Financial Accounting Applications

Week 1 / CH1: An Introduction to Accounting:

1 Explain the business context & the need for decision making.

Accounting provides an economic model of the business world, playing a key role in provision of financial
information for decisions made by people inside / outside the business. The process of decision making, first
identify the issue or the decision to be made. Next, gather relevant information required for analysis. Once
gathered you then identify tool or technique that can provide the analysis of the issue so a decision may be
made. Final step, evaluate results of the analysis & make the decision.

2 Define accounting, describe the accounting process & define the diverse roles of accountants.

Accounting: process of identifying, measuring, recording & communicating economic transactions & events of
a business operation to provide reliable & relevant financial information for decision making. Accountants
practise accounting in four main areas: commercial, public, government & not-for-profit accounting.

3 Explain the characteristics of the main forms of business organisation.

Sole proprietorship: business owned by one person. Partnership: business owned by two or more people.
Company: separate legal entity for which evidence of ownership is provided by shares. Other forms include
trusts, cooperatives, & not-for-profit forms. Trust: relationship or association between two or more parties
whereby one party holds property in trust for the other. Cooperative: form of business organisation which is
member-owned, controlled & used, must consist of five or more people. Not-for-profit sector includes clubs,
charities & government sector.

4 Understand the Conceptual Framework & the purpose of financial reporting.

Conceptual Framework; consists of a set of concepts to be followed by preparers of financial statements &
standard setters. Reporting entity: entity for which it is reasonable to expect the existence of users who
depend on general purpose financial reports for information enabling them to make economic decisions. It
important to determine whether an organisation is a reporting entity as reporting entities must prepare
external general purpose financial reports which comply with accounting standards. Reporting entities tend to
be larger organisations & the financial information provided in external general purpose financial reports
tends to be quite condensed. Both reporting & non-reporting entities also prepare internal reports which
have more detailed information. Objective of general purpose financial reporting: provide financial
information about the reporting entity that is useful to existing & potential equity investors, lenders & other
creditors in making decisions about providing resources to entity.

5 Identify the users of financial reports & describe users information needs.

Internal users are managers who need accounting information for planning, controlling & evaluating business
operations. Main external users: investors & creditors. Investors (shareholders) use accounting information to
help them decide whether to buy, hold or sell shares. Creditors (suppliers & bankers) use accounting
information to assess the risk of granting credit or lending money to a business.
Other groups with indirect interest in a business: customers & regulatory agencies. Users of financial reports
are interested in information about financing activities, involves collecting necessary funds to support the
business; investing activities, involve acquiring the resources necessary to run the business; & operating
activities, involve putting the resources of the business into action to generate a profit.

6 Identify the elements of each of the four main financial statements.

A statement of profit or loss presents the income (revenues & gains) & expenses of an entity for a specific
period of time. A statement of changes in equity reports the amount of comprehensive income for the period
& other changes in equity. A statement of financial position reports the assets, liabilities & equity of a
business at a specific date. A statement of cash flows summarises information concerning the cash inflows
(receipts) & outflows (payments) for a specific period of time.

7 Describe the financial reporting environment.

The Corporations Act regulates the activities of companies. ASIC administers the Corporations Act. The
financial reporting regulations are contained in the Australian accounting standards. The FRC oversees the
AASB & advises the Commonwealth Government on the standard setting process & developments in
international standard setting. The AASB issues accounting standards which certain entities, such as listed
companies, must apply when preparing published financial statements. Listed companies must also comply
with additional financial reporting requirements of the Australian Securities Exchange.
Key professional bodies include CPA Australia, Chartered Accountants Australia & New Zealand & IPA. The
accounting standards issued by both the Australian & New Zealand standard-setting bodies are consistent
with those issued by IASB & are commonly referred to as IFRSs.

8 Explain the accounting concepts, principles, qualitative characteristics & constraints underlying financial
statements.

Basic accounting concepts & principles are: monetary principle, accounting entity concept, accounting period
concept, going concern principle, cost principle & full disclosure principle.
The Conceptual Framework states that for information included in general purpose financial reports to be
useful must be relevant & provide faithful representation of economic phenomena it represents. Relevance &
faithful representation are classified as fundamental qualitative characteristics. Enhancing qualitative
characteristics include comparability, verifiability, timeliness & understandability (CVTU) & are used to
distinguish more useful information from less useful information. Cost is the constraint that limits the
information provided by financial reporting.

9 Calculate & interpret ratios for analysing an entitys profitability, liquidity & solvency.

Profitability ratios, such as profit margin & return on assets, measure different aspects of operating success of
an entity for given time period. Liquidity ratios, such as current ratio, measure entitys short-term ability to
pay its maturing obligations & meet unexpected cash needs. Current cash debt coverage is another measure
of an entitys liquidity. Solvency ratios, such as debt to total assets ratio & cash debt coverage, measure an
entitys ability to survive - long term.