Financial Accounting

Lecture 1

Adapted from Horngren, Harrison 2006 Pearson Education Australia

Accounting & the Business Environment: Objectives

1.

2. 3. 4.

5.
6.

Use accounting vocabulary for decision making & understand role of ethics in accounting Apply accounting concepts and principles to business situations Use the accounting equation to describe an organisations financial position. Use the accounting equation to analyse business transactions Prepare and use financial statements Evaluate the performance of a business.
Adapted from Horngren, Harrison 2006 Pearson Education Australia

Accounting
Accounting is an information system that Identifies economic events Measures business activities Processes information into reports Communicates financial information through reports about an identifiable economic entity for decision making Language of the Business
Adapted from Horngren, Harrison 2006 Pearson Education Australia

Users of Accounting Information: Decision Makers

Individuals Business Managers Investors Creditors Government Regulatory Agencies Taxing Authorities Nonprofit Organisations Other Users

Adapted from Horngren, Harrison 2006 Pearson Education Australia

Users of Accounting Information

External users are those outside the organisation. Those who make decision about the organisation. Internal users are those inside the organisation. Those who make decision for the organisation.

Adapted from Horngren, Harrison 2006 Pearson Education Australia

Fields of Accounting

Financial Accounting focuses on information for external users (creditors, outside investors and government departments) Management Accounting focuses on information for internal decision makers (management)

Adapted from Horngren, Harrison 2006 Pearson Education Australia

GAAP

Generally Accepted Accounting Principles are.. the rules that govern how accountants measure, process and communicate financial information.

Adapted from Horngren, Harrison 2006 Pearson Education Australia

Ethical Standards

Ethical standards in accounting are designed to produce accurate information for decision making.

Adapted from Horngren, Harrison 2006 Pearson Education Australia

Apply accounting concepts and principles to business situations.

The primary objective of financial reporting is to provide information useful for making investment and lending decisions.

Adapted from Horngren, Harrison 2006 Pearson Education Australia

Accounting Concepts: Entity & Time Period

An accounting entity is an organisation or section of an organisation that stands apart from other organisations as a separate economic unit: Entity Concept. Life of business is divided into equal time periods in which accounting data is collected: Time Period Concept.

Adapted from Horngren, Harrison 2006 Pearson Education Australia

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The Reliability (Objectivity ) Principle

States that the information must be reasonably accurate Several individuals would arrive at similar conclusions using the same data Accounting information must report what actually happened Accounting information must be free from bias.
Adapted from Horngren, Harrison 2006 Pearson Education Australia

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The Cost Principle

States that assets and services acquired by an entity should be recorded at their actual cost. Historical cost is used to record the value of the asset while it is owned by the business.

Adapted from Horngren, Harrison 2006 Pearson Education Australia

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The Matching Principle

Matches the inputs and outputs of goods and services. The cost of inputs used up to produce outputs are called expenses. The income from outputs is called revenue. In accounting we attempt to accurately measure profits by linking the revenue earned in the period to the expenses that helped earn the revenue.
Adapted from Horngren, Harrison 2006 Pearson Education Australia

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The Profit Recognition Principle

Revenue less expenses equals profit. But when are revenues earned or expenses incurred?? When the cash changes hands, when goods are taken or received or some other time?? To measure profits accurately we need to know in which accounting period to record the revenue and expenses.
Adapted from Horngren, Harrison 2006 Pearson Education Australia

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Profit Recognition Principle cont. Under the accrual basis of accounting : Profits should be recognised only when a sale has taken place But if a loss is expected, the loss should be recognised immediately This reflects conservatism in accounting.

Adapted from Horngren, Harrison 2006 Pearson Education Australia

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Going Concern or Continuity Concept

Hold that the entity will continue to operate into the foreseeable future, in the same line of business.

This reflects the fact that assets are valued at historical cost, not at their current realisable value.

Adapted from Horngren, Harrison 2006 Pearson Education Australia

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Conservatism Principle

Recognize and disclose all losses as soon as possible; but does not recognize gains unless it is realized

Adapted from Horngren, Harrison 2006 Pearson Education Australia

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Use the accounting equation to describe an organisationss financial position.

Financial Statements are the final product of the accounting process They tell how the business has performed over a period of time, and its financial position at the end of the period.
Adapted from Horngren, Harrison 2006 Pearson Education Australia

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The Accounting Equation

Assets = Liabilities + Owners Equity A = L + OE OR Net Assets = Owners Equity A - L = OE

Adapted from Horngren, Harrison 2006 Pearson Education Australia

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Asset

Something a business owns which has future economic value An economic resource of a business that is expected to be of benefit in the future Examples: Cash, Accounts Receivable, Supplies, Land, Building, Equipment, Patent / Copyright.
Adapted from Horngren, Harrison 2006 Pearson Education Australia

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Liability

Something a company owes to an outside party. Obligations to provide benefits to an outside party at some time in the future. Examples: Accounts Payable, Loan Payable, Services to be performed, Products to be provided.
Adapted from Horngren, Harrison 2006 Pearson Education Australia

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Owners Equity
What is left of your assets after you pay the liabilities Equal to Net Assets The owners claim on the entitys assets

Adapted from Horngren, Harrison 2006 Pearson Education Australia

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Owners Equity is..

Increased by owners investments in the business Decreased by owners withdrawals (Drawings) from the business Increased by revenue earned by the business Decreased by expenses incurred by the business
Adapted from Horngren, Harrison 2006 Pearson Education Australia

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Use the accounting equation to analyse business transactions

Transactions are any event that both affects the financial position of the business and can be reliably measured and recorded.

Adapted from Horngren, Harrison 2006 Pearson Education Australia

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Effects of Transactions on the Accounting Equation

Accounting equation always stays in balance. Each transaction affects at least two accounts, sometimes more (a compound entry). Some transactions affect only one side of the equation; some affect both sides.
Adapted from Horngren, Harrison 2006 Pearson Education Australia

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Prepare & Use Financial Statements

All financial statements will have headings with 3 lines:

Line 1 Line 2 Line 3

Name of the Business Name of the Report or Statement Time Reference, either a point in time
(as at 30 June 2005) or a period

(for the year ended 30 June 2005)

Adapted from Horngren, Harrison 2006 Pearson Education Australia

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Ms Jones Income Statement/Profit and Loss Statement Month ended 30 June 2011 Revenues Fees Earned Expenses Wages Expense Electricity Expense Office Expense Net Profit

1 800
600 500 100 1 200 $ 600

Adapted from Horngren, Harrison 2006 Pearson Education Australia

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Ms Jones Statement of Owners Equity Month ended 30 June 2005

J. Jones, Capital, 1 June 2004 Contribution of Capital Net Profit Drawings J. Jones, Capital 30 June 2004

$ 0 95 000 600 95 600 (500) $95 100

Adapted from Horngren, Harrison 2006 Pearson Education Australia

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Ms Jones Balance Sheet as at 30 June 2011

Assets Cash Accounts Receivable Supplies Land Liabilities Accounts Payable Owners Equity J. Jones, Capital 200

34500 200 600 60000

95 100

Total Assets

$95,300

Total Liab. & Owners Equity $95,300

Adapted from Horngren, Harrison 2006 Pearson Education Australia

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Ms Jones Cash Flow Statement for the month ended 30 June 2011 Cash flows from Operating Activities: Cash receipts from services rendered Cash payments for supplies Operating expenses Net Cash flows from operating activities Cash flows from Investing Activities: Purchase of land

$ 1 600 (400) (1 200) $0 (60 000)

Adapted from Horngren, Harrison 2006 Pearson Education Australia

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Cash flow statement Cont.

Cash flows from Financing Activities: Beginning Balance Investment by Owner Drawings Net Cash flows from financing activities Net decrease in cash Cash at beginning of month Cash at end of month

0 95 000 (500) 94 500 (60 500) 0 $34 500

Adapted from Horngren, Harrison 2006 Pearson Education Australia

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Evaluate performance of business.

Financial Statements and the relationships between the financial statements, allow the users of these statements to evaluate the performance of the business.
Net profit increases owners equity; net loss decreases owners equity

Liquidity, Profitability and Financial Stability can be determined.

Adapted from Horngren, Harrison 2006 Pearson Education Australia

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