Corporate Financial Accounting & Reporting, 2nd Edition

741 Pages·2004·7.93 MB·English

by  Tim Sutton

Corporate Financial Accounting
Reporting
and Tim Sutton second edition
Corporate
The aim of Corporate Financial Accounting and Reporting is to help current and future managers
gain a thorough understanding of companies’ published financial reports. The book takes an
international perspective: international accounting practices are described and illustrated
Financial
throughout the text. The new edition has been thoroughly revised and updated to incorporate
changes in International Accounting Standards.
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The text is divided into three parts: the first part covers the foundations of accounting and d o
introduces students to the main financial statements, the second part looks at the
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components of financial statements in more depth while the third part explores how Accounting
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investors analyse financial statements. e
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Key features: r
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• Comprehensive coverage: includes some topics which do not usually appear in
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introductory texts and explains others in more detail than is customary.
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• Clarity: the book is suitable for a range of students from around the world and i
has been extensively class tested in Europe. n F
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• International approach: covers the most common accounting practices in the
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financial statements of both European and non-European companies as well as n
relevant EU and IAS requirements. Tim Sutton
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New to second edition: im n
• Thoroughly revised to incorporate changes in IAS. c
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• Legal, tax and regulatory frameworks have all been updated. u ia
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• Boxed material is included which broadens the discussion in the text and also t l
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introduces students to ideas from recent academic research. n A
• Includes a downloadable Instructor's Manualwhich is available to lecturers on the
website at www.booksites.net/sutton c
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Corporate Financial Accounting and Reporting is designed for international MBA o
programmes and specialist postgraduate programmes in international business/finance
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in Europe. It can also be used in international business programmes at the undergraduate
level. n
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About the author: i
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Tim Suttonis visiting Professor of Accounting at IESE Business School in Barcelona. He has
held teaching appointments in European and North American business schools, including g
Kellogg in the USA and Insead in France. A chartered accountant, he has UK undergraduate and
postgraduate degrees and a doctorate from the USA. His teaching experience has been across
undergraduate, postgraduate and executive development programmes and he has published
second edition
research in leading academic journals.
second edition
an imprint of
www.pearson-books.com
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Corporate Financial
Accounting and Reporting
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Corporate Financial
Accounting and Reporting
Second Edition
Tim Sutton
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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 2000
Second edition published 2004
© Financial Times Management 2000
© Pearson Education Limited 2004
The right of Timothy G. Sutton to be identified as author of this work
has been asserted by him 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,
90 Tottenham Court Road, London W1T 4LP.
ISBN 0 273 67620-2
British Library Cataloguing-in-Publication Data
A catalogue record for this book is available from the British Library.

10 9 8 7 6 5 4 3 2 1
08 07 06 05 04
Typeset in 10/12pt Minion by 35
Printed and bound by Bell & Bain Limited, Glasgow
The publisher’s policy is to use paper manufactured from sustainable forests.
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Contents
List of boxes ix Key profitability ratios 51
Preface xi Summary 56
Abbreviations xiv Problem assignments 56
Publisher’s acknowledgements xvii
4 Accounting records: structure
1 Financial accounting: an overview 1 and terminology 64
Introduction 1 Introduction 64
What is financial accounting? 2 The general ledger and ledger accounts 65
Overview of the company and its activities 2 The format of a ledger account 66
What are the accounts? 3 The journal and the journal entry 69
What is an accounting entity? 4 The trial balance 71
Who are the users of financial accounts? 5 The recording process: from transaction to
The aim – and desirable qualities – of accounts 6 trial balance 73
The long arm of accounting 8 Accounting record-keeping in European
The structure of the book 9 companies 80
Summary 84
Problem assignments 84
PART 1
Foundations
5 Accrual adjustments and financial
2 The balance sheet: a financial statement preparation 90
picture of the firm 13 Introduction 90
Introduction 13 The accrual basis of accounting 91
The purpose of a balance sheet 14 Accrual adjustments 94
The components of the balance sheet 15 Error adjustments 98
The balance sheet and transactions 17 Closing entries 99
Balance sheet presentation 22 The recording process: from trial balance to
The balance sheet and financial ratios 26 financial statements 101
Valuation fallacy 28 The role of the contra account 110
Summary 29 Dividends: the distribution of profits 112
Problem assignments 31 The extraordinary items fallacy 113
Summary 114
3 The income statement 36 Problem assignments 115
Introduction 36
6 The annual report and accounts 122
The purpose of the income statement 37
The format of the income statement 37 Introduction 122
The link between income statement and Overview 123
balance sheet 38 Management’s report to shareholders 124
The effect of transactions 40 Alternative balance sheet and income
The fallacy of profit and cash flow equivalence 46 statement formats 125
Income statement presentation 48 The income statement fallacy 131
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vi CONTENTS
Notes to the accounts 132 Appendix 8.1: Sum-of-years’-digits and
Governance statement and auditors’ report 134 units-of-production depreciation 223
EU disclosure and audit requirements 136 Appendix 8.2: Investment property 224
The cash flow statement 137 Problem assignments 226
Popular financial ratios among investors 146
Differences in UK/US accounting terms 9 Inventories 235
in financial reports 147 Introduction 235
Summary 148 Inventory records: perpetual and
Appendix 6.1: The EU’s company law periodic systems 236
harmonisation programme 149 The capitalisation decision 238
Problem assignments 151 Flow of product costs: retailer and
manufacturer 239
Inventories at historical cost 243
PART 2
The house of accounting Lower of cost or market rule 248
Inventories at replacement cost 250
7 Key conceptual issues in financial Valuation of inventories: rules and custom 253
accounting 163 Financial statement presentation and analysis 255
Summary 259
Introduction 163
Appendix 9.1: Variable costing 260
Accounting policies and their origins 164
Problem assignments 262
Fundamental accounting principles 169
The ‘conceptual framework’: 10 Recognition of revenue and
a new agenda for accounting 170 valuation of receivables 271
A recognition test for assets and liabilities 172
Introduction 271
Measurement of assets and liabilities 173
Recognition and measurement Section 1: Core issues 272
controversies 177 Revenue recognition revisited 272
Capital maintenance and the measurement Credit sales: terms and methods of payment 276
unit in accounts 177 Receivables valuation 277
Summary 183 Bad and doubtful debts 280
Appendix 7.1: An overview of the IASB and Sales returns and allowances 284
its predecessor, the IASC 183 Section 2: Specialised topics 285
Appendix 7.2: Present value concepts – Long-term contracts 285
an introduction 186 Transfer of receivables 290
Problem assignments 190 Long-term receivables 295
Section 3: Revenues, receivables and
8 Fixed assets, tangible and
financial statement analysis 298
intangible 196
Summary 301
Introduction 196
Problem assignments 302
Section 1: Tangible assets 197
The capitalisation decision 197 11 Liabilities, on and off balance
The depreciation decision 199 sheet 310
Repairs and improvements 205 Introduction 310
Retirement 205
Section 1: General issues 311
The valuation decision 207
Definition, recognition and measurement 311
Section 2: Intangible assets 211 Problem areas 312
Section 3: Fixed assets and financial Section 2: Long-term debt 318
statement analysis 220
Economic and legal background 318
Summary 222 Initial recognition and measurement 319
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CONTENTS vii
Determining the periodic cost of debt 322 Consolidation and acquisition
Derecognition 327 accounting under IAS 439
Accounting for debt: international practice 328 Section 2: Specialised topics 441
Section 3: Leasing 329 Minority interests 441
Types of lease 329 Joint ventures 446
Lessee accounting 330 Divesting a business 447
Section 4: Liabilities and financial Section 3: Consolidated accounts and
statement analysis 335 financial analysis 449
Summary 342 Summary 453
Appendix 11.1: Leasing–lessor accounting 343 Problem assignments 454
Problem assignments 347
15 Transactions and operations in
12 Shareholders’ equity 357 foreign currencies 465
Introduction 357 Introduction 465
Accounting for transactions in
Section 1: Core issues 358
foreign currencies 466
Different forms of business organisation 358
Accounting for foreign operations 471
Share capital 359
Financial statement disclosures and
Accounting for share issues and profit
analysis 480
appropriation 363
Summary 484
Section 2: Specialised topics 371
Problem assignments 485
Purchase of own shares 371
Convertible securities and warrants 374
16 Employment costs 491
State aid to companies 377
Introduction 491
Section 3: Shareholders’ equity and
financial statement analysis 379 Section 1: General issues 492
Types of employee benefit 492
Summary 384
Accounting for employee benefits:
Problem assignments 385
an overview 492
13 Financial investments 394 Section 2: Specialised topics 498
Pension benefits 498
Introduction 394
Employee share options 509
Types of financial investment 395
Section 3: Employment costs and
Recognition and measurement 397
financial analysis 514
Fair value accounting under IAS 400
Derivatives and hedge accounting 408 Summary 519
Disclosure and analysis of financial Problem assignments 520
investments 413
17 Accounting for corporate
Summary 417
Problem assignments 417 income taxes 529
Introduction 529
14 Equity accounting and
Section 1: Core issues 530
consolidations 425
Taxes on companies 530
Introduction 425 Taxation of corporate income:
general framework 530
Section 1: Core issues 426
The cost of income taxes: recognition issues 535
Equity method of accounting 426
International accounting rules and practice 544
Consolidation accounting: the basic
structure 431 Section 2: Deferred tax accounting: extensions 545
Fair value adjustments and goodwill 435 Deferred tax assets 545
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viii CONTENTS
Tax effects of revaluation and consolidation 549 Trend and cross-section analyses of
Measurement issues 550 financial data 608
Section 3: Corporate income taxes and The investor’s financial ratio toolkit 612
financial analysis 552 Profitability, risk and cash flow analysis
illustrated 621
Summary 557
Residual income 629
Problem assignments 558
Summary 631
Appendix 19.1: Market efficiency and its
PART 3
implications 632
Perspectives
Appendix 19.2: Carlsberg Group: annual
accounts and key ratiosfor 2001 634
18 The cash flow statement
Problem assignments 639
revisited 569
Introduction 569 20 Financial statement analysis:
Section 1: Cash flow analysis: extensions 650
benefits to investors 570 Introduction 650
Overview 570
Section 1: Problem areas in financial
Assessing risk 572
statement analysis 651
Measuring performance 574
Major changes in operating activities 651
Forecasting 576
Accounting changes 652
Detecting earnings manipulation 577
Intercompany differences in accounting
Section 2: Specialised topics 579 policies 657
Constructing a cash flow statement from Diversified operations 663
balance sheet data 579 Interim reporting 667
Presentation of cash flows 583
Section 2: Accounting manipulation
Summary 591 and its detection 672
Problem assignments 592
Summary 679
Appendix 20.1: Earnings per share 680
19 Financial statement analysis:
Problem assignments 685
basic framework 603
Introduction 603 Glossary 695
Understanding the company and its Suggestions for further reading 707
environment 604 Index 709
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List of boxes
2.1 The ecobalance 30
3.1 The value added statement 54
4.1 Luca Pacioli, double-entry bookkeeping and capitalism 81
5.1 The accrual basis and government accounts 93
7.1 Legal tradition, investor protection and company financing 167
7.2 Deprival value 175
8.1 Non-financial indicators: making intangibles tangible 218
9.1 The US LIFO puzzle 254
10.1 Securitising receivables 292
10.2 Revenue games 300
11.1 Financial leverage: international differences 341
12.1 Corporate ownership and control: international perspectives 362
12.2 Valuing companies using book value and residual income 383
13.1 Fair value accounting and banks: stock market lessons 416
14.1 Merger accounting 442
15.1 Adoption of the euro: accounting implications 466
16.1 ‘Economic consequences’ of accounting standards 513
17.1 Fair valuation of deferred tax assets and liabilities 553
18.1 Using cash flow data to detect earnings manipulation 578
20.1 Accounting conservatism: international differences in earnings timeliness 661
20.2 Corporate governance and financial reporting 675