Learning Objectives

1. Use accounting vocabulary 2. Apply accounting concepts and principles 3. Use the accounting equation 4. Analyse business transactions 5. Prepare the financial statements 6. Evaluate business performance

Horngren, Best, Fraser, Willett: Accounting 6e 2010 Pearson Australia

Objective 1

Use accounting vocabulary.

Horngren, Best, Fraser, Willett: Accounting 6e 2010 Pearson Australia

Accounting...
is an information system that... measures business activities, processes information, and... communicates financial information. And is called the language of business.
Horngren, Best, Fraser, Willett: Accounting 6e 2010 Pearson Australia

Accounting Information and Its Users

External users make decisions about the entity. e.g. Investors This is Financial Accounting Internal users make decisions for the entity. e.g. Management This is Management Accounting

Horngren, Best, Fraser, Willett: Accounting 6e 2010 Pearson Australia

Standards of Professional Conduct

ICAA and CPAAs Joint Code of Professional Conduct
1. Integrity 2. Objectivity 3. Professional competence and due care 4. Confidentiality 5. Professional behaviour
Horngren, Best, Fraser, Willett: Accounting 6e 2010 Pearson Australia

The Authority Underlying Accounting

Horngren, Best, Fraser, Willett: Accounting 6e 2010 Pearson Australia

Types of Business Organisations

Proprietorships (sole traders) Partnerships Companies

Horngren, Best, Fraser, Willett: Accounting 6e 2010 Pearson Australia

Proprietorships
 What are some advantages? total undivided authority no restrictions on type of business must be legal  What are some disadvantages? unlimited liability limitation on size fundraising power

Horngren, Best, Fraser, Willett: Accounting 6e 2010 Pearson Australia

Partnerships
 What are some advantages? better credit standing - possibly more brain power, but consultation with partners required  What are some disadvantages? unlimited personal liability for general partners need for written partnership agreement
Horngren, Best, Fraser, Willett: Accounting 6e 2010 Pearson Australia

Companies
  What are some advantages? separate legal existence limited liability of shareholders transferability of ownership relatively easy What are some disadvantages? separation of ownership and control extensive governmental regulation

Horngren, Best, Fraser, Willett: Accounting 6e 2010 Pearson Australia

Objective 2

Apply accounting concepts and principles.

Horngren, Best, Fraser, Willett: Accounting 6e 2010 Pearson Australia

Generally Accepted Accounting Principles

 What is the primary objective of financial reporting?
 To provide information useful for making investment and lending decisions.

Horngren, Best, Fraser, Willett: Accounting 6e 2010 Pearson Australia

The Entity Concept Example

 Assume that you decide to open up a garage and coffee shop.  The garage made $250,000 in profits, while the coffee shop lost $50,000.

Horngren, Best, Fraser, Willett: Accounting 6e 2010 Pearson Australia

The Entity Concept Example

 How much money did you make?  At a first glance, we would assume that you made $200,000.  However, by applying the entity concept we realise that the garage made $250,000 while the coffee shop lost $50,000.  Importantly the business activities and the personal affairs of the owner are separate.
Horngren, Best, Fraser, Willett: Accounting 6e 2010 Pearson Australia

The Accounting Period Concept

 Or the accounting time period concept.  Unit of time for which accounting data is collected and the financial statements prepared.  In Australia many companies prepare their statements for the financial year from July 1 to June 30 the following year.

Horngren, Best, Fraser, Willett: Accounting 6e 2010 Pearson Australia

The Cost Principle

Assets and services acquired should be recorded at their actual cost. (Reliable and objective.)
 Example If the garage purchases petrol pumps for $25 000, it would record these at the same amount
Horngren, Best, Fraser, Willett: Accounting 6e 2010 Pearson Australia

The Matching Principle

Relates the inputs and outputs of goods and services to one another.

 What expenses do you incur to earn the revenue?

Horngren, Best, Fraser, Willett: Accounting 6e 2010 Pearson Australia

The Profit Recognition Principle

Recognise revenue when it is earned. GAAP recommends the accrual basis of accounting.
 Example If the garage repairs someones car on credit, they would still recognise the income.
Horngren, Best, Fraser, Willett: Accounting 6e 2010 Pearson Australia

Conservatism (Prudence) Principle

Constrains managements natural optimism.

 Prevents overstating of profits  Anticipate no profits, Anticipate all losses

Horngren, Best, Fraser, Willett: Accounting 6e 2010 Pearson Australia

The Going Concern Principle

The entity will continue to operate in the future.

Horngren, Best, Fraser, Willett: Accounting 6e 2010 Pearson Australia

Australian Accounting Standards

 Standards to govern measurement rules and level of disclosure.  Australian Accounting Standards Board is responsible for technical accounting standards.  Australia, like much of the rest of the world has adopted International Accounting Standards.
Horngren, Best, Fraser, Willett: Accounting 6e 2010 Pearson Australia

Objective 3

Using the accounting equation.

Horngren, Best, Fraser, Willett: Accounting 6e 2010 Pearson Australia

The Accounting Equation

Economic Resources Claims to Economic Resources

Horngren, Best, Fraser, Willett: Accounting 6e 2010 Pearson Australia

Assets
 What is an asset?
 It is something a company owns which has future economic value. land building equipment goodwill

Horngren, Best, Fraser, Willett: Accounting 6e 2010 Pearson Australia

Liabilities
 What is a liability?
 It is something a company owes. money service legal retainers product magazines

Horngren, Best, Fraser, Willett: Accounting 6e 2010 Pearson Australia

Owners Equity
 What is owners equity?
 It is whats left of the assets after liabilities have been deducted. the same as net assets the owners claim on the entitys assets

Horngren, Best, Fraser, Willett: Accounting 6e 2010 Pearson Australia

Transactions that Affect Owners Equity

Horngren, Best, Fraser, Willett: Accounting 6e 2010 Pearson Australia

Revenues
 What are revenues?
 They are amounts received or to be received from customers for sales of products or services. sales performance of services rent received interest received
Horngren, Best, Fraser, Willett: Accounting 6e 2010 Pearson Australia

Expenses
 What are expenses?
 They are amounts that have been paid or will be paid later for costs that have been incurred to earn revenue. salaries and wages electricity and gas supplies used advertising
Horngren, Best, Fraser, Willett: Accounting 6e 2010 Pearson Australia

Objective 4

Analyse business transactions.

Horngren, Best, Fraser, Willett: Accounting 6e 2010 Pearson Australia

Accounting for Business Transactions

 What is a transaction?
 It is any event that both affects the financial position of the business and can be reliably recorded.

Horngren, Best, Fraser, Willett: Accounting 6e 2010 Pearson Australia

Accounting for Business Transactions

1 Paula Lee invests $30,000 to begin Paula Lee eTravel. 2 Lee purchases land, paying $20,000 in cash. 3 She buys office supplies, agreeing to pay $500 in 30 days. 4 She earns and collects $5,500 revenues.
Horngren, Best, Fraser, Willett: Accounting 6e 2010 Pearson Australia

Accounting for Business Transactions

5 Lee performs services, and the client agrees to pay $3,000 within one month. 6 During the month, she pays $3,300 for expenses incurred. 7 Lee pays $300 to the store from which she purchased $500 worth of supplies. What is the effect of these transactions on the accounting equation?
Horngren, Best, Fraser, Willett: Accounting 6e 2010 Pearson Australia

Accounting for Business Transactions

Assets = Liabilities
1) Cash 2) Cash Land 3) Supplies 4) Cash 5) Receivable 6) Cash 7) Cash Totals + $30,000 20,000 + 20,000 + 500 + 5,500 + 3,000 3,300 300 + $35,400 =

Owners + Equity
+ $30,000

+ 500

300 + 200

+ ,500 + 3,000 3,300 + $35,200

Horngren, Best, Fraser, Willett: Accounting 6e 2010 Pearson Australia

Accounting for Business Transactions

 Notice that the equation always stays in balance.  Each transaction affects at least two accounts, sometimes more.  Some transactions affect only one side of the equation; some affect both sides.

Horngren, Best, Fraser, Willett: Accounting 6e 2010 Pearson Australia

Accounting for Business Transactions

 Other transactions that took place were as follows:  The business collected $1,000 from the client.  She sold some land at cost for $9,000.  She withdrew $2,000 from the business.  (See the final result, p 23 of your textbook)
Horngren, Best, Fraser, Willett: Accounting 6e 2010 Pearson Australia

Objective 5

Prepare the financial statements.

Horngren, Best, Fraser, Willett: Accounting 6e 2010 Pearson Australia

Financial Statements...
are the final product of the accounting process.

tell how the business is performing and where it stands.

Horngren, Best, Fraser, Willett: Accounting 6e 2010 Pearson Australia

Financial Statements
 Statement of Comprehensive Income  Statement of Changes in Equity  Statement of Financial Position
Also called Balance Sheet

 Statement of cash flows

Horngren, Best, Fraser, Willett: Accounting 6e 2010 Pearson Australia

Statement of Comprehensive Income

 Also called Income Statement  Summary of an entitys income and expenses over a period of time
 Income part

 Also shows changes in equity not resulting from owners

 e.g. Changes in asset values  Sometimes produced separately

Horngren, Best, Fraser, Willett: Accounting 6e 2010 Pearson Australia

Statement of Changes in Equity

 Shows increases in owners equity from
 Owner investments  Profits  Other comprehensive income

 Shows decreases in owners equity from

 Owner drawings  Losses,  Other comprehensive losses
Horngren, Best, Fraser, Willett: Accounting 6e 2010 Pearson Australia

Statement of Financial Position

 Also called a Balance Sheet  Lists the entity's assets, liabilities and owners equity  Done at a point in time, such as the end of the month or year.

Horngren, Best, Fraser, Willett: Accounting 6e 2010 Pearson Australia

Statement of cash flows

 Also called cash flow statement  Reports the cash coming in and cash going out each period

Horngren, Best, Fraser, Willett: Accounting 6e 2010 Pearson Australia

Financial Statement Headings

 Each statement should have a heading showing three things
1. Name of the business 2. Name of the financial statement 3. The date or time period shown by the statement

Horngren, Best, Fraser, Willett: Accounting 6e 2010 Pearson Australia

Objective 6

Evaluate business performance.

Horngren, Best, Fraser, Willett: Accounting 6e 2010 Pearson Australia

Relationships Among the Statements: Income Statement

Revenue: Fees earned Expenses: Salary expense Electricity and gas expense Equipment rental expense Office rent expense Net profit

$8,500 $1,200 400 600 1,100

3,300 $5,200

Horngren, Best, Fraser, Willett: Accounting 6e 2010 Pearson Australia

Relationships Among the Statements: Statement of Changes in Equity

Paula Lee, capital, April 1, 2007 Add Investments by owner Net profit Less Drawings by owner Paula Lee, capital, April 30, 2007

0 30,000

5,200 2,000 $33,200

Horngren, Best, Fraser, Willett: Accounting 6e 2010 Pearson Australia

Relationships Among the Statements: Balance Sheet

Assets Cash Accounts receivable Supplies Land Total assets $19,900 2,000 500 11,000 $ 33,400

Liabilities Accounts payable Owners Equity, Paula Lee, capital Total liabilities and owners equity

200 33,200

$33,400

Horngren, Best, Fraser, Willett: Accounting 6e 2010 Pearson Australia

Relations Among the Statements: Cash Flows Statement

Cash flows from operating activities: Cash receipts from services rendered Cash payments: To suppliers 2,400 To employees 3,300 Net cash flows from operating activities Cash flows from Investing activities: Acquisition of land (20,000) Sale of land 9,000 Net cash flow from investing activities
Horngren, Best, Fraser, Willett: Accounting 6e 2010 Pearson Australia

$6,500

(3,600) 2,900

(11,000)

Relations Among the Statements: Cash Flows Statement

Cash Flows from Financing activities: Investment by Owner Drawings by the Owner Net Cash Flows from Financing activities Net increase in cash Cash at Beginning of April Cash at End of April
Horngren, Best, Fraser, Willett: Accounting 6e 2010 Pearson Australia

$30,000 (2,000) 28,000 19,900 0 $19,900