AA015: CHAPTER 2 2019/2020

KOLEJ MATRIKULASI LABUAN

ACCOUNTING 1: AA015

Chapter 2 : Basic Accounting Concepts

Learning Outcomes 2.1

2.1 Describe the meaning and the importance of Generally Accepted Accounting Principles
( GAAP)
2.2 Describe the accounting concepts: historical cost, monetary measurement, economic entity,
going concern, consistency, accounting-period, materiality, revenue recognition, expense
recognition, full disclosure, objectivity and fair value measurement.
2.3 Accounting Equations
2.3.1 Describe the accounting equation for service businesses.
2.3.2 Define assets. Liabilities and owner’s equity
2.3.3 Analyse the effects of business transactions on accounting equation.
2.4 Double entry system
2.4.1 Explain the double entry system
2.4.2 Describe the rules of debit and credit on asset, liabilities, owner’s equity, revenue,
expenses and draw.

The meaning and the importance of Generally Accepted Accounting Principles

( GAAP)
i. The accounting profession has developed standards that are generally
accepted and universally practiced. This common set of standards is called
generally accepted accounting principles (GAAP). These standards indicate
how to report economic events.
ii. The different opinions among accountants can be solved by referring GAAP.
iii. It covers conventions, concepts, regulations, procedures and the guidelines
standards.
iv. It is important because the Financial Statements must be completed and easy
to understand by others in order to make a comparison or to make any
economic decision

2.2 Describe the accounting concepts

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a. Historical Cost

i. The acquired assets and services by a company should be recorded at

their actual cost.
ii. The cost is a reliable measure and can be approved and company should
continue reporting the historical cost of an asset over its useful life

b. Monetary measurement

i. Money is the common denominator in business.

ii. Monetary measurement assumption is a principle that assumes business
transactions or events can be measured and expressed in terms
of monetary units and they are stable and dependable. In other words, the
language of business and finance is money.

c. Economic entity

i. The business and it’s owner are two different entities.

ii. The activities of the business must be kept separated and distinctively
from the activities of the owner and of all other economic entities such as
the creditors, suppliers, customers etc.
iii. The entity needs to be evaluated separately from the owner, can hold
properties and debts under it’s own name.

d. Going concern

i. The business will continue operating long enough to carry out it’s existing
objectives. It means that the entity will remain in operation for the
foreseeable future.
ii. Most resources such as supplies, land, buildings and equipment are
acquired to use rather than to sell.

e. Consistency

i. Consistency means that a company uses the same accounting principles

and methods from year to year.
ii. When financial information has been reported on a consistent basis, the
financial statements permit meaningful analysis of trends within a
company.

f. Accounting period

i. Time period covered by financial statements is known as accounting

period.
ii. Time period assumption means business activities can be divided into

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specific period such as a month, a quarter and a year in order to enable

comparison of business performance over time.
g. Materiality

i. Materiality relates to an item’s impact on a firm’s overall financial

condition and operations.
ii. An item is material when it is likely to influence the decision of a
reasonably prudent investor or creditor.
iii. To determine the materiality of an amount, the accountant usually
compares it with such items as total assets, total liabilities and net
income.

h. Revenue recognition

i. Revenue is recognized in the period they are earned.

ii. When the merchandise has arrived to the buyer or when services are
rendered even cash receivable
iii. Criteria to recognize a revenue: -
a. there is a change of ownership/title.
b. buyers are willing to pay.
c. the stability of the currency.
d. Buyers are able to pay.

i. Expense recognition

i. Expenses are recorded in the accounting period in which it has been

involved for a business revenue.
ii. Expenses are recognized when they are incurred even if payment has not
yet been made.
iii. The goal - to find out the actual amount of revenue and expenditure for a
financial period

j. Full disclosure

The company should report the sufficient information (ie: relevant, reliable,
comparable) so that the external parties can make a reasonable decision

k. Objectivity

i. All accounting data should be valid and reliable evidence to support

transactions occurred.
ii. The goal - to prevent accountants in giving subjective and inaccurate
opinion.

l. Fair value measurement

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Assets and liabilities should be reported at fair value when it come to the point of
selling assets or settling liabilities.

2.3 Accounting Equations

2.3.1 Describe the accounting equation for service businesses.

ASSETS = LIABILITIES + OWNER’S EQUITY

ASSETS =LABILITIES + (CAPITAL + REVENUE - EXPENSES –DRAWINGS)

2.3.2. Define assets, liabilities and owner’s equity

i. Assets

Definition: Wealth / resources owned by the business. Assets are divided into two: -

a. Non-current Assets
Assets that have a life of more than one year.
Divided into three: -
 Tangible/fixed assets - can be seen physically.
Example: buildings, vehicles, equipment
 Intangible assets – cannot be seen physically.
Example: - Trademarks, patents, copyrights
 Long-term investments - fixed deposits for more than a
year, the purchase of bonds
b. Current assets
 Exist in one accounting period and can be
converted into cash within a year.
 Constantly of changing form and value.
 Example: - Inventory, Accounts Receivable, Cash,
Bank and so on.
ii. Liabilities

Definition: Debt / businesses obligation to be paid by business entity to another party.

Liabilities divided into 2 types: -
a. Non-current liabilities (> 1 year)
 Debt to be settled within a period exceeding one year.
 Example: - Long-term loans, mortgage
b. Current liabilities (<1 year)
 Debt due in less than a year.
 Example: - Accounts payable, expense payables, unearned
revenue.

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iii. Owner’s Equity

Definition: Owner’s claims on the business. They include:

 Capital invested by the owner into the business.
 The net profit result of the business activities.
 The elements involved in owner’s equity:

Capital
 Consists of assets in the business by the owners.
 It will add the owner's equity.

Drawing
 Owner issuing asset (cash or merchandise) for its own use.
 The effect will be to reduce the value of owners' equity.

Profit
 Expenditure - The effect will reduce the owner's equity
 Income -The effect will add value to the owner's equity.

iv. Revenues

Definition: All income from the sale of goods or the provision of services based on the
concept of revenue recognition.
2 types of revenue:
a. Revenue of Business
Example: - Sales, service revenue
b. Revenue of Non Business
Example: - Interest income, rental income, gains on sales of fixed
assets

v. Expenses
Definition : Expenses use up assets or create liabilities in the course of operating a
business. Expenses decrease equity.
2 type of expenses:
a. Operating expenses
Example: Utilities , sales commissions, delivery expense
b. Non operating expenses
Example: property taxes on the administrative office building

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2.1 Double entry system

2.1.1 Explain the double entry system
Accounting uses the double-entry system, which means that we record the dual effects of
each transaction. As a result, every transaction affects at least two accounts.It would be
incomplete to record only the giving side, or only the receiving side, of a transaction.

2.5.2 Describe the rules of debit and credit on asset, liabilities, owner’s equity, revenue, expenses
and draw.

Double- Entry Accounting

DEBIT = The left side of the account
CREDIT = The right side of the account

The following T-accounts :

Title of account
DEBIT CREDIT

ACCOUNT RECORD DR/CR NORMAL BALANCE

ASSETS DEBIT
EXPENSE DEBIT
DRAWINGS CREDIT
LIABILITES CREDIT
CAPITAL
CREDIT
REVENUE DEBIT

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EXAMPLE 1:

Triplemu Sdn. Bhd commenced its business operations on January 1, 2012. Here are the transactions
for the first month of operation.

Jan 1 Started business by investing RM30,000 in cash , office equipment RM10,000 and vehicle
RM25,000.

2 Hired 3 employees each with a monthly salary of RM800.

5 Served customers amounting to RM12,000 where RM1,000 was received in cash while
the balance was on credit.

6 Purchased supply for office use amounting to RM500 in cash.

14 Received the remaining payment on services rendered to customers on January 5.

15 Business owners took cash of RM2,000 and office supplies worth RM50 for personal use.

22 Provided RM5,000 credit to customers.

25 Purchased additional supplies on credit worth RM1,000.

28 Made half of the payment purchased on January 25.

30 Paid the business vehicle insurance policy for one year from 1 February 2012 worth
RM1,500.

31 Settled the following payments:

Employee wages for 3 people.
Utilities of RM200
Office rental expense RM1,200.

Required:
a. Prepare a tabular analysis of the January transaction for this company.

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Tabular Transaction Analysis

Accts. Assets = Liabilities + Owner’s Notes

Equity

Cash Office Vehicles Accounts Office Prepaid Accounts Capital

Equipment Receivables Supplies Insurance Payable
Balanc - - - - - - - - -
e
Jan 1 30,000 10,000 25,000 65,000

2 No Transactions
5 1,000 11,000 12,000 Service
Revenues
6 (500) 500

14 11,000 (11,000)

15 (2,000) (50) (2,050) Drawings

22 5,000 5,000 Service

Revenue
25 1,000 1,000

28 (500) (500)

30 (1,500) 1,500
 31 (2,400) (2,400) Salary Expense

(200) (200) Utility Expense

(1,200) (1,200) Rent Expense

Jumlah 33,700 10,000 25,000 5,000 1,450 1,500 500 76,150

RM76, 650 = RM76,650