ACC30105 Principles of Accounting

LECTURE 1: Understanding Accounting Equation Concept

Learning Objectives
After studying this chapter, you should be able to: Explain the nature of accounting and its main function Identify the users of accounting information Understand the role of accounting in decision making Understand the differences between accounting for management and accounting for external users Understand the importance of ethics in business Understand the different areas of the economy in which accountants work

What is Accounting?

A service activity To provide and interpret financial information which is useful for making economic decisions

Definition of Accounting

The process of

identifying measuring recording communicating

economic information to allow informed judgments and economic decisions by users of the information.

Role of Accounting in Business

People make decisions Business transactions happen Accountants prepare reports to show the results of business operations

Types of Business Entities

Sole traders Partnerships Companies

Sole Traders

Owned by one person Owners supply cash/assets to business Owners entitled to all profits Owner legally liable for debts Not a separate legal entity But is a separate accounting entity

Partnership

A relationship between two or more people, carrying on a business with the aim to generate profits Three main criteria:

Must have agreement (oral or written) between two or more legally competent persons or entities to carry on a business An aim to earn profits Members must be co-owners of business

Partnership

Partners supply resources and share profits Not a separate legal entity Individual partners are personally liable Is a separate accounting entity

Characteristics of Partnership

Mutual agency Unlimited liability

Characteristics of Partnership

Partnership interest can be sold off legally Limited Life

can be dissolved through

death of a partner bankruptcy of partnership or individual partner expiration of period specified in contract judgment by court

Companies

Limited company by shares

personal liability of members is limited to the par value of their shares and the number of shares taken by them

Advantages and Disadvantages of Different Types of Business Entity

Sole Proprietorship: Advantages

easy and least expensive form of business owner in complete control owner receives all income easy to dissolve
unlimited liability owner personally liable limited source of funds hard to attract talented employees

Sole Proprietorship: Disadvantages

Advantages and Disadvantages of Different Types of Business Entity

Partnership: Advantages

pool resources and multiple skills easier and less costly to establish not subject to much government regulation/supervision flexible not subject to board of directors tax advantages
unlimited liability can be liable for other partners actions in relation to the partnership limited life

Partnership: Disadvantages

Advantages and Disadvantages of Different Types of Business Entity

Companies: Advantages

limited liability broad source of capital continuity of existence transferability of shares use of professional management
greater regulation separation of ownership and management higher cost of incorporation

Companies: Disadvantages

Basic Accounting Terminologies

Assets

resources controlled by the entity result of past events future economic benefits expected to flow into the entity the amount can be reliably measured

Basic Accounting Terminologies (cont)

Liabilities

present obligation of the entity arising from past events settlement expected to result in outflow of economic benefits from the entity the amount can be reliably measured

Basic Accounting Terminologies (cont)

Income/Revenue

increase in economic benefits inflows or enhancements of assets decrease in liabilities not including receipts from shareholders/business owners

Basic Accounting Terminologies (cont)

Expenses

decrease in economic benefits outflow or depletion of assets

Basic Accounting Terminologies (cont)

Capital/Equity

resources supplied by the owners/shareholders

Users of Accounting Information

Internal and External Users

Internal

Employees Managers Chief Executive Officers (CEO) General Managers Accounts Managers Special Purpose Financial Report

Users of Accounting Information (Cont)

External

Shareholders Lenders/Bankers Potential Investors Creditors Government General Purpose Financial Report

Management and Financial Accounting

Management Accounting

concerned with providing financial and other information to all levels of management

Financial Accounting

concerned with reporting information to users that are external to an entity/business.

Accounting Concepts

Established concepts to guide the preparation of financial statements To ensure objectivity and consistency in the way financial information is prepared

Historical Cost Concept/Cost Concept

Assets are normally shown at cost price and this is the basis for valuation of assets

so that every one can agree on the same amount

Meaningful comparison can be made

Money Measurement Concept/ Monetary Assumption

Money is used as the common measurement by which economic activity is measured and reported

Accounting information is concerned with the following:

measurable in monetary units most people will agree to the measurement used

Business Entity Concept/ Accounting Entity Concept

Activities of the entity are separated from both the personal activities of the owners and other entities The only time when the owners resources affect accounting record is:

owner brings in new/additional capital drawings (money, inventory, other assets)

Separate Legal Entity Concept

A company is not seen as being exactly the same as its shareholders/owners A company can sue one or more of its shareholders A shareholder can sue the company Only apply to Limited Company

not partnership and sole proprietorship

Dual Aspect Concept

There are two aspects of accounting

assets of the business claims against those assets

These two aspects are always equal to each other

Assets = Capital + Liability

Time Interval Concept/ Period Assumption

Life of an entity can be subdivided into arbitrary time periods of equal length For periodic determination of financial performance and financial position Reports can be monthly/annually/quarterly Term

accounting period

Accrual Basis Assumption

The effects of all transactions and other events are recognized in the accounting records during the period in which they occur Not when cash is received or paid Provides better information for users

Going Concern Assumption/ Continuity Assumption

Financial reports are prepared under the assumption that the entity will continue to operate for the foreseeable future Foreseeable future

12 months

Disclosure of Accounting Policies

Accounting policies used must be disclosed in the notes to the accounts e. g., depreciation methods, valuation of inventory

Qualitative Characteristics of Financial Statements

Understandability Relevance Free or error Substance over form Neutrality Prudence Completeness Comparability

Understandability

Information in financial statements should be readily understandable by users.

Relevance

Information relevant for users decision making Material information are relevant Information is material if its omission or misstatement could influence decisions of users. Every information that appears in financial statements should be material

Substance Over Form

The legal form of a transaction is different from its real substance

e. g., car on hire-purchase legally, the car belongs to the bank until installments are fully paid however, the car is used by the business and generating benefits from it therefore, the business will treat it as an asset

Neutrality & Completeness

Neutrality

Information in financial statements is free from bias Information presented in the financial reports should be complete

Completeness

Prudence

Accountants must exercise caution when dealing with uncertainty Do not overstate assets and income Do not understate liabilities and expenses

Comparability

Comparability requires consistency Treatment of transactions must be consistent throughout an entity and over time for that entity Then only financial information is comparable

Accounting as a Profession

Public Accounting

Auditing and Assurance Services Taxation Services Advisory Services Insolvency and Administration

Accounting as a Profession

Accountants in Commerce and Industry

General Accounting Cost Accounting Accounting Information System Budgeting Taxation Accounting Internal Auditing and Audit Committee