BUSS1030: Accounting, Business and Society Week 1: Defining accounting Accounting encompasses the information system that measures business activity, processes the data into reports and communicates the results to decision makers o Resources are limited, and hence each decision has consequences for future decisions Financial statements report on a business in monetary terms, and provide key information for internal and external decision making There are two main types of accounting: 1. Financial accounting: which provides information for external decision markers, such as outside investors and lenders 2. Managerial accounting: which focuses on information for internal decision makers, such as business manager Decision markers: The users of accounting information Individuals use accounting information to manage bank accounts, evaluate new jobs and decide whether they can afford certain goods Business owners use accounting information to set goals. They evaluate progress towards those goals and take corrective action when needed. Eg. Is the firm profitable enough to expand? (based on financial statements) Outside investors who have an ownership interest often provide the money to get a business going (why should these people invest in this particular company? Financial statements can reveal how their investments are performing through the company) Creditors evaluate the ability of companies to make loan repayments requiring reports on predicted incomes of the company, based on forecasts from trends evidenced within financial statements Government regulatory agencies make decisions that affect consumer welfare. Eg, ASIC uses accounting information in deciding whether to investigate firms in their role of administering and enforcing the Corporations Law Tax authorities income tax is calculated using accounting information, and businesses determine their goods and services tax from accounting records which show how much they have purchased and sold Non-profit organizations use accounting information similar to how businesses do Employees and labour unions make wage demands based on their employer s reported profit, ie based on financial statements The accounting profession: Career opportunities In Australia, accountants who meet specified entry requirements may become members of the Institute of Chartered Accountants in Australia, CPA Australia or the Institute of Public Accountants The type of work undertaken by qualified accountants falls into two main categories: 1. Many accountants work for a single business privately. In this role, their work ma involve the preparation of financial statements for the business, budgets and plans and internal reports, tax returns for businesses and so on
2. Other accountants work in public practice, serving the general public through auditing, income tax planning and preparation, and management consulting An audit is the independent examination that assures the reliability of the accounting reports that management prepares and submits to investors, creditors and other outside the business; carried out by public practice accountants (CA/CPA) Auditing is important for assurance that the figures are accurate and reliable, so creditors considering loans have all available information, shareholders are accurately in the loop, government agencies have accurate information, etc Tax accounting has two aims: 1. Complying with the tax laws 2. Minimising taxes to be paid Tax work by accountants consists of preparing tax returns and planning business strategy in order to minimize taxes Management consulting is the term used to describe the advice public accountants provide to help managers run a business; providing suggestions on how to improve business management structure and accounting systems based on insights they may have gained from being an auditor of the firm Insolvency involves appointing liquidators to manage the business of a firm that is in financial distress that is, one which cannot meet its financial obligations; in order to receive funds loaned from creditors Managerial accounting analyses a business costs to help managers make better decisions, eg. how to price products or what products to scrap, etc Budgeting sets sales and profit goals, and develops detailed plans called budgets for achieving those goals Information systems design identifies the organisation s information needs, both internal and external, and then develops and implements the system to meet those needs; eg. creating manuals, flow charts and documents to identify the function of the business and placing responsibilities on specific employees Internal auditing is auditing performed by the business s own accountants Accounting regulation Accounting regulations typically govern measurement rules and level of disclosure In Australia, technical accounting standards are formulated by the Australian Accounting Standards Board (AASB), which was formed by federal legislation in 1991. The AASB is solely responsible for preparation, interpretation, revision and approval of technical accounting standards. The AASB is overseen by the Financial Reporting Council (FRC) For international harmonization, Australia s FRC announced the adoption of the International Financial Reporting Standards (IFRSs) and the earlier series of International Accounting Standards (IASs), which was issued and amended by the International Accounting Standards Board (IASB) Corporate and Social responsibility Ethics Accountants are responsible for what goes into and what is left out of financial reports. Although there are laws and codes of conduct in place to address this, ultimately it is the firm s auditors decision to state whether the disclosure is adequate, hence based on their prioritization of morals o Hence, ethics is normative rather than factual
Codes of professional conduct The ICAA and CPAA have a joint code of ethics for professional accountants as part of their professional standards The code places a crux on maintaining and enhancing credibility, professionalism and quality, and the confidence of the public in accounting-related services The principles listed in the code include: integrity, objectivity, professional competence, confidentiality, and professional behavior (legal compliance) Sometimes these overlap, requiring accountants to employ subjective judgment Sustainability One of the very important issues facing all businesses today is whether they are sustainable (both writ small and writ large) Writ small: it has to do with whether a business can continue to be profitable in the future as well as in the present accountants usually assume this when estimating profits from income statements Writ large: it has to do with society and the environment we all live in (meets the needs of the present without compromising the ability of future generations to meet their own needs) Types of business organisations Proprietorship Partnership Company Owners Proprietor there is one owner Partners there are two or more owners Shareholders there are generally many owners Life of organization Limited by owner s Limited by owners Indefinite Personal liabilities of owners for business debts Accounting status Advantages Disadvantages choice or death Proprietor is personally liable The proprietorship is separate from the proprietor Total undivided authority, no restrictions on business (apart from legal), easy to set up Unlimited liability, limitation on size (fundraising power) and little support from others choices or death Partners are personally liable The partnership is separate from the partners Potentially better credit standing, More brain power but consultation with partners required, simple to form Unlimited personal liability for partners, partnership agreement required to avoid potential future clashes Shareholders are not personally liable The company is separate from the shareholders Separate legal existence, limited liability of shareholders, transferability of ownership relatively easy Separation of ownership and control, extensive government regulation Accounting measurement: Concepts and principles Generally accepted accounting principles (GAAPs) inform specific rules and standards that govern how accountants measure, process and report financial information
To be useful, accounting information must be relevant, valid and reliable: o Relevance depends on usefulness to decisions o Validity means that an accounting number really does represent what a user assumes it represents o Reliability means that the number is accurate It must also offer high levels of disclosure, but maintain confidentiality The entity concept An accounting entity is an organization (or section of an organization) that stands apart from other organizations and individuals as a separate economic unit for the purpose of some decision o So in terms of accounting, sharp boundaries are created around the entity so no irrelevant information from its affairs with other entities is collected o Eg, the finances of a proprietor should not be mixed in with the proprietorship because it would become difficult to make well-informed business decisions based on intermingled finances The accounting period concept The accounting period concept defines the unit of time for which accounting data are collected (because its difficult to collect from beginning of time) o Well-established businesses need periodic reports on their progress, and accountants therefore estimate profitability in shorter accounting periods o Eg. the Financial Year is an accounting period The cost principle The cost principle states that accounting measures are based upon transaction costs ie, cash flow (the amount finally received or paid to cover the cost of a purchase or sale), NOT MARKET VALUE Cost is considered by accountants to be a valid and reliable/objective measure valid because it is easy for a user to understand what a cost represents, and reliable because costs can be verified by an independent observer (eg. through invoices) Cost is not relevant, as market costs rather than historical costs may be considered more useful to decision makers concerned with forecasting future events o Eg. if a business has purchased resources which have appreciated in market value, their assets are worth more than considered The matching principle The matching principle relates the outputs of products to the input of raw materials In essence, it compares the expenses used to earn the revenue, demonstrating either a profit or loss All other expenditures are recorded and shown in financial statements as assets (eg. buying a g/s not directly related to outputs is an asset, or not used yet) the expenditure is carried forward is said to be capitalized and used in the next accounting period to produce outputs and written off then (on the condition the business continues to trade and the raw material was in useable condition this allows for some subjective judgment on the part of accountants) The revenue recognition principle Revenue is income that arises in the course of ordinary activities Accountants adopt the position that profit should be recognized when the sales and any other revenues/gains relating to relevant activity are earned and can be reliably measured ie only record sales and expenses when goods/services sold can be matched to the raw materials used. Profits shouldn t be recognized until a sale has taken place
o UNLESS purchase on credit, in which case revenue increases and money owed increases, and when paid, money owed decreases, revenue remains Losses are recognized immediately, even though a sale or other disposal hasn t taken place yet but is going to take place The conservatism (or prudence) principle Since managers try to up-play their reported assets/profits and maintain optimism to appeal to the general public, accountants must employ conservatism as a countertactic to maintain balance and accuracy The going concern assumption Under the going concern assumption, it is assumed that the business as a whole will continue operation for the foreseeable future o In liquidation of a company, liabilities are paid off at current market value, and hence financial statements are more likely to be in current market value than costs to address this concern appropriately, rather than they regularly are as historic costings with the going concern assumption Accountants in most circumstances use the accrual basis of accounting worldwide unless a liquidation is taking place. This includes all of the above principles/concepts/assumptions Week 2: The accounting equation Assets are 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 o Eg. Cash, inventory, land Liabilities are a present obligation of the entity arising from past events, the settlement of which is expected to result in the outflow from the entity of resources embodying economic benefits o Eg. Bank loan Owners Equity, also known as equity refers to the residual interest in the assets of the entity after deducting all of its liabilities the purpose of a business is to raise equity (through either revenue or owner investment of personal assets); equity decreases due to owner withdrawals from the business for personal use or expenses (increasing liabilities or using assets) Assets Liabilities = Owners Equity Owners Equity + Liabilities = Assets Owners Equity Assets = Liabilities Income is defined as all increases in equity other than investments by owners Revenue is the part of income arising from ordinary activities including sales, fees, interest, dividends and royalties Apply the accounting equation to analyse transactions Accounts record the impact of events that are considered to affect the value of entities assets and liabilities (mostly based on evidence from transactions cost principle) A transaction is an event that involves at least two parties exchanging resources it takes place at a point in time an creates a cost that affects the financial position of the business Examples:
Sheena invests $30000 to business, the transaction on the accounting equation is: o 30000 0 = 30000 A balance sheet reports the assets, liabilities and equity of the business at that exact moment in time. A balance sheet for this example would be: Assets = Liabilities Cash 30000 None + Equity Capital investment 30000 Total assets 30000 Total liabilities and equity 30000 Now, consider the business purchased land for $20000 and was left with $10000 cash, office supplies for $500 on a loan agreeing to pay back within 30 days (account payable), earns $5500 revenue and $3000 revenue in credit, where the consumer agrees to pay the cost within one month (account receivable). The balance sheet would look as so: Assets = Liabilities Cash 10000 Office Supplies 500 Land 20000 + Office Supplies 500 Owners Equity Revenue 5500 Capital investment 10000 Accounts receivable 3000 Land investment 20000 Revenue 5500 Accounts receivable 3000 Total Assets Total liabilities and equity 39000 39000 Now, to extend upon the above, consider: Business has to pay $300 on expenses, hence leading to a decrease in assets/equity Lets say the client paid back the $3000 owed, this leads to an increase in cash/capital investment and removes accounts receivable Business sells some land; increase in cash decrease in land no change in equity/liabilities NOTE: REMEMBER THE OWNER S TRANSACTIONS ARE INDEPENDENT FROM THOSE OF THE BUSINESS BY THE ENTITY CONCEPT Assets = Liabilities Cash 13000 300 + 900 Office Supplies 500 Land 20000 900 + Office Supplies 500 Owners Equity Revenue 5500 Expenses 300 Capital investment 13000 Land investment 20000 Revenue 5500 Total Assets Total liabilities and equity 38700 38700