ACCT1501 Study Notes PDF

ACCT1501 Notes Cheryl
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Chapter 1 Introduction to Financial Accounting

The basic purpose of financial accounting is to produce useful info which is used
in many and varied ways.
People use the info generated by financial accounting to improve their
decision-making in allocating scarce resources.
1.2 Financial Accounting
Accounting is a process of identifying, measuring and communicating

economic information to allow informed decisions by the users of that
information.
Financial Accounting periodic financial statements to external decision makers
(investors, creditors)
Financial accounting measures performance and position
Management accounting information for planning and performance reports
(internal decision makers)
Financial performance generating new resources from day-to-day operations

over a period of time
Financial position the enterprises set of financial resources and obligations at a
point in time
Financial Statements reports describing financial performance and position
Notes part of the statements, adding explanations to numbers
1.3 The Social Setting of Financial Accounting
Financial accounting:
o Helps stock market investors buy/sell/hold
o Helps banks and lenders lend?
o Helps mangers run enterprises (in addition to help from management acct)
o Provides basic financial records for day-to-day mgmt, control, insurance and
fraud prevention
o Used by govt in monitoring actions of enterprises and in taxes, e.g. GST
Accounting is not a passive force within the social setting it tells us what is
going on, and in doing so, affects decision making
1.4 The People Involved in Financial Accounting
Main Participants: Information users, information preparers, auditors

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Users
User is someone who makes decisions on his own behalf, or on behalf of an org
Users main demand is for the credible periodic reporting of an enterprises
financial position and performance
Main groups of users: Owners, Potential Owners, Creditors and potential creditors,
Managers, Employees, Regulators/govt, Financial and market analysts,
Competitors, Accounting researchers, customers, miscellaneous third parties
Preparers (Decision Facilitators)
Main groups: Managers, Bookkeepers and clerks, Accountants
Auditors (Credibility Enhancers)
Auditors report on the credibility of the enterprises financial statements, on

behalf of owners and others.
Assists users by verifying financial statements have been prepared fairly
Internal and external auditors
Role is to scrutinise the preparation process
External auditors are appointed by the owners not allowed to be owner or
manager, ensuring that auditor is independent from companys objectivity
Accounting firms offer external auditing, advice on income tax, accounting,
comp systems and many other financial and business topics
1.5 Accrual Accounting
Accrual accounting system, impact of transactions is recognised in the time

period the transactions and expenses occur, rather than when the cash is
received or paid
Revenue sales of goods or services
Expenses the costs of services or resources in the process of generating
revenues
Accrual Accounting versus Cash Accounting
Cash accounting records revenues and expenses when the cash is received or
paid.
Problem: timing of cash flow is in a different accounting period to the substance
of transaction affected by interest rates, exchange rates, depreciation
Using Accrual Accounting to prepare financial statements
Include all the cash receipts and payments that have already happened; for
example, cash sale, cash payment for wages
Incorporate future cash receipts and payments that should be expected, based
on existing transactions
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Measure the value of incomplete transactions (amount of remaining loans can
be recorded as an expense)
Estimate figures when exact amounts are unknown (interest on loans)
Make an economically meaningful overall assessment of awkward problems
1.6 The Key Financial Statements
Balance Sheet shows an organisations resources and claims on resources at a

particular point in time.
Income Statement measures financial performance over a defined period
Cash Flow Statement shows the sources and uses of cash during the period
Retained Profits Note
Balance Sheet
Assets future economic benefits as a result of past transactions or other past

events needs to be measured in monetary terms
Assets cash, accounts receivable, inventory, property
Liabilities future sacrifices of economic benefits that an organisation is
presently obliged to make to other organisations as a result of past events
Liabilities goods on credit, bank loans, mortgages, long service leave, warranty
Liabilities accounts payable, wages payable, provision for employee
entitlements, long term loans
Shareholders Equity excess of assets over liabilities share capital and retained
profits
Shared capital amount that owners have directly invested into the company
Retained profits total cumulative amounts of profits that the company has
retained in the business rather than distributed as dividends
Assets = Liabilities + Owners Equity
Income Statement
Provides info on an organisations profitability for a period of time

Previously called the profit and loss statement
Gross profit = Sales revenue cost of goods
Income statement Sales revenue, Costs of goods sold, Gross profit, Operating
expense, profit before tax, profit after tax
Statement of cash flows
Shows the changes of cash during the period in one balance sheet accounting
Shows receipts and payments of cash
Revenues reported usually do not equal cash collected and expenses do not
equal cash paid, net profit is different from the change in cash for the period
Individual transactions split into:
o operating activities (G&S),
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o investing activities (NCA/capital),
o financing activities (equity and certain borrowings)
1.7 Relationships between the financial statements
The cash flow statement explains the change in cash in the balance sheet.
Net profit appears in income statement, also reflected in retained profits note.
1.8 Information use scenarios
Evaluation of CEOs performance by member of board of directors

Preparation of buy/sell/hold shares recommendations by financial analyst
Review of companys borrow status by bank lending officer
Development of supply contract with the company by a stationery suppliers
sales manager.
Demands on the quality of financial accounting information
Relevance useful, valuable, and timely manner

Reliability objective, undue error, not deliberately misleading
Materiality assessing whether omissions, misstatement of disclosure of info can
affect decisions. Judged by size of error compared to net profit, total assets.
Time.
GAAP (general accepted accounting principles) to assure accepted methods
are followed, auditors opinion is that the statement have been prepared in
accordance with the GAAP, and that the resulting figures are appropriate to its
circumstances.
Prudence controversial criterion that A, R, P should not be overstated and L, E,
Losses, should not be understated if there is uncertainty. Cautiousness
Disclosure make clear to reader which acct methods was followed, provide
supplementary info on debts, share capital, commitments and other necessities
in understanding statements
Understandability reports should be prepared to regard to interests of users,
and making sure they have the ability to comprehend and contempt.
Accounting practices
Comparability financial statements should be prepared in a comparable way
so companies can determine their performance, as absolute sense is ambiguous
Consistency Keeping same accounting methods Following GAAP, changes
in method will be recorded, or record significant events that might have
affected the trend.
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AASB (Australian Accounting Standards Board) Framework
Understandability
Relevance
- Materiality
Reliability
- Faithful representation (represents what really existed/happened)
- Substance over form (substance and economic reality)
- Neutrality (objectivity, freedom from bias)
- Prudence (caution in estimates)
- Completeness (material info not omitted, not misleading)
Comparability
Tradeoffs among accounting principles
Prudence is a bias, interfering with neutrality and reliability

New AASB to conform with GAAP will mean lack of comparability with other
companies that didnt previously use this standard
For the sake of comparability, if other companies change acct methods, a
comp has to decide whether to change or not
reliability or costs, time, relevance
1.9 Financial Statement Assumptions
Accrual basis accrual accounting

Going concern organisation will continue operations as a going concern in the
foreseeable future
Accounting equity separate and distinguishable from owners personal equity
Accounting period discrete equal periods annual or half yearly or quarterly
Monetary Measured in common denominator AUD
Historical Cost
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Chapter 2 Measuring and Evaluating Financial Position and

Performance
2.1 Introduction to the Balance Sheet
Contains 2 lists that have the same dollar total

Describe enterprises financial position at a particular date
List 1: resources/assets
List 2: Liabilities (existing obligations to be paid in future), Shareholders equity
(amounts received from owners, involve permanent financing but do not have
to be repaid, and any past accrual profits)
Must have Company Name and Balance Sheet as at DATE

2 styles side by side: vertical:
Assets: Liabilities: Assets:

Useful Financial Obligations to be Useful Financial Resources
Resources paid
Liabilities:
Equity: Obligations to be paid
Owners Investment
Equity:
Owners Investment
2.2 Explanations of the three Balance Sheet Categories: Assets, Liabilities and Equity
Assets
Assets are resources controlled by the entity as a result of past events and from
which future economic benefits are expected to flow to the entity.
Three essential characteristics future economic benefits, control by the entity,
occurrence of past transactions of past events
Future economic benefits as assets are used to provide G&S for exchange,
aiming to generate net cash flows
Control by entity relates to whether an entity can benefit from asset, and to
deny or regulate access of others public good
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Occurrence of past transactions or other past events means that the transaction
giving the entity control over benefits must have occurred
Other assets may include happy employees or safe working environment
However they do not count into balance sheet
- Cannot verify dollar cost
- Difficult to measure reliability how much more productive?
- Enterprise does not own employees dont have economic control
Expenditure on market research not an asset impossible to calculate future
benefits at date of expenditure.
Current assets sold / used / collected within 1 year.
Liabilities
Liabilities are present obligations of the entity arising from past events, the
settlements of which are expected to result in an outflow from the entity of
resources embodying economic benefits.
Two essential characteristics
A present obligation exists and involves settlement in the future via the sacrifice
of future economic benefits.
- Legally enforceable contracts money borrowed, credit
- Imposed on entity e.g. tax payable, or damages awarded by courts
- Normal business transactions to maintain a good e.g. warranty
Adverse financial consequences for the entity, in that the entity is obliged to
sacrifice economic benefits to one or more entries
Requirement of obligation means that liability occurs if enterprise has already
received a benefit, e.g. received cash from bank
Equity
Equity is the owners interest in the enterprise.

Can be direct contributions from shareholders/owners
Can be derived from profit that are not collected e.g. dividends that have not
been distributed
Assets represent pool of resources provided by all sources regardless of
whether it is provided by owners or not.
Book value of enterprise = residual or net concept of equity
Book value is arithmetically valid idea, but does not tell very much. Impractical
when companies go out of business, because equity (money returned to owners)
will not simply be calculated by the difference between A and L.
Shareholders equity is generally based on historical transactions, and does not,
except by coincidence, equal the current market value of business.
Retained profits or retained earnings represent past accrual profit not yet given
to owners.
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Earning profit means more assets (e.g. cash) or fewer liabilities, so profit is a
source of assets
2.3 Some preliminary analysis of the sound and light balance sheet
Soundly financed?
- Assets come from liabilities look at where assets come from
- Debt to equity ratio L/E
Pay bills on time?
- Able to turn current assets to cash
- Look at current liabilities and cash
- Current assets current liabilities = ___ in working capital
- Working capital / current ratio CA/CL
Companys ability to sell inventory to pay for bills
- Quick ratio/ Acid test ratio Cash + AR / CL
- If less than 1, then that means company has to sell inventory to get pay L
All ratios are only indicators
Should owners declare for dividend?
- By taking out dividend, decreasing retained profits, they decrease cash.
- This can create cash strain
- Most retained earnings are reinvested in land, equipment, inventories, so less
cash
Equipment / Depreciation:
- In calculating profit, accumulated depreciation counts as an expense
- Net book value of equipment = cost of equipment accumulated
depreciation
- Accumulated depreciation is a negative asset
2.4 A closer look at the balance sheet
Comparative balance sheets:

- Contains figures for 2 periods, to help users recognise changes.
- Recent on the left, closer to words
Remember to look for notes when studying financial statements
Buildings (net) means the accumulated depreciation has been deducted
Prepayments are prepaid expenses that have been paid for, for which the
benefits have not been received.
Intangible assets noncurrent assets that have no physical substance
copyrights, patents, trademarks, brand names and good will.
Accrued expenses relate to expenses that have been incurred during the year,
but not yet paid wages, electricity bills
Employee entitlements can be current or non-current
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Where do the figures come from?
Accounting is generally a historical measurement system

Assets are generally valued at what they cost when they were acquired
Liabilities are generally valued at what was promised when the obligation arose
Other terms/notes
Usually, accrued expenses and accounts payable is joint into payables account,
but will be separated in the notes
Sometimes use different terms payables liabilities (no interest) and interest-
bearing liabilities (such as loans, which incur interest)
Current tax liabilities estimate of the amount of income tax to be paid in next
financial year
Deferred tax liabilities
- current profit > profit reported on tax return, liability for income tax is implied
for later
- current profit < profit reported on tax return, deferred tax asset govt has to
pay tax paid back
Derivative financial instruments used to reduce exposure to foreign exchange
and interest rate risks
2.5 Maintaining the accounting equation

Double entry system where accounting equation is always in balance
2.6 Managers and the Balance Sheet
Balance sheets are important, because outsiders read it.

Balance sheet reports what the organisations position is at a point in time.
Shows assets that management has chosen to acquire
Provides useful picture of the state of organisation
Balance sheet does not state how management has performed in using assets
to earn profit
2.7 The Income Statement
Might measure companys fin performance by closing it down, selling it, paying
off liabilities and see whether money left was more than money owners put in
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But this is too drastic just to find out performances.
Income statement uses accrual accounting to measure financial performance
over a period of time, usually a year, 6 months, 3 months.
Net profit for the period = Revenues Expenses
Revenues
Increase in companys wealth arising from the provision of G/S

Wealth increases due to increase in cash, promise for cash or pay with other
forms of wealth, such as providing other assets, or forgiving debts
Interests and dividends
Test for revenue whether the good or services have been rendered (provided)
Expenses
Expenses are the opposite of revenues

Decreases in companys wealth incurred in order to earn revenue
Wealth decreases due to costs of G/S, giving assets to customers, and wear and
tear of long term assets
2 cases when goods are sold enterprise is better off because of revenue
gained and enterprise is worse off because of cost of goods and services
customer takes away
Start with asset account of inventory of unsold goods, transferred to expense
account of cost of goods sold
Whether the firm makes profit depends on whether R > E.
Separate account of Expenses with Revenue
Profit
Net profit = net inflow of wealth to the company during the period
If net profit is negative = net outflow of wealth = loss
Expenses include costs of earning revenue taxes (not including dividends),
depreciation...
The relationship of profit for the period to retained profits
Retained profits is the sum of past net profits since the firm began, minus
dividends declared (even if not yet paid)
Through retained profits, balance sheet can be said to reflect everything that
happened from the beginning a historical information system
Transactions with owners are taken out of RP, not an expense
Owners can be creditors too, if they are owed dividends, or if they lent the
company money in addition to shares they bought
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2.8 Connecting Balance Sheets and Income Statements
CA + NCA = CL + NCL
2.9 A close look at the income statement
Income statement covers period in time not point in time

Subsidiary is considered a controlled entity when parent company has the
capacity to dominate decision-making
Consolidation basically involves totalling revenues and expenses of parent entity
and all the subsidiaries after eliminating any transactions between these entities
When calculating retained profits, use profit AFTER tax.
2.10 Capital Markets, Managers and Performance Evaluation
Importance placed on bottom line profit figure and components

The Australian or the Australian Financial Review show announcements of
companys annual or half yearly profits.
Emphasis on profit never any data on non-financial performance, LT issues, or
managerial efforts
Announcement show sales, profits before and after tax (net), earnings per share
(EPS), interim and financial dividends per share data (ff, p), present share price
Per share data used by investors e.g. own n shares, so earn 0.355n $
Share market prices and profit announcements tend to end up moving in the
same direction, so they are correlated
Managers should be conversant about how his or her performance is measured
in the income statement
2.11 Capital Markets, Managers and Performance Evaluation
Public sector organisations are required to provide balance sheets that discloses
the A,L, E of the govt department
Also an income statement (before June 2001, was called operating statement)
Accumulated surplus or deficit = retained profits for private companies
Reserves
Income Statement
Emphasis on cost of services

Operating revenue is separate and deducted from operating expenses
After net cost of services are included, other revenues are included
Liabilities such as super is included in employee entitlements in addition to
salaries
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When govt takes over liability, providing an appropriation, therefore recorded as
revenue
The income statement enables users to identify:

- cost of services provided by the department during the year
- extent to which costs were covered by revenue
- source of revenue
- changes in resources controlled during the period as a result of operations
Chapter 2 Appendix Background: Sole Traders, Partnerships,

Companies and Financing
A2.1 Four Kinds of Business Organisation
Two general kinds of equity:

- Directly contributed equity owners provide money or other assets to
enterprise
- Indirectly contributed equity owners allowed profits to remain, to help earn
more profits in the future...
Types of owners depends on what type of business organisation
Sole Trader
One owner (the proprietor)

Unincorporated does not legally exist separately from owner
Cannot distinguish between the owners direct contributions to the business and
the indirect contributions by retained profits both lumped together as owners
capital
Balance sheet:
Owners equity
Owners capital $XXXX
Partnership
More than one owners

Unincorporated
Not separate legal entities, and all partners are all personally responsible for
debts of partnership
Since owners personal assets can be claimed by business creditors, there is
somewhat arbitrary distinction between business and personal affairs
Similar to sole trader, lumped together as owners capital
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As with sole traders, partnerships are not legal entities, but are considered
separate entity from partners
Balance sheet:
Owners equity
Partners capital:
Partner A $XXXX
Partner B $XXXX
Partner C $XXXX
Total Capital $XXXX
Company
Legal entities under corporations law

Capital is divided into shares owners = shareholders
Separate legal entities can buy, sell, own assets, enter contracts and sue and
be sued
Limited liability in the event of failure shareholders are not liable for debts once
shares have been paid for in full
Ease of transfer of ownership and increased borrowing powers
Shares can be sold freely, and transfer of ownership does not affect continuity of
operations
Companies may issue debentures or unsecured notes.
Debenture document that evidences an undertaking by comp to repay
particular amount at or before an agreed date, and to pay interest at an
agreed rate a specific intervals
Debt may be secured over floating charge or all assets, or specific charge over
certain assets
Public company can invite public to subscribe to their share capital by
prospectus (listed ones are on ASX)
Private companies (Pty Ltd) cannot invite public and has a limit on number of
shareholders (50) and other restrictions and transferability of shares.
Company: Forms of Share Capital
When shares are first issued, money received comes in as shared capital
Second time sold, money is not received by company but shareholder
Therefore, the millions of transactions on ASX that occur do not affect
companys financial statement
Several classes of shares:
Ordinary shares owners votes basically residual owners, deciding who will be
on the board of directors and managers
Preference shares or otherwise special shares owners usually do not vote, but in
return they have rights, such as receiving fixed dividend, or preference in asset
distribution if company liquidates
Class A, Class B and other categorisations vague terms, because complexity of
rights often prevents simple categorisation such as ordinary or preference
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Face of balance sheet or notes will list all kinds of shares, and specify rights
Cash received is property of company owners have no right to get money
back, except in specific circumstances
Company: Retained profits
Profits can be paid to owners in the form of dividend or retained within company.
Balance sheet:
Shareholders equity $
Share capital:
Class A Shares XXXX
Class B Shares XXXX
Total issued capita XXXX
Retained Profits XXXX
Total Shareholders equity XXXX
Corporate Group
Groups of many companies

E.g. Woolworths, BHP Billiton, Commonwealth Bank
Balance sheet represent what group looks like as a consolidated economic
entity, although there is no such legal entity
Looks like that of single company, with shareholders equity section representing
equity of primary, parent, company in grouo
A2.2 Business Financing
Non - Current Liabilities (debts due more than a year in the future)
Mortgages and other debts extending several years

Special loans from owners, LT tax estimates, estimated liabilities to be paid to
employees in the future
Owners equity
Sole trader and Partnership owners capital

Company shared capital received for each kind of share + retained profits (+
other items if legal or accounting complexities require them)
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Chapter 3 The Double Entry System
3.1 Transaction Analysis + 3.2 Transaction Analysis Extended
A = L
CA + NCA = CL + NCL
CA + NCA = CL + NCL
CA + NCA = CL + NCL
Set out:
- Assets Cash, AR, Inventory, Land and Building, Equipment
- Liabilities AP, Notes Payable, Wages Payable, LT Loans
- Equity SC, R, E, Dividend
3.3 Recording Transactions: Double-entry Bookkeeping
System of debits and credits

Balancing Equation : A = L + SE
CA + NCA = CL + NCL + SC + Op. R
A+E+D = L + SC +
D, C C, D
Resources = Assets
Sources = Liabilities / Equity
Therefore sum of credits must = sum of debits

Transactions measured in terms of countrys currency (AUD)
Recording transactions = entry
Records of transactions = journals / journal entries
Entries are transferred and summarised in accounts, which lie behind all amounts
and descriptions shown on balance sheet
All accounts collected together = ledger accounts
Accountants makes a list of account balances from ledger to make sure Dr = Cr.
(this list is called the trial balance)
All accounts put together = balance sheet
Each double entry record names one (or more) account that is debited, and
one (or more) that is credited
Double entry records = journal entries each journal entry, sum Dr = sum Cr
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3.4 More about Accounts
An account is a record of the dollar amounts comprising a particular A, L, E, R or

Exp.
Net effect of these amounts is debit or credit, and is called the accounts
balance
3.5 How Debits and Credits Work
Negative asset = contra asset has credit balance, e.g. accumulated

depreciation
3.6 Debits and Credits, Revenues and Expenses
Accounting accumulates information about activities

Financial statements are prepared from the accounts that are produced as the
information is accumulated
Double entry recording system creates a set of accounts which is in balance (Dr
= Cr)
From these accounts are produced:
- The income statement
- A note to the accounts showing a statement of retained profits, the bottom
line (ending retained profits), which transfers to
- The balance sheet, which summarises all accounts
3.7 Arranging accounts on the balance sheet
Placement of CA, NCA, CL, NCL, E allows for calculation of meaningful ratios
and other analysis
Thus balance sheet is classified because it is classified into meaningful
categories
Moving items around within Balance sheet is called reclassification
Reclassification done by accountants whenever it is thought to improve
informativeness of financial statement
Three examples of account classification
Current and Non-current portions of noncurrent liabilities

- Liabilities e.g. mortgages, bonds, debentures
- Thus accountants need to reclassify the amount to be paid on principal
within the next year (to Current) and the residual to non current
- Interest owing but not paid is a separate liability
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Bank overdrafts
- E.g. bank overdraft of $500
- This means bank allowed company to remove $500 more cash from
account than there was in it, in effect, lending comp $500
Two ways of representing this:
- Other assets of $12400 minus bank overdraft of $500 = L & E of $11900
- Other assets of $12400 = L&E of $11900 + bank overdraft of $500
Negative amounts left as deductions
- Some negative amounts are left as deductions unlike the bank overdraft
- E.g. accumulated depreciation left as a negative deduction for asset
Three ways of representing this:
- Shown on RHS of balance sheet (before it was, and in some countries still is)
- Separate disclosure as a deduction on LHS of balance sheet, but since
many types of assets and depreciation amounts can make sheet clustered
- Could be deducted from assets cost, so net book value of assets could be
disclosed on balance sheet, but not the accumulated depreciation
This method is becoming more popular, accompanied by note to fin
statements, listing cost and accumulated depreciation amounts separately
3.9 Cash versus accrual accounting revisited
Accrual accounting
Cash sale would increase by revenue and cash in that period
Credit sale will AR and R in that period
When the cash is paid,
AR , Cash
Way accrual financial accounting info is assembled:

- Cash
- Credit transactions
- ST/LT adjustments are needed to prepare financial statements, unless the
comps accounting system is sophisticated enough to have already built
them in
- Extensive narrative and supplementary disclosures (e.g. notes to financial
statements)
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3.10 Example: Simones Jewellery Business
Difficulties of accrual accounting:

Accrual profit requires extra calculation more complex cause confusion as it
leaves more room for error than the simpler calculation
Accrual profit differ from cash profit, differ from change in amount in bank
Accrual accounting can be a lot more complicated tax, rent, time...
3.11 Public Sector Issues
During 1990s, all govt moved from cash based acct system to accrual based
acct system
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Chapter 4 Record Keeping
4.1 The Importance of Good Records
Complete and accurate records provide observations and history of enterprise

This is used by investors, managers to plan for future
Records cost money
Records provide:
The basis for extrapolations into the future
Info for evaluating and rewarding performance
Basis of internal control over existence and quality of enterprises assets
4.2 Financial Accountings Transactional Filter
Accounting is an info system to filter and summarise data.

Economically efficient to have 1 system organise data into information on behalf
of the various users
E.g. of summarising and organising daily newspaper
Like newspaper, info system e.g. financial acct is limited.
Only report what sensors pick up as it seeks out data or filters data
Data bank: ledgers, journals (the books) and supporting records
Recording Classifying... = Bookkeeping
Information = accounting or reporting
Accounting reports are limited by the collected data

Transaction recorded
Not transaction routine accounting system ignores event
Two general kinds of transactions cash transactions or credit transactions
Non transactions natural disasters/ incidents, future delivery, land value /
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Financial accounting transaction fundamental eco or legal characteristics:
- Exchange must involve exchange of G/S, $, legal promises, items of eco
value
- Past exchange must have happened
- External exchange must be between entity and another party
Supplementary characteristics needed for accountings record-keeping:
- Evidence must be some documentation paper/electronic
- Dollars must be measured in the currency relevant in country where
transaction happens (AUD)
Following transaction characteristics define nature and value of fin acct info:
1. Transactions linked to legal and economic concept of exchange (bounded
by legal contract including $ transactions)
2. Constitute large part of underlying rationale for historical cost basis of
accounting, founded on accounting (history has to have happened)
3. Characteristics of transaction provide basis on which records can be verified
(audited) later as part of the process of ensuring info is credible
5 key points exchange, past exchange, external party, evidence, dollars
Adjustments/ adjusting journal entries in data bank when accountant is not

satisfied with set of data and wishes to alter some event which is important
RHS information deciding on adjustments, deciding on reporting format,
making supplementary notes...
4.3 Accountings Books and Records
Accounting cycle
1. Source documents
2. Prepare journal entries
3. Post to ledgers
4. Prepare trial balance (collection of ledger accounts Dr = Cr)
5. Prepare adjusting journal entries
6. Prepare adjusted trial balance
7. Prepare closing journal entries (close revenue, expenses and dividends to RP)
8. Prepare post-closing trial balance
9. Prepare financial statements
Source Documents and transactional style
Source documents show that transactions have occurred

Documents are kept so that the accounting records can be checked and
verified to correct errors; permit auditing; used for disputes; support income tax
claims and other legal action.
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Discounts after ordering: cheque will be less than amount owed
Debit AP, Cr Cash discounts received (other revenue account)
Journal Entries
Record accounting transactions

When business event is first recorded by acct system
Basic transactional records are often called books of original entry
A journal entry can list as many accounts as are needed to record transaction,
but each journal entry must be recorded, so sum of debits equals sum of credits
Dr left, Cr right
Omit $
Traditional to write short explanation called narration below each entry as a
memorandum of what the recorded transaction was about (not compulsory)
Every journal entry must be dated and is usually numbered
Posting reference is given to indicate the ledger account to which each journal
entry is posted. Number obtained from companys chart of accounts.
Enterprises with many transactions to record do not create separate entry for
each transaction, but instead use special records for each routine kind of
transaction... e.g. sales journal, cash receipt journal, cash payment journal and
purchases journal
Posting to ledgers
Ledgers are books or computer records that have a separate page or account
code for each individual account referred in the books of original entry
Where T accounts come in to illustrate simpler version of ledger accounts
General ledgers collection of all the A, L, E, R, Exp, summarising the entire
operations of business
Subsidiary ledgers AR, AP balance isnt based on Dr, Cr, but sum equal
amount in primary account in general ledger
Trial Balance
Balanced journal entries > general ledger accounts > balanced balance sheet
There is always a little uncertainty on whether standard bookkeeping procedure
ensures that ledger adds up all Dr and Cr and makes sure they equal
Therefore calculation is called trial balance
What to do when trial balance doesnt balance?
Re-add trial balance
Check posted journal entries to correct side of ledger accounts
Check that each ledger account is balanced correctly
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Check that each journal entry balances (Dr = Cr)
Determine difference between Dr and Cr and look for account with that
amount maybe left out ledger balance
Difference / 2 and look for that amount means posted to wrong side of ledger
account
If difference is divisible by 9, maybe transposition error 21 instead of 12, 72
instead of 27
Sometimes trial balance cannot pick up error
Adjusting Entries
At end of each acct period, it is necessary to adjust Rev and Exp accounts
Splitting between accounting periods e.g. prepayments for insurance
Closing entries
Needed to facilitate preparation of financial statements

Needed to prepare accounting records to begin next period
Closing entries formally transfer the balances of the revenue and expense
accounts to a profit and loss summary, then to retained profits
Closing entries also reset the rev and exp account balances to zero to being
records for the next accounting period
P&L summary account to decreases everything to 0
Debit sales account to zero, credit expenses account
Debit profit and loss summary account
Then, to balance P&L account, clear it by debiting P&L
Credit retained profits
Post closing trial balance
Put together ledger accounts to see if Dr = Cr
Financial Statements
P&L summary account > Income statement

Post-closing trial balance > Balance sheet
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4.4 An Example: Northern Star Theatre Company
Source documents
General Journal
General Ledger
General Ledger trial balance
General Journal (with adjustments)
General Ledger
General Ledger trial balance
Closing entries returning everything to 0, dr revenue, cr P&L
Financial statements Retained profits, income statement, balance sheet
4.6 Electronic Commerce
Electronic commerce (e-commerce) is a challenge to financial accounting and

internal control, because of the absence of paper trail that has traditionally
supported accounting records.
E.g. moving away from cash and cheque, but using lots of credit cards or
EFTPOS.
Employees are being paid by deposits in personal bank accounts
Implications of e-commerce
- Needs to be compatibility between computing systems for proper
recognition of accounting systems on both sides of transactions
Trust in electronic media to make system work
- Tendency for records and payments to be speedier and separate from
movements of product, means in-transit items can be a challenge to control
and reconcile
- Not only financial statements must be right, but also the underlying records
for business partners enquiries to be answered reliably
Paradox: e-commerce works without paper but demands a good trail of
evidence
4.7 Managers, Bookkeeping and Control (Importance of bookkeeping to managers)
Bookkeeping and its associated record keeping:

- Provide underlying data on which accounting info is built
Decisions and evaluations may be constrained on nature of underlying data
- Provide data and systems used in meeting managements important
responsibilities to safeguard assets and generally keep the business under
control
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The process of accounting also applies to public sector organisations

Accumulated funs = Public sector equity
Recurrent appropriation = govt revenue
User charges = revenue
Grants and subsidies = expense
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Chapter 5 Revenue and Expense Recognition in Accrual

Accounting
5.1 Conceptual Foundation of Accrual Accounting
Revenues are inflows of economic resources from customers earned through

providing goods or services.
Expenses are outflows of economic resources to employees, suppliers, taxation
authorities and others, resulting from business activities, to generate revenue and
serve customers.
Incurring expenses are the cost of earning revenues.
Net profit is the difference between revenues and expenses over time.
Net profit is the measure of success in generating more revenue and it costs to
do so.
Features
Revenue and expenses refer to inflows and outflows of economic resources.
Involve phenomena that arise before or after cash changes hands, as well as
the point of cash flows
Net profit is dependent on how revenues and expenses are measured.
A conceptual system for accrual profit measurement
Need system that recognises revenue and expense before, at the same time
and after cash flows.
Accrual method includes cash accounting
Summary
Revenue before cash collection form asset account (e.g. Accounts receivable)
Expense before cash payment form liability account (e.g. Accounts payable)
Unearned revenue liability
Expense after cash payment asset
Before cash After cash
Rev Asset Liability
Exp Liability Asset

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5.2 Accrual Accounting Adjustments
Adjustments involved implementation of routine accruals, such as those

mentioned above
Sophisticated accounting systems go beyond transactional records and
routinely include many adjustments
Simpler systems make adjustments at year end in a special set of journals
Many small companies dont bother until financial statements are needed
Follow double entry format:
- After each adjustments, A=L+E still balances
- Sum of credit = sum of debit
Adjusting journal entries purpose: augment transaction based figures, add story
told by transactional records.
Objective of accrual accounting improve measurement of financial
performance and position
Accrual > cash provides more complete record, more representative of
economic performance
Four main types of routine adjustments:
- Expiration of assets (after prepayments)
- Unearned revenues
- Accrual of unrecorded expenses
- Accrual of unrecorded revenues
Expiration of assets
Prepayments assets that arise because an expenditure has been made, but
there is still value extending into the future
Usually current assets
Arise whenever payment schedule for an expense does not match the
companys financial period e.g. insurance premiums where policy date
doesnt match financial year
Prepaid expenses do not have market value, but they have economic value
because future resources will not have to be used
E.g. insurance, advertisements
Prepayment DR Prepayment Expense DR

Cash CR OR Cash CR
Prepayment Expense DR Prepayment DR

Prepayment CR Prepayment Expense CR
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Unearned Revenues
Unearned Revenue future revenue where the cash has been received before
earning revenue (deposits)
E.g. newspaper or magazine subscription companies, or airline, phone,
membership
Cash DR
Unearned Revenue CR
Unearned Revenue DR
Sales Revenue CR
Accrual of unrecorded expenses
Involves determining which expenses have been incurred by the organisation

(but not paid in cash) during a particular time period
Involves checking which invoices have been received from suppliers,
incorporating that info into accounting systems (e.g. AP), and making estimates
for expenses for which invoices have not yet been received
Accrued expenses
E.g. wage expense end of pay period and end of financial period occur on
different days
Wages Expense DR
Accrued expense CR
Accrued expense DR
Cash CR
Accrual of unrecorded revenues
Accrued revenue
Occurs when a service has been provided but cash will not be received until the
following period
Interest revenue, unbilled revenues, commissions earned
Accrued Revenue DR
Revenue CR
Cash DR
Accrued Revenue CR
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Multicolumn Worksheets
Useful device to help prepare financial statements
Pre adjusted Adjusting Adjusted Trial Income Balance sheet

Trial Balance Entries Balance statement numbers
numbers
5.3 The Financial Period
As businesses run continuously, financial statements are prepared at specific

points or periods in time
2009 net profit is a measure of economic value added by the project during that
year
IF there are 2 cash inflows 2008 and 2009:
- If 08 cash > 08 revenue, then unearned revenue will be set up
- If 08 cash < 08 revenue, then account received set up
Companies have initial choices about when the financial year begin and end.
Once they made their choice, reasons relating to habit, legal and tax rules force
them to stay with the choice
Australia 30 June is most common
US, Canada, Singapore 31 December
UK, NZ, Japan 31 March
Possible in Australia to use substituted accounting period for taxation purposes
5.4 Introduction to Accounting for Inventory
Several different methods for controlling inventory

Most popular perpetual inventory control method (compared to periodic)
Under perpetual method, inventory is an asset
- Inventory bought debit inventory account
- Inventory sold debit cost of goods sold, credit inventory
- 2 entries are required for sales (revenue and cost of goods expense)
- Return of sales also require 2 entries
5.5 Contra Accounts
Just about every balance sheet account can be considered a control account
Amounts in accounts should be supported by detailed lists or subsidiary ledgers
Sometimes want to change account, and at the same time reluctant to.
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Worried that company might not be able to collect all money back from
customers. Want to recognise bad debts. However that means crediting
accounts receivable. But at the same, since we have not given up on collecting
debts, we should not do that.
Property and plan are being used up economically. Want to record
depreciation expense. But do not want to change asset cost account, because
costs are not changing, but rather economic value is being used.
Contra account set up to allow recognition of expense and related value

changes without changing control account
Contra accounts have balances that are in opposite direction to those of the
control account in which they are associated
Contra accounts only have meaning in conjunction with the control accounts to
which they match.
Most common: accumulated depreciation (amortisation), doubtful debts
receivable
Accumulated Depreciation (Amortisation)
Accumulate depreciation on fixed assets (e.g. buildings and equipments)

DR Depreciation Expense
CR Accumulated Depreciation
Accumulated Depreciation relates to asset account of buildings
Showing both allows users to make rough guess on age of asset
Depreciation expense shows how much depreciated during that period
Accumulated depreciation shows total amount the buildings have depreciated
by
Net book value = cost accumulated depreciation
Contra account is only meaningful in comparison to the cost. When the asset is
gone/sold, neither account is needed anymore.
E.g. Truck bought at 50,000. Depreciates at 8,000 each year. Sold at end of 2nd
year for 37,000
Net book value of truck = 50,000 16,000 = 34,000
Journal Entry for selling truck:
Cash 37,000
Truck asset 50,000
Accumulated Depreciation 34,000

Revenue on sale of truck 3,000
When non-physical assets, e.g. goodwill, patents and trademarks are amortised,
the accumulated amortisation account is used instead of accumulated
depreciation
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5.6 Accounts Receivable and Contra Accounts
Accounts receivable when revenue is recognised but uncollected

DR accounts receivable, CR sales revenue
Such receivables are often called trade receivables
Valuation of accounts receivable
Receivables are valued on BS at lower of cost (original transaction value +

interest charges) or net realisable value (amount expected to be collected)
If collectable amount < expected amount, receivable must be reduced to an
estimated collectable amount.
This is done by subtracting an allowance for doubtful accounts from the
accounts receivable balance
Estimated amount collectable = Trade receivables allowance for doubtful
debts
Therefore allowance adjusts net value down to the lower of cost and current
estimated collectable amount
Other receivables
2 other main types of receivables. If they are large, they are shown separately.
If they are not large, together, theyre called other debtors
Notes receivable
- Supported by signed contract specifying payment schedule, interest rate
and often other legal details.
- Used for large or long term receivables, e.g. motor cars, house, appliances
and loans by banks and finance comps
Other receivables:
- Loans to employees, officers and shareholders, associated companies, tax
Refunds Company is waiting for and other receivables not arising from
revenue transactions.
- Accounted for and valued same as AR and notes receivable.
- Usually arise from peculiar circumstances, where company disclose reasons.
Allowance for doubtful debts
There is always a risk where customers will fail to pay

Therefore portion of debts will be doubtful and portion should be deducted from
revenue in determining profit for the period
To recognise expense:
DR Bad Debts Expense
CR Allowance for doubtful debts
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Reason for not deducting directly to keep balance between accounts
receivable and list of individual accounts.
Company may still try to collect on the accounts
After pursuing non-paying customer for months, company may decide to write
off account.
Then:
DR Allowance for doubtful debts
CR Accounts Receivable
Allowance can be seen as a temporary holding account for amounts the
company believes will not be collected, based on past experience and an
assessment of outstanding accounts.
Another way of writing: Direct write off method

DR Bad Debts Expense
CR Accounts Receivable
Used when company has few accounts receivable or when large account not
included in allowance suddenly goes bad
Purposes of contra accounts are to provide useful information to the readers of
financial statements or to assist in accountings internal control functions
5.8 Managers and Accrual Accounting Assumptions
Accrual accountings purpose: to move beyond cash flows towards a broader

economic concept of profit and financial position.
Implications from a managers point of view:
- Fair evaluation of managerial performance
- Limitation accrual accounting, basing on history reflects on the past rather
than looking into the future, as managers are inclined to do
- Only look at the resulted actions, not the reason why mangers initiated
action
- Evidenced based accounting procedures for recognition of profit and
expenses may not relate very well to economic concepts of earnings, or
managers struggles to increase the value of their companies
- To managers seeking even handed evaluation of their performance,
accounting may seem downwardly biased in its measures
- Criteria for revenue and expenses recognition is subjective some managers
manipulate, some managers find it too loose and flexible
- The shorter the time period, the more mismatch the figures are between
cash flow and accrual profit
Accrual accounting has many advantages and is very widely used, but
managers should not accept it uncritically
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5.9 Accrual Accounting in the public sector
Since 1995, local governments in Australia have been required to produce

financial statements using accrual accounting
Since 1994 NSW govt. 1999 all govt
Key differences with accrual accounting:
Non-cash assets and depreciation
Value of receivables and payables
Liabilities (employee entitlements)
Changing value of financial assets and liabilities (exchange rate)
Cost and revenue of government activities
Cost of consuming assets expense (e.g. depreciation)
Value of goods and services received for free from other bodies (revenue)
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Chapter 5 Appendix Special Journals, Subsidiary Ledgers and
Control Accounts
Business with small set of transactions initially recorded in general journal, then
posted to general ledger
Complex business rather than info captured in 1 journal and posted to 1 ledger,
system of special journals, subsidiary ledgers used
Special journals allow easy recording of the most common transactions
undertaken by a business
Subsidiary ledgers present detailed analysis of info that is eventually transferred
to general ledger account
Sales invoice >>> Journal Entries + Subsidiary ledger AR >>> General Ledger, Trial
Balance
General ledger account called debtors or Accounts receivable
A5.1 Prime Entry Records: Special Journals
Special Journal : Transaction Recorded:

Sales Credit sales of inventory
Purchases Credit purchases of inventory
Cash receipts All cash inflows (including cash sales)
Cash payments All cash outflows (including cash purchases)
Each entry represents a transaction that belongs to the same class as others in
the same journal
Transactions not in special journal are recorded in general journal
Advantages of Special Journals:
- Recording efficiency
- Amounts posted from special journals to general ledger as totals, rather than
individual journal entries
- More than one user can update accounting system, because it consists a
number of related subsystems
- Nature of transaction eliminates need for narrations
- Info such as receipt or invoice number may be recorded for narrations
- Additional info can be added for convenience as it is available from source
documents, e.g. discounts
A5.2 Subsidiary Ledgers and Control Accounts
Most common way of accommodating need for detailed records in the

accounting system, without grossly expanding number of separate general
ledger accounts
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Subsidiary ledger a set of ledger accounts that collectively represents a
detailed analysis of one general ledger account classification
Relevant account in general ledger is called the control account
Accounts in subsidiary ledger can be periodically checked against total data
and balance in control account
Examples of general ledger accounts that have subsidiary ledgers:
- Debtors/Accounts Receivable separate account for each debtor
- Creditors/Accounts payable separate account for each creditor
- Property, plant and equipment Asset Register separate for each piece
- Raw materials Inventory Separate records of each type of raw material
- Finished goods inventory Separate record of each type of finished good
Advantages for subsidiary accounts
Check on accuracy (as subsidiary account and general account balances
should =)
Enable any desired amount of detail to be maintained to explain composition of
selected general ledger account, without overloading general ledger
A5.3 Trade discount and Cash discount
Both Trade discount and cash discounts represents a reduction in the amount
that a customer ultimately pays a vendor for gods and services supplied
Differ in the way they are recorded
Trade Discount
Trade discounts are a means of adjusting the actual price charged to a

customer from a standard list price.
Usually determined by category of customer or normal volume of businesses
Manufacturer may sell at list price to general public, 40% off for retainers and 55%
off to wholesalers
Most enterprises record only net amount of transaction
Effect of trade discount is merely to set an actual price for transaction
Cash Discount
Cash discounts are conditional adjustment after determining the actual selling
price at which the transaction takes place
NOT a change in price of original sales transaction generally recorded as an
additional transaction
Credit terms 2.5/10, n/30 2.5% deducted if money was paid within first 10 days,
the net amount must be paid within the next 30 days
Discounts recorded as Discounts allowed (EXPENSE), or Discounts Received
(REVENUE)
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A5.4 Operation of Special Journals and Subsidiary Ledgers
Sales
Purpose of special journals is to eliminate need for such detailed recording in a

general journal and the general ledger
Totals of special journals posted to control account, because CA only record
aggregates
Sales journal updated everyday
Sales journal posted to AR, Sales revenue, COGS, Inventory
Subsidiary ledger may be established for each customer who buys on credit
Posting reference S1 indicates info comes from page S1 of sales journal
Tick in posting reference indicates that the amount has been posted to the
subsidiary ledger
End of period total of subsidiary ledgers can be checked against balance of
AR control account.
I.e. sum of balance in each debtor should = balance of AR control account
Purchases
Purchases only used for recording the acquisition of goods, on credit, intended
for resale
Source document purchase invoice from supplier, matched against delivery
docket and copy of official purchase order
Even with discounts, the full amount owing is recorded
If discounts are received, then this is recorded in CPJ discount revenue, when
items are paid for
Purchases journal updated every day for each creditor of each item of
inventory
Credit transactions involving acquisition of fixed assets or items to be charged to
expense accounts, such as repairs, maintenance, printing and stationery, are
often recorded in general journal.
Cash Receipts
Source document: evidence of cash receipt, list of cheques received or direct

deposit recorded on bank account statement
Cash receipts journals are designed to meet specific needs of an enterprise
Most businesses include payments from debtors, possibly cash sales
Also sundry or miscellaneous column for cash receipts not otherwise identified by
specific column that represents a particular general ledger account
E.g. proceeds from sale of fixed assets, refunds by creditors, new capital or
mortgage funding
Discount expense column not sundry
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Cash Payments
Source documents: duplicate of cheque or cheque butt, statement and

invoices from creditors, receipt issued by recipient or payroll analysis certified as
correct by responsible staff member
Bank statement evidence of interest charged on any overdraft, together with
info about other bank charges and fees
Minimise postings and provide analysis of payments, separate columns may be
provided to record entries affecting those ledger accounts frequently involved
Sundry or miscellaneous column might be needed.
DO NOT POST total of sundry column
Desirable in all books of prime entry (journals) to provide reference to source
document for each entry
Done by recording cheque number
In addition to postings to general ledger made at end of period, each individual
item in the creditors column will be posted as a debit to the creditors account
A5.5 Role of General Journal and General Ledger
General journal used to record a number of important transactions:

Sales and purchase returns
Credit transactions other than those related to inventory, such as the purchase
of equipment
Adjusting entries
Closing entries
Each entry in general journal is individually posted to appropriate account in
general ledger
At the end of a period, all financial information will be posted to general ledger,
either as an individual entry sourced from general journal (including sundry from
special journal), or in aggregate from columns of various special journals
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Chapter 6 Financial Reporting Principles, Accounting Standards

and Auditing
6.2 Accounting Principles and the use of Accounting Information
Doing accounting takes expert knowledge, considerable experience and

continuous attention to new problems and solutions.
Concepts and principles are important, as they form logical structure that
practising accountants use every day to consider problems to make
recommendations
GAAP (Generally Accepted Accounting Principles) applied differently for
different entities
Rules, standards and usual practices that companies are expected to follow
when preparing financial statements
Stock market crash of 1929 brought GAAP
AASB (Aust Accounting Standards Board)
IASB (International Accounting Standards Board)
AASB uses IASB as foundation, but includes more details applicable to Aust
environment
SACS Statement of Accounting concepts
SAVS established for general concepts and principles to be used in preparing
financial statements
SAC 1 Definition of a Reporting Entity
SAC 2 Objective of General Purpose Financial Reporting
SAC 3 Qualitative Characteristics of Financial Information
SAC 4 Definition and Recognition of the Elements of Financial Statements
Now, SAC 3 and SAC 4 is replaced with Framework for Preparation and
Presentation of Financial Statements
FYI: Difficulties that face accounting and managers by GAAP
Difference in company structures e.g. ABC = not for profit, publicly owned.
Should ABC use same methods as other profit seeking organisations?
Qantas / UNSW employees are not assets. But for sports team, such as Sydney
Swans millions are paid to have certain players on the team. Are they assets or
expenses? Should they be amortised?
Comparing movies net profits hard to measure profitability of certain movies
e.g. star wars attracted many viewers when it was first released. However, due
to its popularity, it continues to generate revenue, through video, dvd, toys,
books
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6.3 Framework for the Preparation and Presentation of Financial Statements
Framework includes the coverage of:

- objectives of financial reports
- assumptions underlying financial reports
- qualitative characteristics that determine the usefulness of financial reports
assets and liabilities
- definition of the elements from which financial reports are constructed:
assets, liabilities, equity, income and expenses
- recognition and measurement of the elements of financial statements
Framework makes distinction between general purpose financial report (for most
users who rely on this as main source of info) and special purpose financial
report (list for issues of shares outside scope of Framework).
Users of financial reports
Investors info on risk and return, including shareholders buy, hold or sell?
Employees including unions stability and profitability and whether company
can afford employee benefits
Lenders whether interest and loans will be able to be paid off
Suppliers and other trade creditors whether amounts owing can be paid
Customers continuance of entity, e.g. with warranties
Governments and their agencies allocation of resources & tax
Public substantial contribution to public e.g. employment
Framework regards investors as the majority of users, so satisfy most the needs of
investors
The objective of financial reports
Objective: provide information about financial position, financial performance

and cash flows that is useful to users in making economic decisions
Users need evaluations of cash generation due to its liquidity to buy inventory,
pay wages, distribute shares etc
Users need info on financial position, financial performance and cash flows to
evaluate this
Financial position balance sheet economic resources (NCA), financial
structure (who finances assets), information on liquidity and solvency (L & ratios)
Financial performance income statement profitability, employment of
resources, potential chances in assets controlled by the entity
Movement in cash cash flow statement operating, investing and financing
decisions
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Underlying Assumptions
Accrual basis of accounting

Going Concern
- entity will continue to operate in the foreseeable future
- book value = cost accumulated depreciation
- liquidation value can be a lot less than book value
- this is because when companies close down, they may not be able to sell
off its assets at the book value
Other authors also regard accounting entity, accounting period and monetary
assumptions as key underlying assumptions.
Key Qualitative Attributes
Understandability concern on complexity of financial statements that could

not be understood by experts. Pozen committee examined US financial
reporting system and made recommendations on the usefulness of reports
Relevance Pozen committee suggests that the increased complexity has led to
less relevant info to users evolution of business strategies and businesses do not
want investors to know about their liabilities
- materiality
Reliability Pozen Committee suggests detailed rules in standards permit

structuring of transactions to achieve particular accounting results, even if results
are inconsistent with transactions
- Faithful representation real existence
- Substance over form inaccordance with substance and economic reality
- Neutrality freedom from bias
- Prudence degree of caution in exercise of judgements
- Completeness material info is not omitted
Comparability Pozen Committee notes that GAAP contain many detailed rules
with several industry exceptions and alternative accounting policies for same
transactions
Elements of Financial Statements
Assets resources controlled by the entity as a result of past events, and from
which future economic benefits are expected to flow from the entity
Asset recognition
- It is probable that any future economic benefits associated with the item will
flow to the entity
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Liabilities 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
Liability Recognition
- probable that any future sacrifice of economic benefits associated with the
item will flow to or from the entity
- the item has a cost or value that can be measured reliably
Equity residual interest in the assets of the entity after the deduction of its
liabilities SE = A L
Equity ranks after liabilities as a claim to the assets of an entity
Income increases in economic benefits during the accounting period in the

form of inflows or enhancements of assets or decreases in liabilities that result in
increase in equity
Issues of shares are not included
2 main components revenue and assets/liabilities
Expenses decreases in economic benefits during the accounting period in the

form of outflows of assets, depletion of assets or incurrences of liabilities that
result in decreases in equity
mainly COGS, wages and depreciation
Measurement of the elements of financial statements
Measurement determining the monetary amounts that the elements of the

financial statements are to be recognised at and included in the balance sheet
and the income statement
Historical cost assets are recorded at the time of acquisition
Current cost assets are carried at the amount that would have to be paid if it
was bought currently
Realisable (settlement) value assets are carried at the amount that could
currently be obtained by selling the asset in an orderly disposal
Present value assets carried at present discounted value of future net cash
inflows that the item is expected to general in the normal course of business
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6.4 Assets and Liabilities: Valuation and Measurement
Five basic methods to measure or value assets and liabilities

- Historical cost
- Price-level-adjusted historical cost
- Current or market value
- Value in use (or present value)
- Liquidation value
Asset: Whether market values are better than historical cost?
Liability: Whether present value or estimation of future cash flows?
Historical cost
Acquisition cost values assets at the amount paid or promised to acquire the
assets, and values liabilities at the amount of any associate promises
Ability to document cost of asset through receipts, invoices or contracts
An asset valued at historical costs is valued at its expected lowest or most
conservative value of future benefits at the date of acquisition
At the point of acquisition, historical cost = market value = value in use (present
value), in most cases.
writing down of unproductive assets
lower of cost or market rule
Price level adjusted historical cost
Adjusts for changes in the value of the dollar, rather than the changes of the
values of the assets
Lack of popularity because if historical cost is unsatisfactory compared to
current values, adjusting the cost for inflation still makes it unsatisfactory, only
now less understandable
Current Price or Market Value (value in exchange)
Records assets and liabilities at their current particular market value

focuses on the individual values of the assets and liability items
assumes that value is market-determined and that profit should be measured
using changes over time in market values.
Input market value entry value refers to the amount it would cost to bring the
asset into the company if it were not currently in it.
Output market value exit value amount an asset is worth if it were sold now
(net realisable value)
Fair value alternative asset valuation method amount of the consideration
that would be agreed upon in an arms length transaction between
knowledgeable, willing parties who are under no compulsion to act.
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Value in use (present value)
Considers that value flow from the generation of cash flows from the asset
Estimated by calculating the net present value of future cash inflows cash
flows minus lost interest expected to be generated by the asset
Present value future cash flow future interest implied by waiting for the cash
Present value = future cash payment / (1+r)
Liquidation Value
going out of business, sell it for what you can business

presumes the entity is not a going concern
6.5 Accounting Regulation in Australia
CLERP Act 1999 Corporate Law Economic Reform Program Act modified
institutional arrangements for the setting of accounting standards in Australia,
recognising that financial reporting requirements can play an important role in
Australia companies ability to compete effectively and efficiently in a global
environment
FRC Financial Reporting Council
6.6 International Accounting Standards
IASB (International Accounting Standards Board) have issued more than 40

individual standards.
Aim: develop common standards that could be used by companies operating
in several countries, and eventually that all countries could use within their
borders
CONVERGENCE
Horror stories of 1 company with huge profits in one country also with huge losses
according to another countrys acct standards are an embarrassment to the
accounting profession and awkward for regulators such as SEC (security
exchange commission) to deal with
Challenge to IAS is the attempt to make even the Canadian, US and Mexican
accounting systems similar, given that the 3 countries have signed the NAFTA.
VERY different in accounting standards, as govts have passed laws that set strict
requirements for financial accounting in accordance with national priorities and
culture
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6.7 The Annual Report and Financial Statements
The standard set of financial statements has five components:

- balance sheet
- income statement
- statement of changes in equity
- statement of cash flows
- notes to the financial statements
Statement of changes in equity reports the profit or loss in equity
Notes to the financial statements provide additional detail on the items in the
financial statements note 1 is accounting policies inventory method,
depreciation method
Public companies and other organisations include their set of financial
statements in a much larger annual report. This report usually contains:
1. Summary data on companys performance for the year, comparisons going
back 5 or more years
2. Letter to the companys shareholders from the chairperson of the BOD or the
managing director, including highlights of the performance and future plans
3. Extensive CEOs report description of the eco, financial and other factors
4. For listed companies a corporate govt statement, required under ASX reg
5. Set of financial statements
6. Directors statement required by Corporations Act 2001 signed by CEO
and CFO that the fins records are prepared in accordance with the
Corporations Act 2001. Debt opinions of directors
7. Independent audit report
8. Directors report names of directors, principle activities, operating results
9. For listed companies, info on substantial shareholders, distribution of
ownership
10. Other voluntary information graphs, details on products, pollution
Full versus concise financial reports
Corporations Act 2001 now requires the publication of both FULL general
purpose financial reports (GPFR) and concise financial reports
GPFR contains the 5 financial statements in addition to the auditors report and
directors declaration
Concise financial statements are sent to all shareholders, with a statement that
the report is concise and GPFR if a shareholder requests
Concise financial statements include the 5 financial statement components
minus notes. Additionally there must be a discussion and analysis of financial
statements to assist the users understanding.
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6.8 The External Auditors Report
Auditors report a routine statement by the auditors that provides an opinion

on whether financial statements are fairly presented
Adverse opinion when auditors deny the fairness of the statements
External auditing refers to the evaluation of an organisations financial
statements by an auditor who should be unconnected with, and therefore
independent of, the management of the organisation
Role of external auditor:

- to have an independent, unbiased and professional perspective
- to render a competent opinion on the fairness of the financial statements
Fundamental objective of professional associations such as CA or CPA is to
protect society by ensuring the professionalism and independence of the
external auditors who belong to them
Independence is maintained because the auditor is appointed by, and reports
to the shareholders, not management
However, in practice, auditor has close working relationship with management
and managers has a strong position to recommend change of auditor
Recent legislative changes have strengthened the independence of audit firms:
- rotation of audit partners every 5 years
- banning the provision of many non-audit services by the firm carrying out
the audit
Audits are opinions, not guarantees.

Audits do not state whether a company is performing good or bad. It simply
states whether the performance and position have been measured and
presented in a generally accepted and unbiased way
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Content and form of auditors report changes every few years, as auditors
rethink how it is best to communicate with the users.
Addressed to owners, titled Independent Audit Report
Standard version of the auditors report includes the following:

1. Identifies company, set of statements and their date and states that the
statements are the responsibility of mgmt and that the auditors responsibility,
having conducted an independent audit of the financial report, is to express
an opinion to them.
2. A section of the report contains the following statements:
a. audit conducted in accordance with AAS to provide reasonable
assurance on whether financial report is free of material misstatement
b. auditors procedures included the examination, on a test basis, of
evidence supporting the amounts in the financial report, and the
evaluation of accounting policies and significant accounting estimates
c. procedures have been undertaken to form an opinion to form an
opinion on whether, in all material respects, the financial report is
presented fairly in accordance with AAS
d. statement that audit opinion expressed in the report has been formed
on the above basis
3. Normally, the third paragraph provides the auditors opinion that the
financial statements give a true and fair view that they are in accordance
with the provisions of the Corporations Act 2001, applicable accounting
standards and other professional mandatory reporting requirements.
Redraft: include paragraph of respective roles of mgmt and auditors and

inclusion of separate section related to the independence of auditors
There are 3 main exceptions to unqualified opinion:
- qualified opinion generally satisfied, but disagree with mgmt
- adverse opinion financial statement not presented in accordance to AAS
- disclaimer unable to express an opinion either way because of a limitation
in the works the auditors were able to do
Even if unqualified opinion is expressed, auditor will still alert reader to the facts in
the financial statements, but not of such nature that it affects the audit opinion
6.9 The Nature of a Profession and Professional Ethics
Professionals are recognised by post-secondary education

3 main professional accounting bodies ICAA (Institute of Chartered
Accountants in Australia), CPA Australia and the NIA (National Institute of
Accountants)
If a professional accounting has not lived up to the standards of conduct held
by the profession, he or she can be reprimanded or expelled by the profession
and/or sued in court
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Professional codes of ethics involve not only behaving in professional manner,
but also maintaining the level of expertise required in order to perform skilfully
APES 110 Code of Ethics for Professional Accountants
Five fundamental principles:

- Integrity
- Objectivity
- Professional competence and due care
- Confidentiality
- Professional behaviour
Compliance with the fundamental principles may be threatened by various

threats, including the following:
- Self interest threats undue dependence on total fees
- Self review threats auditing systems on reports you designed
- Advocacy threats promoting shares in a listed company you are auditing
- Familiarity threats familial relationship with director or officer
- Intimidation threats threatened with dismissal etc
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Chapter 7 Internal Control and Cash
7.1 Internal Control
Internal control is a process, affected by an entitys board of directors,

management and other personnel, designed to provide reasonable assurance
regarding the achievement of objectives in the following categories:
- Effectiveness and efficiency of operations [also reduce risk of asset loss]
- Reliability of financial reporting
- Compliance with applicable laws and regulations
Internal control is not one event or circumstance but a process integrated with
other basic management processes, such as planning and monitoring
CEO is ultimately responsible for internal control
Internal control affects working life of most personnel
Internal control can only provide reasonable assurance rather than absolute
assurance to management and the board of directors regarding the
achievement of an entitys objectives
Limitations of Internal Control:
- Problems of human judgement not follow instructions
- Managers may override prescribed policies or procedures increasing
revenue
- Collusion between individuals can result in control failures
- Internal controls cost money should apply cost benefit principle
Internal control can be considered to be effective for each of the 3 categories if

management and the board of directors have reasonable assurance that:
- They understand the extent to which operation objectives are being
achieved
- Financial statements are being prepared reliably
- Compliance with relevance laws and regulations
5 interrelated components of internal control:
- Control environment integrity, ethical values and competence of entitys
people
- Risk assessment associated with change and establishing objectives
- Control activities ensure necessary action for risk assessment
- Information and communication internal and external
- Monitoring assess quality of systems performance over time ongoing
monitoring and separate evaluations
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Control Activities
Examples of control activities:

- Top level reviews compared to budgets and forecasts to assess which
targets are being achieved
- Information processing controls check accuracy, authorisation and
completeness of transactions
- Separate record keeping from handling assets segregation of duties
where person who physically handles assets is different to person who keeps
records
- Physically protect sensitive assets
Examples of Internal control

Matching independently generated documents matching sales invoices and
shipping documents
Prenumbering and sequencing checking of documents to prevent
unauthorised use
Comparison with independent third party info bank reconciliations of ledger
accounts with bank statements
Cancellation of documentation deal with cheques immediately
Segregation of duties
Demanding timeliness of operations prompt deposit of cash receipts and
depositing cash intact
7.2 Internal Control of Cash
Cash is the asset that is most susceptible to theft because of its liquid and
generally anonymous nature
Common control is locked in sales registered or carefully controlled records
Another way is to have multi copied, pre numbered sales invoices check cash
sales, cash received, credit sales, accounts receivable, inventory
Prevent stealing cash / cheques there should be more than one person
opening, disable function to turn into cash, list of cheques received, should be
posted to register, general ledger, accounts receivable of subsidiary records
Payments of cash: properly authorised documents/invoices and cheques should
be signed by 2 staff members who are independent of invoice approval and
accounting duties, original invoice should be stamped paid
7.3 Bank Reconciliations
Because of high frequency of transactions and potential for error, accuracy of

cash balance in general ledger should be examined periodically
Process is called bank reconciliation based on bank statement
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Bank Reconciliation versus cash accounts
Bank statements summarise the activity in a cheque account and report the
ending monthly balance.
Cash account of depositor = asset, for bank = liability
This is because when cash is deposited in the bank, the bank now owes the
depositor money
End of month bank statement cash balance normally wont agree with
companys cash records
Items on companys record but not on bank statement:
- Deposits in transits receipts entered in a firm but not yet processed by the
bank (debit for company > credit for bank)
- Outstanding (un-presented) cheques cheques written by business but not
yet presented to the bank company issued cheque, but external person
hasnt cashed it yet (credit for comp > debit for bank)
Items reported on the bank statement but not yet entered in the companys
record
- NSF cheques (non sufficient funds/ dishonoured cheque) customer
cheques deposited but refunded due to lack of funds (debit on bank
statement)
- Bank service charges for accounting processing
- Notes receivable and interest collected by the bank collection of interest
or note is reported with a credit memo notation because of depositors
increase in account balance
- Interest earned on the account
In addition to timing differences, errors may cause a discrepancy between the
bank statement balance and company accounting records
The reconciliation process

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If balances do not agree and the reconciling items are deemed correct, there is
a chance that a record keeping error has been made.
Reconciliation not only highlights timing differences but also identify errors made
by either the bank or the depositor
Bank reconciliations contain adjustments to both ending cash balance for bank
and company records
After reconciliation is completed, general journal entries must be prepared for
adjustments made to company records
Adjustments necessary to update cash account in relation to correction of
company errors and info processed by the bank
No journal entries are needed for adjustments made to the ending bank
statement balance
These adjustments reflect items that have already been recorded in a
companys accounts thus no further updating is necessary
7.4 Performing a Bank Reconciliation from information in cash journals
1. Go through last months bank reconciliation statement, ticking off any amounts
that were outstanding last month
Go through bank statement and tick off items appearing in both CJs and bank
Errors: if bank has mistake, inform bank of error.
If business has made a mistake correct relevant cash journal
2. Go through bank statement to see what amounts remained unticked
Enter such amounts into CRJ or CPJ
Go through CRJ and CPJ and see if there are any unticked amounts these are
outstanding deposits and unpresented cheques
CRJ deposit in transit
CPJ unpresented cheques
3. Total CJs and post to bank ledger account
4. Prepare bank reconciliation
7.5 Petty Cash
Under the petty cash system, a fund is established in making small payments,
especially those that are impractical or uneconomical to make by cheque.
E.g. taxi fares or miscellaneous office needs
To establish petty cash funds:
Petty Cash DR
Cash CR
As payments are made from the fund, the custodian completes a form known
as petty cash voucher
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Each voucher indicates amount paid, purpose of expenditure, date and
individual who received money
Petty cash vouchers and invoices and receipts are evidences of disbursements
Cash remaining in fund + Petty cash vouchers + Invoices = Original amount
Replenishing the fund
To replenish fund
Postage expense $$$
Office supplies expense $$$
... $$$
Cash $$$
Note credit is to cash account
Fund is restocked by writing cheque on the companys cheque account
Replenished when funds are low, or at the end of each accounting period
Process is necessary because no formal journal entries have been recorded
Errors in petty cash fund
Occasionally petty cash vouchers and cash will not equal original fund balance
Adopt cash short and over account
Shortage miscellaneous expense
Overage miscellaneous revenue item
7.6 Disclosure of Internal Control in Annual Reports
Australian companies listed with ASX are now required to include section in their
annual reports on corporate governance.
A number of companies include a description of internal controls in this section
Common aspects of these descriptions:
- Board of directors has responsibility for internal control system
- Role of audit committee is noted
- Operating budgets used to monitor performance
- Internal audits are important part
- Controls are important in certain key area including treasury
- These are clearly defined guidelines for capital investment
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7.7 Managers and Internal Control
Internal control is the responsibility of management

Internal control should minimize errors and irregularities
Errors unintentional mistakes, irregularities intentional
Irregularities should be detected except when there is collusion or management
override
No system of internal control can eliminate all errors and uncertainties, but can
decrease the possibility of them occurring and increase chances of detecting
them
Important question how much internal control is necessary
Cost money to implement an extra internal control
Must apply cost benefit analysis
Difficult because benefits of having controls are often difficult to quantify
Based on judgement
Internal control is an integral part of the environment of all public sector entities
June 1995 NSW Treasury issued a statement of best practice internal control
and internal audit
Guidance for govt agencies on such topics as responsibility for internal control,
relationship between management processes and internal control; analysing
risks and establishing controls and effective collection of information,
communication and monitoring
4 critical elements in an effective system of internal control for public sector
entities
Appropriate tone at the top
Well designed control system aimed at mitigating (explaining) risks
Effective collection of info and communication thru agency
Effectively monitoring of system of internal control
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Chapter 8 Inventory
8.1 Inventory Control
Inventory control is an important issue for management because a high

percentage of working capital may be tied up in inventory.
May be consumable or outdated, high potential for theft
Choice of inventory is a record keeping choice as opposed to a reporting
choice
The perpetual inventory control method
When an order of inventory items is received, the quantity received is added to

the quantity recorded as being already on hand.
When they are sold, they are deducted from the recorded quantity
Therefore, the perpetual method shows how many items are supposed to be on
hand at any time
Inventory on hand = quantity on hand at beginning of period + quantity
purchased quantity sold
Perpetual continuously updated figure
Physical count of inventory fails to show that quantity, therefore error or lost or
stolen inventory
Beginning inventory cost (support with physical count if desired) +
Cost of purchases of inventory (records) Cost of inventory sold (records) =
Ending inventory cost
Debit expense, credit inventory
Overage = negative expense where there is more inventory than expected
Overage/shortage expense account would probably be included with COGS in
the income statement
The periodic count method
If complete records of inventory changes are not kept, the enterprise does not
have records to indicate what should be on hand
The only way to tell is to count
This is done periodically when inventory figure is needed for financial statements
or insurance purposes this is called the periodic inventory method.
Periodic count method lacks the parallel record keeping that gives the
perpetual method its value.
There is no way to reconcile counts to records in order to discover errors, but
simple and cheap, as no continuing records are kept
Beginning inventory (count) + purchases (records) ending inventory (count) =
Inventory sold (deduced); that is cost of goods sold
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Because what is sold has been inferred, under the periodic method, cost of
goods sold expense includes all other possibilities (lost, stolen...)
Other forms of control need to exist to indicate theft or so on
E.g. unexpected changes in the ratio of cost of goods sold to sales should be
investigated
Inventory: Cost and benefits of controls
Perpetual method can be costly in terms of record keeping

Car dealership needs perpetual system
Cars are expensive, so large investment must be made if a good supply is to be
on hand for customers to choose from.
Need to keep track of registration, insurance, serial numbers, other types of
identification
Because of small quantity of cars sold by dealerships, record keeping costs are
not high.
Similarly, companies selling more expensive items, e.g. TV, fridge, jewellery, use
perpetual method
Companies with large amount of sales, particularly items with low value, use
periodic inventory method because of lower costs.
However, most organisations now use perpetual because of computer based
inventory systems
Retail companies have optical scanners scanning barcode
Assist with inventory control and helps with planning for ordering additional
inventory
8.2 Accounting Entries for Perpetual and Periodic Inventory
Perpetual includes costs of goods sold and inventory shortage expense

Sales XXX
Less cost of goods sold XXX
Less inventory shortage XXX XXX
Gross profit XXX
Periodic excludes costs of goods sold and inventory shortage expense
Sales XXX
Cost of goods sold:
Opening Inventory XXX
Purchases XXX
Cost of goods available for sale
Less ending inventory XXX
Costs of goods sold XXX
Gross profit XXX
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8.3 Inventory Valuation and Cost of Goods Sold
Inventory accounting uses a modified version of the standard historical cost

valuation basis: lower of cost or market value
Application of accounting conservatism: anticipate no gains but allow for losses
Inventory accounting affects both the balance sheet (inventory valuation) and
the income statement via the COGS
Inventory cost flow assumptions
Cost of inventory varies

Actual cost is usually tracked only for high value items (houses, motor vehicles)
that can be identified by serial numbers and other methods
Method specific identification
As the cost of keeping records decreases, because of computerisation, more
items will be able to be tracked this way.
Impossible to keep track of individual items in inventory, so ASSUME flows of costs
By using periodic method: first calculate COG available for sale
Problem: how to allocate COG available for sale between COGS and ending
inventory asset
Three common inventory cost flow assumptions:
- FIFO First in first out sell the oldest items first
(BS recent cost, COGS old costs)
- AVGE weighted average assumption assume mixture of old and new
items (average unit cost = total cost / total units)
- LIFO Last in first out sell newest items first
(BS old costs, COGS new costs)
8.4 More about Inventory Cost Flow Assumptions
Assumption Periodic Control Perpetual Control
FIFO FIFO FIFO
AVGE Weighted Average Moving weighted average
LIFO Periodic LIFO Perpetual LIFO
FIFO is not affected by inventory control method because it just assigns the most
recent costs to whatever is on hand.
Others depends on control method, as it depends on what happened to
inventory levels during the period
Thus there is 5 methods
There is a six specific identification and 2 others
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In Australia, LIFO is not allowed to be used for either financial reporting or tax
purposes
Because each assumption allocates the available inventory cost between the
inventory asset and the costs of goods sold expense differently, the choice of
assumption has an effect on both the income statement and the balance sheet
If there is little change in purchase costs, the various methods will show very
similar results
FIFO
Used because its convenient where inventory asset are close to current costs
Convenient because only need to keep invoices
Doesnt matter which control, because all info needed is the quantity on hand,
whether by count or by perpetual records
Most popular cost flow assumption for inventories for larger Aust companies
Considered appropriate for current asset because it is the most reasonable
method of physically moving inventory, especially inventory that is perishable or
subject to changes in style
AVGE
When prices are rising, average cost shows a higher cost of goods sold (lower
profit) and lower inventory balance sheet figures than the FIFO method
LIFO
In US, cost flow assumption used for accounting purposes does not have to
match physical flow of items
Allowable method for income tax purposes.
E.g. rising inflation increases purchases costs, produces higher COGS, lower profit
and lower inventory asset value used for tax purposes
Matches revenues and expenses more adequately.
E.g. if company changes prices in response to purchase cost changes, its
revenues reflect recent prices changes
Problem: LIFO produces inventory asset values that are based on older purchase
costs, and this can substantially underestimate the asset value
LIFO is affected by whether its amounts are determined using the periodic or
perpetual control methods,
8.5 An Example: MEEIX LTD
Beginning inventory + purchases = cost of goods sold expense + ending

inventory
MUST refer back to pg 398 when studying.
In a period of rising purchase prices
Inventory asset value: FIFO > AVGE > LIFO
Cost of goods expense: LIFO > AVGE > FIFO
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Larger differences in price, larger differences in end results of method
8.6 Lower of Cost or Market Rule
The lower of cost or market rule states that the value of inventory should be
written down from the cost price to the market price in situations where market is
below costs
To calculate the lower of cost or market value, we just take the cost of the items
and match those costs against the net realisable value and use the lower as the
balance sheet inventory value.
If inventory costs 1000 had a net realisable value at year end of 800:
DR Inventory Write down expense 200
CR Inventory 200
8.7 Retain Inventory and standard costs
Retail inventory method is most application to retailers inventories

Combines purchase costs and selling prices into a single calculation/estimate
Department is charged with total selling value (sale price x time)
Revenue from sale is deducted from total value as items are sold
Ties inventory control to cash control
AT any given point in time, inventory + cash + receipts for credit cards = total
retail value
Retail price of all goods department sales = inventory on hand priced at retail
If physical count doesnt match then use shortage or overage
Retail method is complicated in practice because of the need to keep track of
markdowns, returned goods, special sale prices and other price adjustments if
the method is to work accurately
Another popular method: standard costs
Applicable to inventories manufactured by a company and uses estimated
costs based on standard production costs and volumes
balances, purchases and sales
8.8 Disclosure of Inventories Policies
Accounting standards require the financial reports disclose the value of

inventory split between CA and NCA and further split into the following classes:
- Raw materials and stores
- Work in progress
- Finished goods
- Land held for resale
In addition requires disclosure of general basis of inventory valuation and
methods used to assign costs to inventory quantities
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Within one organisation, more than one method can be used and it may vary
between the type of product or the class of inventories
8.9 Managers and the valuation of inventory
Managers have to choose control method

Perpetual better control, higher costs
Important to managers as both profit figures and balance sheet figures affect
managers performance reports
Therefore managers need to understand the effect, across time, of different cost
flow assumptions on financial statements
Managers must make important judgements
Which cost flow assumption must closely represent the actual physical flow?
What inventory items have a net realisable value which is lower than cost?
8.10 Inventory in the public sector
Inventory is not normally a material item for most public sector organisations.
But there may be exceptions hospital bandages, medicine
When inventory does exist, the same accounting standards apply as in the
private sector.
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Chapter 9 Noncurrent Assets
9.1 The Cost of an Asset: Basic Components
The basic premise of historic cost valuation is to use the cost of an asset, at
acquisition to value that asset on the balance sheet
When machines are bought, there are certain conditions that must exist for the
machine to operate, e.g. temperature, raised floor for wiring, fire protection
system
Therefore a section of the factory must be renovated to meet specifications of
the machine
These costs are known as installation costs
Overall, the cost of an asset includes all those costs required to install it ready for
use
Should the interest on monies borrowed to finance the project be included?
Most the time, no
Enterprises often have policies for how to determine whether expenditures, such
as interest are included in assets costs
Decision between whether to include costs as 1 years expense or included in
assets
Expense profits and income taxes for the year will be lower
Assets total assets will be higher, and this years profit and tax expenses will also
be higher
Capitalising versus expensing choice
When deciding where in BS maintenance goes, think about whether there is
improvement or extension of useful life of asset. If yes asset, if no
maintenance expense
Common components of asset cost:
- Land purchase price, costs of clear title (legal fees), clearing unwanted
items, draining
- Building (purchased) purchase prise, renovation, decoration
- Building (self-constructed) labour, material, insurance
- Purchased Equipment installation, transport, testing
9.2 Depreciation of Assets and Depreciation Expense
Depreciation an allocation of cost as a deduction from profit over the useful

life of the asset
Depreciation expense annual deduction from revenue
Depletion wasting assets are involved
Amortisation intangible assets or leases are involved
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Why Allocate the Cost?
Assets are returns on investments

In accrual accounting, some method is needed to allocate the cost of long
lived assets over their useful lives
If whole asset cost was deducted in the year of acquisition, that years profits will
be very low and subsequent years profits very high
It would also mean that an asset has further benefits that is not recognised
Allocation of cost in order to measure profit
NOT a system to tract value changes in assets or to measure the current value of
those assets in the balance sheet
Balance sheet shows the net of assets original cost minus Acc Dep: it does not
mean the assets current value is that net amount
Why not depreciate land?
Lands economic value is not considered to decline through use

Land is not normally susceptible to physical or economic decline
Equipment can be depreciated via physical causes (wear and tear) and non-
physical causes (obsolete with the advent of newer and faster machine)
Land is considered immune from all this, and is therefore not depreciated
When does cost allocation (depreciation expense) begin?
When the asset is put to use and the benefit begins to be realised, depreciation
of the expense should begin.
Once asset has been put into service, further costs involved in painting,
maintenance, repair and so on are now considered to be expenses
If a cost that is incurred significantly changes the assets economic value in
earning revenue, e.g. betterment of asset, then cost may be capitalised as part
of assets cost, then depreciated along with the rest of the asset.
Other questions
Depreciation is recognised by the following journal entry:

DR Depreciation Expense
CR Accumulated Depreciation
Accumulated depreciation is a contra asset
Depreciation is a prediction it is never exact
Choice of accounting purposes does not affect the tax paid
Why is depreciation any good, if its not exact, it has no cash effect and it does
not match market value changes in assets?
It is used to spread the cost out over the useful life of the asset, which matches
the presumed consumption of that cost with the benefits gained from that use
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9.3 Depreciation Bases and Methods
Assumption Kind of Cost Allocation
Spread evenly over the assets life Straight line

benefits is equal throughout useful life expense is the same each year
Falls over the assets life Reducing balance method

benefits decrease as asset gets older expense is larger in earlier years
Variable over the assets life Units of production

benefits varies according to how much expense depends on each years
production is achieved each year volume of production
Straight line depreciation
Simplest and most widely used

Need 3 pieces of info:
- Cost of the asset: total cost to be depreciated over time
- Estimated useful life: number of periods for which the asset is expected to
benefit the enterprise
- Estimated salvage value: amount expected to be recovered via the sale
of the asset at the end of its useful life
Depreciation for one period = Cost minus estimated salvage value
Estimated useful life (no. of periods)
A common practice for many firms is to assume the salvage value of the asset to
be zero, which then enables depreciation to be expressed in terms of
percentages instead of years
Reducing Balance method
Next most common depreciation method

Assets contribute more of their benefit to the enterprise in early parts of their lives
- Accumulated depreciation: total depreciation recorded since acquisition
- Depreciation rate: % of book value of the asset that is to be depreciated in
the period
Depreciation for one period = (cost accumulated depreciation) x rate
Reducing balance depreciation does not normally take into account salvage
value
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Reducing balance percentage: r = 1 - n

r = required depreciation rate

n = estimated life in years
s = estimated residual value
c = original cost
Units of Production Depreciation and Depletion
Also used to compute depletion of natural resources

- Estimated salvage value: amount expected to be recovered via the sale
of the asset at the end of its useful life
- Estimated number of units to be produced during the life of the asset
Depreciation for one unit = Cost minus estimated salvage value
estimated no. of units of production during life
To determine the depreciation for one year, the charge per unit is multiplied by
the number of actual units produced or used
Whichever method is adopted, the company can always adjust its calculations
later if the expectations about length of useful life or salvage value begin to look
seriously inaccurate
For now, note that it is usual to allocate the remaining book value over the
remaining useful life
9.5 Gains and Losses on Noncurrent Asset Disposals
Selling off assets are kept separate from ordinary revenues via the following kind
of journal entry:
E.g. Truck bought at 50,000. Depreciates at 8,000 each year. Sold at end of 2nd
year for 37,000
Net book value of truck = 50,000 16,000 = 34,000
Journal Entry for selling truck:
Cash 37,000
Accumulated Depreciation 34,000
Truck asset 50,000
Revenue on sale of truck 3,000
If there is a loss, it will be debit revenue
Think of gains and losses as depreciation corrections
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9.6 Assets Revaluations
Carry amount book value

Fair value amount for which an asset could be exchanged between
knowledgeable willing parties in an arms length transaction
In Australia, directors need to ensure that the carrying value of an asset exceeds
the recoverable amount.
If not, the carrying value must be reduced to its recoverable amount
impairment loss
Recoverable amount assets fair value costs to sell it, or an assets value in
use whichever is higher
Value in use is the present value of future cash flows that are expected to be
derived from an asset
Accounting standards state that each class of noncurrent assets must be
measured using either the cost model or the revaluation model
Cost model after recognition of an asset, the asset is carried at cost less
accumulated depreciation and any accumulated impairment losses
Revaluation model after recognition of an asset, the asset whose fair value
can be measured reliably is carried at a revalue amount, which is the fair value
at the date of revaluation less any subsequent accumulated depreciation and
subsequent accumulated impairment losses
Revaluing upwards revaluation increment increase in asset account and
shareholders equity (asset revaluation reserve)
Revaluing downwards revaluation decrement decrease in asset account
and increase in expense account
Increments in asset valuations do not generally affect profit directly, but
decrements do reduce the profit for the year
Changes in asset valuation (except for land) result in different depreciation
expenses in subsequent years
When an asset is revalued, all assets within the same class of assets should also
be valued at the same time on a consistent basis.
Exception: downwards valuation
Land Revaluation increment:
DR Land
CR Revaluation Reserve
Land Revaluation decrement:
DR Loss on devaluation of land
CR Land
Equipment Revaluation increment
DR Accumulated Depreciation
CR Equipment
DR Equipment
CR Revaluation Reserve
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9.6 Intangible Assets
Intangible assets are identifiable, non-monetary assets that do not have a visible
physical existence, unlike land, buildings or equipment
Intangible Assets include:
- patents, copyrights, trademarks and other such legal property
- brand names, which can be registered to maintain exclusive use
- franchises, distributorships and other rights to sell someone elses products in
a certain geographical area
- deferred charges such as incorporation costs, financing costs and other
items that are really long term prepaid expenses
- development costs (including product development costs and mineral
exploration costs), which are capitalised and later expensed at the time
they earn revenue in the future strict criteria applies
AASB require organisations to charge all research costs to an expense account
when they are incurred.
Organisations prohibited from capitalising any expenditure associated with
internally generated brands, publishing titles, customer lists and similar items
What are intangible assets worth?
Existence and value of intangible assets may be doubtful

generally the more clearly identifiable and documented, the less difficulty they
pose
Assets such as brand names, trademarks and franchises have considerable
doubt about their economic value
Development expenditures question on whether they belong on the balance
sheet at all. is it for sure that the product will sell and that it will bring future
economic value? will the revenue be larger than the costs?
Amortisation or impairment of intangibles
Legal useful life is different from economic useful life

If useful life is finite intangible is amortised
If useful life is indefinite intangible would be tested annually for impairment, by
comparing carrying amount with recoverable amount
If carrying amount > recoverable amount, then impairment loss
9.8 Goodwill
Goodwill arises when more is paid for a group of assets, such as a whole business,
than the assets seem to be worth individually
Mew
The rationale for paying the additional amount may be based on such factors
as how the business is organised or the number of customers it has
Goodwill occurs to keep the books in balance
Purchased goodwill is measured as the excess of the cost of acquisition of
another entity over the fair value of the identifiable net asset and contingent
liabilities
Externally generated goodwill is recognised by the accounting system. It is a
transaction, supported by documentation, that shows how much was paid
Internally generated goodwill not recognised by accounting system e.g.
better management and improving friendliness of staff
Internally developed goodwill is never capitalised cannot put an economic
value on it yet e.g. expenditure on office parties to keep employees happy is
an expense
Following the acquisition of goodwill, rather than amortising it over a deemed
useful life an entity will test it for impairment on an annual basis
Or more frequently, if events or changes in circumstances indicate that the
goodwills carrying value has decreased below its recoverable amount
9.9 Financial Leases
Leases are rental agreements in which one individual (lessee) pays, to the owner
of a property (lessor), a certain amount in return for the right to use that property
over a predetermined period
Concern: some companies use leases to avoid putting assets on balance sheet
As a result, AASB established 2 types of leases: finance leases and operating
leases
Finance leases when all the risks and benefits incidental to ownership are
substantially transferred to the lease
Cost present value of the future lease payments using an appropriate interest
rate usually deducted from the lease agreement
At the same time present value of those payments is recorded as a liability
DR Finance lease asset
CR Finance lease obligations liability
After that:
1. Leased asset is amortised
2. Liability is reduced as payments are made on the lease. Each payment
includes interest, but only principle deducted. This maintains the liability at
the present value of the remaining lease payments
3. Expenses for using the leased asset are amortisation and interest
4. Various particulars of significant capital leases are usually disclosed in the
notes to the financial statements so that the readers of the statements may
judge the effects of such capitalisation
Result: leased asset is treated essentially as if it were owned
Mew
Accrual accounting recognises the economic value of the asset and disregards
the legalities of who owns it
If the lease does not result in the economic equivalence of ownership if it is
really a rental situation where the owner is responsible for repairs, the lease is an
operating lease
9.10 Reporting of Non Current Assets and Associated Depreciation/Amortisation
The Corporations Act 2001 and AASB require certain disclosures concerning
noncurrent assets and their related depreciation/amortisation. These include:
- Depreciation and amortisation expense
- Cost and accumulated by major classes of assets
- Description of policies with regards to D/A
- Details concerning revaluation
- If items are measured at fair value include carrying costs and other costs
- Statement that assets have not been valued above their recoverable
amount
- What the recoverable amount is fair value cost to sell/value in use
9.11 Managers and Noncurrent Assets
Managers need to make many judgements related to noncurrent assets.

What should be included in the cost of an asset?
What period/method should it be depreciated?
Value on brand names?
When should assets be revalued and who should do the revaluing?
All of the above judgements (except upward revaluation) will affect the
enterprises profit figure, which is a key indicator of management performance
Infrastructure system assets include items such as roads, water supply, bridges
and transmission lines
Generally valued by govt departments at cost or written-down replacement
value (estimated replacement value accumulated depreciation)
Difficulty in obtaining these figures
Heritage assets cannot be replaced
Valuation of $1 highlights to readers that an asset exists, but at this point in time it
is not clear how to value it.
E.g. Library collection held by State Library
In general, a number of factors have a bearing on the difficulty of reliably
measuring the assets of public sector entities.
E.g. completeness of asset registers, type of asset, extent of assets similarity to
other assets used in other govt departments
Such assets e.g. historic buildings, gardens, monuments
Mew
Chapter 13 The Statement of Cash Flows
13.1 The purpose of Cash Flow analysis
Cash is the most important asset to any entity

Many firms have had positive profit figures, but have still run out of cash and
gone bankrupt
Important for present and potential investors and creditors to have info about a
firms cash inflows and outflows and its resulting cash position
Solvency the ability of a firm to meet all its debts and obligations as they are
due
Liquidity enough cash and short term assets now to recover its immediate
debts and obligations
Too much cash large supply of cash idle does not yield great returns for
investors
Cash should be put to work by making investments and attract new customers
Statement of cash flow provides info on a firms generation and use of cash
and highly liquid short-term assets, hence assist in evaluating the firms financial
viability
Cash profit is not a complete measure of what has happened to the cash
Certain inflows or outflows of cash are not part of the process to generate
revenue and incurring expenses, so they would not be covered even by a cash
profit measure
Purpose of cash flow analysis:
- produce measure of performance that is based on day-to-day cash flow:
cash generated by ordinary business activities, instead of accrual
accounting different perspective on performance and therefore
enhances the info for users
- incorporate other non-operating cash inflows and outflows, such as from
investing in new assets, selling old ones, borrowing or repaying debts. By
including these non-operating cash flows, the statement of cash flows can
provide a complete description of how the firms cash was managed during
the period.
With all this info, the user can evaluate managements strategy for managing
cash and make a better judgement of the companys liquidity, solvency, risk
and opportunities than could be made just from the balance sheet and income
statement
Mew
13.2 Overview of the Statement of Cashflows
Classification of Cash Flow Transactions
Operating activities relate to provision of goods and services

Investing activities relate to the acquisition and disposal of noncurrent assets,
including property, plant, equipment and other productive assets, and
investments such as securities, that do not fall within the definition of cash
Financing activities relate to changing the size and composition of the
financial structure of the entity, including equity, and borrowings not falling
within the definition of cash
Mew
Some important features of this format:

1. Same period as income statement
2. Include some equivalents: very liquid near cash assets
3. Cash may include temporary negative bank balances (overdrafts)
4. Uncertainty explained in the notes to financial statements
5. Focus must stay on cash
6. Transactions without cash are not included
7. Any numbers can be positive or negative
8. Deriving cash flow Aust = direct method (start from cash receipts to cash
payments). Some other countries = indirect method (start with accrual net
profit, then remove effects on profit of non-cash expenses and revenues)
Mew
Chapter 14 Financial Statement Analysis
14.1 Investment and Relative Return
Relative return (return on investment / ROI) = Return

Investment
Main points about ratios:
- Purpose: produce a scale free (because its dependent on same units and
size of company), relative measure of a company that can be used to
compare with other companies, or other years for the company
- Ratio may be unreliable and misleading, if numerator/denominator is
inappropriate. Return can imply EBIT, net profit or cash flow
14.2 Introduction to Financial Statement Analysis
Purpose of financial statement analysis: use statements to evaluate an

enterprises financial performance and financial position
Value of the analysis depends on the value of the financial statements
Financial Evaluation is not just a calculation
Not just a calculation it is a judgement based on the calculations that make

sense for that company and based on substantial knowledge of the company
The more info knew about business, mgmt and acct, the more useful and
credible the analysis
Affected by its own quality whether the statements have been carefully
prepared and are comparable with other companies
Affected by availability of other sources of info that may contain all or part of
what is in the financial statements
Financial acct info is a part of a network of info, not a stand-alone item.
Preparation for intelligent analysis
Requires aim and substantial knowledge of the enterprise

Scale free ratios means that it allows comparisons over certain periods of time,
among companies of different sizes and with other indicators such as interest
rates or share prices
In order to do an intelligent and useful financial statement analysis:
4. Learn about the enterprise, its circumstances and its plans look at
descriptive sections of annual reports and footnotes to financial statements
5. Obtain a clear understanding of the decision or evaluation to which the
analysis will contribute, who the decision maker (investor, lender, creditor,
management) is and what assistance is required
6. Calculate the ratios, trends and other figures that apply to the problem
7. Find whatever comparative info you can to provide a frame of reference for
your analysis industry data, reports by other analysts, etc.
Mew
8. Focus on the analytical results that are most significant to the decision
makers circumstances, and integrate and organise the analysis so that it will
be of most help to the decision maker.
The preparer of financial statements can choose between a number of
accounting policies on which to base the financial information
May want to review such policies, e.g. deducing goodwill from assets, before
computing ratios
Validity of financial analysis based on accounting rations has been challenged
HISTORICAL DATA
Stock markets and other capital markets adjust prices of companies securities
as info comes out, ratios based on publicly available info cannot tell people
anything the markets have not already incorporated into security prices.
14.3 Common Size Statements
Whilst focus on chapter is ratio analysis, another method to analyse financial

statements is common size statements
By calculating all balance sheet figures as a percentage of total assets and all
income statement figures as a percentage of total sales revenue
Sizes of companies is factored out
This procedure assists in comparing companies of different sizes and in spotting
trends over time for a single company
14.5 Financial Statement Ratio Analysis
Ratios are usually done to 2 decimals

They could be done to more decimals, but that would be false accuracy
This is because ratios depend on all sorts of judgements and estimates made in
assembling the financial statements
There should not be thought of as precise quantities but rather as indicators
Profitability Ratios
Return on equity (ROE) = Operating profit after tax

shareholders equity
Indicates how much return the company is generating on the historically
accumulated shareholders investment
There are different versions of ratio e.g. instead of closing year-end equity,
Woolworths uses average equity
Mew
Return on assets (ROA) = Operating profit after tax
total assets
Determines the after tax return the managers are earning on the assets under
their control
Alternative ROA = EBIT

total assets
Determines the return on assets under managements control
Total assets can be year-end figure, or the average over the year
Denominator can also be gross assets (Assets before depreciation) and net
assets
Increase in ROA means that company has a better return on assets under their
control
Du Pont Formula: ROE = ROA x Leverage
Leverage = Total Assets
Total Shareholders Equity
Indicates how much of the companys assets are financed by equity
The higher the ratio, the smaller the shareholders funding of assets, the greater
the proportion of total assets that must have been funded by debt
Return on assets indicates the companys ability to generate a return on its
assets before considering the cost of financing those assets
Helps judging whether borrowing is worthwhile
Profit Margin = Operating profit after tax

Sales
Measures performance of managers in converting sales to net profit
Average profit on each dollar of sales
Useful indication of pricing strategy or competition intensity
Alternative Profit Margin = EBIT

Sales
Measures the ability of mangers to generate profit from sales
Gross Margin = Sales COGS

Sales
Indicates whether sales are profitable
Also known as gross profit ratio
Further indication of companys product pricing and product mix
If Gross Margin = 33%, then revenue = 150% of cost, so mark up of 50%
Increase in profit margin either due to increase in gross margin or decrease in
expenses as a percentage of total sales
Mew
Cash flow to total Assets = Cash flow from operations

Total Assets
Determines the companys ability to generate cash resources relative to
companys size
Approximately factors out size
Alternative measure of ROA, focusing on cash returns rather than accrual profit
Earnings per share (EPS)= Operating profit after tax preference dividends
Weighted no. of ordinary shares outstanding
Relates earnings attributable to ordinary shares to the number of shares issued
Profit figure is after deducting outside equity in the operating profit
Weighted no. of ordinary shares outstanding should be provided should not be
calculated by outsiders
If company has commitment to issue more shares, potential effect of the
exercise of such commitments is calculated by showing both basic EPS and
diluted EPS
Dilution refers to the potential of lowering returns to current shareholders as a
result of other peoples exercising rights
Price to earnings ratio (P/E) = Current market price per share

EPS
Relates to the accounting earnings to the market price per share to reflect
present company performance with market expectations
Since relationship between such earnings and market price of shares is not
straightforward, interpretation is controversial
Idea is that because market price should reflect the markets expectation of
future performance, P/E compares the present info with those performances
High P/E means that company will do better in the future e.g. popular
companies with good share prices
P/E is highly subject to general increases and decreases in market prices, so it is
difficult to interpret overtime and is more useful to compare similar companies
listed in the same stock market at the same time
Dividend Payout Ratio = Annual dividends declared per share

EPS
Measures the portion of earnings paid to shareholders
Stable ratio company has a policy of paying dividends based on profits
Variable ratio factors other than profits are important in the directors decisions
to declare dividents
Mew
Activity (Turnover Ratios)
Total Asset Turnover = Sales

Total Assets
Determines the amount of sales volume associated with each dollar of assets
Similar turnover ratios relate the companys sales volume to its size
Turnover and profit/margin ratios are used together, because they tend to move
in opposite directions
High Turnover = Low margins and vice versa
Pricing low and trying for high volume versus pricing high and high profit
This is because competitive pressures are likely to force down selling prices and
therefore profit margins if a high turnover is desired
Represent contrary marketing strategies or competitive pressures
How much revenue is the company getting out of each dollar of assets?
ROA = profit margin x Asset Turnover
Inventory Turnover = COGS

Average Inventory
Relates the level of inventory to the volume of sales activity
A company with low turnover may be risking deteriorating level of inventories
and or may be incurring excessive storage and insurance costs
Inventory turnover can be converted to measure how long inventory in days,
inventory is held on average
Days in inventory = 365
Inventory turnover
Measures how long on average, inventory is held in stock
Debtors Turnover = Credit Sales

Trade Debtors
Relates the level of debtors to the volume of credit sales activity
Also called accounts receivable turnover
Credit sales may be hard to find as sales is one section
Trade debtors refers to gross trade debtors (before deducting allowance for
doubtful debts)
Days in debtors = 365
Debtors turnover
Measures how long it takes on average, to collect outstanding debtors
Mew
Liquidity Ratios
Current Ratio = Current Assets

Current Liabilities
Indicates whether the company has enough short term assets to cover short
term debts
>1 working capital +ve, <1 working capital ve
Working capital = current assets current liabilities
Usually, high CR = financial stability
But if CR is too high, it implies that the firm is not reinvesting in LT assets to
maintain future productivity
Also indicate problems if inventories are getting larger than they should or
collections of receivables are slowing down
Static ratio measuring financial position at a point in time and not considering
any future cash flows the company may be able to generate to pay its debts
Most useful for companies that have relatively smooth cash flows
Hardest to interpret for those who have unusual assets or liabilities, or depend on
future cash flows to pay current debts
Low current ratio is common for large companies quick cash flow cycle
In general, can buy inventory, sell it and get cash before they have to pay their
accounts payable
Quick Ratio = Cash +AR + Short Term Investments

Current Liabilities
Indicates whether current liabilities can be paid immediately
Also called the acid test
Includes all assets except inventory
Ratio is particularly useful for companies that cannot sell inventory quickly
Interest Coverage Ratio = EBIT

Interest Expense
Indicates the ability of the company to pay interest on borrowings from profit
This and similar coverage ratios based on cash flow figures indicate the degree
to which financial commitments are covered by the companys ability to
generate profit or cash flow
Low coverage level (especially less than 1) means that company is not
operating at a sufficiently profitable level to cover the interest obligation
comfortably, and may also be a warning of solvency problems
Mew
Financial Structure Ratios
Debt to Equity Ratio = Total Liabilities

Measures the proportion of borrowings to the investment by owners
Includes retained profits
Ratio greater than 1 means that liabilities are mostly financed with debt
Ratio less than 1 indicates that liabilities are mostly financed with equity
High ratio = warning about risk: company is heavily in debt relative to its equity
and may be vulnerable to interest rate increases
Debt to Assets Ratio = Total Assets

Total Liabilities
Indicates the proportion of assets financed by liabilities
Ratio highly correlated with debt to equity ratio
Leverage = Total Assets

Indicates how much of the companys assets are financed by equity
The higher the ratio, the smaller the proportion of total assets funded by
shareholders equity, and therefore, the more funded by debt
Summary
Ratios are a quick method of breaking info in the financial statement into a form
that allows comparability with similar companies and with the financial
performance of the company over a number of years
Advantage: different ratios consider different parts of a companys
performance
User do NOT only rely on ratios also on notes to the financial statements,
auditors report, etc
Notes to the financial statements provide further explanations of some key areas
in the statements, e.g. accounting policies, detailed calculation of some
account values, etc

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ACCT1501 Notes Cheryl

Chapter 1 Introduction to Financial Accounting

1.2 Financial Accounting

Accounting is a process of identifying, measuring and communicating

Financial performance generating new resources from day-to-day operations

1.3 The Social Setting of Financial Accounting

1.4 The People Involved in Financial Accounting

Main Participants: Information users, information preparers, auditors

Preparers (Decision Facilitators)

Main groups: Managers, Bookkeepers and clerks, Accountants

Auditors (Credibility Enhancers)

Auditors report on the credibility of the enterprises financial statements, on

1.5 Accrual Accounting

Accrual accounting system, impact of transactions is recognised in the time

Accrual Accounting versus Cash Accounting

Using Accrual Accounting to prepare financial statements

1.6 The Key Financial Statements

Balance Sheet shows an organisations resources and claims on resources at a

Assets future economic benefits as a result of past transactions or other past

Provides info on an organisations profitability for a period of time

Statement of cash flows

1.7 Relationships between the financial statements

1.8 Information use scenarios

Evaluation of CEOs performance by member of board of directors

Demands on the quality of financial accounting information

Relevance useful, valuable, and timely manner

Tradeoffs among accounting principles

Prudence is a bias, interfering with neutrality and reliability

1.9 Financial Statement Assumptions

Accrual basis accrual accounting

Chapter 2 Measuring and Evaluating Financial Position and

2.1 Introduction to the Balance Sheet

Contains 2 lists that have the same dollar total

Assets = Liabilities + Owners Equity

Must have Company Name and Balance Sheet as at DATE

Assets: Liabilities: Assets:

Equity is the owners interest in the enterprise.

2.4 A closer look at the balance sheet

Comparative balance sheets:

Where do the figures come from?

Accounting is generally a historical measurement system

2.5 Maintaining the accounting equation

Assets = Liabilities + Owners Equity

2.6 Managers and the Balance Sheet

Balance sheets are important, because outsiders read it.

2.7 The Income Statement

Increase in companys wealth arising from the provision of G/S

Expenses are the opposite of revenues

The relationship of profit for the period to retained profits

2.9 A close look at the income statement

Income statement covers period in time not point in time

2.10 Capital Markets, Managers and Performance Evaluation

Importance placed on bottom line profit figure and components

2.11 Capital Markets, Managers and Performance Evaluation

Emphasis on cost of services

The income statement enables users to identify:

Chapter 2 Appendix Background: Sole Traders, Partnerships,

A2.1 Four Kinds of Business Organisation

Two general kinds of equity:

One owner (the proprietor)

More than one owners

Legal entities under corporations law

Company: Forms of Share Capital