Acct 1501 Notes Essay Example

Acct 1501 Notes Essay ACCT1501 ACCOUNTING FINANCIAL MANAGEMENT 1A SEMESTER 1 2008 COURSE NOTES Last Revised: 13th August 2008. kaheiyeh. web. officelive. com Contents Page 3: The Nature of Accounting Page 5: The Balance Sheet Transaction Analysis Page 8: The Income Statement Transaction Analysis Page 13: Financial Reporting Principles Page 18: Adjustment to Accounting Entries Page 23: Completing the Accounting Cycle Page 26: Accounting for Cash Holdings Receivables Page 30: Accounting for Inventory Page 37: Accounting for Non-Current Assets I Page 42: Accounting for Non-Current Assets II Page 45: Accounting for Liabilities 2~ Week 1 – The Nature of Accounting What is Accounting? Accounting is the main way in which organisations present the financial performance and financial position of that organisation. Essentially, it is a language. It is also used to convey economic information to the decision-makers (users). The Rise of Economic Consequences Economic consequences have a very acute relation ship with accounting. Take, for example, the collapse of Enron in 2001. This was due to: ? Misleading accounting ? Accounting scandals Accounting along took the business down and also the auditing firm and demonstrates this relationship. There is a focus on economic consequence in equity markets. This means that the decision maker is usually the investor/owner and they decide the value and the amount of shares they are willing the buy or sell. Users of Accounting Some users of accounting include: Management: To Monitor and Control Creditors: To decide lending amounts and terms Customers: To buy the product or not? This generally applies to large buyers, not the end consumer) Tax Office: To see the assessable income Regulators: To check for compliance with legislation and laws Analysts: To provide recommendations to potential and current shareholders Competitors: To gain insight into the businesss strategies Managers: To decide on performance incentives (Pay rises, bonuses etc. ) Employees: To check their work, pay and conditions Accounting is a dynamic field. It can adapt and is responsive to cur rent events. Double Entry Book-Keeping Double Entry Book-Keeping states that for every transaction, there is a source and a resource. We will write a custom essay sample on Acct 1501 Notes specifically for you for only $16.38 $13.9/page Order now We will write a custom essay sample on Acct 1501 Notes specifically for you FOR ONLY $16.38 $13.9/page Hire Writer We will write a custom essay sample on Acct 1501 Notes specifically for you FOR ONLY $16.38 $13.9/page Hire Writer That is: RESOURCES = SOURCES Which turns into: ASSETS = LIABILITIES + OWNERS EQUITY This is known as the Accounting Equation and always balances. ? ? ? ? ? ? ? ? ? ~3~ Assumptions in Accounting There are a few assumptions in accounting: ? Reporting Entity The enterprise which is being reported should be the same entity (Either the legal entity or the economic entity or both) The Legal Entity is the enterprise itself, such as Woolworths Ltd. The Economic Entity is the consolidated business, such as Woolworths Ltd and all its subsidiaries. Monetary Assumption The universally accepted medium of exchange, such as cash, and in common denominators, such as the Australian Dollar, is assumed. ? Going Concern The report is prepared under the presumption that the business will continue to trade for the indefinite future. ? Period Assumption This assumes that reports are generated at set intervals (per month, year etc. ) ? Historical Cost This assumes that transactions are initially recorded at the price they were bought for. Cash Accounting and Accrual Accounting Cash Accounting is when the transaction is recorded when the actual cash is received. Accrual Accounting records a transaction when it happens, not when the cash is received. ~4~ Week 2 – The Balance Sheet Transaction Analysis The Statement of Financial Position The Statement of Financial Position (aka. The Balance Sheet), shows an organisations resources and claims on those resources at a particular point in time. The sheet shows an enterprises assets, liabilities and owners equity. Owners Equity can be described in different ways: ? A Company: Shareholders equity ? A Sole Trader: Proprietors equity ? A Partnership: Partners equity Most importantly, the Balance Sheet shows the accounting equation: ASSETS = LIABILITIES + OWNERS EQUITY The balance sheet is usually laid out in the following: ASSETS LIABILITIES OWNERS EQUITY This emphasises the equality between Assets, Liabilities and Owners Equity. Or ASSETS LIABILITIES OWNERS EQUITY Important elements on the Balance Sheet include: ? The entity ? The date at which the statement was prepared ? The currency and amount ? Assets, Liabilities and Owners Equity Australian Accounting Standards Board (AASB) Requirements The AASB101 requires that the following must be shown on the Balance Sheet: Assets ? ? ? ? ? Cash and cash equivalents Trade and other receivables Inventories Biological assets Investments Other financial assets ~5~ ? ? ? ? Tax assets Property, plant and equipment Investment property Intangible assets Liabilities ? ? ? ? Trade and other payables Interest-bearing liabilities Tax liabilities Provisions Owners Equity ? Contributed equity/Issued capital ? Reserves ? Retained profit ? Minority interest/Outside equity Assets An asset is defined by the AASB Framework as: A resource controlled by the entity as a result of past events from which economic benefits are expected to flow to the entity. AASB Framework Control of an asset is not necessarily limited to legal ownership of the asset. A past event is usually a transaction such as the purchase of an item or through production. Future economic benefit is the potential for the asset to generate profits/cash flows in the future. The asset does not actually need to generate a future economic benefit itself. As long as it helps in generating future economic benefit (such as buildings), it can be classed as an asset. An item must meet all three requirements to be classed as an asset. It must also be noted that persons cannot be considered assets; as you do not control them. An asset should be recognised on the balance sheet if it is probable (more likely than not likely)that any future economic benefit associated with it will flow into the entity and that the asset has a cost or value that can be measured with reliability. The value of an asset can be measured through historical cost, its realisable value (current or market value) (how much you can sell it for now), its present value (value in use) (the amount it can generate), or the current cost (the amount you have to pay to replace it today). Liabilities A liability is defined by the AASB Framework as: 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. AASB Framework ~6~ A present obligation may be due in the near future (A present obligation is not a future commitment. Such as the planning of purchasing an asset in two years is NOT considered a liability) and the giving up of resources embodying future economic benefits is the payment of cash or the provision of services as obliged. A liability should be recognised on the balance sheet with the same requirements as that of an asset, except with an outflow of cash and not an inflow. Equity Equity is defined as: The residual interest in the assets of the entity after deducting all liabilities That is: OWNERS EQUITY = ASSETS LIABILITIES Current vs. Non-Current An asset is considered current if it is: ? Expected to be realised within 12 months of the date ? Unrestricted cash or cash equivalent ? Held primarily to be traded ? Expected to be settled in normal business processes If it does not meet these criteria, it is considered a Non-Current Asset. A liability is considered current if it is: ? Due to be settled in 12 months of the date ? No right to extend the settlement date past 12 months ? Held primarily to be traded If it does not meet these criteria, it is considered a Non-Current Liability. Transactions A Transaction is an impact on the companys assets, liabilities and owners equity. The criteria for a transaction are: ? Exchange of economic value ? External to the entity ? Evidence of the exchange ? In dollars for quantification purposes Balance is always maintained in transactions. There are always two or more things moving, hence, Double entry accounting. More on transactions is revealed in Week 3. ~7~ Week 3 The Income Statement Transaction Analysis Relating Performance and Wealth A companys net assets (ie. Their Owners Equity) increases in wealth as the companys wealth increases. The company is there to benefit shareholders but, does it benefit society? The community? The economy? The environment? Some do, some dont. For us, we will focus on looking at the companys benefit to its shareholders. The Statement of Changes in Equity Changes to owners equity can be calculated in this way: Start of Year Balance Add Contributions (new share issues) Add Profit/Loss (Revenue Expenses) Add Increases in Reserves Less Distributions (dividends) -= End of Year Balance Owners equity can be increased by contributions by owners, share capital and profitable transactions and events. Owners equity can be decreased by distributions to owners, dividends and unprofitable transactions and events. Retained Profit is when a company earns profit. That profit can be distributed amongst shareholders as dividends. NET PROFIT DISTRIBUTIONS = RETAINED PROFITS It must be stressed that DIVIDENDS ARE NOT AN EXPENSE! The Statement of Financial Performance The Statement of Financial Performance (aka. The Income Statement) uses the accrual accounting principle and measures the financial performance of an enterprise over a period of time. Basically, it records the change in financial position of a business. Principally; it presents the difference between revenues and expenses. That is: PROFIT = REVENUES EXPENSES Differences with the Balance Sheet: ? The income statement covers a period of time and not a point in time. ~8~ ? ? Both can have extensive explanatory notes which are referred to throughout the statement. Different types of data are displayed such as detailed revenue, expenses, gross profit, net profit and net profit before tax. The Statement of Financial Performance must include: ? Revenue ? Finance costs ? Share of the profit or loss of associates and joint ventures accounted for using the equity method ? A single amount that combines the post tax profit (loss) of discontinued operations and the post tax gain (loss) on the disposal of the related assets ? Tax expense ? Profit or loss The following may be shown on either the statement or the notes for it: ? Income or expenses items that are material ? Analysis of expenses ? Depreciation ? Amortisation ? Employee benefits ? Dividends to equity holders Elements of the Statement of Financial Performance Income Income increases with economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases in liabilities that result in increases in equity, other than those relating to contributions from equity participants (ie. Those from Owners Equity). Income can be further split into two categories: ? Revenue Revenue arises in the course of ordinary activity of an entity. They include sales, fees, interest, dividends, royalties, rents etc. Revenue should be recognised if the good or service has been rendered (ie. The good or service has been delivered) It should be noted that revenue is any sort of inflow of economic benefits. Even if the activity produces a net loss of equity, the inflow of money is still labelled as revenue. ? Gains Gains are no different in nature from revenue, however, they may or may not arise in ordinary activities and are usually displayed separately in decision making. Expenses Expenses are the opposite of revenues. They are decreases in economic benefits during the accounting period in the form of outflows or depletions of assets or liabilities that result in decreases in equity, other than those relating to distributions to equity participants. ~9~ Capitalising vs. Expensing Capitalising is when the transaction is seen as a deduction in cash but an increase in asset which evens it out with no net change. Expensing is when the transactions is seen as a deduction from cash and also a deduction in Owners Equity. This can create issues if there are large amounts of money involved but not very much with small amounts. If a business continually classes the acquiring of an asset as capitalising (so that Owners Equity is not affected), the business may get into serious problems later on. Recall the definition of an asset from last week. If it does not meet those requirements, consider it under expensing. Cash vs. Accrual Profit An enterprise may post an accrual profit but not a cash profit if the cash has not been received after the day the statement was made. This can cause discrepancies when analysing statements and transactions. In short, the accrual profit is not the same as the cash profit. The incurrence of an expense is not necessarily accompanied by an outflow of cash nor is the earning of revenue necessarily accompanied by an inflow of cash. When should something be recognised? Recognition should occur for revenue when a service has been performed and expenses when you expect to have incurred it. They should be given asymmetric treatment. Under accrual accounting, cash flows are not necessary to recognise revenue and expenses. You do not need to know when cash will arrive, only when cash has been transacted. Expanding the Accounting Equation Consider the Accounting Equation ASSETS = LIABILITIES + OWNERS EQUITY We know what comprises of assets and liabilities: CA + NCA = CL + NCL + OE But what comprises Owners Equity? Owners equity is comprised of: ? Contributions by owners ? Retained Earnings ? Profit (revenue and expenses) ? Distributions ~ 10 ~ Hence, Owners Equity can be described as: Capital Contributions (CC) + Retained Earnings (RE) + Opening Retained Earnings (Op. RE) + Revenue (R) Expenses (E) Distributions (D) = CC + Op. RE + RE + R E D Therefore, the final equation is: CA + NCA = CL + NCL + CC + Op. RE + RE + R E D We see the Revenue and Expenses are part of the Income Statement and the whole equation is part of the Balance Sheet. This provides us with the link between the Balance Sheet and the Income Statement. Double Entry Accounting: Transactions This is an extension of transactions we briefly introduced in Week 2. We already know of one example of double entry accounting; that being: ASSETS = LIABILITIES + OWNERS EQUITY However, there is another example: DEBITS = CREDITS ? Debits are abbreviated to Dr Credits are abbreviated to Cr To consider what credits and debits do to each part of the accounting equation, consult this table: Type of Account Assets Liabilities Share Capital Retained Profits Revenues Expenses Normal Debit Credit Credit Credit Credit Debit Increases result in Debit Credit Credit Credit Credit Debit Decreases result in Credit Debit Debit Debit Debit Credit *Note: The section s in italics are all part of Owners Equity, however different parts of Owners Equity have different effects on where to debit and credit. The general rule of thumb is that Normal or Increases result in a Credit and a decrease results in a Debit; this is only different for Expenses. ~ 11 ~ Remember that in a transaction, there must always be two or more effects. One must be a credit activity and one must be a debit activity. They must also keep the accounting equation balanced. Journal Entries Journal Entries are small entries that document transactions with credits and debits. Remember that in every transactions, there has to be at least two effects; one credit, one debit. An example of a Journal Entry is as follows: ________________________________________________________ Date Debit Account Credit Account Short Statement of transaction PR PR $xxx $xxx ________________________________________________________ *Where PR = Posting Reference. This is usually provided for you in the example, such as A1 or E3. Also take note of the indents, this helps to differentiate debits from credits and show that they balance more easily than if they were accounted for in a straight column. ~ 12 ~ Week 4 – Financial Reporting Principles Note: The entire first section of this week (everything before the accounting cycle) is explained in the document, Framework for the Preparation and Presentation of Financial Statements (Published July 2004 by the AASB) and is available at this link: http://www. aasb. com. au/pronouncements/aasb_standards_2005. htm What is Financial Reporting? Financial reporting is used to provide information about a firms financial position, per formance and cash flows to help the users of that information make good economic decisions. The full set of reports (as required by the AASB) includes: ? The Balance Sheet ? The Income Statement ? The Cash Flow Statement (This uses cash accounting) ? The Statement of Changes in Equity (This is not discussed in ACCT1501. ) ? Notes to these accounts and also other relevant material. The notes to the accounts and reports are not required in a There is a demand for this information which stems from the need to make appropriate and reliable economic decisions for the firm. The people demanding this information want to know about the: ? Performance of the firm ? Financial position of the firm ? Financing and investing with the firm ? Firms compliance with laws Framework Within the AASBs framework, we will need to look at four areas: ? Underlying Assumptions ? Qualitative Characteristics ? The elements of the financial report ? Recognition Principles Underlying Assumptions The underlying assumptions are basically the same as those discussed in Week 1. For more details, look at the Week 1 notes. Listed here briefly are the assumptions: ? Accrual Basis This simply means that financial statements should be produced under accrual accounting methods (to record transactions when they occur, not when the cash is received) so that they can meet their objectives. Going Concern Financial reports should be prepared under the assumption that the business that it is reporting on will continue to operate and function for the foreseeable future. ~ 13 ~ This is so that the business has no assumed intention of liquidation or to scale back its operations. Qualitative Characteristics The accounting statements must fulfil a wide rang e of qualitative characteristics so that it can be understood by all. These are: ? Understandability The statements must be able to be understood by a wide variety of people including professional accountants to high school graduates. The way in which the information is displayed is vital to this (i. e. Logical sequence). Relevant information that is complex should still be presented in statements, but less professional users should be advised to seek professional advice. ? Relevance (Materiality) The information presented on the statements must be relevant to the time period that it is describing. It must be based on current information so that proper predictions can be made. The relevance of information is usually classed by its materiality. Information may be relevant and reliable but it may be immaterial. Including this on statements may do nothing but impair its understandability. If the item will not affect the users decisions (i. e. Transactions of small amounts), then it need not be included. Reliability There should be a faithful representation of transactions and events (i. e. No material bias or error. It should be objective). Prudence must be exercised in that assets or revenue or gains are not overstated and liabilities or expenses are not understated. There, however, may be a small level of bias allowed with small immaterial amounts such as those described above. The information in financial reports must also be complete within the bounds of materiality and cost. An omission can cause information to be false or misleading and thus unreliable and deficient in terms of its relevance. If information is to represent faithfully the transactions and other events that it purports to represent, it is necessary that they are accounted for and presented in accordance with their substance and economic reality and not merely their legal form. The substance of transactions or other events is not always consistent with that which is apparent from their legal or contrived form. For example, an entity may dispose of an asset to another party in such a way that the documentation purports to pass legal ownership to that party; nevertheless, agreements may exist that ensure that the entity continues to enjoy the future economic benefits embodied in the asset. In such circumstances, the reporting of a sale would not represent faithfully the transaction entered into (if indeed there was a transaction). @ ? ~ 14 ~ ? Comparability The information that is generated by the firm must be able to be compared with those generated from other firms and to its own statements from earlier periods as well. This means that the information should be presented in the standards as set by the AASB. The firm should state which policy that it has used, any changes to that policy and the effects of those changes. Reliability vs. Relevancy Information that may be relevant can also be unreliable in nature, or representing it would be useless and/or potentially misleading to the users. Such as a lawsuit against a company would be relevant to the users, but its cost cannot be measured reliably. Thus, these should be mentioned on the notes of the statements. Another issue with this is usually with historical cost of assets. The asset is always relevant to the accounting statements but its measurement is not always reliable. The timeliness of the information also matters as the information will lose its relevance if there is a delay in reporting it. Information should always be relevant to when the statements were prepared and not for a period before. Cost vs. Benefits of Information The cost of providing the information to the user should never outweigh the benefits that can be derived from the information that is produced. There are some problems with this as evaluation of the information is largely by judgement. Also, the costs are not necessarily borne by those who will reap the benefits of that information. In the end, there must always be a trade-off between the qualitative characteristics and this is often inevitable. Appropriate balance must be maintained among these characteristics so that it can meet the objective of financial reports. Financial reports should provide a fair and true view of the financial information of an entity. The appropriate application of and the balance of qualitative characteristics will usually lead to this result. The Accounting Cycle The accounting cycle is a never-ending cycle of gathering economic information and presenting that to the users. The cycle is: 1. 2. 3. 4. 5. Transactions Identifying and measuring (Source Documents) Recording (Journal Entries) Classifying and summarising (Ledgers and Trial Balances) Reporting (The Financial Statements) ~ 15 ~ 1. Transactions First, recall the definition of a transaction: A transaction is an economic event that affects a business and needs to be reflected in its financial statements Characteristics of an external transaction include: ? Exchange of items of economic value ? Past Event ? Involves a party that is external to the business ? Evidence ? Measureable in monetary units Internal transactions are adjustments made to records that introduce new data or alter that existing data. It is normally intended to enhance information. This includes things such as the use of office supplies and the depreciation of an asset. Transactions are a vital first step to the accounting cycle and so must not be left out. 2. Source Documents Source documents are those that provide evidence that a transaction has taken place. These include items such as cheque butts, invoices, bank statements etc. . Journal Entries From source documents, the transactions are transformed into more classified and ordered information that is presented in journal entries. However, the problem with journal entries is that they only show the balance at any one point in time. We need ledger accounts to show a change in balance over time (This is similar to how a balance sheet is to the income s tatement). Journal entries were discussed in Week 3; please see Week 3s notes for more details. 4. Ledger Entries Trial Entries A general ledger is a collection of all individual accounts for a business. It shows a list of all accounts in assets, liabilities and owners equity for a firm but the basic ones are assets, liabilities, owners equity, revenue and expenses. These can be represented in Taccounts. As always, debits are placed on the left while credits are placed on the right. Accounts are used to classify transactions and store information for similar transactions. A chart of accounts is basically, a listing of all accounts in the general ledger. They are usually identified by a single number and are listed in the accounting manual. These are different for each firm and it does not matter how they list them. Writing to a ledger can be in the same way as that of journal entries. Debts and Credits to each of the accounts still follow the same rules as those for journal entries (See Week 3 notes). Writing to the ledger is a very simple process of just transferring the information from journal entries directly to the ledger entry. ~ 16 ~ There are other accounting formats used which includes the narrative format. This method is used more widespread than the T-account because it also includes a column at the right to show the net balance of the account after each debit or credit. Otherwise, it is exactly the same as T-accounts. Trial entries are listings of all accounts with their related balances at certain point in time. They are used to check the accuracy of ledgers and journals by seeing if the total debits equal the total credits. Although, even if all the debits equal the credits, it does not necessarily mean that it is correct. All it means is that there are no obvious errors in the documentation of journals and ledgers. Ways to recheck if the trial balance is not in the balance: ? Re-add the trial balance ? Check that the correct amounts are posted in the journal entries ? Check that each ledger is balanced correctly ? Check that everything balances in the journal entries 5. Reporting Finally, this information is reported in the different forms such as the Balance Sheet, Income Statement etc. References @ Page 18-19, Framework for the Preparation and Presentation of Financial Statements Published July 2004 Australian Accounting Standards Board. ~ 17 ~ Week 5 – Adjustment to Accounting Entries During the course of accounting, a business encounters inaccuracies due to the lack of time that is available to make this accurate. A business with very accurate information would do more accounting than actually doing what the business is supposed to be doing! However, once at the end of the financial period, this is where accuracy matters. Adjusting the accounting entries is what makes this correct in the end. As always, remember that the accrual accounting system is used, period assumption and going concern are also assumed. Revenue Recognition Revenue should only be recognised in the current period if it fits all four criteria: All or most of the good/service has been provided to the customer. Costs to generate the revenue have been incurred and measured. Revenue can be measured accurately. Cash or a promise to pay has been received. ? ? ? ? To recognise a revenue means to include it on the Income Statement for that period. First, we must find out how much should be written down as revenue and when. Revenue is earned only when the goods and services related to the inflows of economic benefits or service potential have been provided. For example: If a magazine company receives money for yearly subscriptions, it cannot be classed as revenue until the magazines have physically been sent out to the customers. This can be divided up as staggered revenue for each individual magazine or as one entire subscription at the end of the year. Expense Recognition Expenses should be recognised in the same period as when the revenue associated with it is recognised (i. e. The matching principal). By matching revenues to expenses, a better picture of the business is created. Recognising in this case is the same as revenue; it means it is included on the Income Statement for that period. Expenses are incurred for that period when there has been consumption or loss of economic benefit or service potential. Buying an asset is NOT considered an expense until it has been used up. i. e. Whiteboard markers are not an expense until they have run out of ink or are lost. The same thing is done with things that are expensed over time, such as pre-paid insurance. The company should show that the items value is being used up each month instead of reporting on bigger loss at the end of the year. This shows a companys financial position and performance much more accurately. ~ 18 ~ Adjusting The Entries The adjusting of entries is done at the end of the accounting period, which is assumed to be equal under the period assumption. There are four types of accounts that must be adjusted at the end of the period. Accruals Revenues Expenses Accrued revenues (an asset) Accrued expenses (a liability) Deferrals Unearned revenues (a liability) Prepayments (an asset) Unearned revenue is cash received but the good or service has not been provisioned yet to the customer. It is also known as: ? Revenue received in advance ? Advances from customers ? Customer Deposits An example would be a customer buying a plane ticket for next month from your firm. This would be unearned revenue for you because you have yet to provision the plane journey for the customer. Prepayments are the like unearned revenues but from the payers perspective. This is considered an asset because you have already paid for goods but they have not been received yet. It may be classified as a current or non-current asset depending on how long the benefits are perceived to last for. Continuing on from the last example, this would be from the customers view. He has paid for the service he wants but he is yet to receive that service from the firm. Note that these can be done in the reverse as well. Sometimes, prepayments are seen as an expense at first until the goods and services arrive, at which then they are not considered expenses anymore. They can also split this into two parts: part prepayment and part expenses. Accrued Revenue is when the good or service has been provided but the cash will not be received until the next accounting period. Accrued Expenses are when expenses are incurred in one period but the outflow of cash associated with it is not paid until the following accounting period. (For example: The wages earned