Accounting

Lecture 1 Financial accounting
Chapter 1: Financial Acct
Learning objectives
LO1: Basic accounting assumptions
LO2: Statement of comprehensive income
LO3: Statement of financial position
LO4: Statement of changes in equity
LO5: Cash flow statement
LO6:Qualitative characteristics
LO7:Conceptual Framework of accounting
Introduction
Imagine you start your own lawn mowing business in January. You use your own money and borrow some from your parents. You purchase a lawn mower and some petrol and mow 28 lawns.
How do you know if this business is successful or if you were better off just getting a job at McDonalds?
Accounting is the process of identifying, measuring and communicating economic information to permit informed judgments and decisions. Accounting is the language of business.
LO1: Basic accounting assumptions
Economic entity assumption:
Financial activities of the business need to be separated from the financial activities of its owner. By keeping financial activities separate, we are able to know the performance of each organisation.
Example: In the lawn mowing example, the business expenses (petrol) will be kept separate from personal expenses (buying petrol for personal use)
Time period assumption:
Accounting information can be communicated effectively over short periods of time.
Example: Most companies report their financial performance and position on a quarterly, half-yearly and annual basis.
Monetary unit assumption:
The dollar, unadjusted for inflation, is the best means of communicating accounting information in Australia.
Example: all Australian annual reports are shown in Australian Dollars. Going concern assumption:
When preparing financial reports it is assumed a company will continue to operate into the foreseeable future.
Example: All fixed assets are shown at their cost but not at their liquidation (sale) values
Review: Analyse the financial statements of David Jones. Identify the implications of the four basic assumptions.
LO2: Statement of Comprehensive Income
∙Also known as the Income Statement or Profit and Loss Statement
∙Answers this question: is the business profitable (is it making money)?
∙Shows the performance of a business during a specific period
∙Revenues – Expenses = Net Profit or Net Loss
Revenues
A revenue is an increase in resources resulting from the sale of goods or the provision of services. Includes:
∙Service revenue
∙Sales revenue
∙Interest revenue
∙Rent revenue
Revenue recognition principle: revenues are recorded when they are earned. Revenue is earned when the sale is made or the service performed and collection is reasonably assured.
Review Question: A customer pays Qantas $2000 in March to fly to New York in November. When should Qantas record the revenue? March or November? Expenses
An expense is a decrease in resources resulting from the sale of goods or provision of services. Includes:
∙Cost of sales (Cost of goods sold)
∙Salaries and Wages
∙Interest
∙Depreciation
∙Taxes
∙Advertising
∙Utilities
Matching Principle: expenses should be recorded in the period resources are used to generate revenues.
For example, the cost of the petrol used to mow the lawns should be matched to the revenue earned from mowing those lawns.
Review: Look at David Jones’ Statement of Comprehensive Income.
What is David Jones’ largest expense? Give the name and amount.
Has the net profit increased or decreased compared to last year?
LO3: S tatement of financial position
∙Also known as the Balance Sheet
∙Shows a company’s assets, liabilities and equity at a specific point in time. ∙It is a snapshot of the business
∙Assets = Liabilities + Equity
Assets
An asset is an economic resource that is objectively measurable, that results from a prior transaction and that will provide future economic benefit. Examples include:
∙Cash
∙Inventories
∙Receivables
∙Property, Plant and Equipment
∙Intangible assets: trademarks and copyright
Historical cost principle (Cost principle): assets should be recorded and reported at the cost paid to acquire them.
Liabilities
A liability is an obligation of a business that results from a past transaction and will require the sacrifice of economic resources at some future date. Examples include:
∙Accounts payable
∙Salaries payable
∙Taxes payable
∙Bank loans
Equity
Equity represents the share of the assets that are claimed by the business’s owners.
Equity = Assets – Liabilities
A company can generate equity in two ways:
1. Contributed Capital: resources that investors contribute to a business
in exchange for an ownership interest. For example, a company
increases contributed capital when it sells shares to investors.
2. Retained Earnings: When a company earns profits and they are kept
within the business, this is recorded as retained earnings. Profits that are distributed to owners are called dividends.
Review: write out the accounting equation for David Jones.
LO4: S tatement of changes in equity
∙Shows how the business owner’s equity is growing.
∙Shows retained earnings and share capital
∙Retained earnings ending balance= beginning balance + net profit –dividends
Review: Look at the David Jones Statement of Changes in Equity for 2011. What is the beginning retained earnings?
What is the profit for the period?
How much was paid in dividends?
What is the ending retained earnings balance? Did it increase or decrease?
Linking the statements
The net profit from the Statement of Comprehensive Income is used to calculate Retained Earnings on the Statement of Changes in Equity.
The ending balance of Retained Earnings is included on the Balance Sheet. Review: Look at how the David Jones financial statements are linked
Module.Ex.01.02 Net income and retained earnings
Based on the following information, calculate profit or loss and ending retained earnings for the year ending 30 June.
Nova corporation reports the following as of 30 June:
Revenue $10 000 Beginning retained earnings 20 000 Expenses 8 000 Dividends 1 000
Required
Calculate profit or loss, and ending retained earnings for the year ending 30 June.
Preparing financial statements
•On 1 January you start up a business as a personal trainer.
•You put in $500 of your own and borrow $1000 from the bank.
•You buy a 6 pairs of boxing gloves ($600), 6 yoga mats ($300) and sports drinks for your clients ($50).
•In January, you train 20 people at $40 each, buy more sports drink ($50), and pay interest ($5).
•During the month you also draw $200 for personal use.
•At the end of January you have Cash ($1015), Sports drink ($35) and are owed $80 from 2 customers.
Required
Prepare an income statement and a statement of retained earnings for the month ending 31 January and a statement of financial position at 31 January.
LO5: C ash flow statement
∙Cash is important for the running of a business, every business needs enough cash to pay its bills
∙The cash flow statement reports the business’s cash inflows and outflows There are three sections:
1. Operating activities
Shows the cash received and paid for the every day operations of the business. This includes cash received from customers, and cash paid for every day running costs
2. Investing activities
Shows the cash paid for purchasing large/long term assets, and cash received when these assets are sold
3. Financing activities
Shows the cash received from borrowings and investors, and the cash used to pay the money back. Also includes cash used to pay dividends.
Review: Look at David Jones’ cash flow statement.
Identify the largest amounts for each category.
Module.Ex.01.06 Classify cash flows LO5
A company entered into the following cash transactions.
1. Cash paid to suppliers
2. Cash received from issuing new ordinary shares
3. Cash paid to purchase new office furniture
4. Cash paid to owners
5. Cash received from customers
Required
Indicate the section of the statement of cash flows in which each item would appear: operating activities (O), investing activities (I), or financing activities (F).
LO6: Q ualitative characteristics
These qualities help make accounting information useful:
1. Understandability
Accounting information should be easy to understand by those who have a reasonable business understanding
2. Relevance
Accounting information should be relevant, which means it makes a difference in decisions. The information should be useful to assess past performance and to predict future performance.
Information is only relevant if it is provided on time.
3. Reliability
To be reliable accounting information:
o should be verifiable- checked/audited
o should have representational faithfulness- an accurate picture of the business
o should be neutral- unbiased
4. Comparability
Accounting information is useful if it can be compared to different businesses.
5. Consistency
Consistency enables a user to compare the accounting information of one business over time.
6. Materiality
This concept is related to relevance.
If an item is material (affects a users decision making) then it must be accounted for exactly following accounting rules.
If an item is immaterial, short cuts may be taken to be more efficient, as it will not affect a users decision.
7. Conservatism
Refers to the manner in which accountants deal with the uncertainty regarding economic situations. The essence of conservatism is to account
for all probable losses but never account for probable gains.
For example, valuation of closing inventory at cost price or market price whichever is lower.
Review:
∙How logical would a comparison between two companies be if each were following a different set of accounting methods?
∙How relevant would an old annual report be for an investor considering buying shares in a company?
LO7: Conceptual Framework of accounting
Conceptual framework of accounting is the collection of concepts that guide the manner in which accounting is practiced.
All the terms, principles, assumptions and characteristics from the lecture today are components of the conceptual framework of accounting.
In summary:
Terms used to identify and describe economic information: ∙Asset
∙Liability
∙Equity
∙Contributed equity
∙Retained earnings
∙Revenue
∙Expense
∙Dividend
Principles used to measure economic information:
∙Revenue recognition
∙Matching
∙Cost
Assumptions made when communicating economic information: ∙Economic entity
∙Monetary unit
∙Time period
∙Going concern
Qualitative characteristics that make accounting information useful: ∙Understandability
∙Relevance
∙Reliability
∙Comparability
∙Consistency
∙Materiality
∙Conservatism
Financial statements used to communicate economic information: ∙Statement of comprehensive income
∙Statement of financial position
∙Statement of changes in equity
∙Cash flow statement。