Week 1 Flashcards
The nature of accounting and its main functions
Accounting is the ‘language of business’.
Accounting is an information system
Designed to communicate financial information
To interested users
For making economic decisions
Financial statements:
Are the outcome of the accounting process
Are a primary information source for users
Are useful for many decisions
The evolution of accounting to meet organisational and society needs
Accounting evolves as society and business changes.
Some of these changes include
Rapid developments in information and communication technologies
Increasing demand for a range of information about organisational impact( financial and non –financial)
Globalisation of business
Development of international regulations and standards
Accounting fulfils two distinct roles
- Stewardship role (discharge accountability)
- Decision-usefulness role
Traditionally, accounting focused more on providing stewardship.
More recently, accounting seems to be focused more on decision-usefulness role
4 Steps of accounting
Identification - (Internal/external)
Measurement - Quantification in monetary terms ($)
Recording - Recording; classification; summarisation
Communication - Accounting reports, Analysis and interpretation
5 Accounting assumptions
Economic entity Going concern Time period Accrual basis assumption Monetary unit
Economic entity
: financial activities of a business can be separated from those of the business’ owner(s) and other entities
Going concern
: financial activities of a business can be separated from those of the business’ owner(s).
Time period
economic information can be meaningfully captured and communicated over short periods of time.
Accrual basis assumption
The effects of transactions are recognised when they occur, not when the cash is received/paid
Monetary unit
accountants assume that the dollar is the most effective means to communicate economic activity.
Fundamental quantitative characteristics
Relevance
Faithful representation
Relevance
the capacity of accounting information to make a difference in decisions
Can influence economic decisions by users
Have a predictive role and confirmative or feedback role
Faithful Representation
Information presented faithfully- without bias(Neutral), free from error and complete
The purpose of accounting
The purpose of accounting is to identify, measure and communicate economic information about a particular entity to interested users.
Enhancing qualitative characteristics
Comparability
Verifiability
Understandability
Timeliness
Comparability
The ability to use accounting information to compare or contrast the financial activities of different companies.
Verifiability
Different, independent observers can reach consensus that information faithfully represents what it claims to
Understandability
The ability of accounting information to be understandable to those who have a reasonable understanding of business
Timeliness
Information is provided in a timely manner as it is more likely to influence decision-making
The income statement
One of the first questions asked of any business is whether it makes money. Stated differently in ‘accounting’ words, is the business profitable? Does it generate more resources than it uses?
Accounting provides answers to these questions with a financial statement called an income statement. An income statement reports a company’s revenues and expenses. Reports financial performance over a specific time period
The balance sheet
Reports financial position of an entity at a specific point in time
Shows assets, liabilities and equity of the entity
Represents the accounting equation
Assets = Liabilities + Equity
The balance sheet is also known as the statement of financial position
The Cash Flow Statement
The income statement reports in income earned and expenses incurred – NOT on cash flows
A statement of cash flows is therefore necessary to report on the cash inflows and outflows of the entity
This allows users to assess the sources and applications of cash
Also the ability of the entity to remain solvent
The statement of changes in equity
A statement of changes in equity shows the change in a company’s equity, particularly in retained earnings over a specific period of time. Owners of a business are usually interested in how their equity is growing as a result of profitable operations. They are also interested in how that equity is distributed in the form of dividends. Such information is reported on the statement of changes in equity. A statement of changes in equity shows the change in a company’s retained earnings over a specific period of time.
Basic structure of the statement of changes in equity:
Retained earnings, beginning balance
+/– Net income/Loss (profit or loss)
– Dividends
= Retained earnings, ending balance
Statement of changes in equity example
Photo in favourites on phone 23/7/18
Generally Accepted Accounting Principles
Generally Accepted Accounting Principles (GAAP) are the accounting standards, rules, principles and procedures that comprise authoritative practice for financial accounting.
In Australia we follow the International Financial Reporting Standards (IFRS), with some modification. The Australian Accounting Standards are developed by the Australian Accounting Standards Board.
Types of transactions
External
Internal
Non-Transactional events
External
Involve an outside party
Exchange of economic resources and/or obligations
Sale of inventory, Purchase of supplies
Internal
Transformation of economic resources
Use of office supplies
Non-Transactional events
Not usually recorded, but may be in the future
Receiving an order from a customer
Not usually recorded, but may be in the future
Receiving an order from a customer
Assets = Liabilities + Equity
Transactions result in changes in assets, liabilities and owners equity
Every accounting transaction must affect at least two accounts. This requirement is known as the dual nature of accounting.
After each transaction is recorded the accounting equation must remain balance
Cost principle
. We record items at historical cost. This saves the subjective opinion of what they are ‘worth’. It may also include conservatism in not anticipating profits.
Matching principle
We record revenue when earned and match it to the period in which it was earned
Time period assumption
An entity cannot randomly change its time period. This also violates ‘consistency.’ An entity should use the same accounting methods year to year and disclose when they change methods.
Revenue recognition principle
Revenue should be recorded in the period during which it is earned.
Example of violation of the revenue recognition principle
The revenue recognition principle has been violated. A receivable and the increase in shareholder’s equity cannot be recorded until the service has been provided and the revenue is earned.
Retained earnings end calculation
Retained earnings beginning + Profits – Dividends = Retained earnings end
Classify bonds payable
Non current liability
