ACCT1501 NOTES

1. Introduction to Financial Accounting

Describe the basic purpose of financial accounting
Accounting-process of identifying, measuring, recording and communicating economic information to
assist users to make decisions-credible and periodic

Financial performance: generation of new resources over a period of time

Financial position: enterprises set of financial resources and obligations at a point in time
NOTE: Financial accounting is for external decision makers e.g. investors, creditors and customers

Identify the users of accounting information and the decisions they make that
require accounting information
Accounting is important since used by:
Management in making business decisions
Shareholders for decision making
Board of directors in takeover battles
Bankers and creditors in lending decisions
Boards in rewarding and removing executives
Management and unions in wage negotiations
Impacts communities and workers

Other users of accounting information: bankers, ASIC, ATO and Trade Unions

Identify the people who are involved in financial accounting

Main participants in financial accounting:
-Decision makers (users): requires credible& periodic reporting to make decisions on behalf of company
e.g. CEO
-Information preparers-decision facilitators, managers, bookkeepers, accountants
-Auditors-assists users by improving the credibility of the information by providing professional opinion
(accounting principles)

Describe how accrual accounting differs from cash accounting

Accrual accounting- impact of transactions on the financial statements in the time period recorded in the
period in which they occur; not when cash is received or paid e.g. credit sales
Cash accounting-Record cash when it is received or paid

Calculate accrual profit for an organisation

Explain the basic contents of the three key financial statements and describe the
purpose of each statement
>Balance Sheet-financial position at a point in time
(Name of reporting entity, type of financial statement, date, currency)

Assets: Resources that will benefit the company this year(current) or in future years (non-current) e.g.
cash, property, equipment, inventory
Liabilities: Future sacrifices of economic benefits that an organisation is presently obliged to make as a
result of past transactions e.g. accounts payable, loan payable
Shareholders Equity: Excess of assets over liabilities e.g. share capital& retained profits (two main
elements)
- Financial structure (mix of debt/equity-debt to equity ratio)
- Liquidity-ease of converting assets to cash in normal course of business (short term
focus) working capital, current ratio
- Solvency-ability to pay debts when they fall due (long term focus) i.e. debt to equity ratio

Assets= liability+ equity

Consolidated financial statement: factors in the holding company (parent) and subsidiaries (shows how
holding company is doing as a group)

Working capital ratio (current ratio) assets/liabilities

>Income statement(profit & loss statement-measures financial performance over a defined period)
Revenue: inflows of economic benefits that increase owners equity
Expenses: use or loss of economic benefits that decrease owners equity
Profit

Net profit for the period=revenues-expenses for the period

revenue>expense is a net profit
revenue<expense is a net loss

Retained profit at end of period=retained profit at beginning of period+ net profit for the period-
dividends

Financial position of a company: Working capital, current ratio

Cost of goods sold (COGS)-amount company pays to acquire goods that customer buys
Retained Profits-When a company earns a profit, it is kept in the business to help the business grow

>Statement of cash flows (sources and uses of cash during the period)
Operating Activities: provision of goods and services
Investing Activities: acquisition and disposal or noncurrent assets
Financing Activities: changing size and composition of the financial structure of entity

Describe the basic principles and assumptions of accounting

Accrual Basis: revenues and expenses are recognised at the time they occur rather than when cash is
received or paid
Accounting entity assumption: entity for which financial statements are prepared
Accounting Period Assumption: life of business is divided into discrete time periods of equal length to
determine financial performance and position
Monetary assumption: measure of economic activity by a common denominator.
Materiality: items with a small dollar value expensed rather than recorded as an asset
Historical cost assumption: transactions initially recorded at their original cost
Going concern assumption: assumes continued operation of accounting entity into foreseeable future
Prepayments: amounts paid in advance for benefits not yet received

Explain why accounting is important

Economy as a whole
Used by management in making business decisions & shareholders
Used by bankers and creditors-determine level of risk
Used by corporate boards in rewarding/removing executives

Economic consequences: Decision maker-investor/owner with decisions based on what value they are willing to buy
or sell shares in the market
Annual report-contains descriptive information about company and general purpose of financial statements
Generally accepted accounting principles (GAAP)-assures users that accepted methods have been followed.
2. Measuring& Evaluating Financial Position & Performance
Describe the contents of a balance sheet
Asset- resource controlled by entity from which future economic benefits are expected to flow to the entity
1. Future economic benefit
2. Control by the entity
3. Occurrence of past transactions or other past events

Liability-present obligation of the entity arising from past events

1. A present obligation exists
2. Entity is obligated to sacrifice economic benefits to one or more other entities
Current and non-current liabilities reason for distinction is to help financial statement user assess short-term
financial position

Not all assets and liabilities are on the B/S-to be recorded they must meet recognition criteria
- probable that any future economic benefit associated with the item will flow to or from the entity,
- item has a cost or value that can be measured reliably

Shareholders equity

Carry out preliminary analysis based on the contents of a balance sheet

Determine what business activities result in changes in a balance sheet
Determine whether an item should be included as an asset or liability in the balance sheet
Show how specific activities affect each item in the balance sheet
Prepare a balance sheet
Determine the effect of transactions on revenue and expenses
Prepare an income statement

Explain the nature of each of the items in the balance sheet and income statement
for a public company
Equity-link between balance sheet and income statement
NOTE: Shareholders equity=Share capital+ retained profits
Income statement accounts are temporary accounts
Balance sheet accounts are permanent accounts
Income statement accounts are closed and their balances transferred to the retained profits account (on
B/S) at end of each accounting period

Describe the contents of the note reconciling opening and closing retained profits
Opening retained profits+ net profit for period (revenues-expense)-distributions (dividends
declared)= Closing retained profits

Explain the importance of both financial statements to managers

Basic score card of managements stewardship of company
Income statement shows how management has performed in using assets to earn profits
 3. Double Entry System
Carry out transaction analysis and determine the impact of transactions on
elements of balance sheets and income statements
To be reported on a balance sheet, assets must meet definition criteria and then meet recognition criteria

Describe how debits and credits work in the double-entry accounting system
Debit is a left hand side entry
Credit is a right hand side entry
The accounting equation must always balance, hence debit= credit

- Increases in assets are debits

- Decreases in assets are credits
- Increases in liabilities and equity are credits
- Decreases in liabilities and equity are debits
- Increase revenues are credit
- Increase expenses are debit

Record transactions using debits and credits

Prepare journal entries
Journal entries=short hand version on transaction analysis and prepared using rules of credit=debit

Determine the balance of an account after a series of transactions

Describe the normal balance for the following types of accounts: assets, liabilities, equity, revenues
and expenses
Explain why financial accounting has become more sophisticated over the centuries
 4. Record-keeping
Describe the importance of good record-keeping
Complete and accurate records-provide observations and history of enterprise
Describe the criteria used to determine if an event involves an accounting
transaction (5)
Financial accounting filter-routinely recorded by accounting system
>3 fundamental economic and legal characteristics
Exchange-of goods
Past- occurred
External- between entity accounted for and external
>2 supplementary characteristics
Evidence-documentation
Dollars-measurable in dollars
>Transaction characteristics
1. Transactions linked to legal and economic concept of exchange
2. Constitutes a large part of underlying rationale for historical cost basis of accounting
3. Characteristics of transaction provides basis on which records can be verified

Identify accounting transactions

1. Payroll department pays employees by deposits to their bank accounts
2. Customer pays, in cash, an account owing since last month and gets a receipt
3. Sales clerk prepares invoice for customer
4. Bank charges bank fees on an account
5. Storeroom receives shipment of spare parts for delivery trucks

Explain the various steps in the accounting cycle

Source documents are the basis for journal entries, which are then posted to general ledger accounts to
summarise transactions
Trial balance taken to ensure total debits equals total credits
End of period accruals, corrections and adjustments incorporated to additional journal entries
Post adjustment trial balance
Further journal entries closes the revenue, expenses and dividend amounts to retained profits
1.Documents to show transaction have occurred
2.Shows when business event is first recorded by accounting
system-provides in chronological order, a record of all transactions
3.Ledgers are records that have a separate page/account code for
each individual account (T-account includes debits and credits
columns- shows amount by which debit entries exceeds credit
entries)
4.Standard bookkeeping procedure to check ledger balances by
adding up all debits and all credits to ensure totals equal
5.At end of accounting period, adjust revenue and expenses,
splitting into two different accounting periods
6. Same as 5
7.Transfers balances of revenue and expense accounts to a profit
and loss summary, then to retained profits
Describe what source documents exists and how they provide data for the
accounting system
Purchase order forms-online system orders, Cheque, Sales invoice, Days collection, Bank transactions
Post to ledger accounts and calculate the closing entries
Prepare financial statements from the trial balance
5. Accrual accounting adjustments
Explain how the timing of revenue and expense recognition differs from cash
inflows and outflows
Revenues-Inflows of economic resources earned from providing goods and services
Expenses-Outflow of economic resources to employees, suppliers, taxation authorities and others,
resulting from business activities to generate revenue
Net Profit-Difference between revenues and expenses over a period of time

Accrual accounting extends measurement of financial performance and financial position by recognising
phenomena before and after cash flows

RECOGNITION OF REVENUE OR EXPENSE AT THE SAME TIME AS CASH INFLOW OR OUTFLOW

e.g. Records cash sale/dividend cheque DR cash increases=CR sales revenue increases

RECOGNITION OF REVENUE OR EXPENSE PRIOR TO CASH FLOW

e.g. Perform service first and bill client later to be paid soon DR accounts receivable= CR Fee revenue
DR Warranty expense=CR Warranty liability

CASH COLLECTIONS OR PAYMENTS RELATED TO PREVIOUSLY RECOGNISED REVENUES AND

EXPENSES
e.g. Receiving full payment from client after bill DR Cash= CR accounts receivable decreases

CASH INFLOW OR OUTFLOW BEFORE REVENUE AND EXPENSE RECOGNITION

e.g. Receiving advance payment for future service (revenue wont be earned until later date-recognition of
revenue is deferred until service has been performed) DR Cash= CR unearned revenue
Deferred expense recognition for insurance DR Prepaid Insurance= CR Cash

RECOGNITION OF REVENUE OR EXPENSE AFTER CASH INFLOW OR OUTFLOW

e.g. When insurance has been used and cost should be recognised as an expense
DR Insurance expense= CR Prepaid insurance, DR Depreciation expense= CR Accumulated depreciation

Recognition of revenue before cash collection is done by crediting asset account (accounts
receivable) which stands in for economic value gained until cash has been collected
 Recognition of expense before cash payment is done by creating a liability account (accounts
payable) which stands in for economic lost until cash is paid
Recognition of unearned revenue when cash is collected is provided by creating a liability account
(unearned revenue) which represents commitment to customer until economic value is gained
Asset account (prepayments inventory or machinery) created when cash is paid

Explain the purpose of accrual accounting adjustments

Accrual accounting adjustments follow same double-entry format (some accounts debited/credited)
Also known as adjusting journal entries
Purpose is to augment transaction-based figures to add to story told by transactional records
Four main types of routine adjustments that need to be accounted for:
Expiration of assets
Unearned revenues
Accrual of unrecorded expenses
Accrual of unrecorded revenues

Describe prepayments, accrued revenue, accrued expenses, revenue received in

advance, depreciation, doubtful debts and contra accounts
Expiration of assets
Prepayments (prepaid expenses)
E.g. Amount paid for insurance premium-prepayment (asset) increased and cash (asset) decreases
At end of the year some of the prepayment will have been used up and amount of asset is reduced and
expired portion of asset it treated as expense

Unearned revenue
At the time of collection, amount received is a liability because goods/services are owing to subscriber
E.g. Magazine subscription

Accrual of unrecorded expenses

Expenses incurred during current period but will not be paid until following period e.g. wages expenses is
increased and accrued wages (wages payable) is increased because there is a liability at end of period

Accrual of unrecorded revenues

E.g. Interest receivable on loans for period (note only account for interest received for accounting period)

Calculate the impact on the financial statements of accrual accounting

adjustments
Prepare journal entries for accrual accounting adjustments
Show the impact on the financial statements and prepare journal entries for the
depreciation of assets and the sale of assets
Multi-column work sheets
Column 1,2-Pre-adjusted trial balance (prepayments)
Column 3,4-Adjusting entry (ledger account)
Column 5,6 Adjusted trial balance
Column 7,8- Income statement numbers
Column 9, 10- Balance sheer numbers

CONTRA ACCOUNTS
Contra accounts are used to accumulate depreciation on fixed assets, such as buildings and equipment
DR Depreciation expense CR Accumulated depreciation
Recognise expenses without changing control account
Have balances in opposite direction to those of control account
E.g. Contra asset accounts have credit balances that are contra the assets debit balances
Common use of contra accounts-accumulated depreciation (amortisation)

7.Interal Control and Cash

Outline the components of a good internal control system

Describe managements responsibilities for maintaining control over an

enterprises assets
Provide information for evaluating an internal control system and for purposes
such as fraud prevention

Develop internal control procedures to protect cash

Locked-in sales registers, multi-copied, prenumbered sales invoices
Explain the role of bank reconciliations as part of an internal control system

Prepare a bank reconciliation statement

Explain the use of petty cash as an internal control for cash