AA101 Notes Lecture 1 1. What is accounting? Accounting is the language of business. What is business?

Business involves the exchange of goods, services and money. It will result in mutual benefits for both buyers and sellers. A business also aims to create value. What are the types of business? Manufacturing is the use of machines, tools and labour to produce goods for use or sale. Merchandising involves purchasing products from companies and selling them to customers. Service (e.g. Salon, nail parlour) a) What are the legal forms of business? Sole Proprietorship is a business carried on an individual on his own and the owner owns all assets and liabilities of the business. Simplest form. Unlimited liabilities. Partnership is a business carried on by 2 or more people. Unlimited liabilities. Limited partnership is similar to partnership except that some partners are limited partners. Limited partner have limited liabilities and cannot participate in the management of the business. General partners have unlimited liabilities and they manage the company. Limited liabilities partnership is a business carried on by 2 or more people. LLP has a separate legal identity and can own property and sue or be sued. b) What do you understand by business owners having unlimited liabilities? Unlimited liabilities: Owners being responsible for all the debts incurred in the business. Risk of losing everything, including personal assets. Limited liabilities: Extent of loss limited to the amount invested into the company c) What factors should one consider when selecting a legal form of business? Tax obligation: Whether it is more beneficial to be taxed at the progressive rates (income tax, sole proprietorship) or flat rate of 17% (corporate tax, corporations) depends on the amount of profits earned. Some companies choose to set up as corporations to enjoy benefits that could offset the higher tax burden. Scale of business Asset liabilities Vision: General, long-term horizon, a destination, a fundamental statement of an organizations values, apirations and goals. Go well beyond financial objectives. Mission: purpose, basis of competition, competitive advantage, more specific and focused on the means which the company competes. Strategic objectives: specific, short-term horizon and operationalize the mission statement

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Describe the value chain of a business. The value chain is made up of 2 different categories of activities: primary and support activities. Primary activities: Inbound logisitics: receiving, storing and distributing inputs to the product. (warehousing, inventory control) Operations: transforming inputs into final product. (machining, packaging, assembly) Outbound logisitics: collecting, distributing the product to buyers. (delivering vehicle operations, order processing, scheduling) Marketing and sales: purchasing of products and services by end users and the inducement used to get them to purchase (promotion, advertisements) Service: providing service to enhance value of product. Support activities: Procurement: function of purchasing inputs (raw materials, machineries) used in the firms value chain. Technology Development Human resource management: recruiting, hiring, training of personnel General administration: general management, planning, finance, legal, accounting, government affairs

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Analyze the external environment of a business. The general environment: demographic, sociocultural, political, technological, economic, global The competitive environment: Competitors, customers, suppliers Porters Five Forces Model of Industry Competition: Threat of new entrants, bargaining power of suppliers, bargaining power of buyers, Threat of substitutes, Rivalry among existing firms.

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What strategies do business use to create value? Overall cost leadership: Low cost position relative to other firms Differentiation: Create products/ services that are unique and valued, non-price attributes for which customers will pay a premium Focus strategy: Narrow product lines, buyer segments or targeting geographical markets. Attain advantages either through differentiation or cost-leadership. Business Risks New entrants Tight cashflow Regulations and compliance Social acceptance risk Managing talents Ways to mitigate risks Raise entry barriers, sustainable competitive advantage Cashflow planning, bank loans Invest time and efforts in compliance Cannot ignore opinions and expectations from social groups Improve employees welfare, change retirement policy, career progression

Lecture 2 1. Ownership theory of the firm: Firm is the property of its owners. The main purpose is to maximise returns to owners. Owners interest are paramount and take precedence over all others. Owners = shareholders/ stockholders Stakeholder theory of the firm: corporations serve a broader public purpose, to create value for society. Profits must be made for owners to survive but creates other values too. Corporations have multiple obligations, to take all stakeholder group into account. 2. Market stakeholders: Those that engage in economic transactions with the company. Creditors, suppliers, stockholders, employees, customers. Non-market stakeholders: People or groups that do not engage on direct economic transactions but are affected by or can affect the firms actions. Government, communities, media, general public, non-government organizations. 3. Power of stakeholders: Voting, economic, political, legal power When their interests are similar, stakeholders may form coalitions to form a stronger power. Stakeholder Map: Stakeholders salience (importance) Vs Postion on the issue (against/for) Usefulness of stakeholder map: It enables manager to see quickly how the stakeholders feel about an issue and whether salient stakeholders tend to be in favour or opposed. It helps managers to see how stakeholder coalitions are likely to be formed. Information asymmetry: The condition in which at least some information is known to some but not all parties involved. Information asymmetry causes markets to be become inefficient since all the market participants do not have acess to the information they need for decision-making.

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6. Pre-contractual issues: Bargaining Failure: Failure to reach an agreement even when a contract could be constructed that would be mutually advantageous. Example: Employment contract Solution: Signalling Adverse selection: The tendency of an individual with private information about something that affects a potential trading partners costs or benefits to extend an offer that would be detrimental to the trading partner. Example: Insurance contracts Solution: Screening and self-selection, Bonding (Gurantee a certain level of performance or else punishment entails) 7. Post-contractual issues: Agency problems are conflicts of interest that arise between principals and agents a a results of differing goals. Goal incongruence. Choice of effort/ Free riding Solution: Monitoring, rewards, punishments Perquisite taking: Managers request for perquisites above their salaries such as exclusive club membership or lavish office furniture. Solutions: Monitoring, rewards, restrict the rights to use firms resources Differential risk exposure: Managers forgo projects that they anticipate to be profitable because they do not want to take the risk. Solutions: Monitoring, rewards and punishments

Differential Horizons: Managers have limited incentives to care about the cash flows that extend beyond their tenure. Solutions: Monitoring, rewards Overinvestment: When managers are reluctant to reduce the size of a firm, or to lay off colleagues and friends in division. Solutions: Restrict decision rights, benchmarking, rewards Employee theft Solutions: Monitoring, internal control, fidelity insurance Bribery Solutions: Restrict decision rights, rewards, corporate culture. Influencing cost: Employees try to influence decision makers to their own benefits. Solutions: Restrict decision rights

8. How do firms minimize agency costs? Agency problems are usually resulted due to goal incongruence where agents maximise their utility not the principals. Firms can secure congruence by changing personal preferences so that all individuals in the organization adopt the principals goal. Firms can reduce agency problems by structuring agents incentives so that when agents maximise their utility, the principals utility is also maximised. Reduce decision rights of employees/employee empowerment. Partition decision rights. Performance evaluation: A process by which managers gain information about the performance of tasks within the firm and judge that performance against pre-established criteria as set out in budgets and goals. Rewards: Help to motivate good performance in order to achieve goal congruence between principal and agent.

9. Characteristics of a good organizational architecture Assigning decision rights: Linking to business environment and linking to strategy Leadership styles Separation of decision management and control Linking knowledge and decision rights Monitoring performance Number of measures Relative weightage for each measure Controllability Data integrity Benefits vs Costs

Rewarding Linked to performance measures Market/industry practice Attractiveness of rewards Culture, compliance to laws

Lecture 3 1. Stakeholders and their information needs:

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Two Primary functions of Financial accounting: To measure business activities of a company To communicate those measurements to external parties for decision-making purposes. A business engage in 3 fundamental activities: Financing activities: transactions involve external sources of funding. Two basic source of external fundng are: Funds invested by owners of the company and creditors that lend money to the company. Investing activities: purchase or sale of 1) long term resources e.g, land, machinery and 2) any other resources not related to the companys normal operations. Operating activities: transactions that relate to the primary operations of the company e.g. providing goods and services to customers and the associated costs of doing so e.g. rent, tazes, advertising , utilities, wages Financial statements: Balance sheet/ Statement of financial position Income statement Statement of changes in equity Statement of cash flows Notes to the financial statement Elements of financial statements (shows what a business owns and owes at a specific date) Assets: economic resources that are expected to benefit the business in the future. Owned, measureable, future benefits Liabilities: payable to be made to third parties other than shareholders Owners equity: external = capital contributions from shareholders, internal = retained earnings (profits kept with the company for further expansion or investment and not distributed to shareholders.

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Elements of income statement (shows the business normal operating activities and profitability for a period of time) Revenue: from sale of goods and services, other gains include foreign exchange gains and gain on disposal of assets Expenses: resources sacrificed incurred in the ordinary course of business to generate revenue, other losses include foreign exchange loss, loss on disposal of assets, loss due to natural disasters Statement of changes in equity: shows changes in owners equity during the year Plus: Additional capital contributed Plus: Net income Minus: Dividends (regular cash payments to stockholders) Two components: common stock (amounts invested by stockholders when they buy shares of stock, external source of stockholders equity) and retained earnings (cumulative amount of net income earned over the life of the company that has not been distributed to the stockholders as dividends, internal source of stockholders equity) Stockholders equity = common stock + retained earnings Statement of cash flows: shows cash receipts and payments during a period. Notes to financial statements: additional notes and information to supplement financial statements, provide detailed computations and breakdown of the numbers reflected in the financial statements

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10. The accounting equation: assets = liabilities + owners equity 11. Uses of financial statements: Monitoring current performance, predict future performance, decision making 12. Limitations of financial statements: timeliness, inadequate closure, not comparable, not necessarily a good predictor of future performance, information risk 13. Qualitative characteristics of accounting information: Understandability: information is readily understandable by users who have reasonable knowledge in business, economic activities and accounting Relevance: information is relevant to the decision making needs of users and has an influence on the decisions made Reliability: information is free from material errors and bias Comparability: information can be compared across time and countries

14. Information risks: Quality of information is affected by: judgement, uncertainty, management incentives. To reduce information risk: assurance, compliance to laws, internal control and procedures. 15. Accounting concepts: A business is separated from its owners. Assets are recorded at purchase cost. An assumption that the business will continue indefinitely. Reliable information are verifiable by independent observers. Business transactions must be measurable in monetary unit.