.3 A public companyÕs Þnancial calendar186

8.4 Criteria for information appearing in a statement of comprehensive

income and statement of Þnancial position186

8.5 The prescribed formats Ð 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 sales189Full Contents¥ixA01_ELLI3325_13_SE_FM.QXD 13/7/09 11:24 Page ixOpenmirrors.com

8.8 Distribution costs193

8.9 Administrative expenses193

8.10 Other operating income or expense193

8.11 What costs and income are brought into account after calculating

the trading proÞt in order to arrive at the proÞt on ordinary activities before tax?193

8.12 Does it really matter under which heading a cost is classiÞed in the

statement of comprehensive income provided it is not omitted? 194

8.13 Discontinued operations disclosure in the statement of

comprehensive income194

8.14 Items requiring separate disclosure196

8.15 Other comprehensive income197

8.16 The prescribed formats Ð the statement of Þnancial position198

8.17 Statement of changes in equity201

8.18 US comprehensive income reporting203

8.19 Segment reporting203

8.20 The fundamental accounting principles underlying the published

statement of comprehensive income and statement of Þnancial position205

8.21 Disclosure of accounting policies205

8.22 Fair view treatment210

8.23 Additional information in the annual report213

8.24 What information do companies provide to assist comparison

between companies reporting under different reporting regimes? 215

Summary219

Review questions219

Exercises221

References228

9 Preparation of published accounts229

9.1 Introduction229

9.2 Stage 1: preparation of the internal statement of comprehensive

income from a trial balance229

9.3 Stage 2: preparation of the statement of comprehensive income

of Illustrious SpA in Format 1 style231

9.4 Stage 3: preparation of the statement of Þnancial position234

9.5 Preparation of accounts in Format 1 following IAS 8 and IFRS 5 235

9.6 Additional information value of IFRS 5239

9.7 Additional information value of IAS 24240

Summary242

Review questions243

Exercises243

References254

Part 3

STATEMENT OF FINANCIAL POSITION Ð EQUITY,

LIABILITY AND ASSET MEASUREMENT AND DISCLOSURE 255

10 Share capital, distributable proÞts and reduction of capital 257

10.1 Introduction257

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10.2 Common themes257

10.3 Total ownersÕ equity: an overview258

10.4 Total shareholdersÕ funds: more detailed explanation259

10.5 Accounting entries on issue of shares262

10.6 Creditor protection: capital maintenance concept263

10.7 Creditor protection: why capital maintenance rules are necessary 264

10.8 Creditor protection: how to quantify the amounts available to meet

creditorsÕ claims264

10.9 Issued share capital: minimum share capital 265

10.10 Distributable proÞts: general considerations 265

10.11Distributable proÞts: 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 assets267

10.14 Repayment of part of paid-in capital to shareholders or cancellation

of unpaid share capital273

10.15 Purchase of own shares274

Summary276

Review questions276

Exercises277

References281

11 Off balance sheet Þnance282

11.1 Introduction282

11.2 Traditional statements Ð conceptual changes282

11.3 Primary Þnancial statements: their interrelationship283

11.4 Primary Þnancial statements: changes in their interrelationship 283

11.5 Reasons that companies borrow284

11.6 Capital gearing and its implications285

11.7 Off balance sheet Þnance Ð its impact287

11.8 Substance over form287

11.9 Impact of converting to IFRS291

11.10 Statement of Þnancial position as a valuation document293

11.11 Why companies take steps to strengthen their statements of

Þnancial position295

11.12 DeÞnitions cannot remove uncertainty: IAS 10 and IAS 37296

11.13 ED IAS 37 Non-Þnancial Liabilities304

Summary310

Review questions311

Exercises313

References316

12 Financial instruments317

12.1 Introduction317

12.2 Financial instruments Ð the IASBÕs problem child317

12.3 IAS 32

Financial Instruments: Disclosure and Presentation320

12.4 IAS 39

Financial Instruments: Recognition and Measurement325

12.5 IFRS 7

Financial Statement Disclosures335

Summary338

Review questions339

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Exercises339

References341

13 Employee beneÞts342

13.1 Introduction342

13.2 Greater employee interest in pensions342

13.3 Financial reporting implications343

13.4 Types of scheme343

13.5 DeÞned contribution pension schemes345

13.6 DeÞned beneÞt pension schemes346

13.7 IAS 19 (revised) Employee BeneÞts348

13.8 The liability for pension and other post-retirement costs348

13.9 The statement of comprehensive income351

13.10 Comprehensive illustration352

13.11 Plan curtailments and settlements354

13.12 Multi-employer plans354

13.13 Disclosures355

13.14 Other long-service beneÞts355

13.15 Short-term beneÞts356

13.16 Termination beneÞts357

13.17 IFRS 2

Share-Based Payment358

13.18 Scope of IFRS 2359

13.19 Recognition and measurement359

13.20 Equity-settled share-based payments359

13.21 Cash-settled share-based payments362

13.22 Transactions which may be settled in cash or shares362

13.23 Transitional provisions363

13.24 IAS 26 Accounting and Reporting by Retirement BeneÞt Plans363

Summary366

Review questions366

Exercises369

References372

14 Taxation in company accounts373

14.1 Introduction373

14.2 Corporation tax373

14.3 Corporation tax systems Ð the theoretical background374

14.4 Corporation tax systems Ð avoidance and evasion375

14.5 Corporation tax Ð the system from 6 April 1999378

14.6 IFRS and taxation379

14.7 IAS 12 Ð accounting for current taxation380

14.8 Deferred tax382

14.9 FRS 19 (the UK standard on deferred taxation)390

14.10 A critique of deferred taxation391

14.11 Examples of companies following IAS 12394

14.12 Value added tax (VAT)396

Summary397

Review questions397

Exercises398

References400

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15 Property, plant and equipment (PPE)402

15.1 Introduction402

15.2 PPE Ð concepts and the relevant IASs and IFRSs402

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 value410

15.9 Calculation of depreciation410

15.10 Measurement subsequent to initial recognition414

15.11 IAS 36 Impairment of Assets416

15.12 IFRS 5

Non-Current Assets Held for Sale and Discontinued Operations422

15.13 Disclosure requirements422

15.14 Government grants towards the cost of PPE423

15.15 Investment properties425

15.16 Effect of accounting policy for PPE on the interpretation of the

Þnancial statements426

Summary428

Review questions428

Exercises429

References435

16 Leasing436

16.1 Introduction436

16.2 Background to leasing436

16.3 IAS 17 (and its national equivalents) Ð the controversy438

16.4 IAS 17 Ð classiÞcation of a lease440

16.5 IAS 17 Ð accounting for leases by lessees442

16.6 Accounting for the lease of land and buildings447

16.7 Leasing Ð a form of off statement of Þnancial position Þnancing

448

16.8 Accounting for leases Ð a new approach449

16.9 Accounting for leases by lessors451

Summary452

Review questions452

Exercises454

References456

17 R&D; goodwill and intangible assets; brands457

17.1 Introduction457

17.2 Accounting treatment for research and development457

17.3 Research and development459

17.4 Introduction to goodwill and intangible assets463

17.5 Accounting for goodwill under IFRS 3463

17.6 Is there a correct treatment for amortising goodwill?466

17.7 Accounting for intangible assets under IAS 38471

17.8 Disclosure of intangible assets under IAS 38473

17.9 Brand accounting476

17.10 Emissions trading478

17.11 Intellectual property480

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17.12 Intellectual capital483

17.13 Review of implementation of IFRS 3484

Summary486

Review questions486

Exercises488

References49618 Inventories49818.1 Introduction498

18.2 Inventory deÞned498

18.3 The controversy499

18.4 IAS 2 Inventories500

18.5 Inventory valuation501

18.6 Work-in-progress508

18.7 Inventory control510

18.8 Creative accounting511

18.9 Audit of the year-end physical inventory count513

18.10 Published accounts514

18.11 Agricultural activity515

Summary518

Review questions519

Exercises519

References52319 Construction contracts52419.1 Introduction524

19.2 The accounting issue for construction contracts524

19.3 IdentiÞcation of contract revenue525

19.4 IdentiÞcation of contract costs525

19.5 Recognition of contract revenue and expenses526

19.6 PublicÐprivate partnerships (PPPs)529

Summary535

Review questions535

Exercises535

References542PART 4

CONSOLIDATED ACCOUNTS 54320 Accounting for groups at the date of acquisition 54520.1 Introduction545

20.2 The deÞnition of a group545

20.3 Consolidated accounts and some reasons for their preparation 545

20.4 The deÞnition of control547

20.5 Alternative methods of preparing consolidated accounts 548

20.6 The treatment of positive goodwill550

20.7 The treatment of negative goodwill550

20.8 The comparison between an acquisition by cash and an exchange

of shares550

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20.10 The treatment of differences between a subsidiaryÕs 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 Þnancial position

after the date of acquisition 562

21.1 Introduction562

21.2 Pre- and post-acquisition proÞts/losses562

21.3 Inter-company balances565

21.4 Unrealised proÞt on inter-company sales566

21.5 Provision for unrealised proÞt affecting a non-controlling interest 570

21.6 Uniform accounting policies and reporting dates570

21.7 How is the investment in subsidiaries reported in the parentÕs own

statement of Þnancial position?570

Summary571

Review questions571

Exercises571

References574

22 Preparation of consolidated statements of comprehensive

income and consolidated statements of changes in equity 575

22.1 Introduction575

22.2 Preparation of a consolidated statement of comprehensive income

Ð the Ante Group575

22.3 The statement of changes in equity (SOCE)578

22.4 Dividends or interest paid by the subsidiary out of pre-acquisition

proÞts578

22.5 A subsidiary acquired part of the way through the year579

22.6 Published format statement of comprehensive income581

Summary582

Review questions582

Exercises582

References590

23 Accounting for associates and joint ventures591

23.1 Introduction591

23.2 DeÞnitions of associates and of signiÞcant inßuence591

23.3 The treatment of associated companies in consolidated accounts 592

23.4 The Brill Group Ð the equity method illustrated592

23.5 The treatment of provisions for unrealised proÞts594

23.6 The acquisition of an associate part-way through the year594

23.7 Joint ventures596

Summary598

Review questions598

Exercises599

References610

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24 Accounting for the effects of changes in foreign exchange

rates under IAS 21 61124.1 Introduction611

24.2 The difference between conversion and translation and the

deÞnition of a foreign currency transaction611

24.3 The functional currency612

24.4 The presentation currency612

24.5 Monetary and non-monetary items612

24.6 The rules on the recording of foreign currency transactions carried

out directly by the reporting entity613

24.7 The treatment of exchange differences on foreign currency

transactions613

24.8 Foreign exchange transactions in the individual accounts of

companies illustrated Ð Boil plc613

24.9 The translation of the accounts of foreign operations where the

functional currency is the same as that of the parent615

24.10 The use of a presentation currency other than the functional currency 615

24.11 Granby Ltd illustration616

24.12 Granby Ltd illustration continued617

24.13 Implications of IAS 21620

Summary621

Review questions621

Exercises621

References624PART 5

INTERPRETATION 62525 Earnings per share 62725.1 Introduction627

25.2 Why is the earnings per share Þgure important?627

25.3 How is the EPS Þgure calculated?628

25.4 The use to shareholders of the EPS629

25.5 Illustration of the basic EPS calculation630

25.6 Adjusting the number of shares used in the basic EPS calculation 631

25.7 Rights issues633

25.8 Adjusting the earnings and number of shares used in the diluted

EPS calculation638

25.9 Procedure where there are several potential dilutions640

25.10 Exercise of conversion rights during Þnancial year642

25.11 Disclosure requirements of IAS 33642

25.12 The Improvement Project645

25.13 Convergence project645

Summary645

Review questions646

Exercises647

References65326 Statements of cash ßows65426.1 Introduction654xvi¥Full ContentsA01_ELLI3325_13_SE_FM.QXD 13/7/09 11:24 Page xvi

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26.2 Development of statements of cash ßows654

26.3 Applying IAS 7 (revised) Cash Flow Statements656

26.4 IAS 7 (revised) format of cash ßow statements657

26.5 Consolidated cash ßow statements662

26.6 Analysing a cash ßow statement664

26.7 Critique of cash ßow accounting668

Summary670

Review questions670

Exercises671

References679

27 Review of Þnancial ratio analysis680

27.1 Introduction680

27.2 Initial impressions680

27.3 Accounting ratios681

27.4 Six key ratios682

27.5 Description of the six key ratios684

27.6 Description of subsidiary ratios686

27.7 Application of pyramid of ratios to JD Wetherspoon plc695

27.8 Segmental analysis698

27.9 Inter-Þrm comparisons and industry averages705

27.10 Ensuring true inter-Þrm comparisons707

27.11 Sources of company information708

27.12 Non-Þnancial ratios708

27.13 Interpretation problems when using ratios and consolidated

Þnancial statements708

Summary711

Review questions711

Exercises712

References723

28 Trend analysis and multivariate analysis724

28.1 Introduction724

28.2 Horizontal analysis between two periods724

28.3 Trend analysis over a series of periods726

28.4 Historical summaries727

28.5 Vertical analysis Ð common size statements728

28.6 Multivariate analysis Ð Z-scores730

28.7 H-scores733

28.8 A-scores733

28.9 Combining cash ßow and accrual data735

28.10 Accounting polices735

28.11 Balanced scorecards736

28.12 Valuing shares of an unquoted company Ð quantitative process 737

28.13 Valuing shares of an unquoted company Ð qualitative process740

28.14 Shareholder value analysis (SVA)741

28.15 Measuring and reporting values in the annual report742

28.16 Shareholder information needs747

28.17 Professional risk assessors750

28.18 Aggressive earnings management755

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28.19 Impact of differences between IFRSs and national standards on

trend analysis 756

Summary 757

Review questions 757

Exercises 759

References 76829 An introduction to Þnancial reporting on the Internet 77029.1 Introduction770

29.2 The reason for the development of a business reporting language 770

29.3 Reports and the ßow of information pre-XBRL771

29.4 What are HTML, XML and XBRL?771

29.5 Reports and the ßow of information post-XBRL773

29.6 XBRL and the IASB774

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 Þnancial statements 778

29.11 Progress of XBRL development for internal accounting779

29.12 Further study780

Summary780

Review questions781

Exercises781

Bibliography782PART 6

ACCOUNTABILITY 78330 Corporate governance 78530.1 Introduction785

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 shareholders786

30.6 Corporate governance in different countries788

30.7 Corporate governance codes and guidelines793

30.8 Codes of Hong Kong, Malaysia and Singapore793

30.9 UK Ð role of non-executive directors in corporate governance 794

30.10 Review of the contribution of NEDs798

30.11 DirectorsÕ remuneration Ð Code provisions799

30.12 DirectorsÕ remuneration Ð performance criteria800

30.13 DirectorsÕ remuneration Ð illustration from the Annual Report of

Diageo plc804

30.14 Share options808

30.15 IFRS 2 Share-Based PaymentÐ a brief discussion of its principles 813

30.16 DirectorsÕ remuneration Ð conclusion814

30.17 Relations with shareholders815

30.18 Institutional investors815

30.19 The Myners Report816xviii¥Full ContentsA01_ELLI3325_13_SE_FM.QXD 13/7/09 11:24 Page xviii

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30.20 Corporate governance Ð directorsÕ remuneration summary817

30.21 Audit committees and audit function818

30.22 Principal qualities of an auditor820

30.23 Current position on the auditor providing consultancy services 823

30.24 Future developments on auditors providing consultancy services 825

30.25 The SarbanesÐOxley Act 2002826

30.26 Review of corporate governance initiatives827

30.27 How effective have the four pillars been in achieving good corporate

governance?828

30.28 How effective have efforts been to control directorsÕ remuneration? 829

Summary830

Review questions830

Exercises832

References836

31 Sustainability Ð environmental and social reporting838

31.1 Introduction838

31.2 How Þnancial reporting has evolved to embrace sustainability

reporting838

31.3 The Triple Bottom Line (TBL)839

31.4 The Connected Reporting Framework840

31.5 IFAC Sustainability Framework842

31.6 The accountantÕs role in a capitalist industrial society844

31.7 The accountantÕs changing role844

31.8 Sustainability Ð environmental reporting845

31.9 Environmental information in the annual accounts845

31.10 Background to companiesÕ reporting practices846

31.11 European Commission recommendations for disclosures in annual

accounts847

31.12 Evolution of stand-alone environmental reports848

31.13 International charters and guidelines852

31.14 Self-regulation schemes854

31.15 Economic consequences of environmental reporting856

31.16 Summary on environmental reporting857

31.17 Environmental auditing: international initiatives858

31.18 The activities involved in an environmental audit859

31.19 Concept of social accounting861

31.20 Background to social accounting863

31.21 Corporate social responsibility866

31.22 Need for comparative data868

31.23 International initiatives towards triple bottom line reporting870

Summary873

Review questions873

Exercises875

References881

Bibliography882

32 Ethics for accountants884

32.1 Introduction884

32.2 What do we mean by ÔethicsÕ?884

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A01_ELLI3325_13_SE_FM.QXD 13/7/09 11:24 Page xix

32.3 The nature of business ethics885

32.4 Ethical codes for businesses886

32.5 The background to business ethics889

32.6 The role of ethics in modern business890

32.7 International Accreditation Programme893

32.8 The role of professional accounting ethics894

32.9 National and international regulation896

32.10 The role of the accountant as guardian of business ethics899

32.11 Growth of voluntary standards900

32.12 Conßict between Codes and Targets903

Summary903

Review questions904

References906

Bibliography906Appendix: Outline solutions to selected exercises907 Index913xx¥Full ContentsA01_ELLI3325_13_SE_FM.QXD 13/7/09 11:24 Page xx

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Our objective is to provide a balanced and comprehensive framework to en able students to acquire the requisite knowledge and skills to appraise current practi ce 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 difÞculty,
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 Þnancial a ccounting to a foundation or Þrst-year level, although the text and exercises have b een 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 Þnal-year undergraduate and postgraduate programmes.

We have therefore

attempted to provide subject coverage of sufÞcient breadth and depth to assist selective use. The text has been adopted for Þnancial accounting, reporting and anal ysis modules on:
second-year undergraduate courses for Accounting, Business Studies and C ombined

Studies;

Þnal-year undergraduate courses for Accounting, Business Studies and

Combined Studies;

MBA courses;
specialist MSc courses; and
professional courses preparing students for professional accountancy exa minations.

Changes to the thirteenth edition

Accounting standards

UK listed companies, together with those non-listed companies that so ch oose, have applied international standards from January 2005. For non-listed companies that choose to continue to apply UK GAAP, the A

SB has stated

its commitment to progressively bringing UK GAAP into line with internat ional standards.

Preface and acknowledgements

A01_ELLI3325_13_SE_FM.QXD 13/7/09 11:24 Page xxi For companies currently applying FRSSE, this will continue. The IASB launched Þeld tests of an SME Exposure draft in June 2007 with an IFRS for non-publicly accountable/

private entities due in 2009.Accounting standards Ð thirteenth edition updatesChapters 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 inßation IAS 29

Chapter 8 Published accounts of companies IAS 1, IAS 37, IFRS 1, IFRS 5 and IRFS 8 Chapter 9 Preparation of published accountsIAS 1, IAS 8, IAS 24 and IFRS 5 Chapter 11 Off statement of Þnancial position Þnance IAS 37 Chapter 12 Financial instruments IAS 32, IAS 39 and IFRS 7 Chapter 13 Employee beneÞts 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 ßows IAS 7

Chapter 30 Corporate governance IFRS 2Income and asset value measurement systemsChapters 1 to 4 continue to cover accounting and reporting on a cash ßow and accrual basis,

the economic income approach and accounting for changing price levels.The UK regulatory framework and analysisUK listed companies will continue to be subject to national company law, and mandatory and

best practice requirements such as the Operating and Financial Reviewand the Combined Code.UK regulatory framework and analysis Ð thirteenth edition changesThe following chapters have been retained and updated as appropriate:

Chapter 10 Share capital, distributable proÞts and reduction of capital

Chapter 11 Off balance sheet Þnance

Chapter 27 Review of Þnancial ratio analysis

Chapter 28 Trend analysis and multivariate analysis Chapter 29 An introduction to Þnancial reporting on the Internet

Chapter 30 Corporate governancexxii¥Preface and acknowlegementsA01_ELLI3325_13_SE_FM.QXD 13/7/09 11:24 Page xxii

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Chapter 31 Sustainability Ð 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 developmentsIn 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 directorsÕ remuneration and company performance. The content of Þnancial 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 quantiÞed and narrative disclosure of environmental and social impacts

and the steps taken to reduce negative impacts.
Auditors favour reports that are veriÞable so that the Þgures can be substantiated to avoid

them being proved wrong at a later date.
Academic accountants favour reports that reßect 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 Þnancial statements in accordance with the historical cost and current

cost conventions, both of which appear in annual Þnancial reports;
an understanding of the main thrust of mandatory and voluntary standards;
an understanding of the degree of ßexibility available to the preparers and the impact of

this on reported earnings and the Þgures in the statement of Þnancial position;
an understanding of the limitations of Þnancial reports in portraying economic reality;

and
an exposure to source material and other published material in so far as time permits.InstructorÕs ManualA separate InstructorÕs 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.Preface and acknowlegements¥xxiiiA01_ELLI3325_13_SE_FM.QXD 13/7/09 11:24 Page xxiiiOpenmirrors.com

WebsiteAn electronic version of the Manual is also available for download at www.pearsoned.co.uk/

elliott-elliott.AcknowledgementsFinancial reporting is a dynamic area and we see it as extremely important that the text

should reßect 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 ÔTaxation in company accountsÕ (Chapter 14); Bala Balachandran of South Bank University ÔCorporate governanceÕ (Chapter 30); Charles Batchelor formerly of FTC

Kaplan for ÔFinancial instrumentsÕ (Chapter 12) and ÔEmployee beneÞtsÕ (Chapter 13); Steve

Dungworth of De Montfort University, for ÔEthics for accountantsÕ (Chapter 32), which Þrst appeared in the third edition; Ozer Erman of Kingston University, for ÔShare capital, distributable proÞts and reduction of capitalÕ (Chapter 10), which Þrst appeared in the second edition; Paul Robins of the Financial Training Company for ÔProperty, plant and equipment (PPE)Õ (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 Þnancial 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 Þnancial 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 QueenÕs University, Belfast, Breda Sweeney of Cork University, Patricia McCourt Larres of QueenÕs 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 TrunkÞeld, 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 CertiÞed 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.xxiv¥Preface and acknowlegementsA01_ELLI3325_13_SE_FM.QXD 13/7/09 11:24 Page xxiv

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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. Finally we thank our wives, Di and Jacklin, for their continued good humoured support during the period of writing and revisions, and Giles Elliott for his critical comment from the commencement of the project. We alone remain responsible for any errors and for the thoughts and views that are expressed.

Barry and Jamie ElliottPublisherÕs acknowledgementsWe are grateful to the following for permission to reproduce copyright material:

The Financial Times

Extract on page 703 from Lex Column: Bayer Ð Another old-style chemical giants have broken themselves up to focus on pharmaceuticals,...-might sniff a bargain, The Financial Times,

17 November 2000; Extract on page 733 from Early Warning Signals, The Financial Times,

5 October 1999 (Urry, M.); Extract on page 900 from Growth of Voluntary Standards:

Social, environmental and ethical reporting is at an early stage but it is receiving increasing . . . stakeholder group. The Financial Times, 2 July 1998, p. 10 (Bolger, A.). In some instances we have been unable to trace the owners of copyright material, and we

would appreciate any information that would enable us to do so.Preface and acknowlegements¥xxvA01_ELLI3325_13_SE_FM.QXD 13/7/09 11:24 Page xxvOpenmirrors.com

MyAccountingLabputs students in control of their own learning through a suite of study and practice tools tied to the online e-book and other media tools. At the core of MyAccountingLab

are the following features:Practice testsPractice tests for each section of the textbook enable students to test their understanding and identify

the areas in which they need to do further work. Lecturers can customise the practice tests or leave

students to use the two pre-built tests per chapter.Personalised study planBased on a studentÕs performance on a practice test, a personal study plan is generated that shows

where further study needs to focus. This study plan consists of a series of additional practice exercises.Guided tour of MyAccountingLabA01_ELLI3325_13_SE_FM.QXD 13/7/09 11:24 Page xxvi

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Additional practice exercises

Generated by the studentÕs own performance on a practice test, additional practice exercises are keyed to the textbook and provide extensive practice and link students to the e-book and to other tutorial instruction resources.

Tutorial instruction

Launched from the additional practice exercises, tutorial instruction is provided in the form of solutions to problems, detailed differential feedback, step-by-step expl anations, and other media-based explanations, including key concept animations.

Additional MyAccountingLab tools

1. Interactive study guide

2. Electronic tutorials

3. Glossary Ð key terms from the textbook

4. Glossary ßashcards

5. Links to the most useful accounting data and information sources on the Internet.

Lecturer training and support

We offer lecturers personalised training and support for MyAccountingLab. We have a dedicated team of Technology Specialists whose job it is to support lecturers in t heir use of our media products, including MyAccountingLab. To make contact with your Technology Specialist please email feedback-cw@pearson.com For a visual walkthrough of how to make the most of MyAccountingLab, visit www.MyAccountingLab.com To Þnd details of your local sales representatives go to www.pearsoned.co.uk/replocater

Guided tour of MyAccountingLab¥xxvii

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PART 1

Income and asset value

measurement systems M01_ELLI3325_13_SE_C01.QXD 13/7/09 11:25 Page 1 M01_ELLI3325_13_SE_C01.QXD 13/7/09 11:25 Page 2

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1.1 Introduction

Accountants are communicators. Accountancy is the art of communicating Þ nancial information about a business entity to users such as shareholders and ma nagers. The com- munication is generally in the form of Þnancial statements that show in money terms the economic resources under the control of the management. The art lies in selecting the information that is relevant to the user and is reliable. Shareholders require periodic information that the managers are accounti ng properly for the resources under their control. This information helps the shareholde rs to evaluate the performance of the managers. The performance measured by the accountant shows the extent to which the economic resources of the business have grown or diminished during the year. The shareholders also require information to predict future performance. At present companies are not required to publish forecast Þnancial statements on a regular basis and the shareholders use the report of past performance when making their predic tions. Managers require information in order to control the business and make i nvestment decisions.

1.2 Shareholders

Shareholders are external users. As such, they are unable to obtain acce ss to the same amount of detailed historical information as the managers, e.g. total administr ation costs are disclosed in the published proÞt and loss account, but not an analysis to show how the Þgure is made up. Shareholders are also unable to obtain associated information, e.g. budgeted sales and costs. Even though the shareholders own a company, their entitlement to information is restricted.

CHAPTER 1

Accounting and reporting on a

cash ßow basis

Objectives

By the end of this chapter, you should be able to:
explain the extent to which cash ßow accounting satisÞes the infor mation needs of shareholders and managers;
prepare a cash budget and operating statement of cash ßows;
explain the characteristics that makes cash ßow data a reliable and fairrepresentation;
critically discuss the use of cash ßow accounting for predicting futu re dividends. M01_ELLI3325_13_SE_C01.QXD 13/7/09 11:25 Page 3 The information to which shareholders are entitled is restricted to that speciÞed by statute, e.g. the Companies Acts, or by professional regulation, e.g. Financial Reporting Standards, or by market regulations, e.g. Listing requirements. This means that there may be a tension between the amountof information that a shareholder would like to receive and the amount that the directors are prepared to provide. For example, shareholders might consider that forecasts of future cash ßows would be helpful in predicting future dividends, but the directors might be concerned that such forecasts could help competitors or make directors open to criticism if forecasts are not met. As a result, this information is not disclosed. There may also be a tension between the qualityof information that shareholders would like to receive and that which directors are prepared to provide. For example, the share- holders might consider that judgements made by the directors in the valuation of long-term contracts should be fully explained, whereas the directors might prefer not to reveal this information given the high risk of error that often attaches to such estimates. In practice, companies tend to compromise: they do not reveal the judgements to the shareholders, but maintain conÞdence by relying on the auditor to give a clean audit report. The Þnancial reports presented to the shareholders are also used by other parties such as lenders and trade creditors, and they have come to be regarded as general-purpose reports. However, it may be difÞcult or impossible to satisfy the needs of all users. For example, users may have different time-scales Ð shareholders may be interested in the long-term trend of earnings over three years, whereas creditors may be interested in the likelihood of receiving cash within the next three months. The information needs of the shareholders are regarded as the primary concern. The government perceives shareholders to be important because they provide companies with their economic resources. It is shareholdersÕ needs that take priority in deciding on the nature

and detailed content of the general-purpose reports.11.3 What skills does an accountant require in respect of external reports?For external reporting purposes the accountant has a two-fold obligation:
an obligation to ensure that the Þnancial statements comply with statutory, profes-

sional and Listing requirements; this requires the accountant to possess technical

expertise;
an obligation to ensure that the Þnancial statements present the substance of the com-

mercial transactions the company has entered into; this requires the accountant to have

commercial awareness.21.4 ManagersManagers are internal users. As such, they have access to detailed Þnancial statements

showing the current results, the extent to which these vary from the budgeted results and the future budgeted results. Examples of internal users are sole traders, partners and, in a company context, directors and managers. There is no statutory restriction on the amount of information that an internal user may receive; the only restriction would be that imposed by the companyÕs own policy.

Frequently, companies operate a Ôneed to knowÕ policy and only the directors see all the4¥Income and asset value measurement systemsM01_ELLI3325_13_SE_C01.QXD 13/7/09 11:25 Page 4

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Þnancial statements; employees, for example, would be most unlikely t o receive information that would assist them in claiming a salary increase Ð unless, of cou rse, it happened to be a time of recession, when information would be more freely provided by m anagement as a means of containing claims for an increase.

1.5 What skills does an accountant require in respect of internal reports?

For the internal user, the accountant is able to tailor his or her repor ts. The accountant is required to produce Þnancial statements that are speciÞcally relev ant to the user requesting them. The accountant needs to be skilled in identifying the information that i s needed and conveying its implication and meaning to the user. The user needs to be conÞdent that the accountant understands the userÕs information needs and will satisfy them in a language that is understandable. The accountant must be a skilled communicator wh o is able to instil conÞdence in the user that the information is:
relevant to the userÕs needs;
measured objectively;
presented within a time-scale that permits decisions to be made with app ropriate information;
veriÞable, in that it can be conÞrmed that the report represents t he transactions that have taken place;
reliable, in that it is as free from bias as is possible;
a complete picture of material items;
a fair representation of the business transactions and events that have occurred or arebeing planned. The accountant is a trained reporter of Þnancial information. Just as for external reporting, the accountant needs commercial awareness. It is important, therefore, t hat he or she should not operate in isolation.

1.5.1 AccountantÕs reporting role

The accountantÕs role is to ensure that the information provided is u seful for making decisions. For external users, the accountant achieves this by providing a general-purpose Þnancial statement that complies with statute and is reliable. For in ternal users, this is done by interfacing with the user and establishing exactly what Þnancial i nformation is relevant to the decision that is to be made. We now consider the steps required to provide relevant information for i nternal users.

1.6 Procedural steps when reporting to internal users

A number of user steps and accounting action steps can be identiÞed w ithin a Þnancial decision model. These are shown in Figure 1.1. Note that, although we refer to an accountant/user interface, this is no t a single occurrence because the user and accountant interface at each of the user decision s teps. At step 1, the accountant attempts to ensure that the decision is based on the ap pro- priate appraisal methodology. However, the accountant is providing a ser vice to a user and, Accounting and reporting on a cash ßow basis¥5 M01_ELLI3325_13_SE_C01.QXD 13/7/09 11:25 Page 5 while the accountant may give guidance, the Þnal decision about methodology rests with the user. At step 2, the accountant needs to establish the information necessary to support the decision that is to be made. At step 3, the accountant needs to ensure that the user understandsthe full impact

and Þnancial implications of the accountantÕs report taking into account the userÕs level of

understanding and prior knowledge. This may be overlooked by the accountant, who feels that the task has been completed when the written report has been typed. It is important to remember in following the model that the accountant is attempting to satisfy the information needs of the individual user rather than those of a Ôuser groupÕ. It is tempting to divide users into groups with apparently common information needs, without recognising that a group contains individual users with different information needs. We return to this later in the chapter, but for the moment we continue by studying a situation where the directors of a company are considering a proposed capital investment project. Let us assume that there are three companies in the retail industry: Retail A Ltd, Retail B Ltd and Retail C Ltd. The directors of each company are considering the purchase of a warehouse. We could assume initially that, because the companies are operating in the same industry and are faced with the same investment decision, they have identical information needs. However, enquiry might establish that the directors of each company have a com- pletely different attitude to, or perception of, the primary business objective. For example, it might be established that Retail A Ltd is a large company and under the Fisher/Hirshleifer separation theory the directors seek to maximise proÞts for the beneÞt of the equity investors; Retail B Ltd is a medium-sized company in which the directors seek to obtain a satisfactory return for the equity shareholders; and Retail C Ltd is a smaller company in which the directors seek to achieve a satisfactory return for a wider range of stakeholders, including, perhaps, the employees as well as the equity shareholders. The accountant needs to be aware that these differences may have a signiÞcant effect on the information required. Let us consider this diagrammatically in the situation where a capital investment decision is to be made, referring particularly to user step 2: ÔEstablish

with the accountant the information necessary for decision making.Õ6¥Income and asset value measurement systems

Figure 1.1 General Þnancial decision model to illustrate the user/accountant interfaceM01_ELLI3325_13_SE_C01.QXD 13/7/09 11:25 Page 6

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We can see from Figure 1.2 that the accountant has identiÞed that:
the relevant Þnancial data are the same for each of the users, i.e. c ash ßows; but
the appraisal methods selected, i.e. internal rate of return (IRR) and net present value (NPV), are different; and
the appraisal criteria employed by each user, i.e. higher IRR and NPV, a re different. In practice, the user is likely to use more than one appraisal method, a s each has advantages and disadvantages. However, we can see that, even when dealing with a si ngle group of apparently homogeneous users, the accountant has Þrst to identify the information needs of the particular user. Only then is the accountant able to identify the relevant Þnancial data and the appropriate report. It is the userÕs needs that are pred ominant. If the accountantÕs view of the appropriate appraisal method or crite rion differs from the userÕs view, the accountant might decide to report from both views. T his approach affords the opportunity to improve the userÕs understanding and encourages go od practice. The diagrams can be combined (Figure 1.3) to illustrate the complete p rocess. The user is assumed to be Retail A Ltd, a company that has directors who are proÞ t maximisers. The accountant is reactive when reporting to an internal user. We observ e this charac- teristic in the Norman example set out in section 1.8. Because the cash

ßows are identiÞed

as relevant to the user, it is these ßows that the accountant will re cord, measure and appraise. The accountant can also be proactive, by giving the user advice and guid ance in areas where the accountant has speciÞc expertise, such as the appraisal met hod that is most appro- priate to the circumstances. Accounting and reporting on a cash ßow basis¥7 Figure 1.2 Impact of different user attitudes on the information needed in relation to a capital investment proposal M0