LECTURE 1: INTRODUCTION

Topic 1
Introduction History and Development of Accounting Definitions of Accounting Introduction to Financial Statements Roles Accounting profession and professional bodies Accounting standards, principles, assumptions and conventions.

Introduction

What is accounting?

History and Development of Accounting

Early history
Accountancy's infancy dates back to the earliest days of human agriculture and civilization (the Sumerians in Mesopotamia), when the need to maintain accurate records of the quantities and relative values of agricultural products first arose. Using system called stewardship. The document facilitate the owner to control and identify their asset, which is under the custody of the steward Simple accounting is mentioned in the Christian Bible (New Testament) in the Book of Matthew, in the Parable of the Talents [4]. The Islamic Quran also mentions simple accounting for trade and credit arrangements [5].

 Twelfth-century A.D. Arab writer Ibn Taymiyyah mentioned in his book (literally, "verification" or "calculation") detailed accounting systems used by Muslims as early as in the mid-seventh century A.D. These accounting practices were influenced by the Roman and the Persian civilisations that Muslims interacted with. The most detailed example Ibn Taymiyyah provides of a complex governmental accounting system is the Divan of Umar, the second Caliph of Islam, in which all revenues and disbursements were recorded. The Divan of Umar has been described in detail by various Islamic historians and was used by Muslim rulers in the Middle East with modifications and enhancements until the fall of the Ottoman Empire.

 Luca Pacioli (1445 - 1517), also known as Friar Luca dal Borgo, is credited for the "birth" of accounting. His Summa de arithmetica, geometrica, proportioni et proportionalita (Summa on arithmetic, geometry, proportions and proportionality, Venice 1494), was a textbook for use in the schools of northern Italy, where the sons of merchants and craftsmen were educated. Includes the first printed description of the method of keeping accounts that Venetian merchants used at that time, known as the double-entry accounting system. Although Pacioli codified rather than invented this system, he is widely regarded as the "Father of Accounting".

 The system he published included most of the accounting cycle as we know it today. He described the use of journals and ledgers, and warned that a person should not go to sleep at night until the debits equaled the credits! His ledger had accounts for assets (including receivables and inventories), liabilities, capital, income, and expenses the account categories that are reported on an organisation's balance sheet and income statement, respectively. He demonstrated year-end closing entries and proposed that a trial balance be used to prove a balanced ledger.

Source: http://en.wikipedia.org/wiki/Accounting#Early_history

Industrial Age: In 19th century the emergence of large corporations, separation of the owners from the managers, makes the businesses reports became more complex. Needs to prepare financial statements to the shareholders. Post Industrial Age: Accounting is a need for decision making information element.

Two areas of accounting

Definitions

What is accounting?
Accounting is an information system that provides quantitative, financial information to stakeholders about the economic activities and condition of a business so that they can make business/economic decisions.

Accounting: Definition
The process of identifying, measuring, recording and communicating economic information to permit informed judgment and decisions by users of the information. (Refer: Jalila et al. (2005), page 2)

Identifying

Measuring

Recording

Communicating

INTERNAL USERS

EXTERNAL USERS

Identifying: Identify those events that are considered as an evidence of economic activity relevant to the business Measuring: all identifiable related economic activity will be measured in RM and cents Recording: Keeping of a chronological diary of measured events in an orderly and systematic manner Communicating: Communicate through the preparation and distribution of accounting reports to the interested parties.

USERS OF FINANCIAL INFORMATION

Internal Users
Managers who plan, organise and run the business e.g. production supervisors, marketing managers, and directors Owners of the business

USERS OF FINANCIAL INFORMATION

continued

External Users
Resource providers
e.g. investors, employees, creditors

Recipients of goods and services

e.g. customers, beneficiaries

Reviewers
e.g. regulatory agencies, media, governments, trade unions, special interest groups

Introduction to Financial Statements

Definition: FRS 101 (MASB 1)

Financial statements are a structured financial representation of the financial position of and the transactions undertaken by an enterprise.

Purpose of Financial Statements

The objective of general purpose financial statements is to provide information about the financial position, performance and cash flows of an enterprise that is useful to a wide range of users in making economic decisions. Financial statements also show the results of managements stewardship of the resources entrusted to it.

 To meet this objective, financial statements provide information about an enterprises: assets; liabilities; equity; income and expenses, including gains and losses; and cash flows. This information, along with other information in the notes to financial statements, assists users in predicting the enterprises future cash flows and, in particular, the timing and certainty of the generation of cash and cash equivalents.

Components of FS
1. Balance Sheet 2. Income Statement 3. A statement showing: All changes in equity Changes in equity other than those arising from capital transaction with owners and distribution with owners 4. Cash Flow Statement, and

5. Accounting policies and explanatory notes

FINANCIAL STATEMENTS

Balance Sheet
Reports assets and claims to those assets at a particular point in time

Income Statement
Reports revenues less expenses for a particular period of time

FINANCIAL STATEMENTS continued

Statement of Changes in Equity

Reports amount of profit for the period and the changes in equity

Cash Flow Statement

Reports information regarding cash receipts and cash payments for a particular period of time

FINANCIAL STATEMENTS continued

Accounting policies and explanatory notes
Important additional notes to define statement prepared e.g accounting policies Any additional information that is not shown in the financial statement will effect the fairly presentation

WONG PTY LTD Balance Sheet as at 31 October 2008 Assets Cash Accounts receivable Advertising supplies Prepaid insurance Office equipment Total assets Liabilities and equity Liabilities Accounts payable Interest payable Revenue received in advance Salaries payable Bank loan Total liabilities Equity Share capital Retained earnings 31/10/08 Total equity $ 2 500 50 800 1 200 5 000 $ 9 550 10 000 2 360 12 360 $21 910 $15 200 200 1 000 550 4 960 $21 910

Income Statement
Wong PTY LTD Income Statement for the year ended 31 October 2008 Service revenues Expenses Salaries expense $3 200 Supplies expense 1 500 Rent expense 900 Insurance expense 50 Interest expense 50 Depreciation expense 40 Profit before tax Tax expense Profit after tax $10 600

5 740 4 860 2 000 $ 2 860

Statement of Changes in Equity

WONG PTY LTD Statement of Changes in Equity (extract) as at 31 October 2008

Profit Retained earnings 1/10/08 Dividends Retained earnings 31/10/08

$ 2 860 0 (500) $ 2 360

WONG PTY LTD Cash Flow Statement Cash Flow Statement for the month ended 31 October 2008 Cash flows from operating activities Cash receipts from operating activities Cash payments from operating activities Net cash provided by operating activities Cash flows from investing activities Purchased office equipment Net cash used by investing activities Cash flows from financing activities Issue of shares Proceeds from bank loan Payment of dividend Net cash provided by financing activities Net increase in cash Cash at beginning of period Cash at end of period

$11 200

(5 500)
$ 5 700 (5 000) (5 000) 10 000 5 000 (5 000) 14 500 15 200 -$15 200

Roles

 Language of Business Decision making tool Create accountability and control As an Information system

DECISION TOOLKIT
Are the business operations profitable? Does the business rely mainly on debt or equity to finance its assets? Does the business generate sufficient cash from operations to fund its investing activities? Is the company using its assets effectively?

DECISION TOOLKIT continued

Is the company maintaining an adequate margin between sales and expenses? Can the company meet its short-term obligations? Can the company meet its long-term obligations?

PROFESSIONAL BODIES

MIA - Malaysian Institute of Accountants

A regulatory body formed in 1969 under Sec 23 Accountant Act 1967. Functions : To oversee development and growth of the accounting bodies. Sole body where the accountants must register. Conducts training and courses for members to ensure they remain with developments in the profession. http://www.mia.org.my

MICPA
Established in 1965 under Company Act 1965. Sole professional accounting body in Malaysia. Function : Provides training and sets professional examinations. To become a member : must pass all the examinations set by the body. has relevant working experiences. (http://www.micpa.com.my)

What is a CPA?
CPA: Certified Public Accountant
Has taken a minimum number of college-level accounting classes. Has passed the exam administered by the MICPA. Has met other requirements set by his/her state.

MICPA: Malaysian Institute of Certified Public Accountants The national organization of CPAs in the Malaysia. Not a government agency.

MASB
The functions and powers of the MASB as provided under the Act are to: issue new accounting standards as approved accounting standards and to review, revise or adopt existing accounting standards as approved accounting standards; issue statements of principles for financial reporting; sponsor or undertake development of possible accounting standards; conduct public consultation as necessary; develop a conceptual framework for the purpose of evaluating proposed accounting standards; make such changes to proposed accounting standards as considered necessary; seek the view of the FRF in relation to new and existing standards, statement of principles, and changes to proposed standards; determine scope and application of accounting standards; and to perform such other function as the Minister of Finance may prescribe.

ACCOUNTING STANDARDS, PRINCIPLES, CONCEPTS AND CONVENTIONS.

Accounting Standard
Accounting Standard is a set of rules to guide the application of accounting principles in a specific situation while preparing the financial statement.

Purpose:
1. A guideline in preparing the financial statements. 2. To improve the quality of financial reporting 3. Define and explain the concept of reporting entity; which should be reported and which is not. 4. Identifying the common information needs of the various users of financial reports. 5. Determine a qualitative characteristics of financial information.

Accounting Policies
Management should select and apply an enterprises accounting policies so that its comply with MASB Standards. - Definition: Accounting policies are the specific principles, bases, convention, rules and practices adopted by the enterprise in preparing financial statements.
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If there is no specific requirement management should develop policies to ensure the financial statement is; a) Relevant b) Reliable represent faithfully, neutral, free of bias, prudent and complete.

Conventions, concepts & principles

Conventions are derived from theories and accounting practices at some point in time. On the other hand, procedures are practices to be followed in an accounting processing activity. Concepts are assumptions in accounting, which cover several situations in a wider scope. On the other hand, principles are more like rules that relate to a certain topic.

Concepts ..
Entity Concept
a. Each and every economic entity stands apart from other organizations and individuals as a separate economic unit. b. Preparation of financial statements for each business entity must be made so as not to include those transactions that do not belong to the entity.

Going Concern Concept

a. Based upon the notion that businesses today are formed without deciding as to the particular time it will cease. b. The accounting records are prepared with the assumption that there are no signs or indication that the entity will cease operation in the foreseeable future. c. This concept gives priority to the use of historical cost in the preparation of financial statements.

 The Stable-Monetary-Unit Concept a. Unit of measure commonly used and in Malaysia, the currency used is ringgit and sen. b. By using ringgit as a medium of exchange the users of financial statements are able to determine the performance and financial position of a company. c. Financial statements are still prepared based upon the concept that the value of ringgit is stable and any changes in the value of ringgit is assumed insignificant.

The Accounting Period Concept

a. In accounting the assumption is that an entity has a life span that cannot be determined unless there are clear indications that the entity will not be operating in the foreseeable future. b. In the interest of producing accounting information, which is timely and in order to measure an entitys performance it is thus necessary for the measurement to be done within fairly rigid specified periods of time, usually a year.

Principles..
Disclosure principle
a. This principle requires all material information to be disclosed or published.

Materiality principle
a. Places importance on that information which will affect ones ability in making decisions. b. Information, which will affect ones ability in making decision, is known as material information. c. The materiality level really depends on judgment and not on any fixed rules. d. The general guideline on materiality is that if an item is important enough in terms of decision-making then it is to be considered material.

 Objectivity principle
a. This

principle places importance in disclosing objective information in the financial statements. Objective information means information, which is true and can be verified by another party.

Cost principle
a.

According to this principle, assets, which are acquired by a business, must be recorded at the price paid in the transaction. Even though the market value or the economic value of the asset, which is in a business, fluctuates but the value that is recorded remains unchanged. b. The value reflected in the balance sheet is not current value.

Consistency principle
a. This principle requires each entity to use the same accounting methods over consecutive time periods i.e. with no changes from year to year.

Conservatism principle
a. In valuing assets such as debts and inventory the lower cost must be opted for. b. Must not overstate profits or assets.

Matching principle
a. Expenses of a business must be recognized when the revenue related to the said expense is recognized.

Accrual Basis of Accounting

transaction and events are recognized when they occurred (not based on cash received or paid) recorded in the accounting record and reported in financial statements of the period to which the transactions are related. Expenses are recognized on direct association basis between cost and income (matching).

Identify the accounting concepts /conventions/principles for each situation:

a. Fikri owns a small business in Shah Alam. He prepared the accounts of the business showing profit of RM25,000. With this situation, he has no intention to sell off the business. b. Fikri only takes into account all the transactions that relate to his business, ignoring transaction made for himself. c. Fikris business made credit sales to Irfan Bhd amounted RM7,000 in July 2008. Irfan Bhd only paid RM3,000 in September that year; the balance will be paid early next year. Farhan still takes into account the RM4,000 in preparing the financial statements for 2007.

What we have covered in topic 1.

Introduction History and Development of Accounting Definitions of Accounting Introduction to Financial Statements Roles Accounting profession and professional bodies Accounting standards, principles, assumptions and conventions.