The Nature of

Accounting
• The accounting information system
Select Process Produce
data data information

– Only data with an economic impact is

selected
– Processed through the accounting process
• bookkeeping v accounting

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 The Accounting
Information
System . . .
– Objective of financial statements is to
provide information about the financial
position, performance and changes in
financial position to a wide range of users in
making economic decisions
(IASB Framework)
• Information focuses on
– Financial position (Statement of financial position)
– Performance (Statement of Profit or Loss)

2
 Information for
Decision Making
• Forecasting cash flows
– External users need to predict the entity’s future
performance and future cash flows
• external users (primary and other) do not have
access to data to generate cash forecasts
• internal users (management) have information,
but reluctant to provide cash forecasts
– External users need to analyse current financial
position and past performance to assess future
financial position and performance
3
 Cash Basis of
Accounting
• Performance measured
as :
Cash inflows
- Cash outflows
= Net cash flow

• Cash investments by
owners and cash
distributions to owners
are excluded

4
 Financial
Statements

• The entity concept

– sole trader and partnership are unincorporated
entities, while CC and company are incorporated
entities
– financial statements prepared from perspective of
business entity, utilising entity concept
 • identification of business enterprise
• separation of recording of transactions of business
enterprise and owner

5
 Basis for Presentation
of
Financial Statements
• IAS 1
– Prescribes basis for presentation of general
purpose financial statements to ensure
comparability
• Format
– General features (Chp 2)
– Structure of financial statements
(Chp 6)
– Contents of financial statements
(Chps 11 to 16)
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 Purpose
of
• financial statements
• According to IAS 1, objective of financial
statements is to provide information about
the
– financial position
– performance
– cash flows
that is useful to users to make economic
decisions
• Consistent with objective stated in the
Accounting Framework
7
 Components
of
Financial Statements
• IAS 1 requires a complete set of financial statements
to include
– Statement of financial position
• Assets, liabilities and equity
– Statement of comprehensive income
• Income and expenses
– Statement of changes in equity
• Changes in wealth
– Statement of cash flows
• Cash flows
– Accounting policies and notes

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 Components
of
Financial Statements . . .
• IAS 1 requires income and expenses to be presented
– In two separate statements
• Statement of profit or loss
– Items of profit and loss
• Statement of comprehensive income
– Components of other comprehensive income
or
– In a single statement, the statement of comprehensive income
• Items of profit and loss
and
• Components of other comprehensive income

9
 Statement
of
Financial Position
• Assets
• Equity
• Liability

10
 Statement
of
Profit or Loss
• Income
• Expenses

11
 Lecture week 2
• Lecture Outcomes: you should be able to:
• 1. Understand the nature of Accounting
• 2. List the principles and concepts
• 3. Explain the elements of financial
statements
• 4. List the qualitative characteristics
• 5. Explain & record the Accounting Equation.
 Introduction
• The framework, provides a foundation that sets out
the objectives and concepts that underlie the
preparation and presentation of financial
statements. We will briefly explore the concepts and
principles on which the practice of accounting is
based.
 Principles
of
Accounting
• The Cost Principle
• The business purchases assets to produce
revenue/income. The business therefore has
to record these assets at the cost. E.g. if we
purchase land today R100 000 in 5 years
time it might be worth R500 000, yet we
record it as R100 000 in our books at cost
• The objectivity Principle
• Another reason for using cost rather than current
market values in accounting for assets is the need for
a definite, factual basis valuation.
• The Realization Principle
• When to record revenue: Revenue is recognised
when it is earned, without regard to when payment
is received.
• The Matching Principle
• When to record expenses: Expenses are incurred for
the purpose of producing revenue. The concept of
offsetting expenses against revenue on the basis of
“cause and effect” is called the matching principle.
• The Double entry principle
• With every debit there
• Should be a contra credit
• The entity Principle
• An entity or business should be defined. All
accounting practices then relate to the particular
entity. Therefore it is important that the affairs of
the owner are never intermingled with that of the
business
• Going concern assumption
• The statement of financial position (balance sheet) of
a business is prepared on the assumption that the
business is a continuing enterprise.
 Materiality
Threshold (If not material,
quality cannot be useful)

Constraints Timeliness Cost/benefit

QUALITIES THAT
MAKE
ACCOUNTING
INFORMATION
USEFUL

RELEVANCE RELIABILITY
Principal (Influences Trade off (Free from error or bias)
qualities decisions of users)

Ingredients of
principle Confirmatory value Prudence
qualities

Predictive value Substance over form

Completeness

QUALITIES, IF
LACKING WOULD
LIMIT THE
USEFULNESS OF
INFORMATION

COMPARABILITY UNDERSTANDABILITY
Principal (Over time and (users have reasonable
qualities between knowledge)
enterprises)

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 Financial Statements
Should be:
• Understandable - Financial Statements must be clear
and show enough detail.
• Relevant – Good Financial Statements should give
users the information that they are looking for so
that users can make decisions that concerns them.
• Reliable – Financial Statements must be accurate
and true. Must be free of significant errors.
 Cont…

• Comparable – Financial Statements must fit in with

others. Users should be able to compare Financial
Statements of different financial periods.
 Cont…

• Timely – “Don’t wait too long” Financial Statements

lose relevance as time passes so they must be on
time
• Cost-Effective – The value of information that users
get from Financial Statements should be more than
the cost of preparing them.
 GENERAL FEATURES

• Underlying assumptions relating to measurement of

financial statement items and reporting of those
items
• Considerations dealt with in IAS 1

– Accrual basis
– Fair presentation
– Going concern
– Consistency of presentation and comparative information
– Materiality and aggregation
– Offsetting
– Frequency of reporting 25
• Fair presentation
– IAS 1 requires that FS fairly present financial position,
performance and cash flows
– Consistent with Companies Act
– Fair presentation requires
• Faithful representation of the effects of transactions
• In accordance with the definitions and recognition
criteria of A, L, OE, I and E
• Going concern
– FS prepared on the basis that enterprise will continue
in operation for foreseeable future 26
• Consistency of presentation and comparative information
– Users need to compare different enterprises as well as a particular
enterprise over time
• Materiality and aggregation
– Item is material if it affects users decisions
– Material classes of similar items as well as dissimilar items are to be
presented separately
• Offsetting
– Assets & liabilities, income & expenses are reported separately
– Offsetting detracts from understandability
• Frequency of reporting
– Complete set of financial statements required to be presented
annually
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 Financial Year

• A financial year is 12 consecutive months

• E.g.
• 1January 2006 – 31 December 2006
• 1 June 2005 – 31 May 2006
• 1 March 2003 – 28 February 2004
 ASSETS

• A present economic resource controlled by the entity

as a result of past events An economic resource is a
right that has the potential to produce economic
benefits.
 Assets are Divided
Into 3 Groups
• 1.Non-Current/ Long-term Assets
These assets will be used for a period of more than 12
months (one year) e.g. Vehicles, Equipment.
• 2.Financial Assets
are cash, contractual rights to receive cash e.g. Investment,
Fixed deposit
• 3.Current Assets
These assets will be converted into cash within (less than)
12months. E.g.
Bank, Inventory, Debtors
 LIABILITIES

• A present obligation of the entity to transfer an

economic resource as a result of past events
• An obligation is a duty or responsibility that the
entity has no practical ability to avoid
 Liabilities are Divided
Into 2 Groups

• 1. Long-term/ Non current Liabilities

- e.g. Long-term/Mortgage Loans

• 2. Current Liabilities
- e.g. Creditors, Short – term loans
 Owners Equity

• The owner’s equity represents the owner’s claim on

the assets of the business.
 Owners Equity

• Capital (+) Increases

• Drawings (-) Decreases
• Income (+) Increases
• Expenses (-) Decreases

• Income - Expenses= Profit/Loss

 REVENUE
&
EXPENSE
• Income - Increases in assets, or decreases in
liabilities, that result in increases in equity, other
than those relating to contributions from holders of
equity claims
• Expenses - Decreases in assets, or increases in
liabilities, that result in decreases in equity, other
than those relating to distributions to holders of
equity claims
 Accrual Basis

• Items are recognised as

– assets, liabilities or equity and as income or
expenses
– when they satisfy the definitions and
recognition criteria
• Effects of transactions are recognised
– when they occur
– not when cash is received or paid
and are reported in the financial statements of
the periods to which they relate.
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 Accrual Basis . . .

• Only amounts earned in a period are

recognised as income
• Only amounts incurred in a period are
recognised as an expense

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 Cash Basis Compared
To
Accrual Basis
• Accrual basis income statement measures results
of operations or performance
– Income recognised as a measure of accomplishment
when earned
• goods sold or services provided
• not dependant on cash received
– Expenses included as measure of effort when incurred
• relates expenses to income
• not dependant on cash paid
• Cash basis factual, but may misrepresent the long
run cash generating ability of the business
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