INTRODUCTION TO ACCOUNTING THEORY AND PRINCIPLES

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Carmel Melton
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1 SECTION 1 INTRODUCTION TO ACCOUNTING CHAPTER 1 THEORY AND PRINCIPLES Note in many cases with theory based questions, alternative answers or additional information may be appropriate. Solution 1.1 Directors, management, shareholders, banks, customers, suppliers, government bodies and staff. Solution 1.2 Do they have the capacity to pay? Is the business a good credit risk? Do they have a good cash flow? Does the business have a profitable history? Have they borrowed money from other bodies? Have they already borrowed excessive amounts (gearing)? Solution 1.3 Business activity usually involves five basic activities or transactions: selling goods or providing services for either cash or on credit (including returns of goods by customers); purchasing goods or services for either cash or on credit (including purchase returns); cash receipts; cash payments; and other transactions, usually internally generated. Solution 1.4 Accounting is the process of collecting, classifying, recording, reporting, interpreting and analysing the effect of financial transactions on a business or organisation to provide information to owners, management and other interested parties. Solution 1.5 The functions of accounting are to: communicate financial information; assist in the decision-making processes; establish responsibility for various tasks; i

2 provide controls; and assist owners, management and other interested parties. Solution 1.6 Directors, management, shareholders, banks, customers, suppliers, government bodies and staff and any interested party who intends to use the financial information to make decisions Solution 1.7 Type of business ownership Advantages Disadvantages Sole trader Partnership Company easy and inexpensive to set up and operate easy to change to another legal structure independence and full control no sharing of profits little government interference and regulatory restrictions no need to have the business name registered minimal formal reporting requirements easy and inexpensive to set up and operate greater access to capital wider skill or knowledge base not all partners need to be active in the business easy to change to another legal structure little government interference and regulatory restrictions workloads, responsibilities, risks and losses can be shared income splitting with family members can reduce taxation shareholders have limited liability for company debts private companies can have up to 50 shareholders, whilst public companies can have thousands or even millions provides a larger potential capital base greater ability to borrow funds can hire shareholders as employees company has a life of its own and not dependent on the continuation of any one shareholder a clear distinction exists between the company and its management financial interests in the company (shares) can be disposed of by sale potential for more skilled management, by hiring professional managers unlimited liability for business debts limited resources available limitations on growth no sharing of workloads, risks or losses narrow skill base owner s death will terminate the business income sharing is difficult loneliness and isolation limits on borrowing capacity each partner has unlimited liability for business debts possible disagreement between partners danger of a bankrupt or insolvent partner acting carelessly profits must be shared as agreed in the partnership agreement death or bankruptcy may terminate the business more complex to set up, operate and terminate companies are strictly regulated by the Corporations Law and their own constitutions the actions of the directors are more closely monitored and subject to severe penalties in cases of neglect and fraudulent actions reporting requirements are greater and more extensive reporting requirements reduce the confidentiality and privacy of the company s activities and results Solution 1.8 Sole traders and partnerships. Solution 1.9

3 Business activity usually involves five basic activities or transactions: selling goods or providing services for either cash or on credit (including returns of goods by customers); purchasing goods or services for either cash or on credit (including purchase returns); cash receipts; cash payments; and other transactions, usually internally generated. Solution 1.10 (a) A customer pays cash for a purchase Copy of cash receipt (b) A business pays rent to building owner Cheque butt (c) A customer buys goods and agrees to pay later Copy of tax invoice (d) the stores manager informs the accounting department that Internal memorandum some inventory has been damaged or destroyed (e) the business receives a cheque from a customer Copy of cash receipt (f) the business makes a payment to the owner of the business Cheque butt (g) goods are returned by a debtor (accounts receivable) Copy of Adjustment (Credit) Note Solution 1.11 The first record that a business has of a transaction actually occurring is called a source document. Source documents record the details of the transaction and start the recording process of the transaction in the records of the business. The source document is the evidence that the transaction took place. The details recorded on the document can be used to prove the details of a transaction in the event of a dispute (examples will vary). Solution 1.12 It is important that all business transactions are recorded. Using accountable documents (e.g. pre-numbered) helps ensure the completeness of these records. Any missing numbers indicate an unrecorded transaction. Secure storage of accountable documents and documented policies and procedures help ensure accountability of these documents Solution 1.13 Details provided in the chapter. Solution 1.14 (i) sale of goods on credit Copy of tax invoice (ii) cash paid to a creditor (accounts payable) Cheque butt (iii) goods returned by a debtor (accounts receivable) Copy of adjustment note (iv) cash received from a debtor (accounts receivable) Copy of cash receipt Solution 1.15 Yes in the event that we need to find the source document in the future to clarify some aspect of the transaction. Solution 1.16 No solution provided. Solution 1.17 Cash accounting concerns the recording of transactions that have been finalised by the purchaser paying the supplier an amount in cash (and cash can include cash, cheque, credit card or EFTPOS). Accrual accounting is involved when the transaction concerned does not involve the actual payment by cash. Therefore, sales or purchases on credit represent accrual accounting. Accrual accounting also involves the recording of end of period adjustments. Solution 1.18 iii

4 All except (c) credit sales will not appear on the deposit slip. Solution 1.19 The GST is a broad-based consumption tax on the supply and consumption of most goods and services within Australia. Solution 1.20 (a) 10% of the cost is GST. Add 10% to the cost to calculate the total invoice value (b) Divide the total invoice vale by 11 to calculate the GST amount. Solution 1.21 (a) $1 320 (b) $90 (c) $ (d) $71 (e) $10 (f) $180 (g) $12.50 (h) $7.58 Solution 1.22 (a) $250 (b) $858 (c) $120 (d) $195 (e) $1 045 (f) $2 079 (g) $ (h) $ Solution 1.23 Transaction GST impact buys a computer valued at $2 000 $200 paid pays their commercial rent valued at $150 paid $1 500 buys stock valued at $5 000 $500 paid Total $850 Solution 1.24 GST = $1 650 / 11 = $150 Value of goods = $1 650 $150 = $1 500 Solution 1.25 GST = $2 260 * 10% = $226. Total invoice = $ $226 = $2 486 Solution 1.26 Transaction GST impact buys a motor vehicle valued at $ $2 500 paid pays their telephone account valued at 85 paid $850 buys stock valued at $ paid sells goods valued at $ (3 500) collected Total payable to ATO (615)

5 Solution 1.27 Assets: (a) land (d) computer equipment (f) cash at bank (h) accounts receivable (amounts owed to us) (j) factory machinery (l) warehouses (n) buildings (o) office furniture Solution 1.28 Liabilities: (c) loan from JLW Finance Company (d) bank overdraft (e) amounts due to suppliers (h) mortgage (i) GST collected (k) accounts payable Solution 1.29 (a) capital Owner s equity (b) plant Asset (c) loan from Sun Bank Liability (d) GST paid Asset (e) creditors Liability (f) premises Asset (g) petty cash Asset (h) mortgage on premises Liability (i) land Asset (j) inventory Asset (k) investments Asset Solution 1.30 (a) accounts Amounts owing by customers receivable (b) accounts payable Amounts owing to suppliers (c) inventory Goods purchased for resale by the business (d) GST collected GST on sales collected by the business and payable to the ATO (e) capital Net value of assets (less liabilities) introduced by the owner to the business (f) drawings Amounts (or assets) taken by the owner for their own personal use (g) income earnings of the business such as sales and fees received (h) expense costs of earning income such as wages and advertising expenses (i) mortgage Amount owning to a lender in relation to borrowing made by the business to acquire an asset (e.g. land and buildings) (j) profit the business makes a profit when the income earned is greater than the expenses (k) bank overdraft Where the business has paid more from their bank account than they deposited and therefore owe this money to the bank a short term or current liability. v

6 Solution 1.31 (a) stock asset (b) A Reubens (a debtor) asset (d) owner s interest in the business owners equity (f) loan from Blue Bank liability (g) cash at bank asset (i) GST collected liability (j) G Greig (a creditor) liability (k) cash withdrawn from the business by the owner for personal use owners equity (l) plant and equipment asset (n) loan to finance manager asset (q) motor vehicles asset (s) building asset (t) cash in petty cash tin asset Solution 1.32 (a) delivery costs Expense (b) sales Income (c) dividends received Income (d) cash Asset (e) shares in other companies Asset (f) rent Expense (g) loan from ACB Finance Liability Company (h) repairs and maintenance Expense (i) equipment Asset (j) bank overdraft Liability (k) interest received Income (l) sales commission paid Expense (m) salaries Expense (n) commission received Income (o) bank charges Expense Solution 1.33 (a) shares in Optecom Ltd Asset (b) rent received Income (c) accounting fees paid Expense (d) insurance Expense (e) GST collected Liability (f) mortgage Liability (g) telephone Expense (h) fees received Income (i) capital Owner s equity (j) shop fittings Asset (k) bank Asset Solution 1.34 Accounting conventions are accepted customs followed by the accounting profession. Accounting Doctrines refer to generally held beliefs or principles. Solution 1.35

7 Business entity convention This convention states that the business exists separately from the owner. The owner s assets or liabilities must not be included with the business assets and liabilities (also known as the accounting entity convention). Accounting period convention The life of the business (seen as indefinite as per the going concern convention) is divided into equal periods, usually of one year. Financial statements are prepared for each of these annual periods. Going concern convention This convention states that the life of a business will continue to exist for the foreseeable future. The financial statements of a business are prepared on this basis. Monetary convention Under this convention, all financial transactions are recorded in the accounting records of the business in Australian dollars. Solution 1.36 Doctrine of consistency This requires the business to follow the same accounting principles or methods from one accounting period to the next. For example, the valuation method used for inventory at the end of one financial year should be the same as that used at the end of the previous financial year. If there is some valid reason to change the valuation method, this reason and the financial impacts of the change should be disclosed in the financial statements. Doctrine of disclosure Under the doctrine of disclosure, the financial statements should be prepared at a sufficient level of detail to allow the owner (or any other interested party) to understand what has occurred in the reporting period and the current financial position of the business. Doctrine of materiality This doctrine states that all significant items relating to the operations of the business or its current financial position must be disclosed. This doctrine also extends to the level of accuracy in the financial statements in relation to reporting to the nearest dollar or the neared dollars. The size of the business will be the main determinant of this level of accuracy. Solution 1.37 (a) (b) Historical cost convention This convention assumes that the value of an asset, liability, income or expense remains unchanged and will be recorded at the actual amount that the business pays or receives (historical cost), regardless of any changes in potential value since the transaction occurred. This convention ignores any changes due to inflation. Market values may increase (or decrease in deflationary period) significantly. Solution 1.38 No, the primary purpose is to match income and expenses for the same period to determine an accurate measure of performance (profit) that may be compared from one period to another. Solution 1.39 Accounting period convention is the main one. The doctrines of materiality and disclosure may also be associated with an expense item. Solution 1.40 (a) monetary convention (b) business entity convention Solution 1.41 Accounting Standards are an attempt to formalise Generally Accepted Accounting Principles into firm rules and codes of accounting practice. Solution 1.42 vii

8 Under the Corporations Law standards issued by the AASB are legally enforceable for companies only. However, all members of the professional accounting associations, under their membership rules, must observe them. Solution 1.43 Australian Accounting Standards (AAS) are issued jointly by the Institute of Chartered Accountants in Australia and CPA Australia (the Australian Society of Certified Practising Accountants). These standards are intended to apply to all reporting entities, both public and private, even if the AASB Standards do not apply under the Corporations Law. The Australian Accounting Standards Board (AASB) was established under the Australian Securities Commission Act The AASB provides published standards, the purpose of which is to establish requirements for the recognition, measurement and disclosure of transactions and other events in financial reports. The AASB standards are enforceable under the Corporations Law. Solution 1.44 No - under the Corporations Law standards issued by the AASB are legally enforceable for companies only. However, all members of the professional accounting associations, under their membership rules, must observe them. Solution 1.45 Members of the accounting professional associations are subject to strict standards of behaviour or ethical standards. Under these standards all members of the accounting associations must observe the AAS standards. Disciplinary action may be taken against who do not conform to the technical and professional standards in their work. Under the corporations Law there are legal, financial and criminal penalties that may be applied for breaches of the law, including the AASB standards. Solution 1.46 (a) depreciation of non-current assets AASB116 (AAS 4) (b) materiality in financial statements AASB1031 (AAS 5) (c) accounting for the acquisition of assets AASB116 (AAS21) (d) profit and loss or other operating AASB101 (AAS 1) statements (e) statement of cash flows AASB107 (AAS 28) Solution 1.47 Like the accounting standards, the Statements of Accounting Concepts (SAC) (the Conceptual Framework) are also an attempt to establish general concepts and principles. However they are limited to the preparation and presentation of financial reports. They do this by defining the reporting entity, defining the objectives and characteristics of financial information and of assets, liabilities, owner s equity, income and expenses. Solution 1.48 The four principal qualitative characteristics are understandability, relevance, reliability and compatibility. No examples provided. Solution 1.49 (a) the company prepares financial statements annually Accounting period (b) the business owner does not include a personal motor vehicle in Business entity the list of business assets (c) the business has been preparing annual financial statements for Going concern the last 12 years and expects to continue to do so (d) the business follows the AASB accounting standards to produce Recognition of law the financial statements (e) the business records the profit on sale of motor vehicles in a Disclosure

9 different account to the motor vehicle running costs (f) the business used a first in first out inventory valuation method Consistency last year and will use the same method this year (g) the business rounded its financial statements to the nearest $1 000 Materiality (h) the business acquired its land and building 10 years ago and still Historical cost records the value at cost despite land values doubling over this time Solution 1.50 and 1.51 No suggested solution Solution 1.52 (a) (b) If you agreed you would not be following the professions code of ethics (may include integrity, technical & profession standards, professional competence and acting in an ethical manner) and would be subject to disciplinary action. If you agreed you would not be following the professions code of ethics (particularly in relation to acting with integrity) and would be subject to disciplinary action. ix

2016 ACCOUNTING ATTACH SACE REGISTRATION NUMBER LABEL TO THIS BOX

2016 ACCOUNTING ATTACH SACE REGISTRATION NUMBER LABEL TO THIS BOX External Examination 2016 2016 ACCOUNTING FOR OFFICE USE ONLY SUPERVISOR CHECK ATTACH SACE REGISTRATION NUMBER LABEL TO THIS BOX RE-MARKED Tuesday 15 November: 1.30 pm Time: 2 hours Pages: 33 Questions: