Introduction to Financial Accounting notes

What is Accounting? It is an information system or process that:

• Identifies (Select transactions)
• Records (Record, classify and summarise)
• Communicates (Prepare accounting reports)

Why is Accounting important?

Decisions are made based on the information provided. Accounting information conveys
information about business performance to others. Poor accounting practices by businesses can
produce information that is inaccurate or misleading. This can lead to corporate collapses and
financial ruin for many people involved.

The Role of Accounting

Accounting is a process that identifies, records, and communicates information for decision-
making purposes. The users of accounting can be classified as:

1. Internal Users
They are managers who plan, organise and run the business. Detail ad frequent information is
needed by them to make decisions on a day to day basis. For example:
• Chief executive officers (CEOs)
• Chief financial officers (CFOs)
• Marketing managers
• Production supervisors
• Other employees

2. External Users
They vary in their nature and information requirements. For example:
• Investors: shareholders (they use information to make decisions to buy, hold or sell shares).
• Creditors/Lenders: suppliers, bankers (they use information to evaluate risks of giving credit
and lending money).
• Government and regulatory bodies: ATO, ASIC (they use information to determine an entity’s
compliance
with rules and regulations).

Forms of Business Organisations

Sole proprietorship (sole trader):
Owned by one person, for example:
• Lawn mowing business
• Handyman business
Partnership:
Owned by more than one individual, for example:
• Accountants
• Solicitors
• Doctors
Company:
Organised as a separate legal entity and owned by shareholders. Most companies have limited
liability. For example:
• BHP
• CSR
• Westpac
What is the Conceptual Framework?
The conceptual framework can be considered the general principles of financial reporting. It is
the underlying set of concepts and theory that underpins accounting. It is used as the basis for
developing specific accounting rules and regulations. They define the nature, subject and content
of accounting.

The AASB Framework

The AASB Framework contains the following:

• Assumptions underlying financial reports:
1. Going Concern: The entity is assumed to continue indefinitely.
2. Accrual Basis: Transactions are recorded whey they occur rather than only when cash is
received/paid.
• Objective of financial reports: To provide financial information about the reporting entity that
is useful to existing and potential investors, lender and other creditors in making decisions about
providing resources to the entity.
• Qualitative characteristics of financial reports: Qualitative characteristics are the attributes that
make the information provided in financial statements useful to
users.
The characteristics are:

Fundamental Characteristics:
- Relevance: If it influences users’ economic decisions through feedback or confirmatory value
and comparability.
Materiality: does its omission or misstatement affect decision making.
- Faithful Representation: It is complete, neutral and free from error.

Enhancing Characteristics:
- Comparability: It must be able to compare financial statements over time and between entities.
- Verifiability: Different knowledgeable and independent observers can reach consensus.
- Timeliness: Financial information should be available to decision makers in time to be capable
of influencing their decisions.
- Understandability: It is readily understandable by users assumed to have a reasonable business
knowledge.

• Elements of financial reports and their recognition criteria:

1. Assets: It is a resource controlled by the entity as a result of a past event and from which
future economic benefits are expected to flow to the entity. Essential characteristics:
• Control by the entity
- Capacity of the entity to benefit from the asset and deny or regulate the access of others.
- Does not necessarily mean ownership.
• Occurrence of past event
- Transaction or other event giving the entity control of the asset must have occurred.
• Future economic benefits
- Potential to contribute, directly or indirectly, to the flow of cash to the entity.
- Generate cash flows through the sale of, or use of, the asset.
Assets can be categorised into current and non-current:
• Current assets:
- Items converted to cash within one year. (e.g. inventory)
- Items consumed within one year. (e.g. office stationery)