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vi PrefAce
Footnotes and Management Disclosures

We incorporate footnote and other management disclosures, where appropriate, throughout the book. We
explain the significance of the footnote and then demonstrate how to use the disclosed information to make
managerial inferences and decisions. A representative sample follows.
ment of the likelihood that customers will pay.
Footnote Disclosures, and Interpretations

In its balance sheets, TomTom reports trade receivables, net of allowance for doubtful receivables
of €115,429,000 at December 31, 2013, and €149,834,000 at December 31, 2012. In the note to
chAPter 6 | Reporting and Analysing Revenues and Receivables
the financial statements, the company provides the following information.
(€ in thousands) 2013 2012

Gross trade receivables . . . . . . . . . . . . . . . . . . . . . . . . . . . 118,546 151,697
Allowance for doubtful receivables . . . . . . . . . . . . . . . . . . 2 3,117 2 1,863
TRADE RECEIVABLES (NET) . . . . . . . . . . . . . . . . . . . . . . . 115,429 149,834
We expect to recover all receivables within a year. An allowance has been made for estimated
unrecoverable amounts from the sale of goods. The carrying amount of trade receivables
approximates their fair value. The group does not hold any collateral over these balances.
The group’s exposure to credit risk is influenced mainly by the individual characteristics
of each customer. There is some concentration of credit risk with certain of our large custom-
ers’ accounts. Management actively monitors the credit risk related to these customers and
Financial Analysis Discussions

Each chapter includes a financial analysis discussion that introduces key ratios and applies them to the finan-
cial statements of the chapter’s focus company. By weaving some analysis into each chapter, we try to instill
in students a deeper appreciation for the significance of the accounting methods being discussed. One such
analysis discussion follows.
ANALYSING FINANCIAL STATEMENTS

LO5 Calculate
Analysis Objective
accounts We want to evaluate a company’s management of its receivables.
receivable turnover
and average
Analysis Tool Accounts receivable turnover (ART) and average collection period (ACP)
collection period.
Sales revenue
Accounts receivable turnover (ART) =
Average accounts receivable
Applying the Accounts Receivable Turnover Ratio to TomTom

$963,454
2013 ART 5 5 7.3 times
1 $115,429 1 $149,834 2 /2
$1,057,134
2012 ART 5 5 6.3 times
1 $149,834 1 $184,939 2 /2
Guidance Accounts receivable turnover measures the number of times each year that accounts
receivable is converted into cash. A high turnover ratio suggests that receivables are well managed
and that sales revenue quickly leads to cash collected from customers.
A companion measure to accounts receivable turnover is the average collection period, also
called days sales outstanding which is defined as:
Average accounts receivable 365 days

Average collection period (ACP) = =
Average daily sales Accounts receivable turnover
PrefAce vii
Assignments that Draw on Real Data

It is essential for students to be able to apply what they have learned to real financial statements. Therefore,
we have included an abundance of assignments in each chapter that draw on recent, real data and disclosures.
These assignments are readily identified by an icon in the margin that includes the company’s name and its
country of origin. A representative example follows.
Estimate the percent depreciated of Koala’s depreciable assets. How do you interpret this figure?
LO6 E8-30. Computing and Interpreting Percent Depreciated and PPE Turnover
BURBERRY GROUP PLC
The following information is from Note 12 to the 2013 annual report of Burberry Group plc, a Brit-
(UNITED KINGDOM) ish luxury goods manufacturer, wholesaler, and retailer (£ millions):
12. Property, plant and equipment
Freehold Fixtures, Assets in the

land and Leasehold fittings and course of
buildings improvements equipment construction Total
Cost
As at March 31, 2013 . . . . . . . . . . . . . . . . 104.2 303.1 366.3 23.2 796.8
As at March 31, 2012 . . . . . . . . . . . . . . . . 54.2 247.6 270.9 34.5 607.2
Accumulated depreciation and impairment
As at March 31, 2013 . . . . . . . . . . . . . . . . 39.2 141.2 207.3 — 387.7
As at March 31, 2012 . . . . . . . . . . . . . . . . 16.9 110.4 151.1 — 278.4
Net book value
As at March 31, 2013 . . . . . . . . . . . . . . . . 65.0 161.9 159.0 23.2 409.1
As at March 31, 2012 . . . . . . . . . . . . . . . . 37.3 137.2 119.8 34.5 328.8
a. Calculate the percent depreciated ratio for each year.

b. Sales revenue totaled £1,998.7 millions in 2013. Calculate the PPE turnover ratio (PPET).
c. Comment on these ratios.
E8-31. Identifying and Accounting for Intangible Assets
BALANCED APPROACH
As instructors of introductory financial accounting, we recognise that the first financial accounting course
serves the general business students as well as potential accounting majors. Financial Accounting embraces
this reality. This book balances financial reporting, analysis, interpretation, and decision making with the
more standard aspects of accounting such as journal entries, T-accounts, and the preparation of financial
statements.
3-Step Process: Analyse, Journalise, Post

One technique we use throughout the book to maintain a balanced approach is the incorporation of a 3-step
process to analyse and record transactions. Step 1 analyses the impact of various transactions on the financial
statements using the financial statement effects template. Step 2 records the transaction using journal entries
and Step 3 requires students to post the journal entries to T-accounts.
Bal ance Sheet I ncome Statement

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PrefAce vii
Assignments that Draw on Real Data

It is essential for students to be able to apply what they have learned to real financial statements. Therefore,
we have included an abundance of assignments in each chapter that draw on recent, real data and disclosures.
These assignments are readily identified by an icon in the margin that includes the company’s name and its
country of origin. A representative example follows.
Estimate the percent depreciated of Koala’s depreciable assets. How do you interpret this figure?
LO6 E8-30. Computing and Interpreting Percent Depreciated and PPE Turnover
BURBERRY GROUP PLC
The following information is from Note 12 to the 2013 annual report of Burberry Group plc, a Brit-
(UNITED KINGDOM) ish luxury goods manufacturer, wholesaler, and retailer (£ millions):
12. Property, plant and equipment
Freehold Fixtures, Assets in the

land and Leasehold fittings and course of
buildings improvements equipment construction Total
Cost
As at March 31, 2013 . . . . . . . . . . . . . . . . 104.2 303.1 366.3 23.2 796.8
As at March 31, 2012 . . . . . . . . . . . . . . . . 54.2 247.6 270.9 34.5 607.2
Accumulated depreciation and impairment
As at March 31, 2013 . . . . . . . . . . . . . . . . 39.2 141.2 207.3 — 387.7
As at March 31, 2012 . . . . . . . . . . . . . . . . 16.9 110.4 151.1 — 278.4
Net book value
As at March 31, 2013 . . . . . . . . . . . . . . . . 65.0 161.9 159.0 23.2 409.1
As at March 31, 2012 . . . . . . . . . . . . . . . . 37.3 137.2 119.8 34.5 328.8
a. Calculate the percent depreciated ratio for each year.

b. Sales revenue totaled £1,998.7 millions in 2013. Calculate the PPE turnover ratio (PPET).
c. Comment on these ratios.
E8-31. Identifying and Accounting for Intangible Assets
BALANCED APPROACH
As instructors of introductory financial accounting, we recognise that the first financial accounting course
serves the general business students as well as potential accounting majors. Financial Accounting embraces
this reality. This book balances financial reporting, analysis, interpretation, and decision making with the
more standard aspects of accounting such as journal entries, T-accounts, and the preparation of financial
statements.
3-Step Process: Analyse, Journalise, Post

One technique we use throughout the book to maintain a balanced approach is the incorporation of a 3-step
process to analyse and record transactions. Step 1 analyses the impact of various transactions on the financial
statements using the financial statement effects template. Step 2 records the transaction using journal entries
and Step 3 requires students to post the journal entries to T-accounts.
Bal ance Sheet I ncome Statement
Cash Noncash Liabil- Contrib. Earned Net

Transaction Asset Assets = ities Capital Capital
Revenues - Expenses = Income
A
N
A
L
(b) Adjusting entry to 1,500 1,500 1,500
Y
S
E
record expiration of Prepaid
Rent
= Retained
Earnings
- Rent
Expense
= 1,500
1 month of prepaid rent
J
O
U (b) Dec. 31 Rent expense ( E, SE) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,500
R
N
A Prepaid rent ( A) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,500
L
I
S
To record rent expense for December.
E
P
O Rent Expense (E) Prepaid Rent (A)
S
T
Dec. 31 (b) 1,500 B al. 9,000 1,500 (b) Dec. 31
The template captures each transaction’s effects on the four financial statements: the balance sheet, income
statement, statement of changes in equity, and statement of cash flows. For the balance sheet, we differentiate
viii PrefAce
between cash and noncash assets to identify the cash effects of transactions. Likewise, equity is separated
into the contributed and earned capital components (the latter includes retained earnings as its major ele-
ment). Finally, income statement effects are separated into revenues, expenses, and net income (the updating
of retained earnings is denoted with an arrow line running from net income to earned capital). This template
provides a convenient means to represent financial accounting transactions and events in a simple, concise
manner for assessing their effects on financial statements.
INNOVATIVE PEDAGOGY
Business Insights
Students appreciate and become more engaged when they can see the real-world relevance of what they are
learning in the classroom. We have included a generous number of current, real-world examples throughout
each chapter inrecorded
Business Insight boxes. The following is a representative example:
each year.
BUSINESS INSIGHT
Investor Beware During fiscal year 2014, the German airline Lufthansa increased the useful
life of its aircrafts by eight years, leading to a €340 million positive accounting effect. Lufthansa, the
world’s largest airline by revenue, indicated that the change would put its depreciation policy in line
with industry practice. While Lufthansa has a legitimate reason to revise its depreciation assumption,
investors should discount any improvement in profit attributed to this one-time accounting change.
Asset Sales and Impairments

Decision Making Orientation
One primary goal of a financial accounting course is to teach students the skills needed to apply their accounting
knowledge to solving real business problems. With that goal in mind, You Make the Call boxes in each chapter
encourage students to apply the material presented to solving actual business scenarios.
YOU MAKE THE CALL

You are the Division Manager You are the division manager for a main operating division of
your company. You are concerned that a declining PPE turnover is adversely affecting your division’s
profitability. What specific actions can you take to increase PPE turnover? [Answers on page 383]
Mid-Chapter and Chapter-End Reviews

Financial accounting can be challenging—especially for students lacking business experience or previous
exposure to business courses. To reinforce concepts presented in each chapter and to ensure student compre-
hension, we include mid-chapter and chapter-end reviews that require students to recall and apply the financial
accounting techniques and concepts described in each chapter.
CHAPTER-END REVIEW
The following footnote is from the 2013 annual report of Cathay Pacific Airways Limited, the flag carrier
of Hong Kong.
  (https://cambridgepub.com)    Page Fit  viii 
viii PrefAce
between cash and noncash assets to identify the cash effects of transactions. Likewise, equity is separated
into the contributed and earned capital components (the latter includes retained earnings as its major ele-
ment). Finally, income statement effects are separated into revenues, expenses, and net income (the updating
of retained earnings is denoted with an arrow line running from net income to earned capital). This template
provides a convenient means to represent financial accounting transactions and events in a simple, concise
manner for assessing their effects on financial statements.
INNOVATIVE PEDAGOGY
Business Insights
Students appreciate and become more engaged when they can see the real-world relevance of what they are
learning in the classroom. We have included a generous number of current, real-world examples throughout
each chapter in Business Insight boxes. The following is a representative example:
BUSINESS INSIGHT
Investor Beware During fiscal year 2014, the German airline Lufthansa increased the useful
life of its aircrafts by eight years, leading to a €340 million positive accounting effect. Lufthansa, the
world’s largest airline by revenue, indicated that the change would put its depreciation policy in line
with industry practice. While Lufthansa has a legitimate reason to revise its depreciation assumption,
investors should discount any improvement in profit attributed to this one-time accounting change.
Asset Sales and Impairments

Decision Making Orientation
One primary goal of a financial accounting course is to teach students the skills needed to apply their accounting
knowledge to solving real business problems. With that goal in mind, You Make the Call boxes in each chapter
encourage students to apply the material presented to solving actual business scenarios.
YOU MAKE THE CALL

You are the Division Manager You are the division manager for a main operating division of
your company. You are concerned that a declining PPE turnover is adversely affecting your division’s
profitability. What specific actions can you take to increase PPE turnover? [Answers on page 383]
Mid-Chapter and Chapter-End Reviews

Financial accounting can be challenging—especially for students lacking business experience or previous
exposure to business courses. To reinforce concepts presented in each chapter and to ensure student compre-
hension, we include mid-chapter and chapter-end reviews that require students to recall and apply the financial
accounting techniques and concepts described in each chapter.
CHAPTER-END REVIEW
The following footnote is from the 2013 annual report of Cathay Pacific Airways Limited, the flag carrier
of Hong Kong.
5. Taxation
(in Hong Kong $ million) 2013 2012
Current tax expenses

Hong Kong profits tax. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 182 145
Overseas tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 182 218
Over provisions for prior years. . . . . . . . . . . . . . . . . . . . . . . . . . . . (36) (149)
Deferred tax
Origination and reversal of temporary differences . . . . . . . . . . . . 347 195
675 409
Required
1. (a) What is the amount of income tax expense reported on its income statement? (b) How much of its
income tax expense is payable in cash? (c) Assuming that its deferred tax liability increased, identify
an example that could account for such a change.
2. Prepare the entry, using both the financial statement effects template and in journal entry form, to
record its income tax expense for 2013.
The solution to this review problem can be found on page 499.
PrefAce ix
Research Insights for Business Students

Academic research plays an important role in the way business is conducted, accounting is performed, and
students are taught. It is important for students to recognise how modern research and modern business practice
interact. Therefore, we periodically incorporate relevant research to help students understand the important
relation between research and modern business.
holders as dividends is classified as cash flows from financing activities.
its own ordinary
shares.
RESEARCH INSIGHT
A recent study examines the classification of interest paid, interest received, and dividends received for
companies from 13 European countries. It finds that (1) 77% of the firms classify interest paid as operating
cash flows and 22% classify it as financing cash flows; (2) 54% of the firms report interest receipts as oper-
ating cash flows and 37% report them as investing cash flows; and (3) 49% of the firms classify dividends
received as operating cash flows and 48% as investing cash flows. It also documents that over 99% of the
firms report taxes paid in operating cash flows and dividends paid in financing cash flows. Source: “Flexibility
in cash flow reporting classification choices under IFRS,” by E. Gordon, E. Henry, B. Jorgensen, and C. Linthicum.
FLEXIBILITY FOR COURSES OF VARYING LENGTHS

Many instructors have approached us to ask about suggested chapter coverage based on courses of varying
length. To that end, we provide the following table of possible course designs:
15 Week 10 Week 6 Week 1 Week

Semester-Course Quarter-Course Mini-Course Intensive-Course
Chapter 1 Week 1 Week 1 Week 1

Day 1
Chapter 2 Week 2 & 3 Week 2 Week 1 & 2
Chapter 3 Week 3 & 4 Week 3 & 4 Week 2 & 3 Day 2
Chapter 4 Week 5 & 6 Week 4 & 5 Optional Optional
Chapter 5 Week 6 & 7 Optional Optional Optional
Chapter 6 Week 7 & 8 Week 6 Week 3 Day 3

Day 4
Chapter 9 Week 11 & 12 Week 9 Week 6 Day 5
Week 6
Chapter 10 Week 12 & 13 Week 10 Skim
(optional)
Chapter 11 Week 14 Optional Optional Optional
Chapter 12 Week 15 Optional Optional Optional

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x PrefAce
In addition to the chapter-specific changes, there have been several changes that span the entire book. Some
of these global changes include: updated numbers for examples, illustrations, and assignments that use real
data; updated footnotes and other nonfinancial disclosures; updated excerpts from the business and popular
press; and some assignments have been revised or replaced with new assignments.
SUPPLEMENT PACKAGE
Fundamentals of Financial Accounting Tutorial
This interactive tutorial is intended for use in programs that either require or would like to offer a pre-term
tutorial that creates a baseline of accounting knowledge for students with little to no prior exposure to financial
accounting. Initially developed as a pre-term tutorial for first year MBA students, this product can be used as
a warm-up for any introductory level financial accounting course. It is designed as an asynchronous, interac-
tive, self-paced experience for students.
Available Learning Modules (You Select)

1. Introducing Financial Accounting (approximate completion time 2 hours)
2. Constructing Financial Statements (approximate completion time 4 hours)
3. Adjusting Entries and Completing the Accounting Cycle (approximate completion time 4 hours)
4. Reporting and Analysing Cash Flows (approximate completion time 3.5 hours)
5. Analysing and Interpreting Financial Statements (approximate completion time 3.5 hours)
This is a separate, saleable item. Contact your sales representative to receive more information or email
customerservice@cambridgepub.com.
Companion Casebook
Cases in Financial Reporting, 8th edition by Michael Drake (Brigham Young University), Ellen Engel
(University of Chicago), D. Eric Hirst (University of Texas – Austin), and Mary Lea McAnally (Texas A&M
University). This book comprises 27 cases and is a perfect companion book for faculty interested in exposing
students to a wide range of real financial statements. The cases are current and cover companies from Canada,
France, Austria, the Netherlands, the UK, India, as well as from the U.S. Many of the U.S. companies are
major multinationals. Each case deals with a specific financial accounting topic within the context of one
(or more) company’s financial statements. Each case contains financial statement information and a set of
directed questions pertaining to one or two specific financial accounting issues. This is a separate, saleable
casebook (ISBN 978-1-61853-122-3). Contact your sales representative to receive a desk copy or email
customerservice@cambridgepub.com.
For Instructors
n Solutions Manual: Created by the authors, the Solutions Manual contains complete solutions to all the
assignment material in the text.
n Test Bank/Computerised Test Bank: The test bank includes multiple-choice items, matching questions,
short-essay questions, and problems. The computerised version of the test bank enables an instructor
to add and edit questions; create up to 99 versions of each test; attach graphic files to questions; import
and export AsCii files; and select questions based on type or learning objective. It provides password
protection for saved tests and question databases and is able to run on a network.
n PowerPoint: The PowerPoint slides outline key elements of each chapter.
n Website: All instructor materials are accessible via the book’s website (password-protected) along with
other useful links and marketing information. www.cambridgepub.com
For Students
n Website: Practice quizzes and other useful links are available to students free of charge on the book’s
website.
PrefAce xi
ACKNOWLEDGMENTS
Special thanks to Eszter Palancz for creating many of the end-of-chapter real-company assignments and for
revising Chapter 5. This book has benefited greatly from the valuable feedback of focus group attendees,
reviewers, students, and colleagues. We are extremely grateful to them for their help in making this project
a success.
Darrin Ambrose, University of Calgary Irene Kim, George Washington University

Ben-Hsien Bao, Hong Kong Polytechnic University Gopal Krishnan, George Mason University
Jan Barton, Emory University Benjamin Lansford, Pennsylvania State University
Dan Bens, INSEAD Dongyoung Lee, McGill University
Anne Beyer, Stanford University Na Li, Singapore Management University
Mary Ellen Carter, Boston College Xu Li, University of Hong Kong
Judson Caskey, UCLA Mingzhi Liu, University of Manitoba
Paul Chaney, Vanderbilt University Xiaohong Liu, University of Hong Kong
Craig Chapman, Northwestern University Gilad Livne, University of Exeter
Travis Chow, Singapore Management University Ana Marques, Nova School of Business and Economics
Hans Christensen, University of Chicago Greg Miller, University of Michigan
John Core, MIT James Naughton, Northwestern University
Maria Correia, London Business School Karen Nelson, Rice University
Mark DeFond, University of Southern California Jeff Ng, Chinese University of Hong Kong
Ramy Elitzur, University of Toronto Christopher Noe, MIT
Tom Fields, Washington University David Oesch, University of Zurich
Yuyan Guan, City University of Hong Kong Eszter Palancz, University of Toronto
Wayne Guay, University of Pennsylvania Tharindra Ranasinghe, Singapore Management University
Luzi Hail, University of Pennsylvania Annelies Renders, Maastricht University
Rebecca Hann, University of Maryland Gianfranco Siciliano, Bocconi University
Haihong He, California State University–Los Angeles Sri Sridharan, Northwestern University
Gilles Hilary, INSEAD Dragan Stojanovic, University of Toronto
Elisabetta Ipino, Concordia University Shyam Sunder, University of Arizona
Kim Jae Bum, Singapore Management University Robert J. Swieringa, Cornell University
Alan Jagolinzer, University of Colorado—Boulder Ken Trotman, University of New South Wales
Duane Kennedy, University of Waterloo Ning Zhang, Queen’s University
Jane Kennedy, University of San Diego Yuping Zhao, University of Houston
Edmund Keung, National University of Singapore Zili Zhuang, Chinese University of Hong Kong
In addition, we are extremely grateful to George Werthman, Jill Sternard, Katie Jones-Aiello, Jocelyn Mousel,
Debbie McQuade, Terry McQuade, and the entire team at Cambridge Business Publishers for their encourage-
ment, enthusiasm, and guidance.
Franco Wong Thomas R. Dyckman Michelle L. Hanlon Robert P. Magee Glenn M. Pfeiffer
Toronto, ON Ithaca, NY Cambridge, MA Evanston, IL Orange, CA
Canada U.S.A U.S.A. U.S.A U.S.A
  (https://cambridgepub.com)    Page Fit  xi 
PrefAce xi
ACKNOWLEDGMENTS
Special thanks to Eszter Palancz for creating many of the end-of-chapter real-company assignments and for
revising Chapter 5. This book has benefited greatly from the valuable feedback of focus group attendees,
reviewers, students, and colleagues. We are extremely grateful to them for their help in making this project
a success.
Darrin Ambrose, University of Calgary Irene Kim, George Washington University

Ben-Hsien Bao, Hong Kong Polytechnic University Gopal Krishnan, George Mason University
Jan Barton, Emory University Benjamin Lansford, Pennsylvania State University
Dan Bens, INSEAD Dongyoung Lee, McGill University
Anne Beyer, Stanford University Na Li, Singapore Management University
Mary Ellen Carter, Boston College Xu Li, University of Hong Kong
Judson Caskey, UCLA Mingzhi Liu, University of Manitoba
Paul Chaney, Vanderbilt University Xiaohong Liu, University of Hong Kong
Craig Chapman, Northwestern University Gilad Livne, University of Exeter
Travis Chow, Singapore Management University Ana Marques, Nova School of Business and Economics
Hans Christensen, University of Chicago Greg Miller, University of Michigan
John Core, MIT James Naughton, Northwestern University
Maria Correia, London Business School Karen Nelson, Rice University
Mark DeFond, University of Southern California Jeff Ng, Chinese University of Hong Kong
Ramy Elitzur, University of Toronto Christopher Noe, MIT
Tom Fields, Washington University David Oesch, University of Zurich
Yuyan Guan, City University of Hong Kong Eszter Palancz, University of Toronto
Wayne Guay, University of Pennsylvania Tharindra Ranasinghe, Singapore Management University
Luzi Hail, University of Pennsylvania Annelies Renders, Maastricht University
Rebecca Hann, University of Maryland Gianfranco Siciliano, Bocconi University
Haihong He, California State University–Los Angeles Sri Sridharan, Northwestern University
Gilles Hilary, INSEAD Dragan Stojanovic, University of Toronto
Elisabetta Ipino, Concordia University Shyam Sunder, University of Arizona
Kim Jae Bum, Singapore Management University Robert J. Swieringa, Cornell University
Alan Jagolinzer, University of Colorado—Boulder Ken Trotman, University of New South Wales
Duane Kennedy, University of Waterloo Ning Zhang, Queen’s University
Jane Kennedy, University of San Diego Yuping Zhao, University of Houston
Edmund Keung, National University of Singapore Zili Zhuang, Chinese University of Hong Kong
In addition, we are extremely grateful to George Werthman, Jill Sternard, Katie Jones-Aiello, Jocelyn Mousel,
Debbie McQuade, Terry McQuade, and the entire team at Cambridge Business Publishers for their encourage-
ment, enthusiasm, and guidance.
Franco Wong Thomas R. Dyckman Michelle L. Hanlon Robert P. Magee Glenn M. Pfeiffer
Toronto, ON Ithaca, NY Cambridge, MA Evanston, IL Orange, CA
Canada U.S.A U.S.A. U.S.A U.S.A
Brief Contents
Chapter 1 Introducing Financial Accounting 3
Chapter 2 Constructing Financial Statements 39
Chapter 3 Adjusting Accounts for Financial Statements 93
Chapter 4 Reporting and Analysing Cash Flows 149
Chapter 5 Analysing and Interpreting Financial Statements 211
Chapter 6 Reporting and Analysing Revenues and Receivables 271
Chapter 7 Reporting and Analysing Inventory 319
Chapter 8 Reporting and Analysing Long-Term Operating Assets 359
Chapter 9 Reporting and Analysing Liabilities 399
Chapter 10 Reporting and Analysing Leases, Pensions, and Income Taxes 447
Chapter 11 Reporting and Analysing Shareholders’ Equity 503
Chapter 12 Reporting and Analysing Financial Investments 553
Appendix A Compound Interest and the Time-Value of Money 616
Glossary 637
Index 657
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Brief Contents
Chapter 1 Introducing Financial Accounting 3
Chapter 2 Constructing Financial Statements 39
Chapter 3 Adjusting Accounts for Financial Statements 93
Chapter 4 Reporting and Analysing Cash Flows 149
Chapter 5 Analysing and Interpreting Financial Statements 211
Chapter 6 Reporting and Analysing Revenues and Receivables 271
Chapter 7 Reporting and Analysing Inventory 319
Chapter 8 Reporting and Analysing Long-Term Operating Assets 359
Chapter 9 Reporting and Analysing Liabilities 399
Chapter 10 Reporting and Analysing Leases, Pensions, and Income Taxes 447
Chapter 11 Reporting and Analysing Shareholders’ Equity 503
Chapter 12 Reporting and Analysing Financial Investments 553
Appendix A Compound Interest and the Time-Value of Money 616
Glossary 637
Index 657
xii
Contents
About the Authors iii Mini Exercises 30
Preface v Exercises 31
Problems 32
1
Cases and Projects 35
Chapter Solutions to Review Problems 36
Introducing Financial Accounting 3
Roche 3
Demand for Accounting Information 4
Chapter 2
Constructing Financial Statements 39
Who Uses Financial Accounting Information? 5
Costs and Benefits of Disclosure 7 Indigo 39
Business Activities 7 Reporting Financial Condition 40
Planning Activities 8 Assets 40
Investing Activities 8 Liabilities and Equity 43
Financing Activities 9 Mid-Chapter Review 1 45
Operating Activities 10 Analysing and Recording Transactions for the Balance
Financial Statements 11 Sheet 45
Balance Sheet 12 Mid-Chapter Review 2 49
Income Statement 12 Reporting Financial Performance 49
Statement of Changes in Equity 13 Accrual Accounting for Revenues and Expenses 50
Statement of Cash Flows 14 Retained Earnings 52
Financial Statement Linkages 15 Analysing and Recording Transactions for the Income
Information Beyond Financial Statements 15 Statement 52
Mid-Chapter Review 16 Reporting on Equity 56
Financial Reporting Environment 17 Analysing and Recording Equity Transactions 56
Generally Accepted Accounting Principles/Practice 17 Statement of Changes in Equity 56
International Financial Reporting Standards 18 Mid-Chapter Review 3 57
Roles of Regulator, Management, and Auditor 19 Journalising and Posting Transactions 57
Analysing Financial Statements 20 T-Account 58
Profitability Analysis 21 Debit and Credit System 58
Analysis Objective 21 T-Account with Debits and Credits 59
Credit Risk Analysis 22 The Journal Entry 59
Analysis Objective 22 Analyse, Journalise, and Post 60
Organisation of the Book 23 Analysing Financial Statements 66
Chapter-End Review 24 Analysis Objective 66
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Contents
About the Authors iii Mini Exercises 30
Preface v Exercises 31
Problems 32
1
Chapter Solutions to Review Problems 36
Introducing Financial Accounting 3
Roche 3
Demand for Accounting Information 4
Chapter 2
Constructing Financial Statements 39
Who Uses Financial Accounting Information? 5
Costs and Benefits of Disclosure 7 Indigo 39
Business Activities 7 Reporting Financial Condition 40
Planning Activities 8 Assets 40
Investing Activities 8 Liabilities and Equity 43
Financing Activities 9 Mid-Chapter Review 1 45
Operating Activities 10 Analysing and Recording Transactions for the Balance
Financial Statements 11 Sheet 45
Balance Sheet 12 Mid-Chapter Review 2 49
Income Statement 12 Reporting Financial Performance 49
Statement of Changes in Equity 13 Accrual Accounting for Revenues and Expenses 50
Statement of Cash Flows 14 Retained Earnings 52
Financial Statement Linkages 15 Analysing and Recording Transactions for the Income
Information Beyond Financial Statements 15 Statement 52
Mid-Chapter Review 16 Reporting on Equity 56
Financial Reporting Environment 17 Analysing and Recording Equity Transactions 56
Generally Accepted Accounting Principles/Practice 17 Statement of Changes in Equity 56
International Financial Reporting Standards 18 Mid-Chapter Review 3 57
Roles of Regulator, Management, and Auditor 19 Journalising and Posting Transactions 57
Analysing Financial Statements 20 T-Account 58
Profitability Analysis 21 Debit and Credit System 58
Analysis Objective 21 T-Account with Debits and Credits 59
Credit Risk Analysis 22 The Journal Entry 59
Analysis Objective 22 Analyse, Journalise, and Post 60
Organisation of the Book 23 Analysing Financial Statements 66
Chapter-End Review 24 Analysis Objective 66
Appendix 1A: Conceptual Framework for Financial Chapter-End Review 68
Reporting 24 Summary 69
The Objective of General Purpose Financial Reporting 25 Guidance Answers . . . You Make the Call 69
Qualitative Characteristics of Useful Financial
Key Ratios 70
Information 25
Fundamental Qualitative Characteristics 25 Key Terms 70
Enhancing Qualitative Characteristics 25 Multiple Choice 70
Summary 26 Discussion Questions 71
Underlying Assumptions and Features 26 Mini Exercises 71
Guidance Answers . . . You Make the Call 28 Exercises 74
Key Ratios 28 Problems 79
Key Terms 29 Cases and Projects 87
Multiple Choice 29 Solutions to Review Problems 88
Discussion Questions 30
xiii
xiv contents
Chapter 3
Adjusting Accounts for
Chapter 5
Analysing and Interpreting
Financial Statements 93 Financial Statements 211
Indigo 93 Vodafone Group Plc 211

Accounting Cycle 94 Introduction 212
Analysing and Recording Transactions 95 Assessing the Business Environment 213
Review of Accounting Procedures 95 Vertical and Horizontal Analysis 213
Review of Recording Transactions 95 Mid-Chapter Review 1 217
Summary 119 Return on Investment 218
Guidance Answers . . . You Make the Call 120 Return on Equity (ROE) 219
Key Terms 120 Return on Assets (ROA) 219
Multiple Choice 120 Return on Financial Leverage (ROFL) 220
Discussion Questions 121 Mid-Chapter Review 2 221
Mini Exercises 122 Disaggregating ROA 221
Exercises 125 Mid-Chapter Review 3 226
Problems 128 Liquidity and Solvency 227
Cases and Projects 137 Liquidity Analysis 229
Solvency Analysis 230
Solutions to Review Problems 139
Limitations of Ratio Analysis 232
Chapter-End Review 234
Chapter 4
Reporting and
Appendix 5A: Analysing and Interpreting Core
Operating Activities 234
Appendix-End Review A 236
Analysing Cash Flows 149 Appendix 5B: Pro Forma Financial Statements 236
Appendix-End Review B 241
Qantas 149 Summary 242
Purpose of the Statement of Cash Flows 150 Appendix 5C: Measuring Return on Financial
What Do We Mean by “CASH”? 150 Leverage 242
What Does a Statement of Cash Flows Look Like? 151 Appendix-End Review C 242
Framework for the Statement of Cash Flows 152 Key Ratios 243
Operating Activities 152 Key Terms 244
Investing Activities 152 Multiple Choice 245
Financing Activities 153 Guidance Answers . . . You Make the Call 245
Usefulness of Classifications 153 Discussion Questions 245
Mid-Chapter Review 1 154 Mini Exercises 246
Preparing the Statement of Cash Flows—Operating Exercises 250
Activities 155
Problems 254
Converting Revenues and Expenses to Cash Flows from
Operating Activities 156 Cases and Projects 263
Summary 181 Solutions to Review Problems 264
Key Ratios 182
6
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xiv contents
Chapter 3
Adjusting Accounts for
Chapter 5
Analysing and Interpreting
Financial Statements 93 Financial Statements 211
Indigo 93 Vodafone Group Plc 211

Accounting Cycle 94 Introduction 212
Analysing and Recording Transactions 95 Assessing the Business Environment 213
Review of Accounting Procedures 95 Vertical and Horizontal Analysis 213
Review of Recording Transactions 95 Mid-Chapter Review 1 217
Summary 119 Return on Investment 218
Guidance Answers . . . You Make the Call 120 Return on Equity (ROE) 219
Key Terms 120 Return on Assets (ROA) 219
Multiple Choice 120 Return on Financial Leverage (ROFL) 220
Discussion Questions 121 Mid-Chapter Review 2 221
Mini Exercises 122 Disaggregating ROA 221
Exercises 125 Mid-Chapter Review 3 226
Problems 128 Liquidity and Solvency 227
Cases and Projects 137 Liquidity Analysis 229
Solvency Analysis 230
Limitations of Ratio Analysis 232
Chapter
Reporting and
4 Appendix 5A: Analysing and Interpreting Core
Operating Activities 234
Appendix-End Review A 236
Analysing Cash Flows 149 Appendix 5B: Pro Forma Financial Statements 236
Appendix-End Review B 241
Qantas 149 Summary 242
Purpose of the Statement of Cash Flows 150 Appendix 5C: Measuring Return on Financial
What Do We Mean by “CASH”? 150 Leverage 242
What Does a Statement of Cash Flows Look Like? 151 Appendix-End Review C 242
Framework for the Statement of Cash Flows 152 Key Ratios 243
Operating Activities 152 Key Terms 244
Investing Activities 152 Multiple Choice 245
Financing Activities 153 Guidance Answers . . . You Make the Call 245
Usefulness of Classifications 153 Discussion Questions 245
Preparing the Statement of Cash Flows—Operating Exercises 250
Activities 155
Problems 254
Converting Revenues and Expenses to Cash Flows from
Operating Activities 156 Cases and Projects 263
Summary 181 Solutions to Review Problems 264
Key Ratios 182
Key Terms 182
Multiple Choice 182
Chapter 6
Reporting and Analysing Revenues
Mini Exercises 184 and Receivables 271
Exercises 188
Problems 193 TomTom 271
Cases and Projects 203 Reporting Operating Income 272
Solutions to Review Problems 206 Revenue Recognition 274
Mid-Chapter Review 1 279
Reporting Accounts Receivable 281
Determining the Allowance for Uncollectible Accounts 282
Reporting the Allowance for Uncollectible Accounts 283
Recording Write-offs of Uncollectible Accounts 284
contents xv
Footnote Disclosures, and Interpretations 285 Discussion Questions 342

Analysing Financial Statements 288 Exercises 345
Earnings Management 290 Problems 348
Chapter-End Review 291 Cases and Projects 351
Appendix 6A: Reporting Nonrecurring Items 291 Solutions to Review Problems 353
Discontinued Operations 292
8
Restructuring Costs 292
Appendix 6A Review 294
Chapter
Appendix 6B: New Standard for Revenue Reporting and Analysing Long-
Recognition 294
Long-Term Contracts 295 Term Operating Assets 359
Disclosure 295
Potential Effects of the New Standard 295 Airbus Group 359
Summary 296 Introduction 360
Guidance Answers . . . You Make the Call 297 Property, Plant, and Equipment (PPE) 360
Key Ratios 297 Determining Costs to Capitalise 361
Key Terms 297 Depreciation 362
Multiple Choice 298 Depreciation Methods 363
Discussion Questions 298 Changes in Accounting Estimates 366
Asset Sales and Impairments 367
Mini Exercises 299
Revaluation Model 369
Exercises 302
Footnote Disclosure 370
Problems 309
Analysing Financial Statements 370
Cases and Projects 312 Analysis Objective 370
Solutions to Review Problems 314 Analysis Objective 372
Cash Flow Effects 373
7
Mid-Chapter Review 374
Chapter Intangible Assets 375
Reporting and Analysing Inventory 319 Research and Development Costs 375
Patents 376
VTech 319 Copyrights 376
Trademarks 376
Reporting Operating Expenses 320
Franchise Rights 376
Expense Recognition Principles 320
Amortisation and Impairment of Identifiable Intangible
Reporting Inventory Costs in the Financial Statements 321
Assets 377
Recording Inventory Costs in the Financial
Goodwill 379
Statements 322
Footnote Disclosures 379
Inventory and the Cost of Acquisition 323
Analysis Implications 381
Inventory Reporting by Manufacturing Firms 323
Summary 382
Inventory Costing Methods 325
First-In, First-Out (FIFO) 327 Guidance Answers . . . You Make the Call 383
Average Cost (AC) 328 Key Ratios 383
Lower of Cost or Market 329 Key Terms 383
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contents xv
Footnote Disclosures, and Interpretations 285 Discussion Questions 342

Analysing Financial Statements 288 Exercises 345
Earnings Management 290 Problems 348
Chapter-End Review 291 Cases and Projects 351
Appendix 6A: Reporting Nonrecurring Items 291 Solutions to Review Problems 353
Discontinued Operations 292
8
Restructuring Costs 292
Appendix 6A Review 294
Chapter
Appendix 6B: New Standard for Revenue Reporting and Analysing Long-
Recognition 294
Long-Term Contracts 295 Term Operating Assets 359
Disclosure 295
Potential Effects of the New Standard 295 Airbus Group 359
Summary 296 Introduction 360
Guidance Answers . . . You Make the Call 297 Property, Plant, and Equipment (PPE) 360
Key Ratios 297 Determining Costs to Capitalise 361
Key Terms 297 Depreciation 362
Multiple Choice 298 Depreciation Methods 363
Discussion Questions 298 Changes in Accounting Estimates 366
Asset Sales and Impairments 367
Mini Exercises 299
Revaluation Model 369
Exercises 302
Footnote Disclosure 370
Problems 309
Cases and Projects 312 Analysis Objective 370
Solutions to Review Problems 314 Analysis Objective 372
Cash Flow Effects 373
7
Mid-Chapter Review 374
Chapter Intangible Assets 375
Reporting and Analysing Inventory 319 Research and Development Costs 375
Patents 376
VTech 319 Copyrights 376
Trademarks 376
Reporting Operating Expenses 320
Franchise Rights 376
Expense Recognition Principles 320
Amortisation and Impairment of Identifiable Intangible
Reporting Inventory Costs in the Financial Statements 321
Assets 377
Recording Inventory Costs in the Financial
Goodwill 379
Statements 322
Footnote Disclosures 379
Inventory and the Cost of Acquisition 323
Analysis Implications 381
Inventory Reporting by Manufacturing Firms 323
Summary 382
Inventory Costing Methods 325
First-In, First-Out (FIFO) 327 Guidance Answers . . . You Make the Call 383
Average Cost (AC) 328 Key Ratios 383
Lower of Cost or Market 329 Key Terms 383
Mid-Chapter Review 2 330 Multiple Choice 384
Financial Statement Disclosure 331 Discussion Questions 384
Analysing Financial Statements 333 Mini Exercises 385
Analysis Objective 333 Exercises 387
Chapter-End Review 337 Problems 390
Appendix 7A: LIFO 337 Cases and Projects 393
Last-In, First-Out (LIFO) 337 Solutions to Review Problems 394
Using LIFO Reserve to Convert LIFO to FIFO 338
Summary 339
Appendix-End Review 339
Guidance Answers . . . You Make the Call 340
Key Ratios 341
Key Terms 341
Multiple Choice 341
xvi contents
Chapter 9
Reporting and
Income Statement Effects of Defined Benefit Pension
Plans 459
Footnote Disclosures—Components of Plan Assets and
PBO 460
Analysing Liabilities 399
Footnote Disclosures—Components of Pension
Expense 462
Samsung Electronics 399 Footnote Disclosures and Future Cash Flows 464
Introduction 400 Other Post-Employment Benefits 465
Current Liabilities 400 Mid-Chapter Review 2 466
Accounts or Trade Payable 402 Accounting For Income Taxes 467
Mid-Chapter Review 1 404 Book-Tax Differences 467
Accrued Liabilities 404 Income Tax Disclosures 471
Mid-Chapter Review 2 408 Deferred Taxes in the Cash Flow Statement 473
Current Nonoperating (Financial) Liabilities 408 Computation and Analysis of Taxes 473
Mid-Chapter Review 3 410 Chapter-End Review 474
Long-Term Liabilities 410 Appendix 10A: Capitalisation of Operating Leases 474
Instalment Loans 410 Appendix-End Review 477
Bonds 412 Summary 478
Pricing of Bonds 413 Guidance Answers . . . You Make The Call 479
Effective Cost of Debt 415 Key Ratios 479
Reporting of Bond Financing 416
Key Terms 479
Effects of Discount and Premium Amortisation 418
Multiple Choice 479
The Fair Value Option 420
Effects of Bond Repurchase 421
Financial Statement Footnotes 422 Mini Exercises 480
Interest and the Cash Flows Statement 423 Exercises 483
Analysing Financial Statements 423 Problems 488
Analysis Objective 423 Cases and Projects 494
Debt Ratings and the Cost of Debt 425 Solutions to Review Problems 498
11
Summary 427
Guidance Answers . . . You Make the Call 428 Chapter
Key Ratios 429 Reporting and Analysing
Key Terms 429 Shareholders’ Equity 503
Multiple Choice 429
Thomson Reuters Corporation 503
Mini Exercises 431
Introduction 504
Exercises 435
Contributed Capital 505
Problems 438 Classes of Shares 505
Cases and Projects 441 Accounting for Share Transactions 507
Solutions to Review Problems 443 Mid-Chapter Review 1 512
Earned Capital 512
10
Cash Dividends 512
Chapter Mid-Chapter Review 2 514
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xvi contents
Chapter 9
Reporting and
Income Statement Effects of Defined Benefit Pension
Plans 459
Footnote Disclosures—Components of Plan Assets and
PBO 460
Analysing Liabilities 399
Footnote Disclosures—Components of Pension
Expense 462
Samsung Electronics 399 Footnote Disclosures and Future Cash Flows 464
Introduction 400 Other Post-Employment Benefits 465
Current Liabilities 400 Mid-Chapter Review 2 466
Accounts or Trade Payable 402 Accounting For Income Taxes 467
Mid-Chapter Review 1 404 Book-Tax Differences 467
Accrued Liabilities 404 Income Tax Disclosures 471
Mid-Chapter Review 2 408 Deferred Taxes in the Cash Flow Statement 473
Current Nonoperating (Financial) Liabilities 408 Computation and Analysis of Taxes 473
Mid-Chapter Review 3 410 Chapter-End Review 474
Long-Term Liabilities 410 Appendix 10A: Capitalisation of Operating Leases 474
Instalment Loans 410 Appendix-End Review 477
Bonds 412 Summary 478
Pricing of Bonds 413 Guidance Answers . . . You Make The Call 479
Effective Cost of Debt 415 Key Ratios 479
Reporting of Bond Financing 416
Key Terms 479
Effects of Discount and Premium Amortisation 418
Multiple Choice 479
The Fair Value Option 420
Effects of Bond Repurchase 421
Financial Statement Footnotes 422 Mini Exercises 480
Interest and the Cash Flows Statement 423 Exercises 483
Analysing Financial Statements 423 Problems 488
Analysis Objective 423 Cases and Projects 494
Debt Ratings and the Cost of Debt 425 Solutions to Review Problems 498
11
Summary 427
Guidance Answers . . . You Make the Call 428 Chapter
Key Ratios 429 Reporting and Analysing
Key Terms 429 Shareholders’ Equity 503
Multiple Choice 429
Thomson Reuters Corporation 503
Mini Exercises 431
Introduction 504
Exercises 435
Contributed Capital 505
Problems 438 Classes of Shares 505
Cases and Projects 441 Accounting for Share Transactions 507
Solutions to Review Problems 443 Mid-Chapter Review 1 512
Earned Capital 512
10
Cash Dividends 512
Chapter Mid-Chapter Review 2 514
Reporting and Analysing Leases, Share Dividends and Splits 514
Pensions, and Income Taxes 447 Share Transactions and the Cash Flows Statement 516
Comprehensive Income 517
Summary of Equity 518
Unilever 447
Introduction 448 Analysis Objective 519
Leases 449 Mid-Chapter Review 4 520
Lessee Reporting of Leases 450
Earnings Per Share 520
Footnote Disclosures of Leases 453
Computation and Analysis of EPS 521
Analysis Objective 455
Appendix 11A: Dilutive Securities: Further
Mid-Chapter Review 1 456 Considerations 524
Pensions 457 Convertible Securities 524
Balance Sheet Effects of Defined Benefit Pension Share Rights 526
Plans 457
contents xvii
Share Options 527 Noncontrolling Interest 575

Appendix 11A Review 528 Reporting of Acquired Assets and Liabilities 577
Summary 529 Financial Statement Analysis 582
Guidance Answers . . . You Make the Call 530 Chapter-End Review 583
Key Ratios 530 Appendix 12A: Equity Method Mechanics 583
Key Terms 530 Appendix 12B: Consolidation Accounting
Multiple Choice 531 Mechanics 584
Discussion Questions 531 Appendix 12C: Accounting for Investments in
Derivatives 586
Mini Exercises 532
Summary 588
Exercises 537
Problems 542
Key Terms 590
Multiple Choice 590
Mini Exercises 591
Chapter 12
Reporting and Analysing
Exercises 594
Problems 603
Financial Investments 553 Solutions to Review Problems 610
A
SMRT Corporation Ltd 553
Introduction 554
Appendix
Fair Value: An Introduction 556 Compound Interest and the
Passive Investments 557
Acquisition and Sale 557
Time-Value of Money 616
Investments Marked to Fair Value 558
Future Value Concepts 616
Investments Reported at Cost 562
Present Value Concepts 618
Financial Statement Disclosures 562
Potential for Earnings Management 565 Using Excel to Compute Time Value 621
Investments with Significant Influence 566
Accounting for Investments with Significant Influence 567 Glossary 637
Financial Statement Disclosures 569 Index 657
Investments with Control 571
Accounting for Investments with Control 572
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contents xvii
Share Options 527 Noncontrolling Interest 575

Appendix 11A Review 528 Reporting of Acquired Assets and Liabilities 577
Summary 529 Financial Statement Analysis 582
Guidance Answers . . . You Make the Call 530 Chapter-End Review 583
Key Ratios 530 Appendix 12A: Equity Method Mechanics 583
Key Terms 530 Appendix 12B: Consolidation Accounting
Multiple Choice 531 Mechanics 584
Discussion Questions 531 Appendix 12C: Accounting for Investments in
Derivatives 586
Mini Exercises 532
Summary 588
Exercises 537
Problems 542
Key Terms 590
Multiple Choice 590
Mini Exercises 591
Chapter 12
Reporting and Analysing
Exercises 594
Problems 603
Financial Investments 553 Solutions to Review Problems 610
A
SMRT Corporation Ltd 553
Introduction 554
Appendix
Fair Value: An Introduction 556 Compound Interest and the
Passive Investments 557
Acquisition and Sale 557
Time-Value of Money 616
Investments Marked to Fair Value 558
Future Value Concepts 616
Investments Reported at Cost 562
Present Value Concepts 618
Financial Statement Disclosures 562
Potential for Earnings Management 565 Using Excel to Compute Time Value 621
Investments with Significant Influence 566
Accounting for Investments with Significant Influence 567 Glossary 637
Financial Statement Disclosures 569 Index 657
Investments with Control 571
Accounting for Investments with Control 572
1. Identify the users of accounting information and discuss

OBJECTIVES
LEARNING
the costs and benefits of disclosure. (p. 4)
2. Describe a company’s business activities and explain how these

activities are represented by the accounting equation. (p. 7)
3. Introduce the four key financial statements including the balance sheet, income
statement, statement of changes in equity, and statement of cash flows. (p. 11)
4. Describe the institutions that regulate financial accounting and their role
in establishing generally accepted accounting principles. (p. 17)
5. Compute two key ratios that are commonly used to assess profitability
  (https://cambridgepub.com)    Page Fit  2 
1. Identify the users of accounting information and discuss

OBJECTIVES
LEARNING
the costs and benefits of disclosure. (p. 4)
2. Describe a company’s business activities and explain how these

activities are represented by the accounting equation. (p. 7)
3. Introduce the four key financial statements including the balance sheet, income
statement, statement of changes in equity, and statement of cash flows. (p. 11)
4. Describe the institutions that regulate financial accounting and their role
in establishing generally accepted accounting principles. (p. 17)
5. Compute two key ratios that are commonly used to assess profitability
and risk—return on equity and the debt-to-equity ratio. (p. 20)
6. Appendix 1A: Explain the conceptual framework for financial reporting. (p. 24)
C H A P T E R
Introducing Financial
Accounting 1
Founded in 1896, Roche is a global healthcare company based in Basel, Switzerland. Roche markets
medicines and diagnostic tests in over 150 countries, produces more than 100 medicines, and oper-
ates 26 manufacturing sites in Brazil, China, Germany, Ireland, Italy, Japan, Singapore, Switzerland, the
United Kingdom, and the United States. Its hold-
ing company, Roche Holding AG, is traded on the
ROCHE SIX Swiss Exchange and the OTCQX market in the
www.Roche.com United States. In 2013, Roche reported net income
of 11.4 billion Swiss francs (CHF) on revenues of
46.8 billion CHF.
Roche operates in two sectors. Its pharmaceuticals division discovers, develops and manu-
factures medicines in oncology, infectious diseases, metabolism, and neuroscience. It is the largest
biotechnology company in the world. Its diagnostics division develops and offers products used to
test blood and other body fluids and tissue samples for the diagnosis, treatment, and monitoring of
diseases. In 2013, pharmaceuticals and diagnostics sales account for 78.2% and 21.8% of Roche’s
revenues, respectively.
Roche is a science-based healthcare company and invests heavily in innovative research and
development. In 2013, it spent 8.7 billion CHF, or 18.6% of its revenues, on research and development.
Moreover, Roche expanded its capabilities by acquiring other companies such as Chugai Pharmaceu-
ticals, a leading biotech company in Japan; Ventana, a leader in tissue diagnostics in the United States;
and Genentech, a world-class biotech company in the United States. Roche also augments its internal
research and development by collaborating with over 150 partners worldwide.
C H A P T E R
Introducing Financial
Accounting 1
Founded in 1896, Roche is a global healthcare company based in Basel, Switzerland. Roche markets
medicines and diagnostic tests in over 150 countries, produces more than 100 medicines, and oper-
ates 26 manufacturing sites in Brazil, China, Germany, Ireland, Italy, Japan, Singapore, Switzerland, the
United Kingdom, and the United States. Its hold-
ing company, Roche Holding AG, is traded on the
ROCHE SIX Swiss Exchange and the OTCQX market in the
www.Roche.com United States. In 2013, Roche reported net income
of 11.4 billion Swiss francs (CHF) on revenues of
46.8 billion CHF.
Roche operates in two sectors. Its pharmaceuticals division discovers, develops and manu-
factures medicines in oncology, infectious diseases, metabolism, and neuroscience. It is the largest
biotechnology company in the world. Its diagnostics division develops and offers products used to
test blood and other body fluids and tissue samples for the diagnosis, treatment, and monitoring of
diseases. In 2013, pharmaceuticals and diagnostics sales account for 78.2% and 21.8% of Roche’s
revenues, respectively.
Roche is a science-based healthcare company and invests heavily in innovative research and
development. In 2013, it spent 8.7 billion CHF, or 18.6% of its revenues, on research and development.
Moreover, Roche expanded its capabilities by acquiring other companies such as Chugai Pharmaceu-
ticals, a leading biotech company in Japan; Ventana, a leader in tissue diagnostics in the United States;
and Genentech, a world-class biotech company in the United States. Roche also augments its internal
research and development by collaborating with over 150 partners worldwide.
In 2013, Roche had over 30 late-stage (phase III) drug development projects, consisting of over
70 new potential medicines and 20 additional indications for existing medicines. It received approvals
from the European Union and United States for three of the compounds and passed phase III trial tests
for four other compounds. It also launched three new diagnostics products in 2013.
In 2013, Roche was the 20th largest company in the world and the third largest in Europe by mar-
ket capitalisation. By 2013, it had increased its dividends for 27 consecutive years. Roche’s success is
not an accident. Along the way, Roche management made countless decisions that ultimately led the
company to where it is today. Each of these decisions involved identifying alternative courses of action
and weighing their costs, benefits, and risks in light of the available information.
Accounting is the process of identifying, measuring, and communicating financial information to
help people make economic decisions. People use financial accounting information to facilitate a wide
variety of transactions, including assessing whether, and on what terms, they should invest in a firm,
(continued on next page)
(continued from previous page)
seek employment in a business, or continue purchasing its products. Accounting information is crucial to any successful busi-
ness, and without it, most businesses would not even exist.
This book explains how to create and analyse financial statements, an important source of accounting information prepared
by companies to communicate with a variety of users. We begin by introducing transactions between the firm and its inves-
tors, creditors, suppliers, employees, and customers. We continue by demonstrating how accounting principles are applied to
these transactions to create the financial statements. Then, we “invert” the process and learn how to analyse the firm’s financial
statements to assess the firm’s underlying economic performance. Our philosophy is simple—we believe it is crucial to have a
deep understanding of financial accounting to become critical readers and users of financial statements. Financial statements
tell a story—a business story. Our goal is to understand that story, and apply the knowledge gleaned from financial statements
to make good business decisions.
Source: www.roche.com; Roche 2013 Annual Report; Roche fact sheet 2013.
CHAPTER
ORGANISATION Introducing Financial Accounting
Demand for
Financial Reporting Financial Statement
Accounting Business Activities Financial Statements
Environment Analysis
Information
n Who Uses n Planning Activities n Balance Sheet n Generally Accepted n Profitability

Financial n Investing Activities n Income Statement Accounting Analysis
Accounting Principles Credit Risk
n Financing Activities n Statement of n
Information? International Analysis
n Operating Activities Changes in Equity n
n Costs and Benefits Financial Reporting
n Statement of Cash
of Disclosure Standards
Flows
n Roles of Regulator,
n Financial
Management, and
Statement
Auditor
Linkages
n Conceptual
Framework
(Appendix 1A)
DEMAND FOR ACCOUNTING INFORMATION

Accounting can be defined as the process of recording, summarising, and analysing financial
(continued from previous page)
seek employment in a business, or continue purchasing its products. Accounting information is crucial to any successful busi-
ness, and without it, most businesses would not even exist.
This book explains how to create and analyse financial statements, an important source of accounting information prepared
by companies to communicate with a variety of users. We begin by introducing transactions between the firm and its inves-
tors, creditors, suppliers, employees, and customers. We continue by demonstrating how accounting principles are applied to
these transactions to create the financial statements. Then, we “invert” the process and learn how to analyse the firm’s financial
statements to assess the firm’s underlying economic performance. Our philosophy is simple—we believe it is crucial to have a
deep understanding of financial accounting to become critical readers and users of financial statements. Financial statements
tell a story—a business story. Our goal is to understand that story, and apply the knowledge gleaned from financial statements
to make good business decisions.
Source: www.roche.com; Roche 2013 Annual Report; Roche fact sheet 2013.
CHAPTER
ORGANISATION Introducing Financial Accounting
Demand for
Financial Reporting Financial Statement
Accounting Business Activities Financial Statements
Environment Analysis
Information
n Who Uses n Planning Activities n Balance Sheet n Generally Accepted n Profitability

Financial n Investing Activities n Income Statement Accounting Analysis
Accounting Principles Credit Risk
n Financing Activities n Statement of n
Information? International Analysis
n Operating Activities Changes in Equity n
n Costs and Benefits Financial Reporting
n Statement of Cash
of Disclosure Standards
Flows
n Roles of Regulator,
n Financial
Management, and
Statement
Auditor
Linkages
n Conceptual
Framework
(Appendix 1A)
DEMAND FOR ACCOUNTING INFORMATION

Accounting can be defined as the process of recording, summarising, and analysing financial
LO1 Identify
the users of
transactions. While accounting information attempts to satisfy the needs of a diverse set of users,
accounting the accounting information a company produces can be classified into two categories:
Financial accounting—designed primarily for decision makers outside of the company
information and
n
discuss the costs
and benefits of n Managerial accounting—designed primarily for decision makers within the company
disclosure.
Exhibit 1.1 compares and contrasts the information needs of decision makers who use financial and
managerial accounting information. Financial accounting reports include information about com-
pany profitability and financial health. This information is useful to various economic actors who
wish to engage in contracts with the firm, including investors, creditors, employees, customers, and
governments. Managerial accounting information is not reported outside of the company because it
includes proprietary information about the profitability of specific products, divisions, or customers.
Company managers use managerial accounting reports to make decisions such as whether to drop
or add products or divisions, or whether to continue serving different types of customers. This text
focuses on understanding and analysing financial accounting information.
chAPter 1 | Introducing Financial Accounting 5
EXHIBIT 1.1 Information Needs of Decision Makers Who Use Financial and Managerial Accounting
Decision Makers Decisions Information

Accounting
Financial
• Investors and analysts • Buy or sell shares? • Sales and costs

• Creditors • Lend or not? • Cash in and out
• Suppliers and customers • Purchase/sell goods or not? • Assets and liabilities
Accounting
Managerial
• Top management • Develop new strategy? • Product sales and costs

• Marketing teams • Launch a new product or not? • Department performance reports
• Production and operations • Manage operations • Budgets and quality reports
Who Uses Financial Accounting Information?

Demand for financial accounting information derives from numerous users including:
n Shareholders and potential shareholders
n Creditors and suppliers
n Managers and directors
n Financial analysts
n Other users
Shareholders and Potential Shareholders Corporations are the dominant form of

FYI
business organisation for large companies around the world, and corporate shareholders are one
Shareholders
of a corporation are
important group of decision makers that have an interest in financial accounting information. A its owners; although
corporation is a form of business organisation that is characterised by a large number of owners managers can
who are not involved in managing the day-to-day operations of the company. 1 A corporation exists own shares in the
as a legal entity that issues shares to its owners in exchange for cash and, therefore, the owners of corporation, most
a corporation are referred to as shareholders or stockholders.

shareholders are not
managers. n
Because the shareholders are not involved in the day-to-day operations of the business, they
rely on the information in financial statements to evaluate management performance and assess
the company’s financial condition.
In addition to corporations, sole proprietorships and partnerships are also common forms of
business ownership. A sole proprietorship has a single owner who typically manages the daily
operations. Small family-run businesses, such as corner grocery stores, are commonly organised as
sole proprietorships. A partnership has two or more owners who are also usually involved in man-
aging the business. Many professionals, such as lawyers and accountants, organise their businesses
as partnerships.
EXHIBIT 1.1 Information Needs of Decision Makers Who Use Financial and Managerial Accounting
Decision Makers Decisions Information
Accounting
Financial
• Investors and analysts • Buy or sell shares? • Sales and costs
• Creditors • Lend or not? • Cash in and out
• Suppliers and customers • Purchase/sell goods or not? • Assets and liabilities
Accounting
Managerial
• Top management • Develop new strategy? • Product sales and costs
• Marketing teams • Launch a new product or not? • Department performance reports
• Production and operations • Manage operations • Budgets and quality reports
Who Uses Financial Accounting Information?

Demand for financial accounting information derives from numerous users including:
n Shareholders and potential shareholders
n Creditors and suppliers
n Managers and directors
n Financial analysts
n Other users
Shareholders and Potential Shareholders Corporations are the dominant form of

FYI
business organisation for large companies around the world, and corporate shareholders are one
Shareholders
of a corporation are
important group of decision makers that have an interest in financial accounting information. A its owners; although
corporation is a form of business organisation that is characterised by a large number of owners managers can
who are not involved in managing the day-to-day operations of the company. 1 A corporation exists own shares in the
as a legal entity that issues shares to its owners in exchange for cash and, therefore, the owners of corporation, most
a corporation are referred to as shareholders or stockholders.

shareholders are not
managers. n
Because the shareholders are not involved in the day-to-day operations of the business, they
rely on the information in financial statements to evaluate management performance and assess
the company’s financial condition.
In addition to corporations, sole proprietorships and partnerships are also common forms of
business ownership. A sole proprietorship has a single owner who typically manages the daily
operations. Small family-run businesses, such as corner grocery stores, are commonly organised as
sole proprietorships. A partnership has two or more owners who are also usually involved in man-
aging the business. Many professionals, such as lawyers and accountants, organise their businesses
as partnerships.
Most corporations begin as small, privately held businesses (sole proprietorships or part-
nerships). As their operations expand, they require additional capital to finance their growth.
One of the principal advantages of a corporation over sole proprietorships and partnerships is
the ability to raise large amounts of cash by issuing (selling) shares and bonds. For example, as
Roche grew from a small business into a larger company, it raised the funds needed for expansion
by selling its bearer shares to new shareholders in the SIX Swiss Exchange. In many countries,
1
Corporations are referred to by different names (abbreviations) around the world. For example, firms that are incorpo-
rated in the United Kingdom, Ireland, and some Commonwealth countries are referred to as a Limited Company (Ltd.)
or Public Limited Company (PLC). Similarly, they are referred to as an Aktiengesellschaft (AG) or Gesellschaft mit be-
schränkter Haftung (GmbH) in Germany, Austria, and Switzerland; a Sociedad Anónima (SA) in Spain, Brazil, and Por-
tugal; a Naamloze Vennootschap (NV) in the Netherlands and the Dutch-speaking part of Belgium; Société Anonyme
(SA) in France, Luxembourg, and the French-speaking parts of Switzerland and Belgium; a Società per Azioni (S.p.A.)
in Italy; and Corporation (Corp.) or Incorporated (Inc.) in Canada and the United States.
6 chAPter 1 | Introducing Financial Accounting
most corporations can raise funds by issuing shares on organised exchanges. Corporations with
shares traded on public exchanges are known as publicly traded corporations or simply public
corporations.
Financial statements and the accompanying footnotes provide information on the risk and re-
turn associated with owning shares in the corporation, and they reveal how well management has
performed. Financial statements also provide valuable insights into future performance by reveal-
ing management’s plans for new products, new operating procedures, and new strategic directions
for the company as well as for their implementation. Corporate management provides this informa-
tion because the information reduces uncertainty about the company’s future prospects which, in
turn, increases the market price of its shares and helps the company raise the funds it needs to grow.
FYI Financial Creditors and Suppliers Few businesses rely solely on shareholders for the cash needed
statements are typically to operate the company. Instead, most companies borrow from banks or other lenders known as
required when a creditors. Creditors are interested in the potential borrower’s ability to repay. They use financial
business requests a accounting information to help determine loan terms, loan amounts, interest rates, and collateral.
bank loan. n
In addition, creditors’ loans often include contractual requirements based on information found in
the financial statements.
Suppliers use financial information to establish credit sales terms and to determine their long-
term commitment to supply-chain relationships. Supplier companies often justify an expansion of
their businesses based on the growth and financial health of their customers. Both creditors and
suppliers rely on information in the financial statements to monitor and adjust their contracts and
commitments with a company.
Managers and Directors Financial statements can be thought of as a financial report card
for management. A well-managed company earns a good return for its shareholders, and this is
reflected in the financial statements. In most companies, management is compensated, at least in
part, based on the financial performance of the company. That is, managers often receive cash
bonuses, shares of the company, or other incentive compensation that is linked directly to the in-
formation in the financial statements.
Publicly traded corporations are required by law to have a board of directors. Directors are
elected by the shareholders to represent shareholder interests and oversee management. The board
hires executive management and regularly reviews company operations. Directors use financial
accounting information to review the results of operations, evaluate future strategy, and assess
management performance.
Both managers and directors use the published financial statements of other companies to
perform comparative analyses and establish performance benchmarks. For example, managers
in some companies are paid a bonus for financial performance that exceeds the industry average.
BUSIN ESS INSIGHT

Recent court cases involving corporations such as Enron, Nortel, Olympus, Parmalat, and Satyam have
found executives, including several CEOs, guilty of issuing fraudulent financial statements. In some cases,
most corporations can raise funds by issuing shares on organised exchanges. Corporations with
shares traded on public exchanges are known as publicly traded corporations or simply public
corporations.
Financial statements and the accompanying footnotes provide information on the risk and re-
turn associated with owning shares in the corporation, and they reveal how well management has
performed. Financial statements also provide valuable insights into future performance by reveal-
ing management’s plans for new products, new operating procedures, and new strategic directions
for the company as well as for their implementation. Corporate management provides this informa-
tion because the information reduces uncertainty about the company’s future prospects which, in
turn, increases the market price of its shares and helps the company raise the funds it needs to grow.
FYI Financial Creditors and Suppliers Few businesses rely solely on shareholders for the cash needed
statements are typically to operate the company. Instead, most companies borrow from banks or other lenders known as
required when a creditors. Creditors are interested in the potential borrower’s ability to repay. They use financial
business requests a accounting information to help determine loan terms, loan amounts, interest rates, and collateral.
bank loan. n
In addition, creditors’ loans often include contractual requirements based on information found in
the financial statements.
Suppliers use financial information to establish credit sales terms and to determine their long-
term commitment to supply-chain relationships. Supplier companies often justify an expansion of
their businesses based on the growth and financial health of their customers. Both creditors and
suppliers rely on information in the financial statements to monitor and adjust their contracts and
commitments with a company.
Managers and Directors Financial statements can be thought of as a financial report card
for management. A well-managed company earns a good return for its shareholders, and this is
reflected in the financial statements. In most companies, management is compensated, at least in
part, based on the financial performance of the company. That is, managers often receive cash
bonuses, shares of the company, or other incentive compensation that is linked directly to the in-
formation in the financial statements.
Publicly traded corporations are required by law to have a board of directors. Directors are
elected by the shareholders to represent shareholder interests and oversee management. The board
hires executive management and regularly reviews company operations. Directors use financial
accounting information to review the results of operations, evaluate future strategy, and assess
management performance.
Both managers and directors use the published financial statements of other companies to
perform comparative analyses and establish performance benchmarks. For example, managers
in some companies are paid a bonus for financial performance that exceeds the industry average.
BUSIN ESS INSIGHT

Recent court cases involving corporations such as Enron, Nortel, Olympus, Parmalat, and Satyam have
found executives, including several CEOs, guilty of issuing fraudulent financial statements. In some cases,
these executives have received substantial fines and long jail sentences. These trials have resulted in
widespread loss of reputation and credibility among corporate boards.
Financial Analysts Many decision makers lack the time, resources, or expertise to efficiently
and effectively analyse financial statements. Instead, they rely on professional financial analysts,
such as credit rating agencies like Moody’s Investors Service, portfolio managers, and security
analysts. Financial analysts play an important role in the dissemination of financial information
and often specialise in specific industries. Their analysis helps to identify and assess risk, forecast
performance, establish prices for new issues of shares, and make buy or sell recommendations to
investors.
Other Users of Financial Accounting Information External decision makers include

many users of accounting information in addition to those listed above. For example, prospective
employees often examine the financial statements of an employer to learn about the company be-
fore interviewing for or accepting a new job.
Labour unions examine financial statements in order to assess the financial health of firms
prior to negotiating labour contracts on behalf of the firms’ employees.
Customers use accounting information to assess the ability of a company to deliver products
or services and to assess the company’s long-term reliability. Tax agencies use financial account-
ing to help establish and implement tax policies. Other government agencies rely on accounting
information to develop and enforce regulations, including public protection, price setting, import-
export, and various other policies. Timely and reliable information is crucial to effective regula-
tory policy. Moreover, accounting information is often used to assess penalties for companies that
violate various regulations.
Costs and Benefits of Disclosure

The act of providing financial information to external users is called disclosure. As with every de-
cision, the benefits of disclosure must be weighed against the costs of providing the information.
One reason companies are motivated to disclose financial information to external decision
makers is that it often lowers financing and operating costs. For example, when a company applies
for a loan, the bank uses the company’s financial statements to help determine the appropriate
interest rate. Without adequate financial disclosures in its financial statements, the bank is likely
to demand a higher interest rate or perhaps not make the loan at all. Thus, in this setting, a benefit
of financial disclosure is that it reduces the company’s cost of borrowing.
While there are benefits from disclosing financial information, there are also costs. Besides
the obvious cost of hiring accountants and preparing the financial statements, financial disclosures
can also result in costs being imposed by competitors. It is common practice for managers to scru-
tinise the financial statements of competitors to learn about successful products, new strategies,
innovative technologies, and changing market conditions. Thus, disclosing too much information
can place a company at a competitive disadvantage. Disclosure can also raise investors’ expecta-
tions about a company’s future profitability. If those expectations are not met, they may bring
litigation against the managers.
There are also political costs that are potentially associated with accounting disclosure. Highly
visible companies, such as defence contractors and oil companies, are often the target of scrutiny by
the public and by government officials. When these companies report unusually large accounting
profits, they are often the target of additional regulation or increased taxes.
Securities market regulators impose disclosure standards for publicly traded corporations, but
the nature and extent of the required disclosures vary substantially across countries. Further, because
the requirements set only the minimum level of disclosure, the quantity and quality of information
provided by firms will vary. This variation in disclosure ultimately reflects differences among com-
panies in the benefits and costs of disclosing information to the public.
YOU MAKE THE CALL

You are a Product Manager There is often friction between investors’ needs for information
employees often examine the financial statements of an employer to learn about the company be-
fore interviewing for or accepting a new job.
Labour unions examine financial statements in order to assess the financial health of firms
prior to negotiating labour contracts on behalf of the firms’ employees.
Customers use accounting information to assess the ability of a company to deliver products
or services and to assess the company’s long-term reliability. Tax agencies use financial account-
ing to help establish and implement tax policies. Other government agencies rely on accounting
information to develop and enforce regulations, including public protection, price setting, import-
export, and various other policies. Timely and reliable information is crucial to effective regula-
tory policy. Moreover, accounting information is often used to assess penalties for companies that
violate various regulations.
Costs and Benefits of Disclosure

The act of providing financial information to external users is called disclosure. As with every de-
cision, the benefits of disclosure must be weighed against the costs of providing the information.
One reason companies are motivated to disclose financial information to external decision
makers is that it often lowers financing and operating costs. For example, when a company applies
for a loan, the bank uses the company’s financial statements to help determine the appropriate
interest rate. Without adequate financial disclosures in its financial statements, the bank is likely
to demand a higher interest rate or perhaps not make the loan at all. Thus, in this setting, a benefit
of financial disclosure is that it reduces the company’s cost of borrowing.
While there are benefits from disclosing financial information, there are also costs. Besides
the obvious cost of hiring accountants and preparing the financial statements, financial disclosures
can also result in costs being imposed by competitors. It is common practice for managers to scru-
tinise the financial statements of competitors to learn about successful products, new strategies,
innovative technologies, and changing market conditions. Thus, disclosing too much information
can place a company at a competitive disadvantage. Disclosure can also raise investors’ expecta-
tions about a company’s future profitability. If those expectations are not met, they may bring
litigation against the managers.
There are also political costs that are potentially associated with accounting disclosure. Highly
visible companies, such as defence contractors and oil companies, are often the target of scrutiny by
the public and by government officials. When these companies report unusually large accounting
profits, they are often the target of additional regulation or increased taxes.
Securities market regulators impose disclosure standards for publicly traded corporations, but
the nature and extent of the required disclosures vary substantially across countries. Further, because
the requirements set only the minimum level of disclosure, the quantity and quality of information
provided by firms will vary. This variation in disclosure ultimately reflects differences among com-
panies in the benefits and costs of disclosing information to the public.
YOU MAKE THE CALL

You are a Product Manager There is often friction between investors’ needs for information
and a company’s desire to safeguard competitive advantages. Assume that you are the product manager
for a key department at your company and you are asked for advice on the extent of information to dis-
close in the annual report on a potentially lucrative new product that your department has test marketed.
What considerations affect the advice you provide and why? [Answer on page 28]
BUSINESS ACTIVITIES
Businesses produce accounting information to help develop strategies, attract financing, evaluate LO2 Describe
investment opportunities, manage operations, and measure performance. Before we can attempt a company’s
to understand the information provided in financial statements, we must understand these business business activities
activities. That is, what does a business actually do? For example: and explain how
these activities
n Where does a company such as Roche find the resources to develop new products and open are represented
new retail stores? by the accounting
equation.
n What new products should Roche bring to market?

n How much should Roche spend on product development? On advertising? On executive
compensation?
n How does Roche’s management determine if a product is a success?
Questions such as these define the activities of Roche and other companies.
Exhibit 1.2 illustrates the activities of a typical business. All businesses plan business ac-
tivities, finance those activities, invest resources in those activities, and then engage in operating
activities. Companies conduct all these activities while confronting a variety of external forces,
including competition from other businesses, government regulation, economic conditions and
market forces, and changing preferences of customers. The financial statements provide informa-
tion that helps us understand and evaluate each of these activities.
EXHIBIT 1.2 Business Activities
g Pla
Competition nin nn
ing Regulation
an
Pl Stock
Certificate
Sto
Ce Sto
rtifick
cate Certifick
Investing cate
Activities Financing
Activities
Operating
Pla Activities
nn g
Customer Preferences
ing nin Economic Conditions
an
Pl
Planning Activities
A company’s goals, and the strategies adopted to reach those goals, are the product of its planning
activities. Roche, for example, states on its website that “Our mission today and tomorrow is to
create added value in healthcare by focusing on our expertise in diagnostics and pharmaceuticals.”
As is the case with most businesses, Roche’s primary goal is to create value for its owners, the
shareholders. How the company plans to do so is the company’s strategy.
A company’s strategic (or business) plan describes how it plans to achieve its goals. The
plan’s success depends on an effective review of market conditions. Specifically, the company
must assess both the demand for its products and services, and the supply of its inputs (both la-
bour and capital). The plan must also include competitive analyses, opportunity assessments, and
n What new products should Roche bring to market?

n How much should Roche spend on product development? On advertising? On executive
compensation?
n How does Roche’s management determine if a product is a success?
Questions such as these define the activities of Roche and other companies.
Exhibit 1.2 illustrates the activities of a typical business. All businesses plan business ac-
tivities, finance those activities, invest resources in those activities, and then engage in operating
activities. Companies conduct all these activities while confronting a variety of external forces,
including competition from other businesses, government regulation, economic conditions and
market forces, and changing preferences of customers. The financial statements provide informa-
tion that helps us understand and evaluate each of these activities.
EXHIBIT 1.2 Business Activities
g Pla
Competition nin nn
ing Regulation
an
Pl Stock
Certificate
Sto
Ce Sto
rtifick
cate Certifick
Investing cate
Activities Financing
Activities
Operating
Pla Activities
nn g
Customer Preferences
ing nin Economic Conditions
lan
P
Planning Activities
A company’s goals, and the strategies adopted to reach those goals, are the product of its planning
activities. Roche, for example, states on its website that “Our mission today and tomorrow is to
create added value in healthcare by focusing on our expertise in diagnostics and pharmaceuticals.”
As is the case with most businesses, Roche’s primary goal is to create value for its owners, the
shareholders. How the company plans to do so is the company’s strategy.
A company’s strategic (or business) plan describes how it plans to achieve its goals. The
plan’s success depends on an effective review of market conditions. Specifically, the company
must assess both the demand for its products and services, and the supply of its inputs (both la-
bour and capital). The plan must also include competitive analyses, opportunity assessments, and
consideration of business threats. The strategic plan specifies both broad management designs that
generate company value and tactics to achieve those designs.
Most information in a strategic plan is proprietary and guarded closely by management. How-
ever, outsiders can gain insight into planning activities through various channels, including news-
papers, magazines, and company publications. Understanding a company’s planning activities
helps focus accounting analysis and place it in context.
Investing Activities
Investing activities consist of acquiring and disposing of the resources needed to produce and
sell a company’s products and services. These resources, called assets, provide future benefits
to the company. Companies differ on the amount and mix of these resources. Some companies
require buildings and equipment while others have abandoned “bricks and mortar” to conduct
business through the Internet.
Some assets that a company invests in are used quickly. For instance, a retail clothing store
hopes to sell its spring and summer merchandise before purchasing more inventory for the fall
and winter. Other assets are acquired for long-term use. Buildings are typically used for several
decades. The relative proportion of short-term and long-term investments depends on the type of
business and the strategic plan that the company adopts.
The graph in Exhibit 1.3 compares the relative proportion of short-term and long-term assets
held by Roche and six other companies from different industries and countries, several of which
are featured in later chapters. Roche has roughly the same proportions of short-term and long-term
assets. Indigo, a Canadian bookseller, requires very little investment in long-term resources. In con-
trast, Qantas Airways, Unilever, TomTom, and BP all rely heavily on long-term investments. These
companies hold relatively small proportions of short-term assets. This mix of long-term and short-
term assets is described in more detail in Chapter 2.
EXHIBIT 1.3 Relative Proportion of Short-term and Long-term Assets
Short-term Assets Long-term Assets
Qantas Airways
Unilever
TomTom
BP
Roche
Airbus
Indigo
0% 20% 40% 60% 80% 100%
Financing Activities
Investments in resources require funding, and financing activities refer to the methods com-
panies use to fund those investments. Financial management is the planning of resource needs,
including the proper mix of financing sources.
Companies obtain financing from two sources: equity (owner) financing and creditor (non-
owner) financing. Equity financing refers to the funds contributed to the company by its owners
Another random document with
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consider some of the antecedents of our modern approach to the
investigation of nature.
In the first place, there can be no living science unless there is a
widespread instinctive conviction in the existence of an Order of
Things, and, in particular, of an Order of Nature. I have used the
word instinctive advisedly. It does not matter what men say in words,
so long as their activities are controlled by settled instincts. The
words may ultimately destroy the instincts. But until this has
occurred, words do not count. This remark is important in respect to
the history of scientific thought. For we shall find that since the time
of Hume, the fashionable scientific philosophy has been such as to
deny the rationality of science. This conclusion lies upon the surface
of Hume’s philosophy. Take, for example, the following passage from
Section IV of his Inquiry Concerning Human Understanding:
“In a word, then, every effect is a distinct event from its cause. It
could not, therefore, be discovered in the cause; and the first
invention or conception of it, à priori, must be entirely arbitrary.”
If the cause in itself discloses no information as to the effect, so that

the first invention of it must be entirely arbitrary, it follows at once
that science is impossible, except in the sense of establishing
entirely arbitrary connections which are not warranted by anything
intrinsic to the natures either of causes or effects. Some variant of
Hume’s philosophy has generally prevailed among men of science.
But scientific faith has risen to the occasion, and has tacitly removed
the philosophic mountain.
In view of this strange contradiction in scientific thought, it is of the
first importance to consider the antecedents of a faith which is
impervious to the demand for a consistent rationality. We have
therefore to trace the rise of the instinctive faith that there is an Order
of Nature which can be traced in every detailed occurrence.
Of course we all share in this faith, and we therefore believe that
the reason for the faith is our apprehension of its truth. But the
formation of a general idea—such as the idea of the Order of Nature
—, and the grasp of its importance, and the observation of its
exemplification in a variety of occasions are by no means the
necessary consequences of the truth of the idea in question. Familiar
things happen, and mankind does not bother about them. It requires
a very unusual mind to undertake the analysis of the obvious.
Accordingly I wish to consider the stages in which this analysis
became explicit, and finally became unalterably impressed upon the
educated minds of Western Europe.
Obviously, the main recurrences of life are too insistent to escape
the notice of the least rational of humans; and even before the dawn
of rationality, they have impressed themselves upon the instincts of
animals. It is unnecessary to labour the point, that in broad outline
certain general states of nature recur, and that our very natures have
adapted themselves to such repetitions.
But there is a complementary fact which is equally true and
equally obvious:—nothing ever really recurs in exact detail. No two
days are identical, no two winters. What has gone, has gone forever.
Accordingly the practical philosophy of mankind has been to expect
the broad recurrences, and to accept the details as emanating from
the inscrutable womb of things, beyond the ken of rationality. Men
expected the sun to rise, but the wind bloweth where it listeth.
Certainly from the classical Greek civilisation onwards there have
been men, and indeed groups of men, who have placed themselves
beyond this acceptance of an ultimate irrationality. Such men have
endeavoured to explain all phenomena as the outcome of an order
of things which extends to every detail. Geniuses such as Aristotle,
or Archimedes, or Roger Bacon, must have been endowed with the
full scientific mentality, which instinctively holds that all things great
and small are conceivable as exemplifications of general principles
which reign throughout the natural order.
But until the close of the Middle Ages the general educated public
did not feel that intimate conviction, and that detailed interest, in
such an idea, so as to lead to an unceasing supply of men, with
ability and opportunity adequate to maintain a coordinated search for
the discovery of these hypothetical principles. Either people were
doubtful about the existence of such principles, or were doubtful
about any success in finding them, or took no interest in thinking
about them, or were oblivious to their practical importance when
found. For whatever reason, search was languid, if we have regard
to the opportunities of a high civilisation and the length of time
concerned. Why did the pace suddenly quicken in the sixteenth and
seventeenth centuries? At the close of the Middle Ages a new
mentality discloses itself. Invention stimulated thought, thought
quickened physical speculation, Greek manuscripts disclosed what
the ancients had discovered. Finally although in the year 1500
Europe knew less than Archimedes who died in the year 212 B. C.,
yet in the year 1700, Newton’s Principia had been written and the
world was well started on the modern epoch.
There have been great civilisations in which the peculiar balance
of mind required for science has only fitfully appeared and has
produced the feeblest result. For example, the more we know of
Chinese art, of Chinese literature, and of the Chinese philosophy of
life, the more we admire the heights to which that civilization
attained. For thousands of years, there have been in China acute
and learned men patiently devoting their lives to study. Having
regard to the span of time, and to the population concerned, China
forms the largest volume of civilisation which the world has seen.
There is no reason to doubt the intrinsic capacity of individual
Chinamen for the pursuit of science. And yet Chinese science is
practically negligible. There is no reason to believe that China if left
to itself would have ever produced any progress in science. The
same may be said of India. Furthermore, if the Persians had
enslaved the Greeks, there is no definite ground for belief that
science would have flourished in Europe. The Romans showed no
particular originality in that line. Even as it was, the Greeks, though
they founded the movement, did not sustain it with the concentrated
interest which modern Europe has shown. I am not alluding to the
last few generations of the European peoples on both sides of the
ocean; I mean the smaller Europe of the Reformation period,
distracted as it was with wars and religious disputes. Consider the
world of the eastern Mediterranean, from Sicily to western Asia,
during the period of about 1400 years from the death of Archimedes
[in 212 B. C.] to the irruption of the Tartars. There were wars and
revolutions and large changes of religion: but nothing much worse
than the wars of the sixteenth and seventeenth centuries throughout
Europe. There was a great and wealthy civilisation, Pagan, Christian,
Mahometan. In that period a great deal was added to science. But
on the whole the progress was slow and wavering; and, except in
mathematics, the men of the Renaissance practically started from
the position which Archimedes had reached. There had been some
progress in medicine and some progress in astronomy. But the total
advance was very little compared to the marvellous success of the
seventeenth century. For example, compare the progress of
scientific knowledge from the year 1560, just before the births of
Galileo and of Kepler, up to the year 1700, when Newton was in the
height of his fame, with the progress in the ancient period, already
mentioned, exactly ten times as long.
Nevertheless, Greece was the mother of Europe; and it is to
Greece that we must look in order to find the origin of our modern
ideas. We all know that on the eastern shores of the Mediterranean
there was a very flourishing school of Ionian philosophers, deeply
interested in theories concerning nature. Their ideas have been
transmitted to us, enriched by the genius of Plato and Aristotle. But,
with the exception of Aristotle, and it is a large exception, this school
of thought had not attained to the complete scientific mentality. In
some ways, it was better. The Greek genius was philosophical, lucid
and logical. The men of this group were primarily asking
philosophical questions. What is the substratum of nature? Is it fire,
or earth, or water, or some combination of any two, or of all three?
Or is it a mere flux, not reducible to some static material?
Mathematics interested them mightily. They invented its generality,
analysed its premises, and made notable discoveries of theorems by
a rigid adherence to deductive reasoning. Their minds were infected
with an eager generality. They demanded clear, bold ideas, and strict
reasoning from them. All this was excellent; it was genius; it was
ideal preparatory work. But it was not science as we understand it.
The patience of minute observation was not nearly so prominent.
Their genius was not so apt for the state of imaginative muddled
suspense which precedes successful inductive generalisation. They
were lucid thinkers and bold reasoners.
Of course there were exceptions, and at the very top: for example,
Aristotle and Archimedes. Also for patient observation, there were
the astronomers. There was a mathematical lucidity about the stars,
and a fascination about the small numerable band of run-a-way
planets.
Every philosophy is tinged with the colouring of some secret
imaginative background, which never emerges explicitly into its
trains of reasoning. The Greek view of nature, at least that
cosmology transmitted from them to later ages, was essentially
dramatic. It is not necessarily wrong for this reason: but it was
overwhelmingly dramatic. It thus conceived nature as articulated in
the way of a work of dramatic art, for the exemplification of general
ideas converging to an end. Nature was differentiated so as to
provide its proper end for each thing. There was the centre of the
universe as the end of motion for those things which are heavy, and
the celestial spheres as the end of motion for those things whose
natures lead them upwards. The celestial spheres were for things
which are impassible and ingenerable, the lower regions for things
impassible and generable. Nature was a drama in which each thing
played its part.
I do not say that this is a view to which Aristotle would have
subscribed without severe reservations, in fact without the sort of
reservations which we ourselves would make. But it was the view
which subsequent Greek thought extracted from Aristotle and
passed on to the Middle Ages. The effect of such an imaginative
setting for nature was to damp down the historical spirit. For it was
the end which seemed illuminating, so why bother about the
beginning? The Reformation and the scientific movement were two
aspects of the historical revolt which was the dominant intellectual
movement of the later Renaissance. The appeal to the origins of
Christianity, and Francis Bacon’s appeal to efficient causes as
against final causes, were two sides of one movement of thought.
Also for this reason Galileo and his adversaries were at hopeless
cross purposes, as can be seen from his Dialogues on the Two
Systems of the World.
Galileo keeps harping on how things happen, whereas his
adversaries had a complete theory as to why things happen.
Unfortunately the two theories did not bring out the same results.
Galileo insists upon ‘irreducible and stubborn facts,’ and Simplicius,
his opponent, brings forward reasons, completely satisfactory, at
least to himself. It is a great mistake to conceive this historical revolt
as an appeal to reason. On the contrary, it was through and through
an anti-intellectualist movement. It was the return to the
contemplation of brute fact; and it was based on a recoil from the
inflexible rationality of medieval thought. In making this statement I
am merely summarising what at the time the adherents of the old
régime themselves asserted. For example, in the fourth book of
Father Paul Sarpi’s History of the Council of Trent, you will find that
in the year 1551 the Papal Legates who presided over the Council
ordered: ‘That the Divines ought to confirm their opinions with the
holy Scripture, Traditions of the Apostles, sacred and approved
Councils, and by the Constitutions and Authorities of the holy
Fathers; that they ought to use brevity, and avoid superfluous and
unprofitable questions, and perverse contentions.... This order did
not please the Italian Divines; who said it was a novity, and a
condemning of School-Divinity, which, in all difficulties, useth reason,
and because it was not lawful [i.e., by this decree] to treat as St.
Thomas [Aquinas], St. Bonaventure, and other famous men did.’
It is impossible not to feel sympathy with these Italian divines,
maintaining the lost cause of unbridled rationalism. They were
deserted on all hands. The Protestants were in full revolt against
them. The Papacy failed to support them, and the Bishops of the
Council could not even understand them. For a few sentences below
the foregoing quotation, we read: ‘Though many complained here-of
[i.e., of the Decree], yet it prevailed but little, because generally the
Fathers [i.e., the Bishops] desired to hear men speak with intelligible
terms, not abstrusely, as in the matter of Justification, and others
already handled.’
Poor belated medievalists! When they used reason they were not
even intelligible to the ruling powers of their epoch. It will take
centuries before stubborn facts are reducible by reason, and
meanwhile the pendulum swings slowly and heavily to the extreme
of the historical method.
Forty-three years after the Italian divines had written this
memorial, Richard Hooker in his famous Laws of Ecclesiastical Polity
makes exactly the same complaint of his Puritan adversaries.[1]
Hooker’s balanced thought—from which the appellation ‘The
Judicious Hooker’ is derived—, and his diffuse style, which is the
vehicle of such thought, make his writings singularly unfit for the
process of summarising by a short, pointed quotation. But, in the
section referred to, he reproaches his opponents with Their
Disparagement of Reason; and in support of his own position
definitely refers to ‘The greatest amongst the school-divines,’ by
which designation I presume that he refers to St. Thomas Aquinas.
1. Cf. Book III, Section VIII.
Hooker’s Ecclesiastical Polity was published just before Sarpi’s
Council of Trent. Accordingly there was complete independence
between the two works. But both the Italian divines of 1551, and
Hooker at the end of that century testify to the anti-rationalist trend of
thought at that epoch, and in this respect contrast their own age with
the epoch of scholasticism.
This reaction was undoubtedly a very necessary corrective to the
unguarded rationalism of the Middle Ages. But reactions run to
extremes. Accordingly, although one outcome of this reaction was
the birth of modern science, yet we must remember that science
thereby inherited the bias of thought to which it owes its origin.
The effect of Greek dramatic literature was many-sided so far as
concerns the various ways in which it indirectly affected medieval
thought. The pilgrim fathers of the scientific imagination as it exists
today, are the great tragedians of ancient Athens, Aeschylus,
Sophocles, Euripides. Their vision of fate, remorseless and
indifferent, urging a tragic incident to its inevitable issue, is the vision
possessed by science. Fate in Greek Tragedy becomes the order of
nature in modern thought. The absorbing interest in the particular
heroic incidents, as an example and a verification of the workings of
fate, reappears in our epoch as concentration of interest on the
crucial experiments. It was my good fortune to be present at the
meeting of the Royal Society in London when the Astronomer Royal
for England announced that the photographic plates of the famous
eclipse, as measured by his colleagues in Greenwich Observatory,
had verified the prediction of Einstein that rays of light are bent as
they pass in the neighbourhood of the sun. The whole atmosphere of
tense interest was exactly that of the Greek drama: we were the
chorus commenting on the decree of destiny as disclosed in the
development of a supreme incident. There was dramatic quality in
the very staging:—the traditional ceremonial, and in the background
the picture of Newton to remind us that the greatest of scientific
generalisations was now, after more than two centuries, to receive its
first modification. Nor was the personal interest wanting: a great
adventure in thought had at length come safe to shore.
Let me here remind you that the essence of dramatic tragedy is
not unhappiness. It resides in the solemnity of the remorseless
working of things. This inevitableness of destiny can only be
illustrated in terms of human life by incidents which in fact involve
unhappiness. For it is only by them that the futility of escape can be
made evident in the drama. This remorseless inevitableness is what
pervades scientific thought. The laws of physics are the decrees of
fate.
The conception of the moral order in the Greek plays was certainly
not a discovery of the dramatists. It must have passed into the
literary tradition from the general serious opinion of the times. But in
finding this magnificent expression, it thereby deepened the stream
of thought from which it arose. The spectacle of a moral order was
impressed upon the imagination of classical civilisation.
The time came when that great society decayed, and Europe
passed into the Middle Ages. The direct influence of Greek literature
vanished. But the concept of the moral order and of the order of
nature had enshrined itself in the Stoic philosophy. For example,
Lecky in his History of European Morals tells us ‘Seneca maintains
that the Divinity has determined all things by an inexorable law of
destiny, which He has decreed, but which He Himself obeys.’ But the
most effective way in which the Stoics influenced the mentality of the
Middle Ages was by the diffused sense of order which arose from
Roman law. Again to quote Lecky, ‘The Roman legislation was in a
two-fold manner the child of philosophy. It was in the first place
formed upon the philosophical model, for, instead of being a mere
empirical system adjusted to the existing requirements of society, it
laid down abstract principles of right to which it endeavoured to
conform; and, in the next place, these principles were borrowed
directly from Stoicism.’ In spite of the actual anarchy throughout
large regions in Europe after the collapse of the Empire, the sense of
legal order always haunted the racial memories of the Imperial
populations. Also the Western Church was always there as a living
embodiment of the traditions of Imperial rule.
It is important to notice that this legal impress upon medieval
civilisation was not in the form of a few wise precepts which should
permeate conduct. It was the conception of a definite articulated
system which defines the legality of the detailed structure of social
organism, and of the detailed way in which it should function. There
was nothing vague. It was not a question of admirable maxims, but
of definite procedure to put things right and to keep them there. The
Middle Ages formed one long training of the intellect of Western
Europe in the sense of order. There may have been some deficiency
in respect to practice. But the idea never for a moment lost its grip. It
was preëminently an epoch of orderly thought, rationalist through
and through. The very anarchy quickened the sense for coherent
system; just as the modern anarchy of Europe has stimulated the
intellectual vision of a League of Nations.
But for science something more is wanted than a general sense of
the order in things. It needs but a sentence to point out how the habit
of definite exact thought was implanted in the European mind by the
long dominance of scholastic logic and scholastic divinity. The habit
remained after the philosophy had been repudiated, the priceless
habit of looking for an exact point and of sticking to it when found.
Galileo owes more to Aristotle than appears on the surface of his
Dialogues: he owes to him his clear head and his analytic mind.
I do not think, however, that I have even yet brought out the
greatest contribution of medievalism to the formation of the scientific
movement. I mean the inexpugnable belief that every detailed
occurrence can be correlated with its antecedents in a perfectly
definite manner, exemplifying general principles. Without this belief
the incredible labours of scientists would be without hope. It is this
instinctive conviction, vividly poised before the imagination, which is
the motive power of research:—that there is a secret, a secret which
can be unveiled. How has this conviction been so vividly implanted
on the European mind?
When we compare this tone of thought in Europe with the attitude
of other civilisations when left to themselves, there seems but one
source for its origin. It must come from the medieval insistence on
the rationality of God, conceived as with the personal energy of
Jehovah and with the rationality of a Greek philosopher. Every detail
was supervised and ordered: the search into nature could only result
in the vindication of the faith in rationality. Remember that I am not
talking of the explicit beliefs of a few individuals. What I mean is the
impress on the European mind arising from the unquestioned faith of
centuries. By this I mean the instinctive tone of thought and not a
mere creed of words.
In Asia, the conceptions of God were of a being who was either
too arbitrary or too impersonal for such ideas to have much effect on
instinctive habits of mind. Any definite occurrence might be due to
the fiat of an irrational despot, or might issue from some impersonal,
inscrutable origin of things. There was not the same confidence as in
the intelligible rationality of a personal being. I am not arguing that
the European trust in the scrutability of nature was logically justified
even by its own theology. My only point is to understand how it
arose. My explanation is that the faith in the possibility of science,
generated antecedently to the development of modern scientific
theory, is an unconscious derivative from medieval theology.
But science is not merely the outcome of instinctive faith. It also
requires an active interest in the simple occurrences of life for their
own sake.
This qualification ‘for their own sake’ is important. The first phase
of the Middle Ages was an age of symbolism. It was an age of vast
ideas, and of primitive technique. There was little to be done with
nature, except to coin a hard living from it. But there were realms of
thought to be explored, realms of philosophy and realms of theology.
Primitive art could symbolise those ideas which filled all thoughtful
minds. The first phase of medieval art has a haunting charm beyond
compare: its own intrinsic quality is enhanced by the fact that its
message, which stretched beyond art’s own self-justification of
aesthetic achievement, was the symbolism of things lying behind
nature itself. In this symbolic phase, medieval art energised in nature
as its medium, but pointed to another world.
In order to understand the contrast between these early Middle
Ages and the atmosphere required by the scientific mentality, we
should compare the sixth century in Italy with the sixteenth century.
In both centuries the Italian genius was laying the foundations of a
new epoch. The history of the three centuries preceding the earlier
period, despite the promise for the future introduced by the rise of
Christianity, is overwhelmingly infected by the sense of the decline of
civilisation. In each generation something has been lost. As we read
the records, we are haunted by the shadow of the coming barbarism.
There are great men, with fine achievements in action or in thought.
But their total effect is merely for some short time to arrest the
general decline. In the sixth century we are, so far as Italy is
concerned, at the lowest point of the curve. But in that century every
action is laying the foundation for the tremendous rise of the new
European civilisation. In the background the Byzantine Empire,
under Justinian, in three ways determined the character of the early
Middle Ages in Western Europe. In the first place, its armies, under
Belisarius and Narses, cleared Italy from the Gothic domination. In
this way, the stage was freed for the exercise of the old Italian genius
for creating organisations which shall be protective of ideals of
cultural activity. It is impossible not to sympathise with the Goths: yet
there can be no doubt but that a thousand years of the Papacy were
infinitely more valuable for Europe than any effects derivable from a
well-established Gothic kingdom of Italy.
In the second place, the codification of the Roman law established
the ideal of legality which dominated the sociological thought of
Europe in the succeeding centuries. Law is both an engine for
government, and a condition restraining government. The canon law
of the Church, and the civil law of the State, owe to Justinian’s
lawyers their influence on the development of Europe. They
established in the Western mind the ideal that an authority should be
at once lawful, and law-enforcing, and should in itself exhibit a
rationally adjusted system of organisation. The sixth century in Italy
gave the initial exhibition of the way in which the impress of these
ideas was fostered by contact with the Byzantine Empire.
Thirdly, in the non-political spheres of art and learning
Constantinople exhibited a standard of realised achievement which,
partly by the impulse to direct imitation, and partly by the indirect
inspiration arising from the mere knowledge that such things existed,
acted as a perpetual spur to Western culture. The wisdom of the
Byzantines, as it stood in the imagination of the first phase of
medieval mentality, and the wisdom of the Egyptians as it stood in
the imagination of the early Greeks, played analogous rôles.
Probably the actual knowledge of these respective wisdoms was, in
either case, about as much as was good for the recipients. They
knew enough to know the sort of standards which are attainable, and
not enough to be fettered by static and traditional ways of thought.
Accordingly, in both cases men went ahead on their own and did
better. No account of the rise of the European scientific mentality can
omit some notice of this influence of the Byzantine civilisation in the
background. In the sixth century there is a crisis in the history of the
relations between the Byzantines and the West; and this crisis is to
be contrasted with the influence of Greek literature on European
thought in the fifteenth and sixteenth centuries. The two outstanding
men, who in the Italy of the sixth century laid the foundations of the
future, were St. Benedict and Gregory the Great. By reference to
them, we can at once see how absolutely in ruins was the approach
to the scientific mentality which had been attained by the Greeks.
We are at the zero point of scientific temperature. But the life-work of
Gregory and of Benedict contributed elements to the reconstruction
of Europe which secured that this reconstruction, when it arrived,
should include a more effective scientific mentality than that of the
ancient world. The Greeks were over-theoretical. For them science
was an offshoot of philosophy. Gregory and Benedict were practical
men, with an eye for the importance of ordinary things; and they
combined this practical temperament with their religious and cultural
activities. In particular, we owe it to St. Benedict that the monasteries
were the homes of practical agriculturalists, as well as of saints and
of artists and of men of learning. The alliance of science with
technology, by which learning is kept in contact with irreducible and
stubborn facts, owes much to the practical bent of the early
Benedictines. Modern science derives from Rome as well as from
Greece, and this Roman strain explains its gain in an energy of
thought kept closely in contact with the world of facts.
But the influence of this contact between the monasteries and the
facts of nature showed itself first in art. The rise of Naturalism in the
later Middle Ages was the entry into the European mind of the final
ingredient necessary for the rise of science. It was the rise of interest
in natural objects, and in natural occurrences, for their own sakes.
The natural foliage of a district was sculptured in out-of-the-way
spots of the later buildings, merely as exhibiting delight in those
familiar objects. The whole atmosphere of every art exhibited a direct
joy in the apprehension of the things which lie around us. The
craftsmen who executed the late medieval decorative sculpture,
Giotto, Chaucer, Wordsworth, Walt Whitman, and, at the present
day, the New England poet Robert Frost, are all akin to each other in
this respect. The simple immediate facts are the topics of interest,
and these reappear in the thought of science as the ‘irreducible
stubborn facts.’
The mind of Europe was now prepared for its new venture of
thought. It is unnecessary to tell in detail the various incidents which
marked the rise of science: the growth of wealth and leisure; the
expansion of universities; the invention of printing; the taking of
Constantinople; Copernicus; Vasco da Gama; Columbus; the
telescope. The soil, the climate, the seeds, were there, and the
forest grew. Science has never shaken off the impress of its origin in
the historical revolt of the later Renaissance. It has remained
predominantly an anti-rationalistic movement, based upon a naïve
faith. What reasoning it has wanted, has been borrowed from
mathematics which is a surviving relic of Greek rationalism, following
the deductive method. Science repudiates philosophy. In other
words, it has never cared to justify its faith or to explain its meanings;
and has remained blandly indifferent to its refutation by Hume.
Of course the historical revolt was fully justified. It was wanted. It
was more than wanted: it was an absolute necessity for healthy
progress. The world required centuries of contemplation of
irreducible and stubborn facts. It is difficult for men to do more than
one thing at a time, and that was the sort of thing they had to do after
the rationalistic orgy of the Middle Ages. It was a very sensible
reaction; but it was not a protest on behalf of reason.
There is, however, a Nemesis which waits upon those who
deliberately avoid avenues of knowledge. Oliver Cromwell’s cry
echoes down the ages, ‘My brethren, by the bowels of Christ I
beseech you, bethink you that you may be mistaken.’
The progress of science has now reached a turning point. The
stable foundations of physics have broken up: also for the first time
physiology is asserting itself as an effective body of knowledge, as
distinct from a scrap-heap. The old foundations of scientific thought
are becoming unintelligible. Time, space, matter, material, ether,
electricity, mechanism, organism, configuration, structure, pattern,
function, all require reinterpretation. What is the sense of talking
about a mechanical explanation when you do not know what you
mean by mechanics?
The truth is that science started its modern career by taking over
ideas derived from the weakest side of the philosophies of Aristotle’s
successors. In some respects it was a happy choice. It enabled the
knowledge of the seventeenth century to be formularised so far as
physics and chemistry were concerned, with a completeness which
has lasted to the present time. But the progress of biology and
psychology has probably been checked by the uncritical assumption
of half-truths. If science is not to degenerate into a medley of ad hoc
hypotheses, it must become philosophical and must enter upon a
thorough criticism of its own foundations.
In the succeeding lectures of this course, I shall trace the
successes and the failures of the particular conceptions of
cosmology with which the European intellect has clothed itself in the
last three centuries. General climates of opinion persist for periods of
about two to three generations, that is to say, for periods of sixty to a
hundred years. There are also shorter waves of thought, which play
on the surface of the tidal movement. We shall find, therefore,
transformations in the European outlook, slowly modifying the
successive centuries. There persists, however, throughout the whole
period the fixed scientific cosmology which presupposes the ultimate
fact of an irreducible brute matter, or material, spread throughout
space in a flux of configurations. In itself such a material is
senseless, valueless, purposeless. It just does what it does do,
following a fixed routine imposed by external relations which do not
spring from the nature of its being. It is this assumption that I call
‘scientific materialism.’ Also it is an assumption which I shall
challenge as being entirely unsuited to the scientific situation at
which we have now arrived. It is not wrong, if properly construed. If
we confine ourselves to certain types of facts, abstracted from the
complete circumstances in which they occur, the materialistic
assumption expresses these facts to perfection. But when we pass
beyond the abstraction, either by more subtle employment of our
senses, or by the request for meanings and for coherence of
thoughts, the scheme breaks down at once. The narrow efficiency of
the scheme was the very cause of its supreme methodological
success. For it directed attention to just those groups of facts which,
in the state of knowledge then existing, required investigation.
The success of the scheme has adversely affected the various
currents of European thought. The historical revolt was anti-
rationalistic, because the rationalism of the scholastics required a
sharp correction by contact with brute fact. But the revival of
philosophy in the hands of Descartes and his successors was
entirely coloured in its development by the acceptance of the
scientific cosmology at its face value. The success of their ultimate
ideas confirmed scientists in their refusal to modify them as the
result of an enquiry into their rationality. Every philosophy was bound
in some way or other to swallow them whole. Also the example of
science affected other regions of thought. The historical revolt has
thus been exaggerated into the exclusion of philosophy from its
proper rôle of harmonising the various abstractions of
methodological thought. Thought is abstract; and the intolerant use
of abstractions is the major vice of the intellect. This vice is not
wholly corrected by the recurrence to concrete experience. For after
all, you need only attend to those aspects of your concrete
experience which lie within some limited scheme. There are two
methods for the purification of ideas. One of them is dispassionate
observation by means of the bodily senses. But observation is
selection. Accordingly, it is difficult to transcend a scheme of
abstraction whose success is sufficiently wide. The other method is
by comparing the various schemes of abstraction which are well
founded in our various types of experience. This comparison takes
the form of satisfying the demands of the Italian scholastic divines
whom Paul Sarpi mentioned. They asked that reason should be
used. Faith in reason is the trust that the ultimate natures of things
lie together in a harmony which excludes mere arbitrariness. It is the
faith that at the base of things we shall not find mere arbitrary
mystery. The faith in the order of nature which has made possible
the growth of science is a particular example of a deeper faith. This
faith cannot be justified by any inductive generalisation. It springs
from direct inspection of the nature of things as disclosed in our own
immediate present experience. There is no parting from your own
shadow. To experience this faith is to know that in being ourselves
we are more than ourselves: to know that our experience, dim and
fragmentary as it is, yet sounds the utmost depths of reality: to know
that detached details merely in order to be themselves demand that
they should find themselves in a system of things: to know that this
system includes the harmony of logical rationality, and the harmony
of aesthetic achievement: to know that, while the harmony of logic
lies upon the universe as an iron necessity, the aesthetic harmony
stands before it as a living ideal moulding the general flux in its
broken progress towards finer, subtler issues.
CHAPTER II
MATHEMATICS AS AN ELEMENT IN
THE HISTORY OF THOUGHT
The science of Pure Mathematics, in its modern developments,

may claim to be the most original creation of the human spirit.
Another claimant for this position is music. But we will put aside all
rivals, and consider the ground on which such a claim can be made
for mathematics. The originality of mathematics consists in the fact
that in mathematical science connections between things are
exhibited which, apart from the agency of human reason, are
extremely unobvious. Thus the ideas, now in the minds of
contemporary mathematicians, lie very remote from any notions
which can be immediately derived by perception through the senses;
unless indeed it be perception stimulated and guided by antecedent
mathematical knowledge. This is the thesis which I proceed to
exemplify.
Suppose we project our imaginations backwards through many
thousands of years, and endeavour to realise the simple-
mindedness of even the greatest intellects in those early societies.
Abstract ideas which to us are immediately obvious must have been,
for them, matters only of the most dim apprehension. For example
take the question of number. We think of the number ‘five’ as
applying to appropriate groups of any entities whatsoever—to five
fishes, five children, five apples, five days. Thus in considering the
relations of the number ‘five’ to the number ‘three,’ we are thinking of
two groups of things, one with five members and the other with three
members. But we are entirely abstracting from any consideration of
any particular entities, or even of any particular sorts of entities,
which go to make up the membership of either of the two groups. We
are merely thinking of those relationships between those two groups
which are entirely independent of the individual essences of any of
the members of either group. This is a very remarkable feat of
abstraction; and it must have taken ages for the human race to rise
to it. During a long period, groups of fishes will have been compared
to each other in respect to their multiplicity, and groups of days to
each other. But the first man who noticed the analogy between a
group of seven fishes and a group of seven days made a notable
advance in the history of thought. He was the first man who
entertained a concept belonging to the science of pure mathematics.
At that moment it must have been impossible for him to divine the
complexity and subtlety of these abstract mathematical ideas which
were waiting for discovery. Nor could he have guessed that these
notions would exert a widespread fascination in each succeeding
generation. There is an erroneous literary tradition which represents
the love of mathematics as a monomania confined to a few
eccentrics in each generation. But be this as it may, it would have
been impossible to anticipate the pleasure derivable from a type of
abstract thinking which had no counterpart in the then-existing
society. Thirdly, the tremendous future effect of mathematical
knowledge on the lives of men, on their daily avocations, on their
habitual thoughts, on the organization of society, must have been
even more completely shrouded from the foresight of those early
thinkers. Even now there is a very wavering grasp of the true
position of mathematics as an element in the history of thought. I will
not go so far as to say that to construct a history of thought without
profound study of the mathematical ideas of successive epochs is
like omitting Hamlet from the play which is named after him. That
would be claiming too much. But it is certainly analogous to cutting
out the part of Ophelia. This simile is singularly exact. For Ophelia is
quite essential to the play, she is very charming,—and a little mad.
Let us grant that the pursuit of mathematics is a divine madness of
the human spirit, a refuge from the goading urgency of contingent
happenings.
When we think of mathematics, we have in our mind a science
devoted to the exploration of number, quantity, geometry, and in
modern times also including investigation into yet more abstract
concepts of order, and into analogous types of purely logical
relations. The point of mathematics is that in it we have always got
rid of the particular instance, and even of any particular sorts of
entities. So that for example, no mathematical truths apply merely to
fish, or merely to stones, or merely to colours. So long as you are
dealing with pure mathematics, you are in the realm of complete and
absolute abstraction. All you assert is, that reason insists on the
admission that, if any entities whatever have any relations which
satisfy such-and-such purely abstract conditions, then they must
have other relations which satisfy other purely abstract conditions.
Mathematics is thought moving in the sphere of complete
abstraction from any particular instance of what it is talking about. So
far is this view of mathematics from being obvious, that we can
easily assure ourselves that it is not, even now, generally
understood. For example, it is habitually thought that the certainty of
mathematics is a reason for the certainty of our geometrical
knowledge of the space of the physical universe. This is a delusion
which has vitiated much philosophy in the past, and some
philosophy in the present. This question of geometry is a test case of
some urgency. There are certain alternative sets of purely abstract
conditions possible for the relationships of groups of unspecified
entities, which I will call geometrical conditions. I give them this
name because of their general analogy to those conditions, which
we believe to hold respecting the particular geometrical relations of
things observed by us in our direct perception of nature. So far as
our observations are concerned, we are not quite accurate enough
to be certain of the exact conditions regulating the things we come
across in nature. But we can by a slight stretch of hypothesis identify
these observed conditions with some one set of the purely abstract
geometrical conditions. In doing so, we make a particular
determination of the group of unspecified entities which are the
relata in the abstract science. In the pure mathematics of
geometrical relationships, we say that, if any group of entities enjoy
any relationships among its members satisfying this set of abstract
geometrical conditions, then such-and-such additional abstract
conditions must also hold for such relationships. But when we come
to physical space, we say that some definitely observed group of
physical entities enjoys some definitely observed relationships
among its members which do satisfy this above-mentioned set of
abstract geometrical conditions. We thence conclude that the
additional relationships which we concluded to hold in any such
case, must therefore hold in this particular case.
The certainty of mathematics depends upon its complete abstract
generality. But we can have no à priori certainty that we are right in
believing that the observed entities in the concrete universe form a
particular instance of what falls under our general reasoning. To take
another example from arithmetic. It is a general abstract truth of pure
mathematics that any group of forty entities can be subdivided into
two groups of twenty entities. We are therefore justified in concluding
that a particular group of apples which we believe to contain forty
members can be subdivided into two groups of apples of which each
contains twenty members. But there always remains the possibility
that we have miscounted the big group; so that, when we come in
practice to subdivide it, we shall find that one of the two heaps has
an apple too few or an apple too many.
Accordingly, in criticising an argument based upon the application
of mathematics to particular matters of fact, there are always three
processes to be kept perfectly distinct in our minds. We must first
scan the purely mathematical reasoning to make sure that there are
no mere slips in it—no casual illogicalities due to mental failure. Any
mathematician knows from bitter experience that, in first elaborating
a train of reasoning, it is very easy to commit a slight error which yet
makes all the difference. But when a piece of mathematics has been
revised, and has been before the expert world for some time, the
chance of a casual error is almost negligible. The next process is to
make quite certain of all the abstract conditions which have been
presupposed to hold. This is the determination of the abstract
premises from which the mathematical reasoning proceeds. This is a
matter of considerable difficulty. In the past quite remarkable
oversights have been made, and have been accepted by
generations of the greatest mathematicians. The chief danger is that

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Financial Reporting Analysis Using Financial Accounting

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Footnotes and Management Disclosures

ment of the likelihood that customers will pay.

Footnote Disclosures, and Interpretations

(€ in thousands) 2013 2012

Financial Analysis Discussions

ANALYSING FINANCIAL STATEMENTS

Applying the Accounts Receivable Turnover Ratio to TomTom

Average accounts receivable 365 days

Assignments that Draw on Real Data

12. Property, plant and equipment

Freehold Fixtures, Assets in the

a. Calculate the percent depreciated ratio for each year.

3-Step Process: Analyse, Journalise, Post

Bal ance Sheet I ncome Statement

Assignments that Draw on Real Data

12. Property, plant and equipment

Freehold Fixtures, Assets in the

a. Calculate the percent depreciated ratio for each year.

3-Step Process: Analyse, Journalise, Post

Bal ance Sheet I ncome Statement

Cash Noncash Liabil- Contrib. Earned Net

Asset Sales and Impairments

YOU MAKE THE CALL

Mid-Chapter and Chapter-End Reviews

Asset Sales and Impairments

YOU MAKE THE CALL

Mid-Chapter and Chapter-End Reviews

(in Hong Kong $ million) 2013 2012

Current tax expenses

The solution to this review problem can be found on page 499.

Research Insights for Business Students

FLEXIBILITY FOR COURSES OF VARYING LENGTHS

15 Week 10 Week 6 Week 1 Week

Chapter 1 Week 1 Week 1 Week 1

Chapter 3 Week 3 & 4 Week 3 & 4 Week 2 & 3 Day 2

Chapter 4 Week 5 & 6 Week 4 & 5 Optional Optional

Chapter 5 Week 6 & 7 Optional Optional Optional

Chapter 6 Week 7 & 8 Week 6 Week 3 Day 3

Chapter 7 Week 9 Week 7 Week 4

Chapter 9 Week 11 & 12 Week 9 Week 6 Day 5

Chapter 11 Week 14 Optional Optional Optional

Chapter 12 Week 15 Optional Optional Optional

Available Learning Modules (You Select)

Darrin Ambrose, University of Calgary Irene Kim, George Washington University

Darrin Ambrose, University of Calgary Irene Kim, George Washington University

Chapter 1 Introducing Financial Accounting 3

Chapter 2 Constructing Financial Statements 39

Chapter 3 Adjusting Accounts for Financial Statements 93

Chapter 4 Reporting and Analysing Cash Flows 149

Chapter 5 Analysing and Interpreting Financial Statements 211

Chapter 6 Reporting and Analysing Revenues and Receivables 271

Chapter 7 Reporting and Analysing Inventory 319

Chapter 8 Reporting and Analysing Long-Term Operating Assets 359

Chapter 9 Reporting and Analysing Liabilities 399