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1.
2.
Accounting elements
Asset
A resource controlled by the entity, as a result of past
transactions, which gives future economic benefits.
Liabilities
A present obligation of the entity, arising from past
transactions, the settlement of which is expected to result
in an outflow of economic resources.
Owner’s Equity
The residual interest of the owner after deducting
liabilities from assets in the business.
Revenue
Inflows of economic benefits or savings in outflows, in
the form of increases in assets, or decreases in
liabilities, that lead to an increase in owner’s equity.
Expenses
Outflows of economic benefits or reductions in inflows,
in the form of decreases in assets, or increases in
liabilities, that lead to a decrease in owner’s equity.
Accounting characteristics
SAC2 specifies that for accounting information to be useful, it must satisfy these
criteria:
Relevance
If information is likely to influence the decision making of the
user of a report, it is deemed to be ‘relevant’ and must be
disclosed
Reliability
Information can be deemed to be reliable if it can be verified
against a business document and is not subject to bias or
personal opinion.
Comparability
The users of a report must be able to compare the business’
operating results from different periods. To allow this,
accounting standards must be applied in a consistent way from
one period to the next.
Understandability
Reports must be prepared in such a way that general users are
able to understand their meaning.
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3.
Accounting principles
Accounting Entity Principle The personal transactions of the owner should be
kept separate from those of the business
(supports relevance).
.
Historical cost principle
All transactions are recorded at their original cost
price
(also satisfies reliability).
Going concern cost principle The business is assumed to go on forever
(therefore, all asset, liability and owner’s equity
accounts can have a carrying balance.)
Reporting period principle
The continuous life of the business is divided into
equal periods of time for the purpose of calculating a
profit or a loss
(supports relevance by matching revenues with
expenses).
Monetary unit principle
All items must be recorded and reported in the
currency of the country of location.
Conservatism principle
A cautious approach should be applied in accounting
methods
(i.e. losses should be allowed for if expected to
occur, and gains recognised only if it has happened).
Consistency principle
Demands that the accounting methods used are
applied consistently from one reporting period to
occur
(supports comparability).
4.
Categorisation of accounts
Individuals General Ledger accounts are categorised so that the information
user can identify whether an account is an Asset, Liability, owner’s Equity,
Revenue or Expense. Asset, Liability and Owner’s Equity Accounts are
reported in the Balance Sheet which indicates the financial status of the
business. Revenue and Expense Accounts are reported in the Profit and Loss
Statement to show whether the period’s trading has resulted in a profit or a
loss.
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Relevance and Understandability
Categorisation of individual accounts meets the accounting characteristic of
Relevance because the information is meaningful and can affect the
decision-making ability of the information users.
It is more understandable to have different types of assets, liabilities,
owner’s equity, revenue and expense accounts as the information user can
make more informed decisions by knowing the impact of transactions on
different assets, liabilities, o/e, revenue and expenses.
5.
Source documents:
Satisfies the accounting characteristic of Reliability.
 Source documents provide written evidence of transactions recorded
in the accounting system.
 They can be used to verify the details of the transaction.
Invoices
SS Exhaust Fittings
Factory 3/244 Kilmore Rd.
Gisborne 3437
Invoice 39
2/6/08
To: Kaysam Mobile Food Van
1 x 33 cm Exhaust 45TT
Plus GST
$800
80
Total payable
$880
Terms
2/7 n/30
Invoice terms shown are 2/7, n/30. This means that:
The customer (Kaysam) can receive 2% discount off the invoice, if the account
is paid within 7 days of the invoice date (2/6/08). Otherwise, the account must
be paid in full within 30 days of the invoice date.
6.
Withdrawal of stock
The withdrawal of stock for personal use needs to be treated as “drawings”.
This is required by the Accounting Entity Principle which requires that
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personal transactions of the owner be kept separate from the
transactions of the business.
7.
GST Clearing Account
The balance in the GST Clearing Account represents the difference between
the amount collected from customers and the amount paid to the Tax Office.
A credit balance means that the GST Clearing A/c is a Liability:
the amount collected from customers > the amount paid to the Tax Office
A debit balance means that the GST Clearing A/c is an Asset:
the amount paid to the Tax Office > the amount collected from customers
and this would occur when the business starts up and has bought a lot of
assets and stock, and not yet received a high level of sales.
8.
Trial Balance
Purpose – to help check the accuracy of the double entry process.
It lists the balances of all General Ledger accounts; the total of all Debits must
total the balance of all Credits.
However, there the Trial balance has limitations:





9.
The incorrect amount is entered for both debit and credit entries
The transaction can be completed omitted
The debit and credit entries are reversed
The debit and credit entry is entered in the wrong ledger accounts
The incorrect transaction amount is entered
Control Accounts and Subsidiary Ledgers
Having control accounts require a business to keep separate ledgers, in
addition to having the General Ledger.
Having two separate ledgers for Debtors and for Creditors, will provide a
checking mechanism to detect accounting errors in these areas. Debtor and
Creditor Subsidiary Schedules prepared at the end of each reporting period will
assist the reconciliation of the Subsidiary Ledgers against the General Ledger.
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Advantages of subsidiary ledgers/control accounts:

Eliminates unnecessary detail from the General Ledger. Without a Control
account, there would be too much detail in the Trial Balance and
accounting reports.

Having subsidiary ledgers will provide a checking mechanism to detect
accounting errors for debtor or creditor accounts.

Control accounts provide internal control to minimise the risk of fraud. One
employee maintains the GL while another maintains the subsidiary ledger.

Having a staff to specialise in the Debtors will improve the management
and collection of debtor accounts. Likewise, staff specialising in
Creditors will improve the management and payment of creditors.
Disadvantages of subsidiary ledgers/control accounts:

Control accounts and subsidiary ledgers increase business costs, by
increasing workload, requiring additional staff and/or special computer
applications. As such, small businesses may find it difficult to justify
having one.
10. Specialised Journals and General Journal
Special journals are used to group together transactions of a similar nature,
making posting to accounts much easier.
CRJ –all cash receipts
CPJ – all cash payments
SJ – all credit sales of stock
PJ – all credit purchases of stock
GJ – everything other type of transaction that cannot fit into the above, that do
not occur on a regular basis.
 Double entries to commence business
 Non-cash contributions by owner
 Non-cash withdrawals by owner
 All balance day adjustments, corrections of errors and omissions
 Purchases of non-current assets (NOT STOCK)
11. Bad debts
A bad debt is an amount owed by the debtor, and is written-off because the
debtor can no longer pay.
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It is classified as an expense because it leads to a decrease in economic
benefits during the reporting period, due to a depletion of an asset –
Debtors. The amount reduced becomes the bad debts expense.
12.
Stock Recording
The cost price of stock = original purchase price + any other costs associated
with getting the stock in position and condition for
productive use.
It is a current asset because it represents future economic value (intended to be
sold) within the next 12 months.
Stock is one of the most important assets – it is used to generate the bulk of
the business revenue.
Stock management is important because there must be enough to meet sales
demand, and not too much held, as it can lead to wastage and excessive use of
business funds.
Perpetual inventory accounting records all movements of stock in the
subsidiary ledger in the form of Stock Cards. Each stock card is used to record
all movements of ONE SPECIFIC LINE OF STOCK in the business. If the
business sells for example, 5 types of barbeques, then 5 separate stock cards
would be used.
At the end of each accounting period, a physical stock stake is done to obtain
the amount of stock on hand.
Stock Loss or Gains
Stock gain: Amount of stock from physical stock take > Stock Control A/c
Stock loss: Amount of stock from physical stock take < Stock Control A/c
The recording of stock gains (revenue) or stock losses (expense) satisfies the
qualitative characteristics of Relevance, in that all revenue or expenses for the
accounting period must be accounted for.
The adjustment in the accounting records also satisfies the characteristic
of Reliability because a physical stock take is proof of the actual stock on
hand.
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Reasons for STOCK LOSS :
 undersupply by suppliers
 oversupply to customers
 theft
 recording errors in stock cards (overstating the actual stock on hand)
 a supplier’s invoice entered more than once
 stocktaking errors
Stock loss is treated as an expense because it represents an outflow of
economic benefits in the form of a reduction of an asset, namely Stock,
that leads to a reduction in Owner’s Equity.
Reasons for STOCK GAIN:
 oversupply by suppliers
 undersupply to customers
 recording errors in the stock cards (understating the actual stock on
hand)
 stock taking errors
Stock gain is treated as a revenue because it represents an inflow in
economic benefits in the form of an increase of an asset, namely Stock,
that leads to an increase in Owner’s Equity.
Advantages:
 Greater control over stock is achieved because at any point in time, we
know how much stock there ought to be.

Slow and fast moving lines of stock can be identified.

The level of stock loss or gains can be measured, provided a physical stock
take is done.
Disadvantages:
 Additional record keeping is required because inventory balances must be
updated each time there is a purchase, sale etc. Additional cost may be
incurred because of this.

There is a need for a physical stock take at the end of each accounting
period.

The level of stock loss or gains can be measured, provided a physical stock
take is done.
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Markup
(i) Given Sales price and markup%,
COS =
e.g.
find cost of sales
Sales price
Markup% + 100
SP= $5000, Markup = 25%
COS = 5000 = 4000
1.25
Given COS and markup%, find Sales Price
(ii)
Sales Price = [1+ markup% ] * COS
e.g.
(iii)
COS = 4000
Markup = 70%
SP = 1.7 * 4000
= 6,800
Given Selling price and COS, find markup %
Markup % = Selling Price * 100
COS
e.g.
SP = 10,000
COS = 4,000
Markup% = 10 000 * 100 = 250%
4 000
or 2.5 times
.
13. Accrual accounting & Balance Day Adjustments
The Reporting Period Principle requires that the life of the business be
divided into arbitrary periods of time so that the performance of the business
can be measured. The characteristic of Relevance requires that all revenue
earned and all expenses incurred be recognised in the period.
Accrual accounting is a system of determining profit where revenue earned is
matched with expenses incurred for the purpose of calculating a profit or loss
for the accounting period.
Reason (advantage) for BDAs:
Balance day adjustments are required to calculate revenue that is truly earned,
and expenses that have been actually incurred for the accounting period
period.
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BDAs serves to improve the accuracy of recording, measurement and
reporting of profit. This way, information users will have the most accurate
information when making decisions.
Disadvantage:
BDAs and accrual accounting require more time and expertise.
14. Depreciation
Depreciation is the allocation of the cost of a non-current asset over its
estimated working life.
Depreciation is an expense because it represents the consumption of
economic benefits in the form of decrease in assets, leading to the decrease
on owner’s equity.
Formula for depreciation
Depreciation expense p.a. =
($) H.C. - Residual/Salvage Value
Estimated Useful Life
The larger the estimated residual value, the smaller the depreciation expense
per annum.
Relevance vs. Reliability
Depreciation breaches the Reliability characteristic because the formula relies
on the estimates useful life and salvage value. However, it meets the
characteristic of Relevance, taking into account this expense in the calculation
of Net Profit for the period. The information user can make decisions based
on more a more accurate measure of profit.
Reporting of depreciation
Under straight-line depreciation, the Depreciation expense is the same in
each accounting period. Depreciation expense is reported in the Profit and
Loss Statement.
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P&L Statement 2007
P&L Statement 2008
P&L Statement 2009
Expenses
Expenses
Expenses
Depreciation exp 1000
Depreciation exp 1000
Depreciation exp 1000
In the Balance Sheet, the Historical Cost of the Non-current asset is the
same figure for each reporting period, as required under the Historical Cost
Principle. GST is not included in the historical cost figure that is reported,
rather is would be recorded separately as GST Refund.
The balance of the Accumulated Depreciation (a minus Asset Account)
increases over the time of the useful life of the asset. At the same time, the
Carrying value of the asset will fall over time.
Balance Sheet 2007
Balance Sheet 2008
Balance Sheet 2009
NCA
NCA
NCA
Vehicle
- Acc. Dep
Carrying value
10 000
2000
8 000
Vehicle
- Acc. Dep
Carrying value
10 000
4000
6 000
Vehicle
- Acc. Dep
Carrying value
10 000
6000
4 000
15. Closing the General Ledger
Revenue and Expense A/Cs
The Reporting Period Principle requires the performance of the business to
be measured at the end of each reporting period.
After a Post Trial Balance, profit or loss is determined by closing off all
revenue and expense accounts. This means returning revenue and expenses
accounts to zero.
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This is done by transferring the aggregate total of all revenue accounts to the
CREDIT side of the Profit and Loss Summary account, and the total of all
expense accounts to the DEBIT side of the Profit and Loss Summary account.
The remaining amount in the P&L Summary Account will either be a Profit or
Loss, which must be transferred to Capital A/C.
The Drawings account is also transferred to the Capital A/C.
Preparation of Profit and Loss Statement
The Profit and Loss Summary A/c which reports the summary amount of
revenue and expenses. In comparison, the Profit and Loss Statement
reports revenue and expenses under different categories. This meet the
characteristic of Understandability, and provides the information user with
more details when making decisions.
Profit and Loss Statement
Revenue
Sales
Less COGS
Profit & Loss Summary A/C
xx
xx
Gross Profit
Less Stock Loss
Adjusted Gross Profit
2000
xx
1700
Plus Other Revenue
xx
1900
Total Exp
Capital
(Profit)
x
Total Rev x
1000
x
Less Expenses
xx
Net profit
1000
Far more detail – very understandable
The three measures of profit provide the user with detailed information to
evaluate the different aspects of business performance.
Gross profit = Sales – COGS
Allows the information user to consider whether the
markup is satisfactory, and if not, should the selling
price be adjusted?
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Adjusted Gross profit = Gross Profit - Stock Loss/+Stock Gain
Because this takes into account stock loss/gain, it
allows the information user to consider the impact of
stock management on profit. E.g., has theft, damage
to stock, errors in recording stock and variations in
deliveries affected the Gross Profit? (these factors
have nothing to do with sales but rather, stock
management)
Net profit = [Adjusted GP + Other Revenue] - Expenses
Other revenue is not from the sale of goods, rather
they are related to secondary sources of income for
the business – bank interest, commission, dividends,
investment interest, discount revenue.
The Net Profit is the final profit gained after all
expenses have been considered. This is the profit
figure used to evaluate return on investment or return
on owner’s equity.
WARNING!!!
These items do not go into the Profit and Loss Statement:
Drawings (-OE)
Loan repayments (L)
Collections from debtors (A)
Payment to creditors (L)
Accumulated depreciation (-NCA)
Cash purchases of stock (A)
Capital contributions (OE)
Purchase of non-current assets (A)
Accrued expenses (CL)
Prepaid expenses (CA)
GST (CA or CL)
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Assets, Liabilities and Owner’s Equity A/Cs
The Going Concern Principle assumes that the business will run indefinitely,
and justifies the carrying forward of assets, liabilities and owner’s equity
accounts. As such, these accounts are balanced at the end of each accounting
period.
16. Statement of Cash Flows
Purpose
The SCF helps the information use to know whether there was sufficient
cash to meet the business’ financial obligations during the reporting
period, and whether there are adequate cash reserves to meet future
requirements.
The movements of cash are categorised into Operating, Investing and
Financing Activities. The net cash inflow or outflow from each section is
reported, showing the impact of those movements on the cash position of the
business. As such, the SCF meets the characteristic of Understandability for
the user of the report, helping him to make more informed decisions.
Preparation
Information is taken from the Cash Receipts and Cash Payments Journal.
Information from the Trial Balance must not be used to prepare the SCF, apart
from the final Cash at Bank balance.
Distinction between Cash and Profit
Cash flow relates to all cash receipts less cash payments.
Profit relates to Revenue earned less Expenses incurred.
Cash situation < Profit
Receipts from Debtors < Credit Sales
Prepaid expenses < Actual expenses
Creditor payment > COS
GST paid – not expense, no effect
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Cash purchases of stock – not expense, no effect
Cash purchase of NCA – not expense, no effect
Stock gain – increases profit but not cash item
Discount revenue – increases profit but not cash item
Cash situation > Profit
Receipts from Debtors > Credit Sales
Paid expenses < Actual expenses (leading to accruals)
Creditor payments < COS
Stock loss – expense, but no payment involved
Discount expense – expense, but no payment involved
Depreciation – expense, but no payment involved
WARNING!!!
These items do not go into the Statement of Cash Flow:
Credit sales
Credit purchases of stock
Depreciation
Discount expense or Discount revenue
Bad debts
Credit purchases of non-current asset
Drawing of assets (other than cash)
Capital contributions other than cash
Accrued expenses (CL)
COS
Stock loss or gains
Unit 3 Exam Summary Notes