Topic 1:

Conceptual Framework,
underlying assumptions
of financial statements and
recording transactions
BX2011 – Foundation of Accounting Principles

Required Reading:
Chapters 10, 2 and 3 - Hoggett, 11e
Conceptual Framework
Learning Outcomes
l Review of BU1002:
l The regulation and development of accounting standards

l Conceptual Framework and assumptions that underpin the

preparation and presentation of financial reports
l Types of business entities

l Financial reports

l The accounting cycle, types of transactions and accounts

l Chart of Accounts
l Double entry accounting and the rules of debit and credit
l Transaction recording in the general journal, posting to the
general ledger and preparation of a Trial Balance
l Identifying errors and their correction
Regulation and development of
Accounting Standards
l History of regulation
l GAAP

l 19th century – industrialised society - increasing complexity

of business organisations, formation of companies
l Companies - separation of ownership and control and
introduction of legislation to protect shareholders
l Financial Reporting Council (FRC)
l Overseer and advisory body to AASB
l Aust. Accounting Standards Board (AASB)
l Role and responsibilities – developing accounting
standards
l Aust. Securities and Investment Commission (ASIC)
l Administers Corporations Act (2001)
Regulation and development of
Accounting Standards cont.
l Australian Securities Exchange (ASX)
l International Accounting Standards Board (IASB)
l IFRIS Interpretations Committee (IFRIS)
l Financial Accounting Standards Board (FASB)
l The Asian Oceanian Standards Setters Group (AOSSG)
The Conceptual Framework
l There is a need for guidance
l Must be consistent and meet needs of users and preparers
l Conceptual framework intended to:
l Develop logical, consistent standards

l Provide guidance where no standard exists

l Enhance understanding of users
The Conceptual Framework cont.
l Definitions of the elements - 5 Elements used in the
preparation of financial statements:
l Assets, Liabilities, Equity, Income and Expenses

l Definition of Asset:
l “a resource controlled by the entity as a result of past
events and from which future economic benefits are
expected to flow to the entity”.
l Key pts – control, future economic benefits and
past event
l i.e bank, accounts receivable, inventory, vehicle

l Tangible or intangible

l Ranked in order of liquidity on balance sheet

The Conceptual Framework cont.
l Definition of Liability:
l “a present obligation of the entity arising from past
events, the settlement of which is expected to result
in an outflow from the entity of resources embodying
economic benefits”.
l Key pts – present obligation, future sacrifice and past
event
l i.e. bank overdraft, creditors, loans, mortgage

l Involves an external party

l Require payment, cash, transfer of assets or

performance of services to cancel the debt.
The Conceptual Framework cont.
l Definition of Equity:
l “residual interest in the assets of the entity after
deducting all its liabilities”.
l Key pts – depends on definitions of assets and liabilities

l i.e. capital, drawings, retained profits

l Creditors have legal precedence in debt repayment over

owners!!
l Other terms – proprietorship, capital

l Manipulation of accounting equation:

OE = A - L
Definitions of the elements cont.
l Definition of Income:
l “increases in economic benefits during the accounting
period in the form of inflows or enhancements of
assets or decreases of liabilities that result in
increases in equity, other than those relating to
contributions from equity participants”.
l Key pts – é assets or ê liabilities, no capital contribution
‘cos entity can’t earn wealth thru’ contributions with its
owners!!
l Note: is broad to encompass both revenue and gains!!

l i.e. revenue, sales, interest received, commission revenue

Definitions of the elements cont.
l Definition of Expenses:
l “decreases in economic benefits during the accounting
period in the form of outflows or depletions of assets
or incurrences of liabilities that result in decreases in
equity, other than those relating to distributions to
equity participants”.
l Key pts – êassets, or é liabilities, no drawings

l i.e. wages, rent, cost of goods sold, rates,

insurance, interest
Recognition criteria for all elements
l If an item meets the definition criteria, the next step is to
recognise how it will be recorded in the accounting system
l “it is probable that any future economic benefit associated
with the item will flow to or from the entity; and
l the item has a cost or value that can be measured with
reliability”.
l Must be probable that the benefit carried forward will be used in
future accounting periods otherwise there is no point recording
the item in the financial reports
l The item must also have a monetary value if it is to be recorded
in the financial reports.
The Conceptual Framework cont.
Remember!!
Revenue > Expenses = Net Profit
This will lead to an increase in Equity

Revenue < Expenses = Net Loss

Will lead to a decrease in Equity
Accounting Assumptions

l Accounting entity assumption – records of business are kept

separate from personal transactions of owner.
l Accrual basis assumption – transactions and events are
recorded when they occur – NOT WHEN CASH IS
RECEIVED.
l Going concern assumption – business entity will continue
indefinitely.
l Period assumption – splitting the business life cycle into
smaller periods of time for profit determination.
Measurement

l Measurement bases for assets, liabilities, income and

expenses:
l Historical cost
l Current cost

l Realisable value

l Present value

l Most common measurement – historical cost,

l IAS 2 / AASB 102 inventories - measured at
lower cost and net realisable value (Topic 2)
l IAS 6 / AASB 116 NCA – measured using cost
basis or revalued to fair value (Topic 7)
Types of business entities

l Single proprietorship / sole trader

l owner provides assets,

l entitled to all profits

l liable for all debts to extent of personal wealth

l Accounting entity concept – record business

transactions separately from personal transactions.
Types of business entities cont.

l Partnership
l 2 or more owner people providing resources or services
as per partnership verbal / written agreement.
l profits split as per agreement

l liable for all debts to extent of personal wealth

l Accounting entity concept – record business transactions

separately from personal transactions of partners.
l Covered in Topic 10.
Types of business entities cont.

l Company / corporation
l separate legal entity

l owned by shareholders

l profits distributed as dividends to shareholders at directors

discretion.
l Shareholders liability limited to amount unpaid on shares.

l greater regulation for accounting and reporting purposes.

l Covered in further accounting subjects.

Basic financial statements

l 3 General Purpose Financial Reports

l Income Statement - performance

l Balance Sheet (Statement of Financial Position) – financial

position of an entity at a point in time
l Statement of Cash Flow – assesses the entity’s ability to
generate cash to meet its objectives
Income Statement
l Flow statement measuring entity performance over time
l Based on accounting equation: I – E = NP or NL
l Linked to Balance Sheet as NP or NL forms part of equity.
l Heading: business name, income statement, for the …..
Ending…. (Be specific of timeframe!!)
Balance Sheet or
Statement of Financial Position
l Snapshot at a point in time and shows the resources and
claims on those resources.
l Split into 3 sections:
l Assets – current and non current

l Liabilities – current and non current

l Equity

l Based on accounting equation A = L + OE or A – L =OE

l Heading: business name, balance sheet, as at ……
l Should always balance!!
Balance Sheet or
Statement of Financial Position cont.

l “T” format or account format of presentation

Balance Sheet or
Statement of Financial Position cont.

l Narrative format
of presentation
Statement of Changes in Equity
l Is the connecting link between the balance sheet and the
income statement and explains the changes that took place
with equity.

l Shows ALL changes to equity, net profit / loss, capital

contribution and drawings
Statement of Cash Flows

l Linked to Balance Sheet as it identifies changes in bank

between respective balance sheets.
l Indirect links to Income Statement due to impact of revenue
and expenses on assets, liabilities and equity.
l Split into 3 categories:
l Operating – focus on daily operations

l Investing – acquisition and disposal of NCA

l Financing – changes to financial structure, equity and

borrowings
l Bank @ beg + total Cash flow = Bank @ end
l Heading: business name, Statement of Cash Flow,
for the …… (Covered in Topic 9)
Statement of Cash Flows cont.
Double entry accounting
l There are at least 2 accounts in every transaction
l Equation must always balance!!
l Debits = Credits
l Other terms:
l Transaction – item that fulfils the definition and recognition
criteria of an element so it can be recorded in the
accounting information system
l Account – record of the $ amount comprising of a
particular asset, liability, equity revenue or expense item
l Account balance – net effect of amounts Dr and Cr to the
account.
l Note if accounts become negative they may change
classification, i.e positive bank a/c = asset, negative bank
a/c is an o/draft = liability
Rules of Debit and Credit

l Debit and credit rules

l Balance sheet accounts – Hoggett 10e

Assets = Liabilities + Owner’s Equity

Debit to Credit to Debit to Credit to Debit to Credit to
increase decrease decrease increase decrease increase

Normal Normal Normal

balance balance balance
Rules of Debit and Credit cont.

l Debit and credit rules

l Income statement accounts – Hogg and Edwards

Expenses Revenues
Debit to Credit to Debit to Credit to
increase decrease decrease increase

Normal Normal
balance balance
Rules of Debit and Credit cont.

l PALER Rules!!

é Cr Dr Cr Dr Cr

P A L E R

ê Dr Cr Dr Cr Dr

l P = Proprietorship or Owners Equity

l For normal account balances refer to “é” rules
Normal account balances:
Expanded Accounting Cycle

Transactions

Financial Statements Source

Documents

Trial Balance Journals

Ledger
Expanded Accounting Cycle

Transactions

Financial Statements Source

Documents

Trial Balance Journals

Ledger
Expanded Accounting Cycle

Transactions

Financial Statements Source

Documents

Trial Balance Journals

2019
Ledger
Expanded Accounting Cycle

Transactions

2019

Financial Statements Source

Documents

Trial Balance Journals

Ledger
Expanded Accounting Cycle INTELLECT MANAGEMENT SERVICES
Trial Balance
as at 30 June 2019

Transactions

Financial Statements Source

Documents

Trial Balance Journals

Ledger
Chart of Accounts
l Listing of the complete ledger
account titles and their related
numbers.
l Used in both manual and
computerised accounting
systems.
l Simple numbering system of
accounts in consecutive order.
l Categorised into asset, liability,
equity, income and expenses.
l Numbers should be spaced to
allow for new accounts to be
inserted if and when required
The Accounting Information System

l Information will only be recorded as a transaction if it fulfils

the following characteristics
l Legal and economic concept of exchange
l Past – historical cost

l Involve an external party

l Evidence – can be verified

l Dollars

l (note these are similar to the characteristics used in

defining elements!!)
General Journal

l Book of original entry, first place that a transaction is

recorded in the accounting information system.
l First step of internal control.

General Journal Pg 1
Post
Date Details Ref Debit Credit

Jul-01 Bank 001 10,000

Capital 300 10,000

Owner contributed cash to commence
business
General Journal Recording

l Step 1 – identify two or more accounts involved in the

transaction.
l Step 2 – identify if the accounts are é or ê.
l Step 3 – apply the rules of debit and credit or “PALER”.
l Step 4 – record the transaction in the GJ.
l Step 5 – check to make sure that the DR = CR.
The ledger account

l A ledger account – used to record and summarise what has

happened to a particular account over time.
l Accounts are summaries of the recorded transactions, i.e like a
filing system.

Ledger – individual General Ledger – group of

account individual ledgers
Types of Ledger a/cs - “T” accounts

Account Name : Account Number:

Date Particulars Post Amount Date Particulars Post Amount
Ref Ref

Debit or DR side Credit or CR side

Types of Ledger a/cs – Columnar
or running balance

Account Na m e : Account Num be r :

Da te P a rticula rs P ost De bit Cre dit Ba la nce
Re f De bit Cre dit
Posting the Journal to the ledger

l From the General Journal, post the debit entry amount to

debit side of particular ledger a/c
l post credit entry amount to credit side of particular ledger a/c
l cross referencing / swap corresponding a/c titles in each
ledger
Posting the Journal to the ledger
General Journal Pg 1

Date Details Post Ref Debit Credit

Jul-01 Bank 100 10,000
Capital 300 10,000
Owner contributed cash to commence business

Cash at Bank Capital

Jul 1 Capital 10,000 Jul 1 Bank 10,000

Balancing “T” Ledger Accounts

l Columnar accounts maintain a running balance

l “T” accounts :
l necessary to find the difference between the two amounts
on each side of the account.
l Step 1 – identify the type and nature of account i.e. assets

l Step 2 – add up DR side

l Step 3 – add up CR side and deduct from DR side to

determine final balance
 Cash at Bank

Capital 10,000 Rent 1,000

Sales 4,000 Wages 1,500
A/C Receivable 2,000 Advertising 300
Interest Receiv’d 80 Stationery 60
Inventory 3,500
6,360
Bal at end 9,720
16,080 16,080

Op Bal 9,720
Trial Balance
l Used to identify errors in the recording process.
l a list of all accounts and balances.
l prepared after the balances in each ledger account.
l accounts are listed in the order of the chart of accounts.
l debit and credit column must be equal. This should follow on
from the rules of double entry.
l heading - business name, Trial Balance, as at..
l Used as a basis for preparing financial statements!!

DR CR
Trial Balance Issues !!

A trial balance won’t show errors where:

l correct amount entered in the wrong accounts
l incorrect amount used for both the debit and credit side
of the T.Balance
ie Dr $1079... Cr $1097
l a transaction is omitted
Identifying errors in Trial Balance
1. Check totals
2. Calculate difference between totals
l Divisible by 2 – entry omitted or recorded as Dr / Cr

l Divisible by 9 – may be transposition (rearranging

numbers ie $4,160 as $4,610), or slide (moving decimal
place $4,610 to $461)
3. Compare balances in TBal with bal in general ledger.
4. Recalculate balances in general ledger.
5. Verify debits = credits in original journal entry.
6. Check postings from general journal to general ledger.
Correcting errors

l Correcting prior to posting to the general ledger – cross out

the error so that it can still be seen, and record the correct
entry.

General Journal Pg 1
Date Details Post Ref Debit Credit

Jul-10 Bank 100 10,000

Accounts Receivable 105 10,000

Customer paid money owing on account
Correcting errors cont.

l Correcting prior to posting to the general ledger – cross out

the error so that it can still be seen, and record the correct
entry.

General Journal Pg 1
Date Details Post Ref Debit Credit
1,000
Jul-10 Bank 100 10,000
1,000
Accounts Receivable 105 10,000
Customer paid money owing on account
Correcting errors cont.

l Correcting after posting – necessary to record a journal entry

to correct.
l A debtor paid $1,000 that was incorrectly recorded and
posted to the sales account, the entry to correct would be:

General Journal Pg 1
Date Details Post Ref Debit Credit
Jul-25 Sales 400 1,000
Accounts Receivable 105 1,000
Entry to record receipt of money from debtor incorrectly recorded
and posted to the sales account.
Topic Summary

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the opportunity to write your own
summary notes for topic 1.
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Subject Outline so that you are
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