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Department of Accounting and Finance Slide 1

ACC 1000
Principles of Accounting and Finance
Lecturer John Gerrand

Topic 1
Accounting in Action

Reference: Principles of Accounting and Finance (Second edition)
(Carey 2010) Chapter 1


Department of Accounting and Finance Slide 2
Learning Objectives
At the end of this topic you should be able to:
1. explain what accounting is;

2. identify the users and uses of accounting;

3. understand how accounting standards have been regulated and developed;

4. explain the nature of a reporting entity;

5. state the basic accounting equation, and define assets, liabilities and owners
equity;

6. understand the two recognition criteria that must be met before an item can be
included in the financial statements;

7 Apply to an unusual transaction



Department of Accounting and Finance Slide 3
Lecture Overview
What is accounting?
Why is accounting important?
The accounting conceptual framework
The elements definition and recognition criteria
How to account for unusual transactions


Department of Accounting and Finance Slide 4
What is accounting?
An information system or process that:

Identifies
Records
Communicates

economic events of an entity to interested users.
What is Accounting? (continued)
The Accounting Process
Department of Accounting and Finance Slide 6
Why is Accounting Important ?
Accounting information conveys information about
business performance to others.
Decisions are made based on the information
provided.
Poor accounting practices by businesses can
produce information that is inaccurate or misleading.
This can lead to corporate collapses and financial
ruin for many people involved.
Department of Accounting and Finance Slide 7
The role of accounting
To assist people in making decisions about the
allocation of scarce resources.

Accounting measures business activity, and
processes it into reports to enable communication of
the information to users who are internal or
external to the entity.

Department of Accounting and Finance Slide 8
Internal users
Managers who plan, organise and run the business

e.g., marketing managers, production supervisors, chief
financial officers, other employees.

Detailed and frequent information is needed by these
managers to make business decisions on a day-by-
day basis.
Department of Accounting and Finance Slide 9
External users
Vary in their nature and information requirements.

Investors eg. Shareholders (use information to make
decisions to buy, hold or sell shares)
Creditors e.g. Suppliers, bankers (use information to
evaluate risks of giving credit and lending money)
Government and regulatory bodies e.g. ATO, ASIC (use
information to determine an entitys compliance with rules
and regulations)

Department of Accounting and Finance Slide 10
History of regulation of accounting
Over time, Generally Accepted Accounting
Principles (GAAP) have developed to guide the
practice of accounting.

As entities grew in size and complexity, more
formal rules for accounting were required.

Today, accounting standards are mandatory for
many entities to follow in the preparation of
financial statements.
Department of Accounting and Finance Slide 11
History of regulation of accounting (continued)
Australia has adopted standards that are consistent with those
produced by the International Accounting Standards Board (IASB).
The current trend in accounting standard setting is to follow global
standards. IASB is promoting this global covergence. Australia's
accounting standards are consistent with these global
developments
(http://www.ifrs.org/Use+around+the+world/Use+around+the+world.
htm).

While these accounting standards provide rules for dealing with
various accounting issues, there exists an underlying conceptual
framework upon which the standards are based.

This framework attempts to derive a theory for determining the
information to be provided in financial statements.
Department of Accounting and Finance Slide 12
The Australian Conceptual Framework (ACF)
in summary: (there are 3 components)
SAC 1 defines a reporting entity ie who needs to
report.
SAC 2 provides the objective of general purpose
financial reporting.
The Framework explains the qualitative
characteristics of information, and the constraints
on preparation, as well as defining the five
elements of accounting and the criteria for their
recognition.
Department of Accounting and Finance Slide 13
Statement of Accounting Concepts (SAC)1
(1
st
component of ACF)
Definition of the Reporting Entity

Defines a Reporting Entity as any entity in which it
is reasonable to expect the existence of users who
depend on general-purpose financial statements for
information to enable them to make economic
decisions.

Process for determining a reporting entity

For each user group, ask two questions:
1. Do they need the information?
2. Do they have the power to get it?
If they need the information and do not have the
power to get it they are a dependant user
group
AND thus the entity is a reporting entity.
Department of Accounting and Finance Slide 15
SAC 1 (continued)
Factors to help determine whether dependent
users are likely to exist:

Separation of management from economic
interest
Economic or political importance /influence
Financial characteristics
Department of Accounting and Finance Slide 16
Why is this definition important?
Entities defined as reporting entities must
produce general purpose financial statements in
compliance with accounting standards and make
them publicly available so the dependent users
can access the information for their decision
making.

Not all entities are reporting entities, even though
they produce annual financial statements.
Balance Learning Exercise


The Reporting Entity
Example:

Company has two shareholders who run the
business and 200 employees with high staff
turnover. They have no borrowings.

Is the company a reporting entity?
Process for determining a reporting entity

For each user group, ask two questions:
1. Do they need the information?
2. Do they have the power to get it?
If they need the information and do not have the
power to get it they are a dependant user
group
AND thus the entity is a reporting entity.
Process
User Group

Need Power

Shareholders



Employees
Conclusion: it is a reporting entity?
Department of Accounting and Finance Slide 21
Statement of Accounting Concepts (SAC) 2
(2
nd
component of ACF)
Objective of General Purpose Financial Reporting

General purpose financial reporting focuses on
providing information to meet the common
information needs of users who are unable to
command the preparation of reports tailored to their
particular information needs.

This highlights the fact that reports are prepared for
dependent users.

Department of Accounting and Finance Slide 22
AASB Framework
(3
rd
component of ACF)
Adapted from the IASB Framework, it contains the
following:

Objective of financial reports
Assumptions underlying financial reports
Qualitative characteristics of financial reports
Elements of financial reports
Recognition criteria for the elements of financial
statements.
Department of Accounting and Finance Slide 23
AASB Framework objectives of
financial reports
To provide information:

About the financial position, performance and
cash flows of an entity that is useful in making
economic decisions.

Showing the results of accountability of
management for the resources entrusted to it.

Department of Accounting and Finance Slide 24
AASB Framework assumptions
underlying financial reports
Accrual Basis


Going concern
Department of Accounting and Finance Slide 25
AASB Framework qualitative
characteristics of financial reports
Provide guidance for entities that need to prepare
financial statements as to the qualities of the
information that should be contained in them.

The two fundamental characteristics are relevance
and faithful representation (the latter is proposed
to replace the current qualitative characteristic of
reliability)


Department of Accounting and Finance Slide 26
AASB Framework elements of financial
statements
There are five elements of accounting:

Assets
Liabilities
Owners Equity
Income
Expenses
Department of Accounting and Finance Slide 27
1. Assets
Definition:
a resource controlled by the entity as a result of a
past transaction or other past events and from which
future economic benefits are expected to flow to the
entity

Essential characteristics:

Future economic benefits
Under control of entity (rather than owned)
Result of past transaction

Assets - Example
Mikes Inner City Cab Service
purchased a taxi for $49,000 to carry
passengers around Melbourne.

Does the taxi meet the definition of asset?
Provides future economic benefits
Controlled by Mike
Result of a past transaction
Department of Accounting and Finance Slide 29
2. Liabilities
Definition:
a present obligation of the entity arising from past
events, the settlement of which is expected to result in an
outflow from the entity of resources embodying economic
benefits

Essential characteristics:

Future sacrifice
Present obligation
Result of past transaction

Department of Accounting and Finance Slide 30
Liabilities - Example
Mikes Inner City Cab Service borrowed
$43,000 from the State Bank to purchase
the taxi.

Does the bank loan meet the definition of
liability?

A present obligation exists
A future sacrifice will be required
Result of a past transaction
Department of Accounting and Finance Slide 31
3. Owners Equity
Definition:
the residual interest in the assets of the entity after
deduction of its liabilities

This definition is more of a formula, and creates the
Accounting equation, the foundation of accounting:

Owners Equity = Assets Liabilities

or
Assets = Liabilities

+ Owners Equity





Department of Accounting and Finance Slide 32
Owners Equity - Example
Mikes Inner City Cab Service has a taxi worth $49,000,
and a bank loan of $43,000 owing to the State Bank.
What is Mikes owners equity?

Owners Equity = Assets - Liabilities

6000 = $49,000 - $43,000

This is Mikes personal contribution to commence his
business.

Department of Accounting and Finance Slide 33
4. Income (revenue)
Definition:
increases in economic benefits during the accounting
period in the form of inflows or enhancements of assets
or decreases of liabilities that result in increases in equity,
other than those relating to contributions from equity
participants

Essential characteristics:

An increase in economic benefits
Result in an increase in equity, but
Excludes owners contributions of equity
Income - Example
Mikes Inner City Cab Service
charged a passenger $10 for a short
trip in Melbourne.

Does the taxi fare meet the definition of income?

Inflow of economic benefits (cash)
Contributes to an increase in equity
Was NOT contributed by Mike
Department of Accounting and Finance Slide 35
5. Expenses
Definition:
decreases in economic benefits during the accounting
period in the form of outflows or depletions of assets or
incurrences of liabilities that result in decreases in equity,
other than those relating to distributions to equity
participants

Essential characteristics:

A decrease in economic benefits
Result in a decrease in equity, but
Exclude distributions to owners



Expenses - Example
Mikes Inner City Cab Service filled
the petrol tank with fuel before picking
up more passengers.

Does the petrol meet the definition of expense?

Decrease of economic benefits (cash)
Causes a reduction in equity
Was NOT a distribution to Mike
Department of Accounting and Finance Slide 37
AASB Framework Recognition Criteria
for the elements
We have learned the definitions of the elements, but
there are two recognition criteria for the elements as
well:





An item cannot be recorded in the entitys accounts
unless it satisfies both of these recognition criteria.
Note that Owners Equity does not have recognition criteria.
Department of Accounting and Finance Slide 38
Decision Path for Asset Recognition
Does the item have all three essential
characteristics of an asset?
Does the asset meet both
the recognition criteria?
Details might appear in
the annual report
Asset recognised in the
entitys balance sheet
Separately disclosed in
the notes
No
No Yes
Yes
Department of Accounting and Finance Slide 39
Students should be able to:

Understand the definitions and
recognition criteria of the elements

Apply to an unusual transaction
Department of Accounting and Finance 3
9
Approach to answering a question on how to
record this unusual transaction
1. Identify issues possible journal entry
2. Analyse Definition step by step
3. Analyse recognition criteria step by step
4. Repeat 2 & 3 since we use double entry accounting
5. Conclusion
Template
Definition
Future Economic Benefits
Control
Past Event
Recognition Criteria
Probable
Reliable Measurement
Conclusion
Template
Definition
Future Economic Benefits
Control
Past Event
Recognition Criteria
Probable
Reliable Measurement
Conclusion
Put it into practice

Department of Accounting and Finance Slide 44
Blended Learning Question
You own a Horse Feed Manufacturing Company.



The owner of Phar Lap, a good friend of yours has decided to remove
Phar Lap from the Museum of Victoria
Gives Phar Lap to your company as a gift.
How do you account for this gift, using the
Conceptual Framework for guidance?
Department of Accounting and Finance 4
4
Today

Step 1
1. Identify issues possible journal entry
Possible Journal entry
Dr Asset
Cr Revenue
Asset
Definition
Future Economic Benefits
Control
Past Event
Recognition Criteria
Probable
Reliable Measurement
Conclusion
Asset
Definition
Future Economic Benefits
Control
Past Event
Recognition Criteria
Probable
Reliable Measurement
Conclusion
Asset
Definition
Future Economic Benefits
Control
Past Event
Recognition Criteria
Probable
Reliable Measurement
Conclusion
Asset
Definition
Future Economic Benefits
Control
Past Event
Recognition Criteria
Probable
Reliable Measurement
Conclusion
Asset
Definition
Future Economic Benefits
Control
Past Event
Recognition Criteria
Probable
Reliable Measurement
Conclusion
Asset
Definition
Future Economic Benefits
Control
Past Event
Recognition Criteria
Probable
Reliable Measurement
Conclusion
Asset
Definition
Future Economic Benefits
Control
Past Event
Recognition Criteria
Probable
Reliable Measurement
Conclusion
Revenue
Definition
Increase in economic benefits
Results in an increase in equity
Excludes owners contributions of equity
Recognition Criteria
Probable
Reliable Measurement
Conclusion
Revenue
Definition
Increase in economic benefits
Results in an increase in equity
Excludes owners contributions of equity
Recognition Criteria
Probable
Reliable Measurement
Conclusion
Revenue
Definition
Increase in economic benefits
Results in an increase in equity
Excludes owners contributions of equity
Recognition Criteria
Probable
Reliable Measurement
Conclusion
Revenue
Definition
Increase in economic benefits
Results in an increase in equity
Excludes owners contributions of equity
Recognition Criteria
Probable
Reliable Measurement
Conclusion
Revenue
Definition
Increase in economic benefits
Results in an increase in equity
Excludes owners contributions of equity
Recognition Criteria
Probable
Reliable Measurement
Conclusion
Revenue
Definition
Increase in economic benefits
Results in an increase in equity
Excludes owners contributions of equity
Recognition Criteria
Probable
Reliable Measurement
Conclusion
Are brand names assets?

Are staff development and advertising costs
assets?

Are footballers assets?

How do we approach such a question?
Where is Nicks, and Kossies etc worth
shown on the Balance Sheet?
Why are they not
shown on the
Balance Sheet as
Assets?
Economic Benefit?
Controlled?
Past Transaction?
Department of Accounting and Finance Slide 62
BL Question 2
The accounting process is correctly
sequenced as:

A. identification, communication, recording
B. recording, communication, identification
C. identification, recording, communication
D. communication, recording, identification
Department of Accounting and Finance Slide 63
BL Question 3
Which of the following groups would use
accounting information to determine whether
an advertising proposal will be cost effective?

A. Investors in shares
B. Marketing managers
C. Creditors
D. Chief financial officer
Department of Accounting and Finance Slide 64
BL Question 4
The accounting standards issues by the
Australian Accounting Standards Board are
consistent with those issued by the

A. Financial Reporting Council.
B. Australian Taxation Office.
C. Urgent Issues Group.
D. International Accounting Standards Board.
Department of Accounting and Finance Slide 65
BL Question 5
Which of the following is an essential
characteristic of income according to the
Conceptual Framework?
A Income arises from central, ongoing
operations.
B Income arises from providing goods and/or
services.
C Income takes the form of increases in assets
or decreases in liabilities.
D All increases in equity are income.

Department of Accounting and Finance Slide 66
BL Question 6
The two fundamental qualities that information
should have for it to be included in general
purpose financial reports are:

A Relevance and Faithful Representation;
B Relevance and Understandability;
C Verifiability and Faithful Representation;
D Understandability and Verifiability;
E Verifiability and Relevance.


Department of Accounting and Finance Slide 67
BL Question 7
Which of the following would definitely not satisfy the
definition of income according to the Conceptual
Framework?

A Donation to the entity from a rich old man.
B Sale of an item of inventory on credit.
C Capital contribution by an owner.
D Both (a) and (c)
E None of the above