This is a set of comprehensive notes that cover the entire VCE Accounting course in detail and were written by a student who maintained a 97% average in her SACs and got a raw 41 study score.
ACCOUNTING UNIT THREE AND FOUR
Elements of financial statements
Assets
Banks, inventory, premises, accounts receivable
o Economic resources controlled by an entity. FOR EXAMPLE: cash, is an economic resource and is
controlled by a person
o Because of past events à by paying for it, sales etc.
o Which have the potential to produce economic benefits = opportunity to spend on,
o Type of assets
Ø Current assets: the asset will be converted into cash within the next 12 months or the
future economic benefit will be consumed within the next 12 months
Ø Non-current assets: longer term assets where the future economic benefit will be
consumed over a period longer than 12 months. These help the business generate income
over several accounting periods. EXAMPLES: vehicles, furniture, equipment
Liabilities
Loans, accounts payable, bank overdraft etc.
o Present obligations
o To transfer economic benefits
o Because of past events
o Types of liabilities
Ø Current liabilities: where the obligation to repay, the debt is within the next 12 months.
EXAMPLES: bank overdraft, accounts payable, short term loans, accrued revenue.
Ø Non- current liabilities: obligations that don’t need to be settled within 12 months of the
current reporting period. EXAMPLES: a 5-year loan
Owner’s Equity
Capital (the personal funds an individual put into a business), profit, drawings
o The residual value in the assets of an entity after deducting all its liabilities
Revenues
Sales, interest on investments, commission on sales, discount revenue
o Increases in assets or decreases in liabilities
o That result in an increase in owner’s equity
o Excluding any capital contribution
Expenses
Wages, rent, cost of sales, discount expense
o Decreases in assets or increase liabilities
o That result in a decrease in the owner’s equity
o Doesn’t include capital contribution
Relationship between assets and expenses
According to the period assumption a business’s life is divided into arbitrary periods of time and thus its
operations consume assets and make them expenses
o Assets are only an asset when it is a present economic resource of the entity, but when that
economic resource is used up, it is an expense
o By making these expenses, and using up these assets, the entity generates a revenue
, ACCOUNTING UNIT THREE AND FOUR
Ø Hence, to generate a profit, the revenue earned for the work must be greater than the value
of the assets that were consumed as expenses
Qualitative Characteristics
Use the acronym RFV – CUT
All accounting reports must satisfy the following 6 characteristics
o Relevance: inclusion of ALL information that is relevant to decision making and exclusion of all
irrelevant information.
Ø Materiality: the relevance of information is determined by the nature of the item, and if its
capable of making a difference to decision making
Ø If the size or significance is small it can be omitted from reports
o Faithful representation: the report should contain information that is true, complete, free of
opinion/bias and an accurate reflection of the real world economic events it claims to represent.
o Verifiability: the information presented in reports accurately represents what it is intended to
represent and reports is supported by evidence to prove accuracy (i.e. source documents, invoice
statements, receipts. Relevant to how much tax is paid)
o Comparability: should follow consistent accounting standards/practices, to be compared from year
to year or from business to business
o Understandability: should be prepared in a manner that is simple to understand, clear and concise
so that users with a reasonable knowledge of business and economic activities are able to
understand the information. This is done using headings and subheadings.
o Timeliness: reports need to be prepared on a timely basis, so that they are available to users as
quickly as possible and the information remains relevant to decision making
Accounting Assumptions
Use the acronym RAGE
Accountants apply certain principles when preparing financial information
o Reporting period: the life of the business must be broken into periods of time to allow for profit to
be calculated and reports to be prepared (i.e. monthly reporting period) businesses MUST report at
least once per financial year for tax purposes
o Accrual basis: revenue must be recorded when it is earned NOT when it is received and expenses
must be recorded when incurred
o Going concern: the life of the business is assumed to continue indefinitely/forever. Regardless of:
possibility of bankruptcy, near retirement age. If business is bankrupt in 1 month, assets can’t be
considered as sources of economic benefit and reports cannot be made.
o Entity: the business is assumed to be separate from its owner, so business records must be kept
separate. (i.e. one person owns both a salon and a supermarket, even though the profit is all under
one person separate records must be kept, in the case that the owner wishes to sell the business)
What is the difference between Verifiability and Faithful representation?
Faithful representation refers to reports being free from material error, means they can be verified by
source documents, hence verifiability is a subset of F.R
What are 3 features of accrual accounting?
1. Accrual accounting determines an accurate profit figure by offsetting the expenses incurred in a
reporting period against the revenue earned in that same period. Expenses may be recognised as
, ACCOUNTING UNIT THREE AND FOUR
incurred, regardless of whether they have been paid. Revenues may be recognised as earned,
regardless of whether they have been received.
2. Balance day adjustments are recorded at the end of a period to ensure that the accounts reflect
both revenue earned and expenses incurred. When these adjustments are recorded they also have
an effect on the assets in the Balance Sheet (prepaid expenses, accrued revenues, accumulated
depreciation) and current liabilities (accrued expenses, prepaid revenues).
3. Thus, accrual accounting is a method that helps determine an accurate profit figure for each
reporting period and an accurate Balance Sheet at the end of each period.
Balance sheet
A = L + OE
Working capital
o It is the liquid funds of a business that can be used in its day-to-day trading operations
o Current assets – current liabilities
o Drawings: are a negative OE account meaning that they have the opposite effect of other OE
transactions
A + E + D = L + OE + R + C
o An increase in the left side is a debit (and a decrease is a credit)
o An increase in the right side is a credit (and a decrease is a debit)
General Journal
What is it?
o All transactions must be recorded in a journal before they are posted to the general ledger
o What to include?
Ø Date
Ø Debit and credit entries
Ø Should always have narrations for each transaction unless specifically stated otherwise: a
brief and complete description of the transaction – always include the document number
§ For accounts, payable/receivable include name of account
o Two accounting conventions to follow
Ø Debit entries are shown first, followed by the credit entries
Ø The credit entries in the general journal are indented to the right
Specific entries
, ACCOUNTING UNIT THREE AND FOUR
o Commencement of double entry records
Ø This is the first entry made when the business first opens the general ledger
Ø These figures should be verifiable and be sourced from reliable sources, however not all can
such as assets that have depreciated
Ø Since this cannot be verified with a single transaction a memo is provided as the source
document - write this in the narration
Ø The entries are cross referenced to balance in the general ledger accounts
o Assets
Ø Ensure that asset depreciation is accounted for: relevance takes priority over the need for
verifiability.
§ This is called fair value
o Contribution of assets and/or liabilities
Ø Ensure that the cross reference is to capital in the general ledger accounts, not to balance
Ø If a vehicle/home or any asset that has a loan will carry onto the business too
Ø The agreed/fair value of these assets becomes their historical cost – not the purchase cost,
rather it is the estimated value of the asset
§ The need of relevance takes priority over the need to satisfy verifiability, as it is a
more accurate representation of the assets future economic benefit
o Withdrawals/drawings
Ø Is recorded under the drawings account rather than the capital account
Ø It is a negative owner’s equity account – meaning it has the opposite effect of normal OE
accounts
o Inventory used for advertising purposes
Ø Inventory can be taken out of the store by the owner for use in a display, donations or to
generate goodwill
Ø This is classified under advertising
o Drawings of inventory by the owner
Ø If the owner withdraws assets for personal use it is classified as drawings
Ø Can be either inventory or cash etc.
General Ledger Accounts
Balancing accounts
o At balance date, we balance the account
Ø Through this we determine the balances to be included in the trial balance and financial
reports
o The general ledger should be updated on a regular basis (preferably daily) – so that all relevant
information in available to the owner or manager in a timely manner. This satisfies two accounting
characteristics
o Balancing involves
1. Add up each side of the account and write the larger total on both sides
2. Rule a line above this figure and double lines underneath (closes the account)
3. Calculate the difference between the sides (this becomes the balance)
4. Record the balance as a ledger entry on both the debit and credit side
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