Organisations and Society What is financial accounting and what are the sources of regulation?

Question 1

Financial accounting

Answer 1

The practice of financial accounting relates to the
preparation and presentation of financial information
for a variety of users so as to enable them to make
decisions about where they shall allocate their
resources.

Question 2

The financial statements

Answer 2

• Balance sheet (known as statement of financial position)
• Income statement (known as a statement of comprehensive
income)
• The statement of changes in equity
• The statement of cash flows
• Notes to Financial statements

Question 3

Accounting principles

Answer 3

CHER@MCG

Accounting entity

Accounting period

Monetary unit assumption

Going concern

Accrual basis of accounting

Conservatism

Question 4

Accounting entity

Answer 4

The accountant is only to recognise transactions and events, which affect the financial performance or position of the organisation. The organisation is separate from the owners and other entities.

Question 5

Accounting period

Answer 5

Whilst the life of an organisation might be considered to be indefinite, the accountant nevertheless determines the financial performance of the entity for smaller periods – for example, for 6 or 12 months. This can create a variety of potentially dysfunctional effects as will be discussed elsewhere in this course.

Question 6

Monetary unit assumption

Answer 6

The practice of financial accounting typically only recognises transactions or events if a related monetary value can be assigned to them. This also creates some dysfunctional effects that we will consider elsewhere in this course.

Question 7

Going concern

Answer 7

Unless there is evidence to the contrary, the financial accountant assumes that the organisation (the accounting entity) will continue operating into the foreseeable future. This has various implications for how various assets, liabilities, income and expenses are measured.
 If it is considered that the going concern assumption is not appropriate (for example, it is not able to pay its debts as and when they fall due), then financial statements have to be prepared on another basis – for example, on the basis of liquidation values.

Question 8

Accrual basis of accounting

Answer 8

Financial accounting is general done on an ‘accruals basis’. This means, for example, that income is recognised when it is earned (which is not necessarily when the
related cash is actually received), and expenses are recognised as the expense isincurred (which is not necessarily the same time as when the related cash payment is made). Accrual accounting can be contrasted with accounting, which is undertaken on a ‘cash basis’.

Question 9

Conservatism

Answer 9

This generally accepted concept assumes that financial accountants shall not overstate the value of assets and shall not understate the value of liabilities.

Question 10

Sources of regulation

Answer 10

ASIC
ASX
ATO
AASB

Question 11

ASIC

Answer 11

In Australia, the major source of company regulation is the
Corporations Act, which is enforced through the Australian
Securities and Investments Commission (ASIC).

Question 12

ASX

Answer 12

The Australian Securities Exchange (ASX) also has various

disclosure requirements for companies listed on the ASX.

Question 13

ATO

Answer 13

The Australian Taxation Office also has various reporting
requirements for companies (and other organisations and
individuals)

Question 14

AASB

Answer 14

Within Australia, accounting standards are released by the

Australian Accounting Standards Board (AASB)

Question 15

GPFS VS SPFS

Answer 15

• General Purpose Financial Reports (GPFR)
− prepared to meet the information needs common to
users who are unable to command reports to meet
their own needs.

• Special Purpose Financial Reports (SPFR):
− prepared to suit a specific purpose for a special
group.

Question 16

AASB Conceptual framework

Answer 16

A central goal in establishing a conceptual framework is
to establish consensus on issues such as:
1. The scope and objective of financial reporting;
2. The qualitative characteristics that financial information
should possess;
3. What are the elements of financial reporting?

Question 17

5 elements of the financial statements

Answer 17

Assets
Liabilities
Equity
Income
Expenses

Question 18

Assets

Answer 18

A resource controlled by the
entity as a result of past events
and from which future economic benefits are expected to flow to the entity.

Question 19

Liabilities

Answer 19

A present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits.

Question 20

Equity

Answer 20

The residual interest in the
assets of the entity after deducting all its liabilities (will be increased by contributions and income, and reduced by drawings and expenses)

Question 21

Income

Answer 21

Income Increases in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases of liabilities that result in increases in equity,
other than those relating to
contributions from equity
participants.

Question 22

Expenses

Answer 22

Decreases in economic benefits during the accounting period in the form of outflows or depletions of assets or incurrences of liabilities
that result in decreases in equity, other than those relating to distributions to equity participants

Question 23

Once we have defined the elements, we need to:

Answer 23

• Determine when to recognise them,
• How to measure them, and
• How to present and disclosure them.

Question 24

Business transactions and the accounting equation

Answer 24

Business transactions have to be recorded in a way

that reflects financial status of a business. All of these are reflected in an Accounting Equation

Question 25

The accounting equation

Answer 25

A simple representation of the accounting equation:
Assets (A) = Liability (L) + Owner’s Equity (OE) i.e. when an organisation has assets, certain parties – either owners, or external creditors - will have a claim against those assets. The total of assets will balance the total of liabilities and owners equity. This will be reflected within the balance sheet.

Question 26

Expanding the accounting equation

Answer 26

• Our original equation was:
A = L + OE
• Owners equity will be influenced by profits – which is the difference between
income (I) and expenses (E) – as well as by contributions (C) from owners, and distributions/Drawings (D) made to owners
• That is changes in owners equity equals:
OE = (profits/Loss) + Capital
(I - E) + C - D
• Substituting this equation into the original accounting equation (above) gives us:
A = L + I - E + C - D

Question 27

The double entry effect

Answer 27

• One business transaction will affect at least two
accounts.
• After recording the transaction, the accounting
equation keeps balance.
• A particular asset is effected – say increased - then
there needs to be a corresponding decrease in another
asset, or a corresponding increase in either a liability
or an equity account.
• Otherwise the equation will not balance!

Question 28

Examples 1 and 2 of how Business transactions affect the

accounting equation

Answer 28

Transactions often affect both sides of the equation
For example:
Entity buys car through a bank loan:
 Vehicle (Asset) increases, Loan (Liability) increases
But transactions can also just affect one side
Entity buys car for cash:
 Cash (Asset) decreases and vehicle (Asset) increases.

Question 29

Example 3 of Business transactions affect the accounting

equation

Answer 29

For each of the following business transaction, describe
how it affects the accounting equation?
a) A sole trader purchases $5,000 goods for his shop on
credit.
Inventory (asset) increases by $5,000, accounts payable
(liability) increases by $5,000.

Question 30

Example 4 of Business transactions affect the accounting

equation

Answer 30

For each of the following business transaction, describe
how it affects the accounting equation?
b) The partner withdraws furniture value $1,000 from the
business for home use.
Equipment (asset) decreases by

Question 31

Financial accounting information is used by people who are external to an organisation (as well as by people who are internal).

Answer 31

Financial accounting information

Question 32

Financial accounting for external purposes

Answer 32

For external reporting purposes, it generates information that is historical in nature. That is, it provides the results for a past time period – for example, the profits or losses for the preceding year (the income statement); the cash flows for the preceding year (the statement of cash flows); and the assets, liabilities and owners equity as at a recently past date (the balance sheet).

Question 33

Financial information is historical

Answer 33

Being historical in nature means that the reports will provide an indication of how management has used the funds (stewardship function). Past results might also provide an indication of future performance.

Question 34

Financial accounting and regulation

Answer 34

Financial accounting is heavily regulated with respect to the procedures to be used to generate general purpose financial statements. By regulating financial reporting, this helps ensure that current financial reports are comparable with the organisation’s previous financial statements as well as with those of other organisations.

Question 35

• Why produce financial accounting information?

Answer 35

The most obvious answer here is that an extensive amount of regulation requires it (general purpose financial statements). Nevertheless even without regulation, investors and other stakeholders with a financial interest in the organisation would demand it.
Investors (owners) would demand it to allow them to assess how well their funds are being used in terms of their investment aims (which might be high capital growth and receipt of dividends). It is also important for managers. Hence, in the absence of regulation we would still expect it. The financial statements represent a communication tool that aims to assist users with their decision making.

Question 36

Who are the stakeholders to whom the disclosures will be directed?

Answer 36

The primary audience of financial accounting information would be investors, creditors, and managers. Many other stakeholders would also have an interest in the financial position and performance and cash flows of an organisation (for example, employees so as to consider whether an organisation can pay higher wages, or customers - is the organisation earning large profits which might justify calls for price decreases).

Question 37

What types of disclosures?

Answer 37

The types of disclosures required are heavily regulated. For example, by accounting standards, stock exchange requirements, and corporations law requirements.

Question 38

How will the disclosure be made

Answer 38

The format of the disclosures and the medium for disclosure will tend to be regulated (for general purpose financial statements).

Question 39

The objective of financial accounting

Answer 39

The objective of general purpose financial reporting is to provide financial information about the reporting entity that is useful to existing and potential investors, lenders and other creditors in making decisions about providing resources to the entity.

Question 40

To satisfy this objective the Conceptual Framework identifies a number of qualitative characteristics that financial information should possess. These include:

Answer 40

Relevance
Faithful representation
Comparability 
Verifiability
Timeliness
Understandability

Question 41

Relevance

Answer 41

(Capable of influencing the decisions of users. Would include considerations of ‘materiality’)

Question 42

Faithful representation

Answer 42

(Ideally information should be complete, neutral and free from error).
To be useful information, it needs to be both relevant and faithfully represented. There can be some trade-offs.

Question 43

Comparability

Answer 43

Entity uses same accounting principles each year
Different entities use the same accounting principles
Some variation in methods is allowed under the standards, but the method used must be disclosed

Question 44

Verifiability

Answer 44

Information provided can be sourced back to a transaction or event.

Question 45

Timeliness

Answer 45

If collection of information spans too long a period, it is no longer relevant.

Question 46

Understandability

Answer 46

Issues of ‘understandability’ need judgements to be made of the capabilities of financial statement users.

Question 47

Why is financial accounting regulated

Answer 47

Because governments have traditionally embraced a view that organisations must demonstrate a high level of accountability in relation to their financial performance and financial position – particularly large corporations – then minimum levels of disclosures have been legislated.

Question 48

levels of regulation

Answer 48

 That is, particularly for large companies, they can’t simply disclose what they would prefer to disclose
• Contrast this with disclosures about social and environmental performance which are relatively unregulated
• For smaller organisations which typically have less separation between ownership and management there tends to be less regulation (perception that the risks for owners is lower)

Question 49

Current and non current assets

Answer 49

An entity shall classify an asset as current when:
a. it expects to realise the asset, or intends to sell or consume it, in its normal operating cycle;
b. it holds the asset primarily for the purpose of trading;
c. it expects to realise the asset within twelve months after the reporting period; or
d. The asset is cash or a cash equivalent (as defined in AASB 107) unless the asset is restricted from being exchanged or used to settle a liability for at least twelve months after the reporting period.
An entity shall classify all other assets as non-current.

Question 50

Tangible assets

Answer 50

Those assets that have a physical substance (e.g. plant and machinery, motor vehicles).

Question 51

Intangible assets

Answer 51

Assets which, while providing expected future benefits, have no physical substance (e.g. copyrights, patents).

Question 52

Property, plant and equipment:

Answer 52

Property, plant and equipment are tangible items that:
(a) are held for use in the production of, or supply of, goods or services, for rental to others, or for administrative purposes; and (b) are expected to be used during more than one period (AASB 116).

Question 53

Contra accounts

Answer 53

A contra asset account is an account with its balance is to be the opposite of the normal balance found in an asset account. For example, an asset such as a building will be shown as a non-current asset and a contra account for depreciation will be subtracted from its value.

Question 54

Current and non current liabilities

Answer 54

An entity shall classify a liability as current when:
a. It expects to settle the liability in its normal operating cycle;
b. It holds the liability in its normal operating cycle;
c. the liability is due to be settled within twelve months after the end of the reporting period; or
d. it does not have an unconditional right to defer settlement of the liability for at least twelve months after the reporting period.
An entity shall classify all other liabilities as non-current

Question 55

Provisions

Answer 55

An estimated liability for which there is greater uncertainty regarding the amount or timing of the amount than for a normal liability.

Question 56

Contingent liabilities

Answer 56

A potential liability that might arise in the event of a particular event occurring. It will become a liability contingent on that event happening.

Question 57

Separate accounts and the chart of accounts

Answer 57

We need to set up separate accounts for each item of information we would like to know about.
 For example, we might have a separate account for each of the assets cash at bank, motor vehicle, warehouse, inventory, accounts receivable
 An organisation would typically have a ‘chart of accounts’ which identifies the various accounts being used