Assets
Cash
Cash at bank
Inventory (goods for
sale/stock)
Prepaid rent
PPE (property, plant,
equipment)
Accumulated depreciation
(negative value)
Accounts receivable
Liabilities
Loans, mortgages and debts
Bank overdraft (withdraws exceed
deposits)
Accounts payable
Unearned revenue (deposits or cash
receipts before completion of sale)
Notes payable (accounts payable but
supported by signed contracts usually
carrying interest)
Accrued wages
Provisions (amount/timing of future
sacrifice is uncertain e.g. warranty
provisions)
Owners Equity
Retained
profits/earnings
Reserves (transferred
from retained profits to
here indicates the
amount is unlikely to
be paid out in
dividends)
Issued capital/share
capital (portion of
companys equity
obtained by issuing
shares in return for
cash)
Assets
Mixture of resources the company needs to do business and resources it has accumulated as a
result of doing business
Formal definition: resources controlled by the entity as a result of past events and from which
future economic benefits are expected to flow to the entity
Three characteristics:
o Future economic benefits used to provide goods and services with the objective of
generating net cash flows
o Controlled by the entity ability of an entity to benefit from the asset and deny/regulate
access of others
o Occurrence of past transactions/events the events give the entity control over the future
economic benefits
Liabilities
Present obligations of the entity arising from past events, the settlements of which are expected to
result in an outflow from the entity of resources embodying economic benefits
Not all are paid in cash; some are paid by providing goods or services e.g. a deposit is received
from a customer for goods to be shipped later (comes out of inventory)
Many house mortgages extend for years into the future but are partly paid each year so the balance
sheet would show both a current and noncurrent portion for them
Two characteristics:
o
o
Present obligation exists obligation involves settlement in the future via the sacrifice of
future economic benefits
Adverse financial consequences for the entity obliged to sacrifice economic benefits to one
or more entities
Equity
The owners interest in the enterprise; often referred to as the book value of the whole enterprise
Can be derived from direct contributions the owners have made or from accumulation of profits that
havent been withdrawn (profits that havent been distributed as dividends)
Generally based on historical transactions and does not equal the current market value of the
business
The Income Statement (Statement of Financial Performance)
Uses accrual accounting to measure financial performance over a period of time, usually a year, six
months, three months or one month, indicating the bottom line net profit for the period
Covers a period of time whereas the balance sheet covers a point in time
Right hand side refers to the parent company (e.g. Woolworths Limited) and on the left are
consolidated figured that refer to the parent company and its controlled subsidiaries (this involves
aggregating revenues and expenses of the parent entity and all the subsidiaries after eliminating
transactions between these entities)
Subsidiary: a controlled entity where the parent company has the capacity to dominate decisionmaking in relation to the financial and operating policies of that subsidiary
= Retained profits at
Transaction Analysis
- A useful way of understanding how any transaction or event affects a companys financial
statements (accounting equation)
- Transaction: events that affect the operations or finances of an organisation
- Expanding the accounting equation:
Assets
= Liabilities + Shareholders equity
= Liabilities + (Issued capital + Retained profits)
= Liabilities + Issued capital + (Opening retained profits + Net profit Dividends)
= Liabilities + Issued capital + Opening retained profits + (Revenue Expenses)
Dividends
Double-entry Bookkeeping
- Double-entry records are called journal entries; a system of accounting involving debits and credits
- Debits: increases to resources (assets) on the left side where the money goes to
- Credits: increases to sources (liabilities and equity) on the right side where the money comes from
- The previous reverses when they are decreasing instead of increasing e.g. decrease in assets is a
credit
- Because revenues increase SE they are credits and expenses decrease SE so they are debits
- Every transaction has two or more effects and requires a debit and credit entry
- Account: a record of the dollar amounts comprising a particular asset, liability, equity, revenue or
expense
- Ledger: all the accounts collected together
- Trial balance: list of the account balances from the ledger to make sure the sum of debits equals the
sum of credits
- Bookkeeping provides underlying data on which accounting information is built
- Management decision-making and evaluations of management performance depend on accounting
information
Importance of Good Records
- The provide the observations and history of the enterprise
- Investors and managers cannot make plans for the feature and learn from past actions without
knowing what has happened
- Enterprises have become very large so the number of events/transactions is too great for anyone
to keep track of without keeping complete and accurate records
Steps in Accounting Information System
Accounting Cycle
Source
documents
Journal
entries
When the business event is first recorded by the accounting system (original entry)
Provides a complete record of all transactions recorded by an organisation in
chronological order
Includes accounts debited and credited
Post to
ledgers
Books (or computer records) that have a separate page for each account with a
summary of all the transactions relating to that particular account
Accountants may use a simplified version of an account called a 'T-account'
Basis of financial statements - the central record of the financial accounting system
Trial
balance
Errors may have been made so this checks that the total of debits equals the total
of credits
If it doesn't balance then re-add the trial balance, check you posted the correct
amounts, check each journal entry balances, determine the different between DR
and CR then look for an account with that balance (you may have left this ledger
balance out)
Adjusted
trial
balance
Closing
entries
Postclosing
trial
balance
Close the revenue, expenses and dividend amounts to retained profits to make all
of those accounts' balances zero in preparation for the next period
Revenue have credit balances so they are closed with a debit and then a credit to
the P&L summary
Expenses have debit balances so they are closed with a credit and then a debit to
the P&L summary
Prepared after closing entries to ensure that the total of debits still equals the total
of credits
Financial Items in P&L summary can be used as a basis for the income statement
statement Items in post-closing trial balance can be used to prepare the balance sheet
s
Electronic Commerce
Many business transactions are now being entirely conducted in an electronic format
E-commerce is a challenge to financial accounting because its essence is the absence of the paper
trail which has traditionally supported accounting records enterprises still need good records
- Most see little cash and cheques with more payments being made by credit card and EFT and
paying employees by depositing their pay directly into their personal bank accounts
Implications
- Needs to be some compatibility between computer systems on both sides of a transaction
- Needs to be trust in the electronic media to make the system work e.g. encryption and WebTrust
- Can be a lot of in transit activities because physical transfers are usually slower than the electronic
system which can be a challenge to control and reconcile
- Parties can be bound together quite closely with the ability to make enquiries into each others
computer systems
- Becoming continuous rather than waiting for the ritual quarterly or annual reporting dates
- Likely to change accounting and financial reporting dramatically in future years
Conceptual Foundation of Accrual Accounting
Cash accounting involves recording transactions at the time the cash is received or paid. Conversely,
accrual accounting recognises transactions regardless of when cash transactions occur. Its extends the
measurement of financial performance and position by recognising phenomena before and after cash
flows, as well as at the point of cash flows (which cash accounting already does) i.e. it recognises a
revenue and expense before, at the same time, and after cash inflow or outflow. Revenues are inflows
of economic resources whereas expenses are outflows of economic resources.
Accrual accounting spreads out events over time. For example, a building is originally recorded as an
asset and cost is periodically recognised as a depreciation expense over the life of the asset.
Transaction
Recognition of revenue before cash collection
Recognition of expense before cash payment
Recognition of unearned revenue when cash is
collected
Effect
Increase accounts receivable
Increase accounts receivable
Increase in liabilities (unearned revenue)