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38 views22 pagesACCTG
Accounting (2)
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Rhona LusterioCopyright
© © All Rights Reserved
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/ 22
feo
Crick
Cand
Pea
Key terms aie printed in bold
when they fist aber and ore
ned in the end-of book
era wana
TERMINOLOGY
Se)
Re el
eee
fe se
Pr
References thoughout the
per tie the accountng
concepts you o learning to the
story that opened the chapter.
CO
evita ie)
Cre id
eek
Bree
. 2
What is accounting: . sors and commits te egg
identifies. ‘i
stem tht loser ook at hese he actives
Lets econ ates LAD 18 ag
varie by Nike, the providing of servis
poring clubs ae examples of economic eens
Pomded to provide a history of the enfiy’s fax
activities. Recording consists of keeping a systematic, chronological diary of events, measur
in dollars and cents, In recording, economic events are also classified and summarised,
3, The identifying and recording activities are of litle use unless the information is comma
cated to interested users, Financial information is communicated through accounting repens
tements, To make the reported finan
the most common of which are called financial stat ;
information meaningful, accountants report the recorded data in a standardised way. Io
mation resulting from similar transactions is accumulated and totalled.sFor example, al
Billabong’s sales transactions are accumulated over a certain period of time and report x
‘one amount in its financial statements. Such data are said to be reported in the ageregue. By
presenting the recorded data in the aggregate, the accounting process simplifies a multe
transactions and makes a series of activities understandable and meaningful
‘A vital element in communicating economic events is the accountant’ ability to analyse at
interpret the reported information. Analysis involvts the use of ratios, percentages, graphs and
charts to highlight significant financial trends and relationships. Interpretation involves expla
the uses, meaning and limitations of reported data. Financial statements will be referred tint
umber of chapters of this book. At this point, they probably strike you as complex and confi
By the end of this course, you'll be surprised at your ability to understand and interpret them.
‘The accounting process may be summarised as shown in figure 1.1.
Accounting is an information sy'
events of an entity to interested users
1. Identifying economic events invol
‘entity. The sale of running shoes a
Jim's Group, the payment of wages bi
and the payment of expenses by major 5
2. Once identified, economic events are re
Why is accounting important?
‘Accounting is often referred to as the ‘language of business’. The purpose of accounting
assist people, whether internal or external to an entity, to make decisions about the allocation
scarce resources. For example, if you are a holder of a number of Billabong shares, you Fl)
the regular reporting of accounting information to help you to decide whether or not yO!
continue to hold your shares
yan _ Introduction: Accounting and ts Environs
_____——_
‘Thus, accounting is principally the process of identifying, measuring and
sim mnunicating economic information to permit informed judgments and
decisions by users of the information
f financial statements, the
ta business entity to
‘counting is the set o!
gin terms
A key product of ac
documents that report financial information abou
Gecision makers. They tell us how well a business is performing
where it stands in financial terms.
of profit and losses and
siness surrounds us and accounting is the language
The world of bu:
spoken in the world of business.
‘Types of Accounting Information
re many types of economic decisions, there are many LPI
Just as there ai
of accounting information. ‘The terms financial accounting, management
sccounting, tak accounting and not-for-profit accounting often are used in
tion that are widely used in
describing four types of accounting informa
the business community.
Financial Accounting
Financial accounting refers to information describing the financial
resources, obligations, and activities of an economic entity (either an
organization or an individual). Accountants use the term financial
position to describe an entity's financial resources and obligations at
cone point in time and the term results of operations to describe its
financial activities during the year. .
igned primarily to assist
e to place their scarce
t to society, as they
the financial
Financial accounting information is desi;
deciding wher
investors and creditors in
tment resources. Such decisions are important
anies and industries will receive
owth, and which will not.
J accounting information also is used by managers in incom
counting information is used for |
often is called “general-purpo:
invest
determine which comp
resources necessary for gr
Financia
tax returns. In fact, financial acc
many different purposes that it
accounting information. A Chapters
Management Accounting
Management (or managerial) accounting involves the developmen,
and interpretation of accounting information intended specifically 4,
aid management in running the business. Managers use this
information in setting the company’s overall goals, evaluating the
performance of departments and individuals, deciding whether to
introduce a new line of products, and in making virtually all types of
managerial decisions.
A company’s managers and employees constantly need such
information in order to run and control daily business operations. For
example, they need to know the amount of money in the company’s
bank accounts, the types and quantities of merchandise in the
company’s warehouse, and the amounts owned to specific creditors,
Much management accounting information is financial in nature but
has been organized in a manner relating directly to the decision at
hand. However, management accounting information often includes
evaluations of nonfinancial factors, such as political and
environmental considerations, product quality, customer satisfaction,
and worker productivity.
Tax Accounting
The preparation of income tax returns is a specialized field within
accounting. To a great extent, tax returns are based on financial
accounting information. However, the information often 1s adjusted
or reorganized to conform with income tax reporting requirements.
The most challenging aspect of tax accounting is not the preparation
of an income tax return, but tax planning. Tax planning meas
anticipating the tax effects of business transactions and structuring
these transactions in a manner that will minimize the income '™
burden.
Not-for-Profit Accounting
Not-for-profit accounting is used for government agencies, churches
non-governnient organizations (NGO’s), charitable institutions, 4
schools. Accountants for these organizations prepare budgets Chapter | Accounting - The Language of Business 5
Underlying Assumptions
There are two underlying assumptions in the preparation of financial statements.
These are (a) accrual basis and (b) going concer. Accrual basis of accounting means
that the effects of transactions and other events are recognized when they occur and not
when cash or its equivalent is received or paid, The effects of transactions and events are
recorded in the accounting books and reported in the financial statements of the periods to
which they relate whether or not cash has been received or paid, Going concern
assumption means that the business will continue in operation for the foreseeable future,
that the enterprise does not intend nor need to liquidate or cut its operation toa material
extent
of Financial Statements
Qualitative Characteris
(ajunderstandability,
‘The qualitative characteristics of financial statements are:
er
(b) relevance, (c) materiality, (d) reliability, (e) faithful representation, (f) substance o
form, (g) neutrality, (h) prudence (conservatism), (i) completeness, and () comparability
Users are assumed to have a reasonable knowledge
of business and economic activities as well as
accounting and a willingness to study the information
with reasonable diligence
(a) Understandability
Information has the quality of relevance when it
influences the economic decisions of users by helping
them evaluate past, present or future events or
confirming, or correcting, their past evaluations.
(b) Relevance -
= Information is material ifits omission or misstatement
could influence the economic decisions of users taken
on the basis ofthe financial statements. Materality
depends on the size of the item or error judged in the
particular circumstances of its omission or
misstatement.
(c) Materiality
Information has the quality oftelibility when itis free
from material error and bias and can be depended
‘upon by users to represent faithfully that which iteither
purports to represent or could reasonably be expected
torepresent.
(d) Reliability : 6 Chapter Accounting - The Language of Business
(¢) Faithful representation
(f Substance over form =
(g) Neutrality :
(h) Prudence (conservatism)
(i) Completeness
) Comparability :
~*~ /
Information must represent fi
ithfy
andotherevetsiteither purports
reasonably be ex} on of
pected to represen, apron!
shouldrepresent fathlly the transact ala
events that result in assets, liabilities anye'®*'lag”
. liabilities ange
emerprise “ya
Ifinformationisto represent fithfly the
and other events that it purports to repsw"*%y
necessary that they are accounted for one it,
inaccordance with their substance ang °°
reality andnot merely theirlegal form, “Mc
The information in the financial statements
neutral, thas, fee from bias. Financia sige
arenot neutral if, by the selection or preseniain”
information, they influence the making ofa dew
or judgement in order to achieve a predeterm™
result or outcome. mt
Prudence or conservatism is the inclusion ofa deg,
of caution in the exercise of the judgements needed,
making the estimates requited under conditions;
uncertainty, such that assets or income are ny
overstated and liabilities or expenses are ng
understated. However the exercise of prudence
conservatism does notallow, for example, the creatin
of hidden reserves or excessive provisions, ti
deliberate understatement of assets or income, ot
deliberate overstatement of liabilities or expenses
‘An omission can cause information to be falseor
‘misleading and thus unreliable and deficient inter
ofits relevance.
‘The measurement and display ofthe financial es
oflike transactions and other events must be
‘out ina consistent way throughout an enterprise a!
overtime for that enterprise and ina consistet! wa)
for different enterprises. This will enable thewses
compare the financial statements of an enterpr*
dg cH APTER 18
LIABILITIES
IN
opucTIo!
INTR ibed in the Conceptual Framework is 8 present obj .
Liability, 98 deseril ast events, the settlement of which is expecteq : tn
entity, arising re atty of resources embodying economic benefits,“
outflow from the
CHARACTI ERISTICS OFA LIABILITY
The above description gives rise to the following characteristics of g li
1. The entity has a present obligation.
This means that the entity has a duty or responsibility to act or pers
consequence of a binding contract or statutory requirements. Foren
when goods or services are received from another party, the m
obliged to settle the corresponding consideration (liability) to t.
party.
2. The liability results from past transactions or other past events.
For example, the purchase of goods and the use of services gives
trade payables (unless paid for in advance or delivery). Likens:
preci of the proceeds of a bank loan results in an obligation 0%
loan
The settlement of a present obligation involves the enti
melources embodying economic benefits in order to satisfy te
other party
Settlement of a Present of
(@) payment of cash
(b) transfer of, other assets
(©) provision Of services
@ “eplacement of that
bligation may occur ina number of W2*
©) conversion pg oe ligation with another obligato"
© the areting i ob igation to equity; or
“Ning or forfeiting its rights to collect: Liabilities _ 623
RECOGNITION OF LIABILITIES
A liability is recognized in the statement of financial position when it is probable
that an outflow or resources embodying economic benefits will result from the
settlement of a present obligation and the amount at which the settlement will
take place can be measured reliably.
The principle of recognition under PFRS 9 is that an entity should recognize a
financial liability on its financial statements when, and only when, the entity
becomes a party to the contractual provisions of the instrument. ,
Examples of applying the recognition principle are as follows:
(a) Unconditional payables are recognized as liabilities when the entity
becomes a party to the contract, as a consequence has a legal obligation to
pay cash.
(b) Liabilities to be incurred as a result of a firm commitment to purchase
goods or services are generally not recognized until at least one of the
parties has performed its obligation under the agreement.
(c) A forward contract is within the scope of PFRS 9 is recognized as a
liability on the commitment date rather than on the date on which
settlement takes place.
(d) Planned future transactions regardless of how likely they will occur are not
liabilities because the entity has not Become.
MEASUREMENT OF LIABILITIES
The Conceptual Framework provides different measurement bases that may be
employed to different degrees and in varying combinations for liabilities. They
include the following:
(a) Historical cost
Liabilities are recorded at the amount of proceeds received in exchange for
the obligation or in some circumstances (e.g., income taxes), at the
amounts of cash or cash equivalents expected to be paid to satisfy the
liability in the normal course of business. 624 _ Chapter 1§____— ee
(b) Current cost
Liabilities are carried at the undiscounted amount of cash
equivalent that would be required to settle the obligation currently "
(c) Realizable (settlement) value
Liabilities are carried at their settlement values; that is, the undiseg,
aevints of cash or cash equivalents expected 10 be paid to sat tt
liabilities in the normal course of business. FY te
(d) Present value
Liabilities are carried at the present discounted value of the future net oy
outflows that are expected to be required to settle the liabilities in t
normal course of business.
CLASSIFICATION OF LIABILITIES
Liabilities can be classified as either (a) financial or (b) non-financial.
A. FINANCIAL LIABILITIES
Financial Liability as defined in PAS 32, par. 11, is any liability that is:
(a) a contractual obligation :
(i) to deliver cash or another financial asset to another entity; or
liabilities with anol
(ii) to exchange financial assets or financial ‘
le 10
entity under conditions that are potentially unfavorabl
entity; or
(b) a contract that will or may be settled in the entity’s own &
instruments and is:
aed ®
(i) a non-derivative for which the entity is ot may be oblige
deliver a variable number of the entity’s own equity inst"
qui
or
o . y te
(ii) a derivative that will or may be settled other the Die
exchange of a fixed amount of cash or another financial
a fixed number of the entity’s own equity instruments.
- Chapter 1 Accounting - The Language of Business 9
Current Assets
‘Anasset shall be classified as current when it satisfies any of the following criteria:
a) itis expected to be realized in, or is intended for sale or consumption in, the
entity’s normal operating cycle;
b) itis held primarily for the purpose of being traded;
©) itis expected to be realized within twelve months after the balance sheet date;
or
d) itis cash or acash equivalent (as defined in IAS 7 Cash Flow Statements)
unless it is restricted from being changed or used to settle a liability for at least
twelve months after the balance sheet date.
Allother assets shall be classified as non-current
Current Liabilities
A liability shall be classified as current when it satisfies any of the following criteria:
a) itisexpected to be settled in the entity’s normal operating cycle;
b) itisheld primarily for the purpose of being traded;
c) itis dueto be settled within twelve months after the balance sheet date; or
d) the entity does not have an unconditional right to defer settlement of the liability
for at least twelve months after the balance sheet date...
All other liabilities shall be classified as non-current
Illustrations of the three types of financial statements are at the end of this chapter. Also
illustrated are Statement of | Management’s Responsibility and Independent Auditor’s Report. Liabilities 625
Examples of Financial Liabilities:
« Accounts payable
* Notes payable
* Loans payable
© Bonds payable (Discussed in Chapter 21)
* Other debt instruments issued by the entity
* Accrued expenses payable
* Derivative financial liabilities
* Obligations to deliver own shares worth a fixed amount of cash _
© Some derivatives on owners’ equity
* Mandatorily redeemable share (i.e., a share that will be redeemed by
the entity at a future date)
Categories of Financial Liabili
The two principal categories of financial liabilities are:
I. Financial Liabi
(FL@FVTPL)
ies. at Fair Value through Profit or Loss
This category consists of financial liabilities that meet the definition of
held for trading or upon initial recognition are irrevocably designated by
the entity as at FVPL or credit derivative designated either upon initial
recognition or subsequently as at FVPL.
“Held for Trading” financial liabilities are those that are incurred for the
purpose of selling or repurchasing them in the near term or for short-term
profit taking.
Il. Financial Liabilities Measured at Amortized Cost (FL@AC)
Loans, trade and other payables which are not designated as financial
liabilities at FVPL are classified as financial liabilities at amortized cost.
Financial liabilities classified under this category are subsequently
measured at amortized cost using the effective rate method. ess
cater! Accounting The Language of Bis
4 p
Elements of Financial Statements
ents, namely: (a) balance sheet, (b) ing,
je financial statem ) t
There are tre basic nancial sr rnents ofthe diferent financial stateme
statement, and (c) cash flow statement hi iy
are
1 of (a)_ assets
sheet = measurement 0 assets
Balance Ste financial position (b) liabilities
(c) owners’ equity
Income Statement — measurement of (a) income
performance (b) expenses
Cash Flow Statement — measurement of (a)_balance sheet elements
changes in financial (b) income statement elements
position
Definition of Elements
Asset isa resource controlled by the enterprise as a result of past events and
from which future economic benefits are expected to flow tothe enterprise.
Liability is a present obligation of the enterprise arising from past events, the
settlement of which is expected to result in an outflow from the enterprise
of resources embodying economic benefits.
Equity is the residual interest or remainder of the asset of the enterprise afer
deducting all its liabilities.
Income are increases in economic benefits during the accounting period in the
form of inflows or enhancements of assets or decreases of liabilities that
‘esult in increases in equity, other than those relating to contributions from
equity participants.
are decreases in economic benefits during the accounting period in the
form of outflows or depletions of assets or incidences of liabilities
result in decreases in equity, other than those relating to distribution ®
equity participants,
Expenses 10 Chapter! Accounting - The Language of Business
Definition of Common Account Titles
Cash on Hand
Petty Cash Fund
Cash in Bank
Accounts Receivable
Notes Receivable
Unused Supplies
Prepayments
Like Prepaid Rent
Prepaid Insurance
Land
Buildings
Accumulated ;
Depreciation Building
Equipment
Laboratory Equipment
‘Medical Equipment
Office Equipment
ASSETS
Coins, currency, checks, postal money orders
money orders. Cash that is intended to be de, and iy
the bank when a petty cash fund is maintained edi
Coins, currency and replenishment check. These
used for petty or small payments that: cannot become
made with checks. "i
Cash deposited in savings and/or checking accounts Tk
payments are made by checks,
Amounts due from customers arising from credit sales
credit services.
Amounts due from others supported by promissory note:
Laboratory supplies, medical supplies, office supplies bought
but not yet used,
Expenses paid in advance, They are assets at the time of
Payment. They become expenses through the passage of
time.
Real property owned and in use in the normal operationof
business.
Physical structure on land, ‘These are used in business
Cumulative part of the cost of the building that has been
recognized as expense
Equipment used by the business foritto be able to perform
itsmain function or objective es of accounting
‘questions:
ie governance such as increased disclosure of information and effective moni
ne n from the response to the corporate failures and collapses,
nial povemance hes Town in importance, including the increasing number of small investors,
thir your verge ‘mums and dads’ owning shares; the globalisation of markets that has led tg
ieerensed competition between entities; the freeing up of capital ‘markets with more pressure onthe
attraction of capital; and the rapid growth of accessible information, which is mone readily avai.
able to the public at large. This means there are more interested people demanding accountability
In summary, why is corporate governance important? There are various Participants who have
an interest in the entity and who determine and influence the
direction and performance ofthe
éatity, namely, for a company, shareholders, management and the board of directors. However,
shareholders do not manage the company; managers are entrusted with thie decision-maki
authority. The principal (shareholders) delegates its decision rights o the
to act in the principal's best interest. This con
itoring
there are various reasons why
‘means shareholders may
be protected from divergent behaviour,
Given its importance,
@ number of bodies througt
thout the world have introduced ¢
Buidelines and principles
. The Australian Securities Exct
management and oversight.
- Structure the board to add value.
. Promote ethical and responsible deci
- Safeguard integrity in financial reporting.
Make timely and balanced disclosures,
. Respect the rights of shareholders
Recognise and manage risk.
. Remunerate fairly and responsibly.
Better quality accounting information is expected to be provided to shareholders if entities ab%¢
the above principles. For example, if entities are guided by the principles in making timely and 8
anced disclosures of accounting information and make decisions in the running of the entity ut?