Week 1 - Lecture 1 Flashcards
define accounting
accounting is the process of identifying, measuring and communicating economic information about an entity to a variety of users for decision making purposes
what is the role of accounting information in decision making?
- accounting information is designed to meet the needs of both internal and external users
- accounting information is extremely valuable to an entity’s owner or management (internal users)
define external users (stakeholders)
parties outside the entity who use information to make decisions about the entity
stakeholders can include:
- shareholders (both current and prospective)
- customers
- suppliers and banks
- employees
- government authorities (eg. ATO and ASIC)
define shareholders
information to assess the future profitability of an entity, the future cash flows for dividends and the possibility of capital growth of investment
define banks
information to determine whether the entity has the ability to repay a loan
define suppliers
information to determine the entity’s ability to repay debts associated with purchases
define employees
information concerning job security, the potential to pau awards and bonuses, and promotion opportunities
define consumers
information regarding the continuity of the entity of the entity and its ability to provide appropriate goods and services
define government authorities
information to determine the amount of tax that should be paid and any future taxation liabilities or taxation assets
define regulatory bodies
information to determine whether the entity is abiding by regulations such as the Corporations Act and Australian taxation law
define community
information to determine whether the entity is contributing positively to the general welfare and economic growth of the local community
define special interest groups
information to determine whether the entity has considered environmental, social and/or industrial aspects during its operation
how do businesses relate to accounting
- businesses sell goods or provide services to create economic benefits for the business owners
- a business prepares accounting information to supports various types of decision making
what decisions need to be made in businesses and accounting?
- decisions of internal users (people who work in the business)
- e.g. the purchase manager needs accounting information to decide when to place an order with the supplier
- decisions of external users (people who are not involved in running the business): general members of society needs accounting information to decide whether to invest in a business
define financial accounting
versus Management Accounting
- prepared for both internal and external users
- the disclosure of a business’ financial accounting information is prescribed by regulations
- financial accounting records and reports financial information about past transactions
define Management accounting
versus financial accounting
- prepared for internal users only
- whether to prepare management accounting information is a voluntary managerial decision
- management accounting records and reports both financial and non-financial information, the information may be historic or forward looking
what are the 5 basic elements to record and report transactions
financial accounting
- assets
- liabilities
- equity
- income
- expenses
three general forms of business organisations
- sole trader
- partnerships
- companies
what factors affect the choice of an appropriate business structure?
- needs to best suit the needs of the entity
- the different business structures differ in terms of owner liability, equity structure, funding opportunities, decision-making responsibilities and taxation
define sole traders
- the simplest form of a business - owned by a single individual and typically managed by the owner (eg. cafe)
- a sole trader is an individual who controls and manages a business
define partnerships
- more complex than a sole trader in terms of business structural organisation
- owned and typically also managed by multiple individuals who typically share a common interest or have the same expertise
- eg. accounting firms PwC and KPMG
define companies
- a company is a business structure that has a separate legal identity from its owners (shareholders)
- companies can be private or publicly listed on a stock exchange
advantages of a sole trader
- quick, inexpensive and easu to establish; inexpensive to wind down
- not subject to company regulation
- owner has total autonomy over business decisions
- owner claims all the profits of the business and all the after-tax gains if the business is sold
disadvantages of a sole trader
- unlimited liability - bears full responsibility for business debts and legal actions such as negligence
- limited by skill, time and investment of owner
- restrictive structure due to non-legal status of the entity
- business will cease to exist if owner leaves, retires or dies
advantages of a partnership
- relatively easy and simple to set up
- informal business structure - not bound by accounting standards
- ability to share:
- capital contributions
- skills, talents, knowlege
- workload between two or more people
disadvantages of a partnership
- unlimited liability for business debts and obligations by all partners
- limited life: if one partner dies or withdraws from the business then the partnership must dissolve
- mutual agency: each partner is seen as being an agent for the businesses and so is bound by any partnership contract
- many partnership disputes arise from profit sharing and decision-making issues
advantages of a company
- limited liability for shareholders
- business expansion networks made easier due to legal structure
- can raise additional equity (capital) through public share offerings
- tax rate
disadvantages of a company
- more time consuming and costly to set up
- must comply with complex company rules and other legal requirements
- separation of ownership and control
define assets
Basic accounting elements
- an economic resource controlled by a business as a result of past events and has the potential to produce future economic benefits
- in practical terms: assets are resources a business has available for use
define equity (or Owners’ Equity)
basic accounting elements
- the owners’ residual interest in the assets of a business after dedicting all its liabilities
- ie. equity = assets - liabilities (often known as Net Assets)
- in practical terms: equity is the value of the business to the business owners
define Liabilities
basic accounting elements
- a present obligation of a business as a result of past events and ultimatley results in an outflow of future economic benefits
- in practical terms: liabilities are the business’ debts to others outside of the business
what is the Accounting Equation
Assets = Liabilities + Equity
- describes a businesses’s financing structure:
- a business’s economic resources (Assets) are financed either by debt (liabilities) or the owners’ own wealth (equity)
Assets - Liabilities = Equity
- emphasises owners’ residual claim on the business’ assets
- the part of assets that is not financed by debt (liabilities) is under the owners’ legal claim (Equity)
- the accounting equation always ____
The Accounting Equation & Transactions
balances
consider the following scenario:
At the start of the year, you have $3 millions savings and no other wealth or bent under your name
what is the accounting equation for this scenario?
Assets = Liabilities + Equity
$3M (cash asset that you can use) = 0 (no bent) + $3M (all your cash asset is under your claim as you are under no obligation to pay or repay anyone)
consider the following scenario:
on Jan 1st, you would like to purchase a property for a listed price of $15M, you decide to:
- Use all your cash $3M
- Take out a mortgage (long-term borrowing from the bank) of $12M
Your accounting equation after the purchase becomes:
Assets = Liabilities + Equity
$15M (the house) = $12M (your debt to the bank) + $3M (what you contribute to the purchase of the house = your wealth invested in the house)
consider the following scenario:
at 31st december, you sold the house for $20M:
- recieve $20M cash from the buyer
- you pay off the mortgage of $12M and have $8M cash left (ignore any interest you may have to pay for the mortgage
Your accounting equation after the sale becomes:
Assets = Liabilities + Equity
$8M (cash available for you to use after you sold the house and paid off the mortgage) = $0 (no mortgage anymore) + $8M (the cash available for you to use is fully yours as you are now under no obligation to pay or repay anyone)
The Accounting Equation & Transactions
what is the change in equity for the below scenario?
the change in equity, ie, the change in your wealth = $8M - $3M = $5M
define income
Basic accounting elements
an increase in assets, or a decrease in liabilities that is not due to contributions from the owners and results in an increase in equity in a period
define expenses
Basic Accounting elements
a decrease in assets, or an increase in liabilities that is not due to distributions to the owners and results in a decrease in equity in a period
what does income - expenses equal?
= profit (or loss)
explain the accounting entity concept
- regardless of its organisation ( a sole trader, a partnership or a company), a business is a separate accounting entity to its owners
- each business records and reports business transactions separately from the personal transaction of the owner(s)
- if the owner uses the business entities funds for personal use, this wil be shown as a reduction in cash and equity (distribution of profits) and not a business expense
example of the accounting entity concept
belltop cafe is a sole trader business owned by Master Barista
- Master Barista must keep his personal transactional records separate from Belltop’s for accounting purposes
- Master Barista has to magae two separate bank accounts: one for his personal use, one for Belltop
what are the 4 types of financial statements?
- The Balance Sheet or Statement of Financial Position
- The Income Statement or Statement of Profit & Loss
- The Statement or Cash Flows
- The Statement of Changes in Equity
what does The Balance Sheet report on?
The Balance Sheet (the Statement of Financial Position) reports on the Financial Position at a point in time
- it shows the Accounting Equation
what does the Income Statement report on?
the Income Statement (the Statement of Profit or Loss) reports on the Financial Performance for a period
- it shows Income - Expenses = Profit or Loss
what does the statement of Cash Flows report on?
the statement of cash flows reports on the outcomes of decisions that affect cash inflows and outflows for a period
