Chapter 1

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Chapter 1 Accounting and the business environment

Learning Objectives 1. Use accounting vocabulary 2. Apply accounting concepts and principles 3 Use the accounting equation 3. 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.



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.

Internal users make decisions for the entity.

e.g. Investors

e.g. Management

This is Financial Accounting

This is Management Accounting


Standards of Professional Conduct ICAA and CPAA’s Joint Code of Professional Conduct 1 Integrity 1. I t it 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


Types of Business Organisations Proprietorships (sole traders) Partnerships Companies


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



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


Companies  – – –  – –

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


Objective 2

Apply accounting concepts t and d principles. i i l



Generally Accepted Accounting Principles  What is the primary objective of financial reporting?  To provide information useful for making ki iinvestment t t and d llending di decisions.


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 $50,000. 000


The Entity Concept Example  How much money did you make?  At a first glance, we would assume that you made $200,000. y applying pp y g the entity y concept p  However, by 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.


The Cost Principle Assets and services acquired should be recorded at their actual cost. (Reliable and objective 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 someone’s car on credit, they would still recognise the income. Horngren, Best, Fraser, Willett: Accounting 6e © 2010 Pearson Australia

Conservatism (Prudence) Principle Constrains management’s natural optimism.

 Prevents overstating of profits  Anticipate no profits, Anticipate all losses


The Going Concern Principle

The entity will continue tto operate t in i the th future. f t



Australian Accounting Standards  Standards to govern measurement rules and level of disclosure.  Australian Accounting g 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 equation.


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


Liabilities  What is a liability?  – – –

It is something a company owes. money service – legal retainers product – magazines


Owners’ Equity  What is owners’ equity?  It is what’s left of the assets after liabilities have been deducted. – the same as net assets – the owner’s claim on the entity’s assets



Transactions that Affect Owners’ Equity


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 inc rred to earn re revenue. en e – salaries and wages – electricity and gas – supplies used – advertising Horngren, Best, Fraser, Willett: Accounting 6e © 2010 Pearson Australia


Objective 4

Analyse business transactions transactions.


Accounting for Business Transactions  What is a transaction?  It is any event that both affects the financial position of the business and can be reliabl reliably recorded recorded.


Accounting for Business Transactions 1 Paula Lee invests $30,000 to begin Paula Lee eTravel. 2 Lee purchases land, paying $20,000 in cash 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 + ,500 + 3,000 – 3,300 – 300 + 200

+ $35,200


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



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 fi financial i l statements. t t t


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 Al called ll d B Balance l Sh Sheett

 Statement of cash flows


Statement of Comprehensive Income  Also called Income Statement  Summary of an entity’s 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


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 time, such as the end of the month or year.


Statement of cash flows  Also called cash flow statement  Reports the cash coming in and cash going out each period


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



Objective 6

Evaluate business performance.


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 $1 200 400 600 1,100

3,300 $5,200


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



Relationships Among the Statements: Balance Sheet

Assets Cash

$19,900

Accounts receivable Supplies Land Total assets

2,000 500 11,000 $ 33,400

Liabilities Accounts payable Owner’s O ’ E Equity, it Paula Lee, capital Total liabilities and owner’s equity

$

200 33,200

$33,400


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

$6,500

(3,600)

Net cash flows from operating activities

2,900

Cash flows from Investing activities: Acquisition of land (20,000) Sale of land 9,000 Net cash flow from investing activities

(11,000)


Relations Among the Statements: Cash Flows Statement

Cash Flows from Financing activities: Investment by Owner Drawings by the Owner

$30,000 (2 000) (2,000)

Net Cash Flows from Financing activities

28,000

Net increase in cash

19,900

Cash at Beginning of April Cash at End of April

0 $19,900



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