ACCOUNTING PRINCIPLES

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1 ACCOUNTING PRINCIPLES ENTITY The business must be a separate accounting entity from its owner and from other entities. This includes multiple businesses as they are each a separate accounting entity in their own right so informed decisions can be made. It is important to identify for whom we are preparing financial reports. The isolation of drawings in the Owner s Equity section is an example of this principle. QUESTION 6 Matt owns an interior design business and his partner Nathan owns an architectural business. They plan to combine the financial results of both businesses. Explain how the entity principle and a qualitative characteristic is being breached if this plan is adopted. MONETARY UNIT In order to record financial events and understand the meaning of reported information it is necessary to use a common unit of measurement: the Australian dollar. GOING CONCERN It is assumed that the business will be ongoing. The business will have an indefinite life. The purpose of this rule is so that a distinction can be made between assets, which will provide benefit to future reporting periods, and expenses that are totally consumed within one reporting period. The principle allows accountants to cater for transactions that overlap over two consecutive years (credit transactions) credit sales and credit purchases of stock. Accountants can report long-term assets on Balance Sheet compared to being written off as expenses in their year of purchase Direct Link Reporting Period Principle. The School For Excellence 2016 The Essentials Unit 3 Accounting Book 1 Page 11

2 QUESTION 7 Explain how the Going Concern Principle is reflected in the reporting of depreciable Non- Current Assets in the Balance Sheet. Motor Vehicle $50,000 Less: Accumulated Depreciation 15,000 35,000 HISTORICAL COST Transactions are recorded at their original value (as this is reliable). Items are shown in the accounting records at their original price. QUESTION 8 The owner also contributed a motor vehicle to the business that was originally purchased for $40,000. The accountant and the owner determined the vehicle s agreed value to be $25,000. Discuss why agreed value should be used and not historical cost in this instance. The School For Excellence 2016 The Essentials Unit 3 Accounting Book 1 Page 12

3 CONSISTENCY The accounting methods used by the business should be applied consistently from one reporting period to another to enable meaningful comparisons to be made. QUESTION 9 The owner wants to change the depreciation percentage on his assets to reduce his expenses in the next period. Explain why this is breaching an accounting principle. CONSERVATISM It is acknowledged that gains will not be recognised until earned and losses will be recognised as soon as they are likely to occur. This will avoid overstating assets and revenue and understating liabilities/expenses. QUESTION 10 The stock on hand of $28000 could be sold for $ The owner wants to record this revenue and related profit in this reporting period. Explain why is this not an acceptable accounting practice? The School For Excellence 2016 The Essentials Unit 3 Accounting Book 1 Page 13

4 REPORTING PERIOD The ongoing life of a business is broken into regular intervals of time for the preparation of accounting reports. Profit is calculated by matching revenue earned against expenses incurred in a particular reporting period for the purposes of decision-making. Jul 2015 Aug Sep Oct Nov Dec Jan 2016 Feb Mar Apr May Jun QUESTION 11 The owner has recommended to the accountant that he should not worry about including any amounts for unpaid wages as they will be definitely paid in the next reporting period. Explain why the owner is incorrect. QUALITATIVE CHARACTERISTICS RELEVANCE To be useful, information must be relevant to the decision-making needs of users. Information has the quality of relevance when it influences the economic decisions of users by helping them evaluate past, present or future events or confirming, or correcting their past evaluation. Materiality provides a cut-off point which information must have if it is to be useful. The omission or misstatement could influence the economic decisions of users taken on the basis of the financial report. It depends on the size of the item or error. Items that are too small or insignificant to affect decision-making may be considered to be immaterial, meaning they can be reported in the value of a larger item or omitted from the reports. Materiality Example Relevance allows us to omit from the Balance Sheet $1.95 spent on stationery (as it is such a small amount) and instead report this as an expense. Inclusion (or exclusion) in the Balance Sheet will not affect decision making in any material way. The School For Excellence 2016 The Essentials Unit 3 Accounting Book 1 Page 14

5 QUESTION 12 The business has more than 40 debtors and the owner believes that they should be individually listed in the Balance Sheet. How would the characteristic of relevance deal with this issue? QUESTION 13 A school has a stock of stationery items that are consumed on a regular basis. Items include pens, glue, staplers, rulers, etc. Determine the treatment of these all these stationery items as stationery in the Balance Sheet. RELIABILITY Reports must reflect what they say without bias or undue influence. This is achieved when reports are prepared from verifiable evidence, such as source documents. QUESTION 14 Explain how the use of time sheets to record wages is an example of reliability. UNDERSTANDABILITY An essential quality of the information provided in financial reports is that it is readily understandable by users. For this purpose, users are assumed to have a reasonable knowledge of business, economic activities and accounting, and a willingness to study the information with reasonable diligence. However, information about complex matters should be included in the financial report because of its relevance to the economic decisionmaking needs of users, and should not be excluded merely on the grounds that it may be too difficult for certain users to understand. Reports presented in such a way that users with limited accounting knowledge are able to comprehend their meaning. Present reports in a format that users can understand using headings and sub-headings, totals and sub-totals, graphs, tables or charts. The School For Excellence 2016 The Essentials Unit 3 Accounting Book 1 Page 15

6 QUESTION 15 The business is currently facing a law suit for selling genetically modified seeds to unsuspecting customers. The lawyer estimates potential damages at $100,000. The owner believes that this should be ignored until the case is resolved. He also believes that the issue is too confusing for investors and other users of the financial information. Explain with reference to two qualitative characteristics why this information should be reported. Can you also identify an Accounting Principle that would apply to this situation? COMPARABILITY For reports to be useful there is a need to use similar accounting methods, both over time and between different businesses in order to effectively compare results when making decisions. The measurement and display of the financial effect of like transactions and other events must be carried out in a consistent way throughout an entity and over time and in a consistent way for different entities. QUESTION 16 Explain the link between the Accounting Principle of Consistency and the Qualitative Characteristic of Comparability. The School For Excellence 2016 The Essentials Unit 3 Accounting Book 1 Page 16

7 QUESTION 17 Balance Sheet as at 31 st January 2016 $ $ Current Assets Bank Stock Control Debtors Control Prepaid advertising expense ,700 Non-Current Assets Vehicle Less Accumulated Depreciation ,500 Total Assets 159,200 Current Liabilities Accrued wages 200 Creditors Control Loan NAB Non-current Liabilities Loan NAB Owner s Equity Capital Plus: Net Profit Less: Drawings ,000 Total Equities 159,200 Remember that the Balance Sheet represents the accounting equation for just one day in the life of the business. The School For Excellence 2016 The Essentials Unit 3 Accounting Book 1 Page 17

8 Identify where the Qualitative Characteristics are evident in the Balance Sheet. Relevance, Reliability, Understandability, & Comparability Identify where Accounting Principles are evident in the Balance Sheet. Monetary, Consistency, Reporting Period, Conservatism, Going Concern, Historical Cost & Entity Relevance Reliability Understandability Comparability Monetary Consistency Reporting period Conservatism Going concern Historical cost Entity The School For Excellence 2016 The Essentials Unit 3 Accounting Book 1 Page 18

9 Date Creditor Invoice No. TEMPLATES Purchases Journal Stock Control GST Creditors Control Sales Journal Date Debtor Invoice No. Cost of Sales Sales GST Debtors Control Cash Receipts Journal Date Details Rec. No. BANK Disc. Exp. Debtors Control Cost of Sales Sales *** Sundries GST To calculate the BANK figure: ignore Cost of Sales, subtract discount expense from Debtors Control and add all other column totals Cash Payments Journal Date Details Chq. No. BANK Disc. Rev. Creditors Control Stock Control *** *** Sundries GST To calculate the BANK figure: Subtract discount revenue from Creditors Control and add all other column totals. General Journal General Ledger Subsidiary Ledger Date Details Debit Credit Debit Credit GENERAL ADVICE The details in the General journal, cash receipts & cash payments journals must be the ledger account name that will be debited or credited. How do students post from the journals? When posting into the general ledgers from the general journal and special journals the date shown should be the end of month date. The actual date of the transaction is used only in the subsidiary ledgers. What is contained in the narration for a General Journal entry? The narration should include a cross reference of the transaction being recorded. Reference should be made to document numbers or source documents (including memos). If it is a stock gain or loss include the quantity and stock item and unit cost in the narration. The narration needs to be very specific and detailed. The School For Excellence 2016 The Essentials Unit 3 Accounting Book 1 Page 19

10 GENERAL LEDGERS STOCK CONTROL The actual name of the ledger account must be used at all times when recording in journals & ledgers. Dates are posted at the end of month from the general & special journals. Date Date Cross Reference Amount $ Cross Reference Amount $ Jan Balance 31 Jan Cost of Sales 3 31 Jan Creditors Control 1 Cost of Sales 3 1 Jan Balance Bank 2 Advertising 4 Stock Gain 6 Drawings 5 Stock Loss 6 Balance The cross reference is the name of the other ledger involved in the transaction. The totals of the debits and credits must be equal. The balancing amount will ensure this result. 1 Posted from purchases journal. Direct link with Creditors Control ledger but does not include GST. 2 Posted from the Stock column in the Cash payments Journal. 3 Posted from Cash receipts and Credit sales journals. 4 Stock used for promotion purposes. This will be posted from an internal memo. 5 Stock withdrawn by the owner for personal use. This will be posted from an internal memo. 6 Stock-take is higher or lower than the stock cards. This will be posted from an internal memo. The balance at the end of the period is carried forward to the start of the next period. This does not apply to revenues and expenses. Each entry must have a corresponding entry in the other account on the opposite side of that ledger and for the identical amount. This ensures that your trial balance will be arithmetically correct. In the example above: The Creditors Control, Bank and Stock Gain ledgers would have a credit for the same amount with the cross reference being STOCK CONTROL. The Cost of Sales, Advertising, Drawings and Stock Loss ledgers would have a debit for the same amount with the cross reference being STOCK CONTROL. The School For Excellence 2016 The Essentials Unit 3 Accounting Book 1 Page 20

11 SECTION 2 GOODS & SERVICES TAX GST

12 NO EFFECT Income Statement GST is collected on behalf of the Australian Government. It is not revenue or an expense. Net Assets (A L) do not change as a result of any GST transaction and therefore Owner s Equity cannot change. The business does not buy & sell GST. NO GST recorded on Stock Cards. Operating Activities Inflows Statement of Cash Flows GST received (cash sales) GST refund (received from ATO) Outflows GST payments (cash payments) GST paid to ATO (GST settlement) All 4 items relate to the Bank figures shown below in the GST Clearing Account RECORDING & REPORTING FOR THE GST Balance Sheet Balance in Clearing Account DEBIT CREDIT Current Asset Current Liability Refund due Owed To ATO GST charged by Creditors but not yet paid. No immediate effect on cash flow. However will be part of payment to creditors in the future. This will affect cash flow if refunds are received from ATO before payments to creditors. GST CLEARING ACCOUNT Balance Balance Bank (CPJ) Bank (CRJ) Creditors Control (PJ) Debtors Control (SJ) Bank (settlement) Bank (refund) (CPJ sundries) (CRJ sundries) Balance Balance GST charged to Debtors. Not yet collected. No immediate effect on cash flow. However will be part of debtor collections in the future. This will affect cash flow if debtor collection is slower than monthly or quarterly GST payments to ATO. The School For Excellence 2016 The Essentials Unit 3 Accounting Book 1 Page 21

13 GST (GOODS & SERVICES TAX) GST CLEARING Businesses collect 10% GST from their sales on behalf of the Australian Taxation Office. Businesses that pay 10% GST on their asset purchases and expenses reduce the amount required for payment to the Australian Taxation Office. The supplier is obliged to pay the 10% to the government. GST Charged on Credit Sales and GST Collected from Cash Sales GREATER THAN GST Charged on Credit Purchases of Stock and GST Paid on Expenses and Assets = CURRENT LIABILITY GST Charged on Credit Purchases of Stock and GST Paid on Expenses and Assets GREATER THAN GST Charged on Credit Sales and GST Collected from Cash Sales = CURRENT ASSET Rules! GST collected from the business Cash Sales increases their GST Liability. GST charged on the business Credit Sales increases their GST Liability. GST paid on cash purchases of assets and expenses decreases their GST Liability. GST charged on the credit purchases of stock decreases their GST Liability. GST does not get included in the Income Statement because it is neither revenue nor an expense. GST does not produce any change in Net Assets and therefore no change in Owner s Equity. GST on sales increases Assets (bank or debtors) and increases the GST Liability. No change in A L. GST on purchases and expenses decreases Assets (bank) or increases Liabilities (creditors) and decreases the GST Liability. No change in A L. The School For Excellence 2016 The Essentials Unit 3 Accounting Book 1 Page 22

14 EFFECT ON ASSET VALUES GST creates a separate Asset or Liability Account called GST Clearing. GST is not included in the cost of stock or the cost of non-current assets because it is not a business cost that can be used to generate revenue. The GST on purchases is recorded as a temporary asset (refund entitlement) or reduces an existing GST liability. If we included GST in the cost of assets we would then be expensing a government tax when we depreciated assets or sold stock. Credit Balance = Current Liability CLASSIFICATION OF GST GST is 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 in the next 12 months when the GST settlement is paid to the ATO. Debit Balance = Current Asset GST is 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 in the next 12 months when the refund is received from the ATO. GST CLEARING ACCOUNT Date Cross Reference Amount $ Date Cross Reference Amount $ Jan 31 Creditors Control (GST charged by suppliers) 500 Jan 1 Balance (Opening Balance) 300 Bank (GST paid on purchases) Bank (GST settlement to ATO) 350 Jan Debtors Control (GST invoiced to customers) Bank (GST received on cash sales) 1,000 Balance 950 2,100 2,100 Feb 1 Balance (Balance bought forward) 950 Only use the words in bold in your ledgers. All Bank items will be reported in the Statement of Cash Flows. A debit opening balance will result in a GST refund (credit entry) during the month. 800 The School For Excellence 2016 The Essentials Unit 3 Accounting Book 1 Page 23

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