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Summary Financial Accounting 188 Notes
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Comprehensive notes for the entire module of Financial Accounting 188
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Financial Accounting 1882017 Year Notes
, Financial Accounting 188
Chapter 1: Nature and Objective of
Accounting
+
Chapter 2: The Conceptual Framework
for Financial Reporting
,Forms of Entities
Form Sole Prop. Partnership Close Company
corporation
Ownership One owner 2 or more 1 – 10 Shareholders
partners members
Liability Not a separate Not a separate Separate legal Separate legal
legal entity legal entity entity entity
Enforcement No acts No acts Close Companies
Corporation Act
Act
Profit Profits belong Profits Profits Profits belong
to owner distributed in allocated as to company
specific ratios profit share to and paid out
members to
shareholders
as dividends
Fundamental Qualitative Characteristics
Financial info is useful when it is relevant and faithfully represented
Relevance is info that can make a difference (influence decisions)
o Predictive value
Info that can be used by users to make their own predictions
o Confirming value
Info that provides feedback about previous evaluations
Faithful representation of events = useful information
o Completeness
Material omission can result in information being false and
misleading and therefore unreliable and irrelevant
o Neutrality
Information is neutral as it is presented not to achieve a
predetermined result
o Free from error
Info must be free from error in terms of description and the
process to produce the info
Enhancing characteristics
Comparability
o People want to be able to judge tendencies over time and between
similar entities to evaluate their own relative financial position
(performance)
o Measurements and presentation for similar transactions must be done
consistently within the entity and across different entities
Verifiability
o Means different knowledgeable and independent observers could
make sense of the info and reach a consensus
, Timeliness
o Linked to consistency, info should be available for users to make
decisions
Understandibility
o Info should be presented in a user friendly manner
Underlying assumptions
Financial statements are usually prepared according to the accrual basis
o This means that transactions are recorded as they occur
o Financial statements on the accrual basis provide info on past
transactions that resulted in the movement of cash as well as future
payments of the entities obligations or future recovery of amount due to
the entity
In a going concern, financial statements are prepared with the assumption
that the entity will continue to be in business for the foreseeable future
o The entity does not plan to scale down or turn assets into cash
Elements of Financial Statements
They are classified according to their economic characteristics
They relate directly to measurement of financial position (assets, liabilities,
and equity) as reflected in the balance sheet
They related directly to measurement of performance (income and expenses)
as reflected in income statements
1. Assets
A resource that is controlled by the entity as a result of events in the past and
from which future economic benefits will flow to the entity
Non-current asset
o Long-term (more than 12 months)
o Primary purpose is to utilise asset for a long period of time to maximise
the generation of income
Current asset
o Short term (less than 12 months)
o Primary purpose is to sell as quickly as possible to convert the asset
into a more liquid asset such as cash
2. Liabilities
A present obligation of an entity arising from past events, the settlement of
which is expected to result in an outflow of resources from the entity
Non-current liability
o Long-term (more than 12 months)
o Bond/mortgage
Current liability
o Short term (less than 12 months)
o Creditors/bank overdraft
,3. Equity
The residual interest in the assets of the entity after deducting all its liabilities
Capital [C]
o The difference between capital contributions and capital withdrawals
Profit/loss
o The difference between income and expenses
o Profit [+Po] = proceeds of sale > cost price
Increases Owner’s equity
o Loss [-Lo] = proceeds of sale < cost price
Decreases owners’ equity
4. Income
The increase in economic benefits during the accounting period, in the form of
inflows or enhancements of assets, or decrease in liabilities that result in an
increase in equity
o Revenue [ +I ]
Arises from the ordinary activities of an entity
o Profits (aka gains)
Do not necessarily arise from ordinary activities of an entity
5. Expenses
The decrease in economic benefits during the accounting period in the form of
outflows of assets or incurrence of liabilities that result in a decrease in equity
o Current expenses [-E]
Expenses arising from ordinary activities of an entity for the
accounting period
o Losses [-Lo]
Result from the sale of non-current assets as well as unforeseen
disasters such as fires/floods
A + D + E/Lo = L + C + Ci + I/Po
Recognition and Measuring of Elements of financial statements
The process of including an item, which complies with the definition of an
element above and satisfies the criteria of recognition, in the balance sheet or
income statement
An item should be recognised when
o It is probable that future economic benefits will flow to or from the entity
o Item has a cost or value which can be measured reliably
Fair value is the amount for which an asset should be exchanged or a liability
settled, between two knowledgeable, willing parties in an arm’s length
transaction
,Measuring the elements of financial statements
The process of determining the amount at which the elements of the financial
statements are recognised and reflected
This depends on the choice of measurement basis
o Historical cost
Assets: cash/cash equivalents paid
Liabilities: settlement amount
o Current cost
Assets: cash/cash equivalents to acquire the same asset today
Liabilities: undiscounted cash/cash equiv. needed to settle the
obligation today
o Realisable cost
Assets: cash/cash equiv. that could currently be obtained by
selling the assets in an orderly disposal
Liabilities: cash/cash equiv. expected to be paid to settle the
liability in the ordinary course of business
o Present value
Assets: present discounted value of the future net cash inflows
expected to be generated in the normal course of business
Liabilities: present discounted value of the future net cash
outflows required to settle the liabilities in the normal course of
business
The Entity Concept
A separate set of financial records and financial statements are required for
each enterprise/entity as well as for the owners/shareholders of the
enterprise/entity
The entity receives its equity/capital from its shareholders and external
lenders of money
o These funds are used to purchase assets in the name of the entity,
which in turn can be used to generate income for the entity
, Financial Accounting 188
Chapter 3: Accounting Equation and
Financial Statements
, The Accounting Equation
1. The Accounting Equation
Will always balance!
Assets = Equity + Liabilities
Owner of the business provides capital/equity to the business which gives him
interest in the business (A=E)
The business can also make use of loans/liabilities as additional financing
(A = E + L)
The business uses capital and liabilities to purchase assets
o The double entry rule states that an increase on the left side of the
equation will bring about an equal increase on the right hand side of
the equation
Equity is remaining interest after all liabilities have been deducted (E = A – L)
2. Expanded accounting equation
Equity is now separated into four components
o Capital contributions, Income, Capital Withdrawals and Expenses
Therefore the expanded equation will look like this:
Assets = [Cap Contr. + Income – Cap Withdrawals – Expenses] + Liabilities
Items that have negative impact on equity can be carried over to the asset
side of the equation:
Assets + Cap Withdrawals + Expenses = Cap Contr. + Income + Liabilities
A good way to remember this is DAX = CIL
o DAX refers to Drawings, Assets and Expenses
o CIL refers to Capital, Income and Liabilities
The Objective of Financial Statements
To provide info on the financial position, financial performance and cash flow
of an entity
Financial statements are prepared during the financial/accounting period
o Financial period for internal reporting = 1 month
o Financial year does not have to correspond with calendar year
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