GAAP AND REVISION. DEFINITION OF ELEMENTS OF FINANCIAL STATEMENTS Revision concepts

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Ilene Griffith
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GAAP AND REVISION INTRODUCE THE GENERALLY ACCEPTED ACCOUNTING PRINCIPLES (GAAP) Accounting standards The Conceptual Framework Accounting concepts & principles CONCEPTUAL FRAMEWORK Describes objective

1 GAAP AND REVISION INTRODUCE THE GENERALLY ACCEPTED ACCOUNTING PRINCIPLES (GAAP) Accounting standards The Conceptual Framework Accounting concepts & principles CONCEPTUAL FRAMEWORK Describes objective of and concepts for financial reporting Purpose o Assist IASB to develop Standards based on consistent concepts o Assist preparers to develop consistent accounting policies when no Standard applies to a particular transaction/event o Assist all parties to understand and interpret the Standards CF isn't Standard but guides preparation of Accounting Standards Set of Concepts defining the nature, purpose and content of general purpose of financial reporting Used by preparers and standard setters OBJECTIVE OF GENERAL PURPOSE FINANCIAL REPORTING AND THE REPORTING ENTITY Objective o 1st element and foundation of conceptual framework Provide financial info about reporting entity useful to existing and potential equity investors, lenders and other creditors for making decisions about providing resources to entity Info useful should be based on ethical accounting practices Info based on ethical accounting practices possess number of qualitative characteristics Reporting entity o Entity which it s reasonable to expect the existence of users who depend on general purpose financial reports to make eco decisions o Entity which prepares general purpose financial reports according to accounting standards QUALITATIVE CHARACTERISTICS Relevance- Fundamental Faithful representation- Fundamental Comparability- Enhancing Verifiability- Enhancing Timeliness- Enhancing Understandability- Enhancing Constraints o Benefits to costs DEFINITION OF ELEMENTS OF FINANCIAL STATEMENTS Revision concepts IDENTIFY THE ELEMENTS OF THE FOUR MAIN FINANCIAL STATEMENTS Main financial reports o Statement of Profit or Loss Reports profit/loss Revenues less expenses for a particular period of time Purpose is to report success/failure of entity's operations for period of time Main elements Income- revenues and gains Expenses- expenses and losses o Statement of Financial Position Reports assets and claims on those assets at a specific point in time Based on basic accounting equation Main elements Assets Liabilities Equity o Statement of Changes in Equity 1

o Reports total comprehensive income for the period and changes in equity Elements Profit Retained earnings Dividends Capital contributions Revenue Statement of Cash Flows Reports net cash

2 o Reports total comprehensive income for the period and changes in equity Elements Profit Retained earnings Dividends Capital contributions Revenue Statement of Cash Flows Reports net cash provided/used during period Elements Cash receipts Cash payments REVISE THE ACCOUNTING CONCEPTS AND PRINCIPLES Monetary principle Accounting entity concept o Owners personal transactions shouldn t be accounted for in business records Accounting period concept o Life of business can be divided into periods more accurately reflects profits Going concern principle o Statements should be prepared on a going concern basis unless the entity will cease trading or go into liquidation Full disclosure principle o Requires any info that could impact decisions of users should be disclosed in the financial statements Materiality REVIEW DEBITS & CREDITS, JOURNALS, POSTING TO LEDGER AND TRIAL BALANCE Accounting transactions and events must be recorded as they effect assets, liabilities and equity Accounting equation must always balance o Assets = Liabilities + Equity Accounting process o Analyse each transaction in terms of effects on accounts o Enter transaction info in a journal o Transfer journal info to appropriate accounts in ledger Running balance format vs T account format Balance each of ledger accounts o Prepare a trial balance OVERVIEW RATIO ANALYSIS FOR EVALUATING ENTITY S PROFITABILITY, LIQUIDITY AND SOLVENCY Ratio analysis o Highlights relationships among items of financial statement data o Expressed as percentages, rates or proportions Insights into underlying conditions/helps in evaluations o May not be apparent from simply viewing financial statements Other info o Industry averages, economic conditions Main analyses o Profitability, liquidity, solvency Profitability o Measure operating success of an entity for a given period of time Profit margin Measures % each sales dollar that results in profit Liquidity o Short-term ability to meet current obligations Current ratio Current assets/current liabilities 1.5:1 accepted ratio Solvency o Measures ability of entity to survive over long period of time Debt to total assets ratio Total liabilities/total assets Higher debt more income needed to cover interest 2

ACCRUAL ACCOUNTING CONCEPTS DIFFERENTIATE BETWEEN CASH AND ACCRUAL BASIS OF ACCOUNTING Cash-based accounting o Revenue recognised when cash is received o Expenses recognised when cash is paid o

at time when goods delivered and services provided o Expenses recognised when reduction in assets/increase in liabilities become probable and can be measured reliably o Usually occurs when decrease

3 ACCRUAL ACCOUNTING CONCEPTS DIFFERENTIATE BETWEEN CASH AND ACCRUAL BASIS OF ACCOUNTING Cash-based accounting o Revenue recognised when cash is received o Expenses recognised when cash is paid o Profit/loss difference between cash in/cash out Accrual-based accounting o Revenue recognised when increase assets/decrease liabilities become probable and can be measured reliably o Usually occurs at time when goods delivered and services provided o Expenses recognised when reduction in assets/increase in liabilities become probable and can be measured reliably o Usually occurs when decrease in future eco benefits for g/s received EXPLAIN CRITERIA FOR REVENUE AND EXPENSE RECOGNITION Accounting period concept o Economic life of a business divided into artificial periods for reporting purposes Revenue recognition criteria o Recognised in period when increase in asset/decrease in liabilities become probable and measured reliably Expense recognition criteria o Recognised in period when decrease in asset/increase in liabilities become probable and measured reliably Revenue and expense criteria o Form part of generally accepted accounting principles (GAAP) EXPLAIN WHY ADJUSTING ENTRIES ARE NEEDED AND IDENTIFY THE MAJOR TYPES OF ADJUSTING ENTRIES Prepayments 1. Prepaid expenses Cash outflow precedes the entity receiving goods or services 2. Revenue received in advance Cash inflow precedes the entity supplying goods or services to customers Accruals 1. Accrued revenues Amounts not yet received or recorded for which goods or services have been provided 2. Accrued expenses The receipt of goods or provision of services precedes cash outflow to suppliers PREPARE ADJUSTING ENTRIES FOR PREPAYMENTS AND ACCRUALS PREPAYMENTS Prepayments are initially treated as assets/expenses Adjustment is needed for the expired future economic benefit Adjustment needed to recognise future economic benefit that remains in the asset Adjustment needed for amount of revenue no long in advance We prepare adjusting entries at the end of accounting periods ACCRUALS Accrued revenues o Revenues haven't been received and unrecorded at end of reporting period o Even though goods have been delivered/services provided to customers o Revenue and receivable recorded when cash received the receivable reduced Accrued expenses o Expenses not yet paid/recorded at end of reporting period o Even though goods have been delivered/services provided by suppliers o Expense and payable recorded when cash paid the payable reduced 3

DESCRIBE THE NATURE AND PURPOSE OF THE ADJUSTED TRIAL BALANCE Adjusted trial balance is prepared after all adjusting entries have been made Used to prove the

statements Statement of profit or loss prepared from revenue and expense accounts Current period profit and dividends paid transferred to retained earnings account

revenues, expenses, dividends Permanent accounts o Carried forward to future accounting

4 DESCRIBE THE NATURE AND PURPOSE OF THE ADJUSTED TRIAL BALANCE Adjusted trial balance is prepared after all adjusting entries have been made Used to prove the equality of total debit balances and total credit balances after adjusting entries are made Adjusted trial balance is the main basis for preparation of the financial statements Statement of profit or loss prepared from revenue and expense accounts Current period profit and dividends paid transferred to retained earnings account Statement of financial position prepared from A, L, E and balance of retained earnings accounts EXPLAIN THE PURPOSE OF CLOSING ENTRIES Temporary accounts o Relate to only one accounting period o E.g. revenues, expenses, dividends Permanent accounts o Carried forward to future accounting periods o E.g. assets, liabilities, equity Closing entries o Used to transfer the balances in temporary ledger accounts to a permanent equity account Retained earnings or capital o Close temporary accounts for new accounting period Resent to zero balance Each revenue and expense account closed to Profit or Loss Summary o Temporary account Profit or Loss Summary account closed to Retained Earnings Dividends closed to Retained Earnings Will result in all temporary accounts having closing balance of zero REVENUE EXPENSES PROFIT OR LOSS SUMMARY 4

DIVIDENDS PREPARING A POST-CLOSING TRIAL BALANCE List of permanent accounts and their balances after closing entries journalised and posted Purpose is to prove equality

THE REQUIRED STEPS OF THE ACCOUNTING CYCLE 1. Analyse transactions 2. Journalise transactions 3. Post transactions 4. Prepare trial balance 5.

Post-closing trial balance DESCRIBE THE PURPOSE AND BASIC FORM OF A WORKSHEET Worksheets are spreadsheets prepared manually/electronically to assist in preparation of

5 DIVIDENDS PREPARING A POST-CLOSING TRIAL BALANCE List of permanent accounts and their balances after closing entries journalised and posted Purpose is to prove equality of permanent accounts carried forward to next accounting period Sole proprietorship o Replace retained earnings with capital o Replace dividends with drawings DESCRIBE THE REQUIRED STEPS OF THE ACCOUNTING CYCLE 1. Analyse transactions 2. Journalise transactions 3. Post transactions 4. Prepare trial balance 5. Journalise and post adjusting entries 6. Adjusted trial balance 7. Prepare financial statements 8. Journalise and post-closing entries 9. Post-closing trial balance DESCRIBE THE PURPOSE AND BASIC FORM OF A WORKSHEET Worksheets are spreadsheets prepared manually/electronically to assist in preparation of adjusting entries and preparation of financial statements Worksheet not permanent accounting record Neither journal/general ledger Merely a device used to make it easier to prepare adjusting entries and financial statement 5

ACCT1006 Notes TYPES OF FINANCIAL STATEMENTS

ACCT1006 Notes TYPES OF FINANCIAL STATEMENTS - 4 financial statements o Statement of changes in equity Changes in OE s capital, reserves, and earnings How aspects in OE change over the period o Statement