31266 Final: Accounting-for-Business-descisions- A- notes
UTS 2014 – Accounting for Business Decisions A
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LECTURE 1 – FINANCIAL ACCOUNTING
Accounting is the process of identifying, measuring and communicating economic
information to permit informed judgements and decisions. I.e. ‘’language of business’’
Learning Objectives
Describe the four assumptions made when communicating accounting information.
The economic entity assumption states that the financial activities of a business can be
accounted for separately from the business’s owners.
We do not have to worry that the financial information of the owner is mixed with the
financial information of the business.
The time period assumption states that accounting information can be captured and
communicated effectively over short periods of time.
Most businesses prepare quarterly, half-yearly or annual financial statements. Publicly
traded companies like BHP Billiton are required to file statements to the ASX twice a year.
The monetary unit assumption assumes that the dollar, unadjusted for inflation, is the best
means of communicating accounting information.
Accountants do not adjust for inflation/deflation – $1 earned in 1980 is same as $1 in 2014.
All transactions in foreign currencies are converted to dollars.
The going concern assumption states that the company for which we are accounting will
continue its operations indefinitely.
Most companies are assumed to be going concerns but those that are not going concerns
are often in the process of liquidation (so selling their resources + paying off obligations).
If an entity is not selling its assets, then the cost principle is appropriate.
Describe the purpose and structure of a statement of comprehensive income and the
terms and principles used to create it.
The statement of comprehensive income (or an income statement) shows a company’s
revenues and expenses over a specific period of time.
oIts purpose is to demonstrate the financial success or failure of the company over that
specific period of time.
oIts structure is as follows:
oRevenue is an increase in assets resulting from selling a good or providing a service.
The revenue recognition principle states that revenues are recorded when they are earned.
A resource (revenue) is earned when either the sale of the good or the provision of the
service is substantially complete and collection is reasonably assured.
Therefore, the receipt of cash is not required to record revenue.
oExpense is a decrease in assets resulting from selling a good or providing a service.
The matching principle states that expenses are recorded in the time period when they are
incurred to generate revenue.
For many assets, the cost of the asset must be spread over the periods when it is used.
Describe the purpose and structure of a statement of financial position and the terms and
principles used to create it.
The statement of financial position (or the balance sheet) shows a company’s assets,
liabilities and equity at a specific point in time.
oIts purpose is to show, at a given point in time, a company’s resources and its claims against
those resources. It is often referred to as a ‘’snapshot of a business’’.
oIts structure is shown by the accounting equation:
UTS 2014 – Accounting for Business Decisions A
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o An asset is a resource of a business – it is objectively measurable and it results from a prior
transaction + it should provide future economic benefit.
Examples of an asset are cash, inventories, receivables, property, plant and equipment –
along with intangible assets which have no physical form such as trademarks or copyright.
The cost principle states that assets should be recorded and reported at the cost paid to
acquire them.
Except in a few cases, market values are not used for reporting asset values.
o A liability is an obligation of the business – that results from a past transaction and will
require the sacrifice of economic resources at some future date.
Example of liabilities – account payable to suppliers, salaries payable and tax payables.
o Equity is the difference between a company’s assets and liabilities – and represents the
share of assets that are claimed by the business’s owner(s).
E.g. A homeowner’s equity refers to the difference between the value of the home and the
amount owed to the bank.
Contributed capital is the resources that investors contribute to a business in exchange for
ownership interest.
Contributed equity is equity resulting from contributions from owners (often from issuing
ordinary shares).
Retained earnings are the profits that are kept in the business – they represent the equity
generated and retained from profitable operations.
Describe the purpose and structure of a statement of changes in equity and how it links
the statement of comprehensive income and the statement of financial position.
The statement of changes in equity reports the changes in a company’s retained earnings
over a specific period of time.
o Its purpose is to inform the owners of a business – how their equity is growing as a result of
profitable operations and how that equity is distributed in the form of dividends.
o Its structure is as follows:
o Dividends are the profits that are distributed to owners (usually called drawings if the
business is not a company).
o Retained earnings refer to equity resulting from profitable operations.
The statement of comprehensive income’s link to other statements is that – net profit goes
to the statement of changes in equity to calculate retained earnings.
The statement of financial position’s link to other statements is that – the balance in
retained earnings comes from the statement of changes in equity.
Similarly, the statement of changes in equity’s link to other statements is that – ending
retained earnings goes to the statement of financial position.
Describe the purpose and structure of a cash flow statement and the terms and principles
used to create it.
A cash flow statement shows a company’s inflows and outflows of cash over a specific
period of time.
o Its purpose is to report a firm’s sources and uses of cash over a specific period of time.
o Its structure is as follows:
Financing activities – most businesses raise funds to begin. Borrowing money from creditors
and receiving contributions from investors are both ways to finance a business’s operations.
Investing activities – once a company has raised sufficient capital from creditors + investors,
it usually acquires the revenue-generating assets that it needs for operations.
UTS 2014 – Accounting for Business Decisions A
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Operating activities – after the proper equipment is acquired, a business can begin
operations. Operating a business includes the purchase of supplies, the payment of
employees and the sale of products.
The statement of financial position’s link to other statements is that – the balance in cash
should agree with the ending cash balance on the cash flow statement.
Conversely, the cash flow statement’s link to other statements is that – the ending cash
balance should agree with the balance in cash on the statement of financial position.
Describe the qualitative characteristics that make accounting information useful.
Understandability refers to the ability of accounting information to be comprehensible to
those who have a ‘reasonable understanding of business and economic activities and
accounting and a willingness to study the information with reasonable diligence’.
Thus, users must spend a reasonable amount of time studying accounting information for it
to be understandable.
Relevance refers to the capacity of accounting information to affect decisions.
Therefore, information should have predictive value or feedback value and should be timely.
Feedback value refers to the ability to assess past performance, while predictive value refers
to the ability to form expectations of future performance.
Information is relevant only if it is generated on a timely basis.
Reliability refers to the extent to which accounting information can be depended upon to
represent what it purports (intends) to represent, both in description and in number.
So information should be verifiable or free from error, a faithful representation and neutral.
One can often prove that accounting information is free from error by comparing the
information to an original source document such as an invoice or a contract.
Information has representational faithfulness when the description corresponds to the
underlying phenomenon. E.g. you purchased a ‘petrol can’ to store your fuel and in your
balance sheet, it was reported as an ‘asset’. This reporting was a faithful representation.
Information is neutral if it is presented in a way that is unbiased regarding the reporting
entity. I.e. does not portray an entity in a more /less favourable light than the info requires.
Comparability refers to the ability to use accounting information to compare or contrast the
financial activities of different businesses.
Thus, entities must disclose the accounting methods that they use so that comparisons
across companies can be made.
Being able to compare information across firms allows an entity to assess its market position
within an industry, to gauge its success against competitors and to set future goals based on
industry standards. But, comparability does not imply uniformity. Accounting rules allow for
some discretion in the manner in which accounting is applied to economic phenomena.
As a result, two firms with the same economic phenomena could have different accounting
info because they use different acceptable accounting methods or make different estimates.
Consistency refers to how accounting information should be comparable across different
time periods within a business.
Is highest when entity uses the same accounting methods year after year. Year to year
comparisons are useful as they reveal trends – allows for predictions. Entities can change
manner in which they account for particular economic event this needs to be disclosed.
Materiality refers to the threshold over which an item begins to affect decision making.
So when an amount is small enough, normal accounting procedures are not always followed.
Conservatism states that when uncertainty exists, accounting information should present
the least optimistic alternative.
Thus, an entity should choose accounting techniques that guard against overstating
revenues or assets.
An example of conservatism is the lower-of-cost-or-market rule for inventory where
inventory must be recorded + reported at the lower of its cost or its current market value.
Document Summary
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