Introduction to Financial Accounting Introduction to Accounting Accounting is a process that identifies, records and communicates information to interested users. Who Uses Accounting Data? Internal Users Operate a business E.g. Managers Need detailed and frequent information Have access to Financial and Management Accounting Information External Users Investors E.g. Shareholders use information to make decisions to buy, hold or sell shares Creditors E.g. Suppliers use information to evaluate risks of lending money Government E.g. ATO use information to determine an entity s compliance with rules and regulations Management Accounting provides information for internal users. Includes both financial and non-financial information Relates to subunits of business Frequently reported Focussed on the present and future Financial Accounting provides information for external users. Includes only financial information Relates to business as a whole Half-yearly reported Focussed on the past Corporate Governance is a system in which entities are controlled and managed. Promote ethical and responsible decision-making Respect rights of shareholders Remunerate fairly and responsibly Commencing a Business Types of Business Entities Sole Proprietorship: Business owned by one person Partnership: Business owned by two or more persons Company: Public or Private
Elements of Financial Statements Asset Resources controlled by entity Provides future economic benefits Result of past transactions Liability Present debts/obligations Outflow of economic benefits Result of past events Owner s Equity Owner s share of a business Residual interest (leftover) Owner s Equity = Assets Liabilities Income Increases assets/decreases liabilities Inflow of economic benefits Excludes owner s contribution of equity Expense Decreases assets/increases liabilities Outflow of economic benefits Excludes distribution to owners Recognition Criteria for Elements Probable Occurrence Must be probable that future benefits will flow (asset) Must be probable that a sacrifice will be required (liability) Reliable Measurement Qualitative Characteristics Relevance Must have a cost or value which can be measured (in $) reliably Sensible and logical connection Reliability Accurate and free from errors Comparability Same accounting principles used Understandability Information is presented clearly Verifiability Different readers reach general agreement Timeliness Having information available at an appropriate time
The Recording Process 1. Transaction Analysis Extended Accounting Equation: Assets = Liabilities + Equity + Income Expenses Drawings Both sides of equation must always be equal Debits and Credits Assets + Expenses + Drawings = Liabilities + Equity + Income Debit: Receipt of cash Credit: Payment of cash Assets, Expenses and Drawings Liabilities, Equity and Income 2. Journalising Journalising is the process of chronologically (date) entering transactions into the journal. Simple Entry: Involves only two accounts Compound Entry: Involves three or more accounts
3. Posting Posting is the process of transferring journal entries to the ledger accounts. Record the correct corresponding account name A General Ledger maintains the entire group of a business accounts, providing each account s balances. Must be kept in order of the Chart of Accounts Steps to Balance a T-Ledger 1. Total the side of the account that contains the largest numeric value. 2. Copy that amount to the other side of the account. 3. Work out what amount is missing from the other side (Closing balance). 4. Carry that amount down to start the new period.
Recording Transactions for a Service Entity Cash and Accrual Accounting Cash Accounting records income when cash is received and expenses when cash is paid Accrual Accounting records income when it is earned and expenses when they are incurred Example ABC Repairs operates from a rented shop. The business pays its rent in advance on 1 January each year, for the year ahead. The rent is $4,000 per month. a) How much rent expense would be recorded for the month of January under CASH accounting? $48,000 b) How much rent expense would be recorded for each month between February and December under CASH accounting? $0 c) How much rent expense would be recorded for the month of January under ACCRUAL accounting? $4,000 d) How much rent expense would be recorded for each month between February and December under ACCRUAL accounting? $4,000 e) Which approach provides more relevant information to users? Accrual accounting Chart of Accounts order ledger accounts according to the elements. Both assets and liabilities are each divided into current and non-current based upon their expected life Current: Below 12 months Non-current: Over 12 months