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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
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Department of Accounting and Finance Slide 2
Learning ObjectivesAt 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 owner ’s
equity;
6. understand the two recognition criteria that must be met before an item can beincluded in the financial statements;
7 Apply to an unusual transaction
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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
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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.
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What is Accounting? (continued)
The Accounting Process
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Department of Accounting and Finance Slide 6
Why is Accounting Important ?
Accounting information conveys information aboutbusiness performance to others.
Decisions are made based on the informationprovided.
Poor accounting practices by businesses canproduce information that is inaccurate or misleading.
This can lead to corporate collapses and financialruin for many people involved.
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The role of accounting
To assist people in making decisions about theallocation of scarce resources.
Accounting measures business activity, andprocesses it into reports to enable communication of
the information to users who are internal orexternal to the entity.
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Internal usersManagers who plan, organise and run the business
e.g., marketing managers, production supervisors, chieffinancial officers, other employees.
Detailed and frequent information is needed by these
managers to make business decisions on a day-by-day basis.
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External usersVary in their nature and information requirements.
Investors eg. Shareholders (use information to makedecisions to buy, hold or sell shares)
Creditors e.g. Suppliers, bankers (use information toevaluate risks of giving credit and lending money)
Government and regulatory bodies e.g. ATO, ASIC (useinformation to determine an entity’s compliance with rulesand regulations)
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History of regulation of accounting
Over time, Generally Accepted AccountingPrinciples (GAAP) have developed to guide the
practice of accounting.
As entities grew in size and complexity, moreformal rules for accounting were required.
Today, ‘accounting standards’ are mandatory formany entities to follow in the preparation offinancial statements.
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History of regulation of accounting(continued)
Australia has adopted standards that are consistent with thoseproduced by the International Accounting Standards Board (IASB).
The current trend in accounting standard setting is to follow globalstandards. IASB is promoting this global covergence. Australia's
accounting standards are consistent with these globaldevelopments(http://www.ifrs.org/Use+around+the+world/Use+around+the+world.htm).
While these accounting standards provide ‘rules’ for dealing withvarious accounting issues, there exists an underlying ‘conceptualframework’ upon which the standards are based.
This framework attempts to derive a theory for determining theinformation to be provided in financial statements.
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The Australian Conceptual Framework (ACF)in summary: (there are 3 components)
• SAC 1 defines a ‘reporting entity’ ie who needs toreport.
• SAC 2 provides the objective of general purposefinancial reporting.
• The Framework explains the qualitativecharacteristics of information, and the constraintson preparation, as well as defining the fiveelements of accounting and the criteria for their
recognition.
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Statement of Accounting Concepts (SAC)1(1st component of ACF)
Definition of the Reporting Entity
Defines a ‘Reporting Entity’ as any entity in which itis reasonable to expect the existence of users whodepend on general-purpose financial statements for
information to enable them to make economicdecisions.
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Process for determ ining a repo rt ing ent i ty
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 usergroup
AND thus the ent i ty is a report ing ent i ty.
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SAC 1 (continued)
Factors to help determine whether dependentusers are likely to exist:
Separation of management from economicinterest
Economic or political importance /influence
Financial characteristics
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Why is this definition important?
Entities defined as ‘reporting entities’ mustproduce general purpose financial statements in
compliance with accounting standards and makethem publicly available so the dependent userscan access the information for their decisionmaking.
Not all entities are reporting entities, even thoughthey produce annual financial statements.
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Balance Learning Exercise
The Reporting Entity
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Example:
Company has two shareholders who run thebusiness and 200 employees with high staffturnover. They have no borrowings.
Is the company a reporting entity?
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Process for determ ining a repo rt ing ent i ty
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 usergroup
AND thus the ent i ty is a report ing ent i ty.
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Process
User Group Need Power
Shareholders
Employees
Conclusion: it is a reporting entity?
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Department of Accounting and Finance Slide 21
Statement of Accounting Concepts (SAC) 2(2nd component of ACF)
Objective of General Purpose Financial Reporting
General purpose financial reporting focuses onproviding information to meet the commoninformation needs of users who are unable tocommand the preparation of reports tailored to their
particular information needs.
This highlights the fact that reports are prepared fordependent users.
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Department of Accounting and Finance Slide 22
AASB Framework(3rd component of ACF)
Adapted from the IASB Framework, it contains thefollowing:
Objective of financial reports
Assumptions underlying financial reports
Qualitative characteristics of financial reports
Elements of financial reports
Recognition criteria for the elements of financialstatements.
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Department of Accounting and Finance Slide 23
AASB Framework –
objectives offinancial reports
To provide information:
About the financial position, performance andcash flows of an entity that is useful in makingeconomic decisions.
Showing the results of accountability ofmanagement for the resources entrusted to it.
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Department of Accounting and Finance Slide 24
AASB Framework – assumptions
underlying financial reports
Accrual Basis
Going concern
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Department of Accounting and Finance Slide 25
AASB Framework – qualitativecharacteristics of financial reports
Provide guidance for entities that need to preparefinancial statements as to the qualities of theinformation that should be contained in them.
The two fundamental characteristics are relevance and faithful representation (the latter is proposedto replace the current qualitative characteristic of‘reliability’)
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Department of Accounting and Finance Slide 26
AASB Framework –
elements of financialstatements
There are five elements of accounting:
Assets
Liabilities
Owner ’s Equity
Income Expenses
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Department of Accounting and Finance Slide 27
1. AssetsDefinition:
“… a resource controlled by the entity as a result of apast transaction or other past events and from which
future economic benefits are expected to flow to theentity”
Essential characteristics:
Future economic benefits
Under control of entity (rather than ‘owned’)
Result of past transaction
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Assets - Example
‘Mike’s 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
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Department of Accounting and Finance Slide 29
2. LiabilitiesDefinition:
“… a present obligation of the entity arising from pastevents, the settlement of which is expected to result in an
outflow from the entity of resources embodying economicbenefits”
Essential characteristics:
Future sacrifice
Present obligation
Result of past transaction
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Department of Accounting and Finance Slide 30
Liabilities - Example
‘Mike’s Inner City Cab Service’ borrowed$43,000 from the State Bank to purchase
the taxi.
Does the bank loan meet the definition ofliability?
A present obligation exists A future sacrifice will be requiredResult of a past transaction
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Department of Accounting and Finance Slide 31
3. Owners EquityDefinition:
“… the residual interest in the assets of the entity afterdeduction of its liabilities”
This ‘definition’ is more of a formula, and creates theAccounting equation , the foundation of accounting:
Owner ’ s Equity = Assets – Liabilities
or
Assets = Liabilities + Owner ’ s Equity
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Department of Accounting and Finance Slide 32
Owner ’s Equity - Example
‘Mike’s Inner City Cab Service’ has a taxi worth $49,000,and a bank loan of $43,000 owing to the State Bank.
What is Mike’
s owner ’
s equity?
Owner ’s Equity = Assets - Liabilities
6000 = $49,000 - $43,000
This is Mike’s personal contribution to commence hisbusiness.
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Department of Accounting and Finance Slide 33
4. Income (revenue)
Definition:
“… increases in economic benefits during the accountingperiod 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 equityparticipants”
Essential characteristics:
An increase in economic benefits
Result in an increase in equity, but
Excludes owner ’s contributions of equity
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Income - Example
‘Mike’s 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
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Department of Accounting and Finance Slide 35
5. Expenses
Definition:
“…decreases in economic benefits during the accountingperiod 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 equityparticipants”
Essential characteristics:
A decrease in economic benefits
Result in a decrease in equity, but
Exclude distributions to owner ’s
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Expenses - Example
‘Mike’s 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
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Department of Accounting and Finance Slide 37
AASB Framework – Recognition Criteria
for the elements
We have learned the definitions of the elements, butthere are two ‘recognition criteria’ for the elements as
well:
An item cannot be recorded in the entity’s accountsunless it satisfies both of these recognition criteria.
• Note that Owner ’s Equity does not have recognition criteria.
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Department of Accounting and Finance Slide 38
Decision Path for Asset Recognition
Does the item have all three essentialcharacteristics of an asset?
Does the asset meet both the recognition criteria?
Details might appear inthe annual report
Asset recognised in theentity’ s balance sheet
Separately disclosed inthe notes
No
No Yes
Yes
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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
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Approach to answering a question on how torecord 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
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Template
Definition
Future Economic Benefits
Control
Past Event
Recognition Criteria
Probable
Reliable Measurement
Conclusion
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Template
Definition
Future Economic Benefits
Control
Past Event
Recognition Criteria
Probable
Reliable Measurement
Conclusion
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Put it into practice
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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 removePhar 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
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Step 1
1. Identify issues – possible journal entry
Possible Journal entry
Dr AssetCr Revenue
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Asset
Definition
Future Economic Benefits
Control
Past Event
Recognition Criteria
Probable
Reliable Measurement
Conclusion
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Asset
Definition
Future Economic Benefits
Control
Past Event
Recognition Criteria
Probable
Reliable Measurement
Conclusion
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Asset
Definition
Future Economic Benefits
Control
Past Event
Recognition Criteria
Probable
Reliable Measurement
Conclusion
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Asset
Definition
Future Economic Benefits
Control
Past Event
Recognition Criteria
Probable
Reliable Measurement
Conclusion
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Asset
Definition
Future Economic Benefits
Control
Past Event
Recognition Criteria
Probable
Reliable Measurement
Conclusion
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Asset
Definition
Future Economic Benefits
Control
Past Event
Recognition Criteria
Probable
Reliable Measurement
Conclusion
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Revenue
Definition
Increase in economic benefits
Results in an increase in equity
Excludes owner ’s contributions of equity
Recognition Criteria
Probable
Reliable Measurement
Conclusion
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Revenue
Definition
Increase in economic benefits
Results in an increase in equity
Excludes owner ’s contributions of equity
Recognition Criteria
Probable
Reliable Measurement
Conclusion
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Revenue
Definition
Increase in economic benefits
Results in an increase in equity
Excludes owner ’s contributions of equity
Recognition Criteria
Probable
Reliable Measurement
Conclusion
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Revenue
Definition
Increase in economic benefits
Results in an increase in equity
Excludes owner ’s contributions of equity
Recognition Criteria
Probable
Reliable Measurement
Conclusion
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Revenue
Definition
Increase in economic benefits
Results in an increase in equity
Excludes owner ’s contributions of equity
Recognition Criteria
Probable
Reliable Measurement
Conclusion
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Revenue
Definition
Increase in economic benefits
Results in an increase in equity
Excludes owner ’s contributions of equity
Recognition Criteria
Probable
Reliable Measurement
Conclusion
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• Are brand names assets?
• Are staff development and advertising costs
assets?
• Are footballers assets?
– How do we approach such a question?
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Where is Nicks, and Kossies etc worth
shown on the Balance Sheet?
• Why are they not
shown on theBalance Sheet as Assets?
• Economic Benefit?
• Controlled?• Past Transaction?
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Department of Accounting and Finance Slide 62
BL Question 2
The accounting process is correctlysequenced as:
A. identification, communication, recording
B. recording, communication, identification
C. identification, recording, communication
D. communication, recording, identification
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Department of Accounting and Finance Slide 63
BL Question 3Which of the following groups would useaccounting information to determine whetheran advertising proposal will be cost effective?
A. Investors in shares
B. Marketing managers
C. Creditors
D. Chief financial officer
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Department of Accounting and Finance Slide 64
BL Question 4The accounting standards issues by the
Australian Accounting Standards Board areconsistent with those issued by the …
A. Financial Reporting Council.
B. Australian Taxation Office.
C. Urgent Issues Group.
D. International Accounting Standards Board.
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Department of Accounting and Finance Slide 65
BL Question 5
Which of the following is an essentialcharacteristic of income according to theConceptual Framework?
A Income arises from central, ongoingoperations.
B Income arises from providing goods and/orservices.
C Income takes the form of increases in assetsor decreases in liabilities.
D All increases in equity are income.
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Department of Accounting and Finance Slide 66
BL Question 6
The two fundamental qualities that informationshould 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.
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BL Question 7
Which of the following would definitely not satisfy thedefinition 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