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 Third Edition

Financial Accounting
Financial
Third Edition

Financial Accounting
An International Introduction
An International Introduction
David Alexander
Christopher Nobes

Accounting
Key features
“I find this book highly readable
• Expanded and amended coverage of group
and a very useful introduction to accounting and of financial analysis.
financial accounting, in particular the • Real-life examples are included from a wide
regulatory framework influencing range of countries.
accounting in an international context” • ‘Activities’ and ‘Why it Matters’ boxes
Fredrik Ljungdahl, Senior Lecturer,
Jönköping International Business School
integrated throughout each chapter to
challenge students and stimulate further
interest.
An International Introduction
Financial Accounting is the ideal choice for • New bookkeeping appendix provides
all those looking for an introductory text in step-by-step coverage of the key techniques.
financial accounting, particularly those with
little or no previous knowledge of the subject.
With a clear writing style, this accessible book
• Extensive exercises at the close of each
chapter. David Alexander
is unique in teaching financial accounting
in a way that is not country-specific, using
• Includes a glossary of terms used in IFRS
(and UK and US) accounting. Christopher Nobes
International Financial Reporting Standards • Ideal for undergraduate and MBA students
(IFRS) as its framework to explain key concepts worldwide, taking a first course in financial
and practice. Building on the success of the accounting.
second edition, this truly international book
continues to draw contemporary examples from
Europe, the US and beyond, and has been fully
updated to incorporate the extensive accounting
changes of the past three years.

David Alexander is Professor of Accounting at Third

the University of Birmingham Business School, Edition
England.
Christopher Nobes is PricewaterhouseCooper’s

Nobes
Alexander
Professor of Accounting at the University of
Reading, England. From 1993 to 2001 he was a
representative on the board of the International
Accounting Standards Committee.

www.pearson-books.com
an imprint of

9780273709268_COVER.indd 1 18/4/07 16:17:03

FINA_A01.qxd 4/13/07 2:07 PM Page i

FINANCIAL ACCOUNTING
An International Introduction

Visit the Financial Accounting: An International Introduction, third

edition Companion Website at www.pearsoned.co.uk/alexander
to find valuable student learning material including:

n Self-assessment questions to check your understanding

n Weblinks to relevant Internet resources to facilitate in-depth
independent research
n Newly updated and improved presentation of double-entry
bookkeeping principles

..
FINA_A01.qxd 4/13/07 2:07 PM Page ii

We work with leading authors to develop the strongest

educational materials in accounting, bringing cutting-edge
thinking and best learning practice to a global market.

Under a range of well-known imprints, including

Financial Times Prentice Hall, we craft high-quality print
and electronic publications which help readers to
understand and apply their content, whether studying
or at work.

To find out more about the complete range of our

publishing, please visit us on the World Wide Web at:
www.pearsoned.co.uk

..
FINA_A01.qxd 5/10/07 4:33 PM Page iii

Third edition

FINANCIAL ACCOUNTING
An International Introduction

David Alexander and

Christopher Nobes
with an Appendix on Double-entry Bookkeeping
by Anne Ullathorne

..
FINA_A01.qxd 4/13/07 2:07 PM Page iv

Pearson Education Limited

Edinburgh Gate
Harlow
Essex CM20 2JE
England
and Associated Companies throughout the world

Visit us on the World Wide Web at:

www.pearsoned.co.uk

First published 2001

Second edition published 2004
Third edition published 2007

© Pearson Education Limited 2001, 2007

The rights of David Alexander and Christopher Nobes to be identified as authors of this work
have been asserted by them in accordance with the Copyright, Designs and Patents Act 1988.

All rights reserved. No part of this publication may be reproduced, stored in a retrieval system,
or transmitted in any form or by any means, electronic, mechanical, photocopying, recording
or otherwise, without either the prior written permission of the publisher or a licence permitting
restricted copying in the United Kingdom issued by the Copyright Licensing Agency Ltd,
Saffron House, 6–10 Kirby Street, London EC1N 8TS.

All trademarks used herein are the property of their respective owners. The use of any trademark
in this text does not vest in the author or publisher any trademark ownership rights in such
trademarks, nor does the use of such trademarks imply any affiliation with or endorsement of
this book by such owners.

ISBN: 978-0-273-70926-8

British Library Cataloguing-in-Publication Data

A catalogue record for this book is available from the British Library

10 9 8 7 6 5 4 3 2 1
11 10 09 08 07

Typeset in 9.5/12.5pt Stone Serif by 35

Printed and bound by Ashford Colour Press, Gosport

The publisher’s policy is to use paper manufactured from sustainable forests.

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FINA_A01.qxd 4/13/07 2:07 PM Page v

Contents

Foreword to the first edition xi

Preface xiii
Acknowledgements xv
Abbreviations xvi

Part 1 THE CONTEXT OF ACCOUNTING 1

1 Introduction 3
Objectives 3
1.1 Purposes and users of accounting 4
1.2 Accounting regulation and the accountancy profession 7
1.3 Language 9
1.4 Excitement in accounting 10
1.5 The path ahead 10
Summary 11
Exercises 11

2 Some fundamentals 13
Objectives 13
2.1 Introduction 14
2.2 The balance sheet 14
2.3 The income statement 21
2.4 Two simple equations 27
2.5 How cash flows fit in 29
Summary 30
Exercises 30

3 Frameworks and concepts 34

Objectives 34
3.1 Introduction 35
3.2 Underlying concepts 37
3.3 The IASB’s concepts 38
3.4 A hierarchy of concepts and some inconsistencies 42
3.5 Possible future developments 44
Summary 44
References and research 45
Exercises 45

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Contents

4 The regulation of accounting 47

Objectives 47
4.1 Introduction: various ways to regulate accounting 48
4.2 Legal systems 48
4.3 Entities 50
4.4 Examples of regulation 53
4.5 The regulation of International Standards 58
Summary 59
References and research 59
Exercises 60

5 International differences and harmonization 61

Objectives 61
5.1 Introduction: the international nature of the development
of accounting 62
5.2 Classification 63
5.3 Influences on differences 70
5.4 Harmonization in the European Union 80
5.5 The International Accounting Standards Board 85
5.6 Where next for harmonization? 88
Summary 90
References and research 90
Exercises 91

6 The contents of financial statements 93

Objectives 93
6.1 Introduction 94
6.2 Basic financial statements 95
6.3 Cash flow statements 109
6.4 Notes to the financial statements 111
6.5 Other general disclosure requirements 111
Summary 114
References and research 115
Exercises 116

7 Financial statement analysis 117

Objectives 117
7.1 Introduction 118
7.2 Ratios and percentages 118
7.3 Profit ratios 121
7.4 Profitability ratios 124
7.5 Liquidity ratios 131
7.6 Interest cover 132
7.7 Funds management ratios 133

vi

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Contents

7.8 Introduction to investment ratios 135

7.9 Some general issues 137
Summary 138
Exercises 139

Part 2 FINANCIAL REPORTING ISSUES 145

8 Recognition and measurement of the elements

of financial statements 147
Objectives 147
8.1 Introduction 148
8.2 Primacy of definitions 148
8.3 Hierarchy of decisions 150
8.4 Income recognition 159
Summary 162
References and research 162
Exercises 163

9 Tangible and intangible fixed assets 164

Objectives 164
9.1 Preamble: a tale of two companies 165
9.2 Introduction 166
9.3 The recognition of assets 167
9.4 Should leased assets be recognized? 169
9.5 Depreciation of cost 172
9.6 Impairment 184
9.7 Measurement based on revaluation 187
9.8 Investment properties 190
Summary 191
References and research 192
Exercises 192

10 Inventories 195
Objectives 195
10.1 Introduction 196
10.2 Counting inventory 198
10.3 Valuation of inventory at historical cost 199
10.4 Inventory flow 200
10.5 Other cost methods 205
10.6 Valuation of inventory using output values 206
10.7 Practice 206
10.8 Current replacement cost 208

vii

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Contents

10.9 Construction contracts 208

10.10 Construction contracts in practice 211
Summary 213
References and research 213
Exercises 213

11 Financial assets, liabilities and equity 216

Objectives 216
11.1 Introduction 217
11.2 Cash and receivables 217
11.3 Investments 220
11.4 Liabilities 223
11.5 Equity 228
11.6 Reserves and provisions 231
11.7 Comparisons of debt and equity 234
Summary 235
References and research 236
Exercises 236

12 Accounting and taxation 237

Objectives 237
12.1 Introduction 238
12.2 International differences in the determination of taxable income 240
12.3 Tax rates and tax expense 243
12.4 Deferred tax 244
Summary 248
References and research 250
Exercises 251

13 Cash flow statements 252

Objectives 252
13.1 Introduction 253
13.2 An outline of the IAS 7 approach 254
13.3 Reporting cash flows from operating activities 256
13.4 The preparation of cash flow statements 257
13.5 A real example 263
Summary 263
References and research 263
Exercises 265

14 Group accounting 267

Objectives 267
14.1 Introduction: the group 268
14.2 Investments related to the group 271

viii

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Contents

14.3 Accounting for the group 274

14.4 Uniting of interests 282
14.5 Proportional consolidation 283
14.6 The equity method 285
14.7 Conclusion on group relationships 286
14.8 Hope for international harmonization 287
Summary 288
References and research 288
Exercises 289

15 Foreign currency translation 292

Objectives 292
15.1 Introduction 293
15.2 Transactions 293
15.3 Translation of financial statements 296
15.4 A numerical illustration 298
Summary 299
References and research 300
Exercises 300

16 Accounting for price changes 302

Objectives 302
16.1 Introduction 303
16.2 Effects of price changes on accounting 303
16.3 European disagreement 309
16.4 General or specific adjustment 309
16.5 General price-level adjusted systems 314
16.6 Current value accounting 316
16.7 Mixed values – deprival value 320
16.8 Partial adjustments 323
16.9 Fair values 324
Summary 325
References and research 325
Exercises 326

Part 3 ANALYSIS 329

17 Financial appraisal 331

Objectives 331
17.1 Introduction 332
17.2 More on investment ratios 332
17.3 Interpreting the balance sheet 338

ix

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Contents

17.4 Valuation through expectations 341

17.5 Valuation through market values 342
17.6 Accounting policies and financial appraisal 343
Summary 351
References and research 351
Exercises 352

18 International analysis 356

Objectives 356
18.1 Introduction 357
18.2 Language 357
18.3 Differences in financial culture 361
18.4 Accounting differences 362
18.5 Help by multinationals 363
18.6 Increasing international harmonization 364
Summary 367
References and research 367
Exercises 368
Annex: GlaxoSmithKline plc: Note on reconciliation from IFRS to US GAAP 369

Appendices 375
A Double-entry bookkeeping 377
B An outline of the content of International Financial
Reporting Standards 422
C An outline of the content of the EU’s Fourth Directive
on Company Law (as amended in 2001, 2003, etc.) 433
D Feedback on exercises 435

Glossary of terms 453

Index 470

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FINA_A01.qxd 4/13/07 2:07 PM Page xi

Foreword to the first edition

For many years Professor Christopher Nobes and I have worked together as the
two British representatives on the Board of the International Accounting Standards
Committee. He and I have argued in many fora for the notion that there should be
one single set of high quality worldwide standards so that a transaction occurring
in Stuttgart, Sheffield, Seattle or Sydney should be treated in exactly the same way.
That is not the case at present.
In a book recently published by Professor Christopher Nobes and David Cairns,
‘The Convergence Handbook’, they outlined the existing differences between
British and International Accounting Standards. The intention of the book and
the request by the UK’s Accounting Standards Board for its production was to
eliminate these differences. It is particularly important this should be done over
the next five years as the European Commission has stated its intention that
all consolidated statements of Listed Companies in the European Union should
comply with International Accounting Standards by 2005. Clearly British Standards
will have to change, although as British Standards themselves are of high quality
it is very likely that some International Standards will also change.
To meet this challenge and to ensure that all countries have the same account-
ing standards, the International Accounting Standards Committee has been
reconstituted with effect from 2001 to form a virtually full-time International
Accounting Standards Board whose main mission is to seek convergence of
accounting standards throughout the world.
This book by my friends, David Alexander and Christopher Nobes, is there-
fore particularly timely. It is based on a background in the European Union. It is
written extremely clearly. (The real mark of a teacher is not to complicate but to
simplify and the authors have certainly done that.) It is unusual in that it takes as
its base not one country’s standards but International Accounting Standards, which
I firmly believe are going to be the worldwide requirements of the future.
The book will be of interest not only to the beginner but to those who wish to
understand the thrust of International Accounting Standards. The authors make
clear that accounting is still in many ways a primitive subject and is in a period
of change, removing the most irrelevant aspects of the historical cost model and
replacing them with accounting for fair values. Those coming into accounting now
are going to see huge changes in the first few years of their careers as many of the
ideas promulgated by academics many years ago become professional practice
and as each country’s national standards are changed to converge with the inter-
national consensus.
I enjoyed reading this book and I am sure that its many readers will also. I
congratulate the authors for their foresight in producing such an excellent book
and wish them well.
SIR DAVID TWEEDIE
January 2001 Chairman, International Accounting Standards Board

xi

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FINA_A01.qxd 4/13/07 2:07 PM Page xii

Supporting resources
Visit www.pearsoned.co.uk/alexander to find valuable online resources

Compaion Website for students

n Self-assessment questions to check your understanding
n Weblinks to relevant Internet resources to facilitate in-depth independent
research
n Newly updated and improved presentation of double-entry bookkeeping
principles

For instructors
n Complete, downloadable Instructor’s Manual
n PowerPoint slides that can be downloaded and used for presentations

Also: The Companion Website provides the following features:

n Search tool to help locate specific items fo content
n E-mail results and profile tools to send results of quizzes to instructors
n Online help and support to assist with website usage and troubleshooting

For more information please contact your local Pearson Education sales
representative or visit www.pearsoned.co.uk/alexander

..
FINA_A01.qxd 4/13/07 2:07 PM Page xiii

Preface

This is the third edition of our book that is designed as an introductory text
in financial accounting. What sets it apart from dozens of other books with that
basic aim is that this book is not set in any one national context. Consequently,
instead of references to national laws, standards or practices, the main reference
point is International Financial Reporting Standards (IFRS).
Nevertheless, real entities operate in real countries even where they follow IFRS,
and so such entities also operate within national laws, tax systems, financial
cultures, etc. One of the backgrounds chosen in this book is the European Union
(EU) and the wider European Economic Area (EEA). Where useful, we refer to
the rules or practices of particular European countries or companies. However,
we also take examples from elsewhere, e.g. Australia.
This book is intended for those with little or no previous knowledge of
financial accounting. It might be particularly appropriate for the following types
of financial accounting courses taught in English at the undergraduate or post-
graduate (e.g. MBA) level:
n courses in any country in the EU (or EEA), given the increasing use of IFRS by
companies including the compulsory use for listed companies’ consolidated
statements;
n courses outside the EU where IFRS are a relevant reference point, e.g. in Australia,
New Zealand, Singapore and other parts of the (British) Commonwealth;
n courses in China or other countries where standards are now converging with
IFRS;
n courses anywhere in the world with a mixture of students from several different
countries.
Depending on the objectives of teachers and students, stress (or lack of it) might
be placed on particular parts of this book. For example, it would be possible to
precede or accompany a course based on this book with an extensive examination
of double-entry bookkeeping, such that Appendix A is unnecessary. Or, on some
courses, there might not be space or appetite for coverage of issues such as foreign
currency translation (Chapter 15) or accounting for price changes (Chapter 16).
In writing this book we have, of course, made use of our experience over many
years of writing and teaching in an international context. Thus, in some places
we have adapted and updated material that we have used elsewhere in more
specialist books to which the intended readers of this text would not have easy
access. We have tried to remove British biases, but we may not have been fully
successful and we apologize to readers who can still detect some.
This edition is updated for the extensive changes of the three years since writ-
ing the second edition. We have also increased the coverage of double-entry-
bookkeeping, now found in Appendix A. We have moved the self-assessment
exercises, previously at the end of chapters, to the Companion Website.

xiii

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Preface

There are four appendices, which we hope readers will find useful during and
after a course based on this book. Appendix A is a substantial treatment of double-
entry bookkeeping. Appendices B and C summarize the requirements of IFRS and
the EU Fourth Directive respectively. Appendix D provides outline feedback to the
first two of each chapter’s closing exercises. Feedback on the other exercises is
given in an Instructor’s Manual that is available electronically via the Companion
Website at www.pearsoned.co.uk/alexander. The manual also contains other
material to assist lecturers. This book ends with a glossary and an index.
In preparing the first edition, we were greatly assisted by comments from
an apparently tireless team of reviewers, listed immediately hereafter. Certain
reviewers have commented further this time. We are also grateful for much help
from colleagues at Pearson. Despite all this help, there may be errors and omissions
in our book, and for this we must be debited (in your books).
DAVID ALEXANDER
University of Birmingham
CHRISTOPHER NOBES
University of Reading

Reviewers
This book has benefited very much from the advice and critical evaluation of
the following reviewers, whose comments throughout the preparation of this
edition are greatly appreciated:
Simon Pallett – University of Newcastle
Jim Hanly – Dublin Institute of Technology
Noreen Dawes – London Metropolitan University
Fredrik Ljungdahl – Jönköping International Business School
Deborah Lewis – Swansea University
Robert Major – University of Portsmouth

xiv

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FINA_A01.qxd 4/13/07 2:07 PM Page xv

Acknowledgements

We are grateful to the following for permission to reproduce copyright material:

Table 4.2 from Plan comptable général, Conseil National de la Comptabilité; Table 5.2
from The Accounting Review (Nair and Frank 1980), © American Accounting
Association; Figure 5.2 from (Nobes 1998) A judgemental international classifica-
tion of financial reporting practices, Journal of Business Finance and Accounting,
Spring 1983, Blackwell Publishing; Figure 5.3 from (Nobes 1998) Towards a
general model of the reasons for international differences in financial reporting,
Abacus Vol. 34, No. 2, 1998, Blackwell Publishing; Table 5.14 from Use of
IASs in France, University of Reading Discussion Papers in Accounting, Finance
and Banking, No. 58 1998 (Zambon S. and Dick W.) © Professor C.W. Nobes,
reproduced with permission; Table 5.15 from Die Wirtschaftsprüfer, 1 April 2000,
(Spanheimer, J. and Koch, C. 2000); Figures 6.1, 6.2, 6.3, 12.1 and 13.6 from
Bayer Annual Report 2005; Figures 7.5 and 8.7 from Marks and Spencer plc Annual
Report 2006; Figure 8.5 from CEPSA’s Consolidated Statement of Income for Year
Ended 31 December 1998; Table 9.1 from FORTUNE 500, 1995, 1999 and 2005 ©
1995, 1999, 2005 Time Inc. All rights reserved; Tables 9.8 and 10.13 from FEE,
European Survey of Published Accounts 1991 (London, Routledge 1991). © Thomson
Publishing Services, reproduced with permission; Table 11.5 from Deutsche Bank’s
equity figures 1994 and 1995; Table 14.6 from Astra Zeneca’s net assets for 1998
and 1999, reproduced with the kind permission of Astra Zeneca UK Ltd.; Table 18.1
from UK and US accounting terms in BT Annual Report (1996 and 2006); Table 18.2
from (McLeay, S.J. in Nobes, C.W. and Parker R.H. eds), Comparative International
Accounting, Pearson Education 2006; Figures 18.1 and 18.2 from GlaxoSmithKline
Annual Report 2005; Table 18.3 from Norsk Hydro Annual Reports 1991, 1993, 2005.
Chapter 18 Annex from GlaxoSmithKline Annual Report 2005.
In some instances we have been unable to trace the owners of copyright material,
and we would appreciate any information that would enable us to do so.

xv

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FINA_A01.qxd 4/13/07 2:07 PM Page xvi

Abbreviations

ABC activity-based costing

AE anonymos etairia (public company, Greece – transliteration of
Greek equivalent)
AG Aktiengesellschaft (public company, Austria, Germany and
Switzerland)
AktG Aktiengesetz (German Stock Corporation Law)
ApS anspartsselskab (private company, Denmark)
AS aktieselskab (public company, Denmark)
aksjeselskap (private company, Norway)
ASA almennaksjeselskap (public company, Norway)
BV besloten vennootschap (private company, Belgium and the
Netherlands)
COB Commission des Opérations de Bourse (former Commission for Stock
Exchange Operations, France)
CoCoA continuously contemporary accounting
CONSOB Commissione Nazionale per le Società e la Borsa (National Commission
for Companies and the Stock Exchange, Italy)
CPP current purchasing power
CRC current replacement cost
CV current value
DCF discounted cash flow
DRSC Deutches Rechnungslegungs Standards Committee (German Regulatory
Standards Committee)
DV deprival value
EBIT earnings before interest and tax
EEA European Economic Area
EFRAG European Financial Reporting Advisory Group
EPE etairia periorismenis efthynis (private company, Greece –
transliteration of Greek equivalent)
EPS earnings per share
EU European Union
EV economic value
FAR Föreningen Auktorisade Revisorer (a national accountancy body,
Sweden)
FASB Financial Accounting Standards Board (of the USA)

xvi

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FINA_A01.qxd 4/13/07 2:07 PM Page xvii

Abbreviations

FIFO first in, first out

GAAP generally accepted accounting principles
GmbH Gesellschaft mit beschränker Haftung (private company, Austria,
Germany and Switzerland)
GPLA general price level adjusted
HC historical cost
HGB Handelsgesetzbuch (Commercial Code, Germany)
IAS International Accounting Standard
IASB International Accounting Standards Board
IASC International Accounting Standards Committee
IASCF International Accounting Standards Committee Foundation
IFAC International Federation of Accountants
IFRIC International Financial Reporting Interpretations Committee
IFRS International Financial Reporting Standard(s)
IOSCO International Organization of Securities Commissions
JV joint venture
Lda sociedade por quotas (private company, Portugal)
LIFO last in, first out
Ltd private limited company (United Kingdom)
NBV net book value
NRV net realizable value
NV naamloze vennootschap (public company, Belgium and the
Netherlands)
NYSE New York Stock Exchange
Oy Osakeyhtiö-yksityinen (private company, Finland)
Oyj Osakeyhtiö julkinen (public company, Finland)
PE price/earnings
PCG plan comptable général (general accounting plan, France)
plc public limited company (United Kingdom)
PPE property, plant and equipment
RC replacement cost
RJ Raad voor de Jaarverslaggeving (Council for Annual Reporting, the
Netherlands)
ROCE return on capital employed
ROE return on equity
ROOE return on ordinary owners’ equity
SA sociedade anónima (public company, Portugal)
sociedad anónima (public company, Spain)
société anonyme (public company, Belgium, France and Luxembourg)

xvii

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FINA_A01.qxd 4/13/07 2:07 PM Page xviii

Abbreviations

Sarl société à responsabilité limitée (private limited company, Belgium,

France and Luxembourg)
SEC Securities and Exchange Commission (United States)
SIC Standing Interpretations Committee (former IASC body)
SORIE statement of recognized income and expense
SpA società per azioni (public company, Italy)
SRL società à responsabilità limitata (private company, Italy)
sociedad de responsabilidad limitada (private company, Spain)
SRS Svenska Revisorssamfundet (a Swedish accountancy body)
TFV true and fair view
UK United Kingdom
US United States

xviii

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FINA_C01.qxd 4/13/07 2:08 PM Page 1

Part 1

THE CONTEXT OF ACCOUNTING

1 Introduction

2 Some fundamentals

3 Frameworks and concepts

4 The regulation of accounting

5 International differences and harmonization

6 The contents of financial statements

7 Financial statement analysis

..
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