Financial Accounting Applications WEEK 1 - INTRODUCTION TO FINANCIAL ACCOUNTING APPLICATIONS Financial & Management Accounting Financial Accounting is the preparation and presentation of financial information that enables users to make economic decisions regarding the entity/business. General Purpose Financial Statements (GPFS) are prepared to meet the information needs common to users who are unable to command reports to suit their own needs. Special Purpose Financial Statements are prepared to suit a specific purpose and do not cater for the generalised needs common to most users. This information is governed by the generally accepted accounting principles (GAAP), which provide accounting standards for preparing financial statements. Financial accounting is also guided by rules set out in the Corporations Act and the Listing Rules of the ASX. Financial accounting is traditionally based on historical figures that stem from the original transaction; for example, the purchase of a building for $500,000 would be shown in the financial statement as an asset of $500,000. Even though the 500K may not reflect the current market value of the building, the building is still shown at its historical cost, which is the original amount paid for the asset. Management accounting is a field of accounting that provides economic information for internal users, that is, owners and management. The core activities of management accounting include formulating plans and budgets, and providing information to be used in the monitoring and control of different parts of an entity. Management accounting reports are bound by few rules and are therefore less formal. The Process of Accounting The Diverse Roles of Accountants Commercial accountants work in industry and commerce. Companies like Domino’s and Qantas employ a number of accountants in different roles, such as management accounting and financial accounting. Public accountants, as the name suggests, provide their professional services to the public. They can practise in business organisations that range from small, single-person-run offices to very large organisations with branches all over the world and thousands of employees. Public accountants tend to specialise in one or more areas of accounting when providing services to the public. Government accountants, employed within government entities, engage in a variety of roles and activities, such as financial accounting and auditing. Local councils, state governments and the federal government receive and pay out large amounts of funds each year and these activities need to be accounted for. Not-for-profit accountants, working in the not-for-profit sector, engage in many activities including planning, decision making, and preparing financial and management reports for both internal and external users. Forms of Business Organisation Refer to Accounting in Context for additional notes A sole proprietorship is a business owned by one person. It is the simplest form of business structure, and has very few legal formalities. It is quick and inexpensive to establish, and inexpensive to wind down. Under this structure, the owner of the business has no separate legal existence from the business. A partnership is a relationship or association between two or more entities, carrying on a business in common with a view to making a profit. Entities forming the partnership may be individuals or companies. There is little formality involved in creating a partnership. Partnerships are often formed because one individual does not have enough resources to initiate or expand the business, or because partners bring unique skills or resources to the partnership. A company or corporation is a separate legal entity formed under the Corporations Act 2001 (Cwlth) in Australia. The owners of a company are called shareholders and their ownership interests are represented by the number of shares they own in the company. Other forms include: - Trust - Cooperatives - Associations The Conceptual Framework The objective of general purpose financial reporting is to provide financial information about the reporting entity that is useful to existing and potential investors, lenders and other creditors in making their decisions about providing resources to the entity. The Australian conceptual framework defines the reporting entity as an entity in which it is reasonable to expect the existence of users who depend on general purpose financial reports for information to enable them to make economic decisions. Three main indicators determine whether an entity is a reporting entity. This includes: 1. Managed by individuals who are not owners of the entity 2. Politically or economically important 3. Sizable in any of the following ways: assets, borrowings, customers or employees. Users & Uses of Financial Information Internal users include: - Marketing managers - Production supervisors - Directors - Other managers Uses include: - Financing activities - Investing activities - Operating activities - Sustainability reporting Financial Statements Refer to Accounting in Context for additional notes These include: - Statement of Profit or Loss - Statement of Changes in Equity - Statement of Financial Position - Statement of Cash Flows Also discusses: - Current and non-current liabilities - Current and non-current liabilities The Financial Reporting Environment Refer to Accounting in Context for additional notes This includes: - Australian Securities and Investments Commission (ASIC) - Financial Reporting Council - Australian Accounting Standards Board (AASB) - Australian Securities Exchange WEEK 2 - TRANSACTION ANALYSIS & THE RECORDING PROCESS Accounting Transactions & Events ASSETS = LIABILITIES + EQUITY Transaction analysis is the process of identifying the specific effects of transactions and events on the accounting equation. The accounting equation must always balance. Therefore, each transaction has a dual (double-sided) effect on the equation. For example, if an individual asset is increased, there must be a corresponding: - Decrease in another asset, or - Increase in a specific liability, or - Increase in equity. Debit & Credit Procedures Under the universally used double-entry system, the dual (two-sided) effect of each transaction is recorded in appropriate accounts. This system provides a logical method for recording transactions. Dr/Cr procedures for assets and liabilities Dr/Cr procedures for equity Other forms of equity in textbook; page 103 Important: for Dividends - Dividends are a distribution of profit and not an expense. - A dividend transaction affects assets and equity, as cash and retained earnings are decreased. The Journal & Ledger Refer to Accounting in Context for additional notes WEEK 3 - RECORDING TRANSACTIONS IN THE GENERAL JOURNAL & POSTING TO THE GENERAL LEDGER Learning Objectives 1. Describe the required steps in the accounting cycle. 2. Recording transactions in the General Journal. 3. Differentiate between the cash basis and the accrual basis of accounting. 4. Explain why adjusting entries are needed and identify the major types of adjusting entries. 5. Prepare adjusting entries for prepayments and accruals. Normal Account Balance Increase Decrease Debit Credit A, Ex L, E, I L, E, I A, Ex Equity Investment in entity: Increase Debit Equity Drawings from entity: Increase Credit General Journal - It is a complete record of all transactions - It is presented in chronological order What do we need to know? - Has a transaction occurred? - What accounts are affected by the transaction? - What types of accounts are these? - What was the effect of this transaction in terms of the accounting equation? - Does my journal balance? Recording Transactions in General Journal - EXAMPLES Accrual vs Cash Based Accounting Accrual based accounting: - Revenue recognised when goods and services are provided. - Expenses recognised when assets are consumed or liabilities incurred. Cash based accounting: - Revenue recognised when the cash is received or paid. - Expenses recognised when the cash is received or paid. Example Adjusting Entries Adjusting entries are necessary to make sure: - Revenues and expenses are recorded in the correct accounting period (accounting period concept). - Recognition criteria are followed for assets, liabilities, revenues and expenses (conceptual framework criteria). Types of Adjusting Entries Prepayments 1. Prepaid expenses: Amounts paid in cash and recorded as assets until used. 2. Revenue received in advance: Amounts received from customers and recorded as a liability until services performed or goods delivered. Accruals 1. Accrued revenues: Amounts not yet received and recorded for which goods or services have been provided. 2. Accrued expenses: Amounts not yet paid or recorded for goods or services already received. Adjusting Entries for Prepayments Prepayments are either: 1. Prepaid expenses. 2. Revenues received in advance. Example - Supplies Example - Insurance Example - Revenue Adjusting Entries for Accruals Accruals may either be: 1. Accrued revenues. a. Accrued revenues are revenues earned from providing goods or services that have not as yet been recorded. b. Revenue and receivable are recorded for revenue not received and not recorded. c. One cash is received, receivable is reduced. 2. Accrued expenses. a. Accrued expenses are expenses not yet paid or recorded at balance date. Example - Revenue Example - Expense WEEK 4 - ACCOUNTING FOR INVENTORY & GST Learning Objectives 1. Describe the nature of inventory and retail operations 2. Identify the differences between a service business and a merchandising business 3. Explain the recording of purchases and sales under a perpetual inventory system 4. Impact of GST on sales and purchases Inventory - AASB 102/IAS2: Inventories - Inventory means goods or property purchased and held for sale in the operating cycle of a business - Other assets may be sold rom time to time but do not constitute inventory - Also known as stock or stock in trade Different Types of Business Operations - Service firms: - Provide services to customers - Eg: lawyers, accountants, hairdressers, schools - Manufacturing firms: - Purchase raw materials and convert them to finished products, which they then sell - Eg: bakeries, car manufacturers, Levi Strauss - Merchandising firms: - Purchase and resell finished products for profit - Eg: department stores, newsagents, Just Jeans Merchandising Operations - Revenues are referred to as sales revenue - Expenses are divided into two categories - Cost of sales - Operating expenses - SALES REVENUE - COST OF SALES = GROSS PROFIT - GROSS PROFIT - OPERATING EXPENSES = PROFIT (LOSS) Inventory Systems - Perpetual System - Detailed inventory system in which the cost of inventory is maintained - Records continuously show to inventory that should be on hand - Eg: car dealerships, furniture stores - Periodic System - Inventory system in which detailed records are not maintained - Cost of sales is determined only at end of accounting period by a physical inventory account - Used widely by small businesses - Note that the COS account balance is already recorded under the Perpetual system - Under the Periodic system, COS needs to be calculated - Perpetual = more work and more detail/control - Periodic = less work, less detail/control Which method? - Cost/benefit Recording Purchases of Inventories in a Perpetual Inventory System Accounting for GST Purchases Returns & Allowances - A purchase return is the return of goods by the customer - The customer will receive a refund in the form of either credit or cash - A purchase allowance occurs where the customer keeps the goods and a reduction in price is granted Accounting for GST Purchase Discounts - Settles account outstanding of $3,500 and receives discount of $70 - List price quoted is $5,000 and trade discount given of 10% Freight Costs - Cost of freight is added to the cost of inventory where cost is charged to buyer - Cost is allocated to freight-in account and is part of cost of sales - Freight costs incurred by the seller are an operating expense to the seller - These costs are included as part of delivery or freight-out expenses Recording Sales of Inventory in a Perpetual Inventory System - Two entries are required: 1. To record the sales of goods 2. To record the cost of sales Sales Returns and Allowances - Return of goods by a customer - Two entries are required: 1. To record sales return at selling price 2. To record return to inventory at cost price WEEK 5 - CONTROL ACCOUNTS, SUBSIDIARY LEDGERS & SPECIAL JOURNALS Control Accounts, Subsidiary Ledgers & Special Journals - Subsidiary ledgers are groups of accounts with a common characteristic - Details from subsidiary ledgers are summarised in the general ledger control account - Two common subsidiary ledgers are: - Accounts Receivable (customers) - Accounts Payable (suppliers) Advantages of Subsidiary Ledgers 1. Show transactions in a single account providing up to date information 2. Free the general ledger of excessive details 3. Provide effective control 4. Enable segregation of duties Special Journals Special journals are used to record similar types of transactions Advantages of Special Journals - Enable segregation of duties - Simplifies posting process to general ledger - Used to record sales of inventory on account - Cash sales recorded in cash receipts journal Example of Sales Journal Posting the Sales Journal - Posting made daily to individual accounts receivable in the subsidiary ledger - At the end of the month column totals of sales journal are posted to the general ledger - Debit to Accounts Receivable account - Credit to Sales account - Debit to Cost of Sales account - Credit to Inventory account Checking the Ledgers Cash Receipts Journal - Used to record all receipts of cash - - - Debit columns - Cash - Discount allowed Credit columns - Accounts Receivable - Sales - Other accounts Debit and Credit column - Cost of sales and inventory Purchases Journal - Used to record purchases of inventory on account - Note: cash purchases of inventory are recorded in the cash payment journal - Some businesses expand the purchases journal to a multicolumn journal. This records all purchases on account and is posted in the same manner as the multi-column cash receipts and cash payments journals. Posting the Purchases Journal - Postings made daily to individual accounts payable in the subsidiary ledger - At the end of the month column totals of purchases journal and posted to the general ledger - Debit to Inventory account - Credit to Accounts Payable Cash Payments Journal - Used to record all cash payments - Credit columns - Cash paid - Discount received - Debit columns - Accounts Payable - Cash purchases - Other accounts paid Effects of Special Journals on General Ledger - Reduces the number of transactions requiring recording in the general journal. - Where control and subsidiary ledgers used: - Journalising: both control account and subsidiary ledger must be identified - Posting: transaction posted to control account and subsidiary account WEEK 6 - ACCOUNTING FOR DEPRECIATION + DEPRECIATION METHODS Learning Objectives 1. Describe how the cost principle applies to property, plant and equipment assets 2. Explain the concept of depreciation 3. Calculate depreciation using various methods and contrast the expense patterns of the methods 4. Account for subsequent expenditures 5. Indicate how non-current assets are reported in the statement of financial position Property, Plant & Equipment - Property, Plant & Equipment (PPE) are physical assets used in the business to provide future economic benefits for a number of years. - According to AASB 116/IAS 16, economic benefits derived from the use of an asset’s useful life - This decline is recognised as depreciation expense in the income statement - Two classes of PPE assets: - Property - Includes land and buildings - Plant and equipment - Includes cash registers, computers, office furniture, factory machinery, motor vehicles Depreciation - Depreciation is the process of allocating to expense the cost of a PPE asset over its useful (service) life in a rational and systematic manner - Carrying amount equals cost less accumulated depreciation - - Four factors that contribute to the decline in value of a depreciable asset: 1. Usage of the asset 2. Wear and tear through physical use of the asset 3. Technical and commercial obsolescence 4. Legal life Factors in calculating depreciation: - Cost - Useful life - Residual value Depreciation Methods - Straight-line - Depreciation expense same each year as benefits are consumed at same rate each year - Calculation for annual charge: - (cost of asset - residual value) / useful life of the asset - Example: ($13,000 - $1,000) / 5 = $2,400 - Diminishing-balance - Depreciation expense decreases each year as greater benefits are consumed earlier in assets life - Calculation: - Depreciation rate = 1 - or 1 – (r / c)1/n - - - - Example: 1 - ($1,000 / $13,000) ^⅕ - = 1 - 0.5987 - 40% (approx.) Units-of-production - Useful life is expressed in terms of total units of production or use expected from the asset Calculation of depreciation cost per unit: - Depreciable cost of asset / useful life of the asset - Example: $12,000 / 100,000 units = $0.12 per unit Depreciation expense: - Depreciation cost per unit x yearly units of production - Example: $0.12 x 15,000 units = $1,800 WEEK 8 - TRIAL BALANCE & CORRECTION OF ERRORS The Trial Balance A trial balance is a list of accounts and their balances at a given time. Customarily, a trial balance is prepared at the end of an accounting period. The accounts are listed in order in which they appear in the ledger. Debit balances are listed in the left column and credit balances in the right column. The totals of the two columns must be equal. These are the procedures for preparing a trial balance: 1. List the account numbers, names and their balances. 2. Total the debit and credit columns. 3. Verify the equality of the two columns. QUICK NOTE: DIVIDENDS is typically recorded as a DEBIT Example WEEK 9 - BANK RECONCILIATIONS Learning Objectives - Identify the effect of business transactions on cash - Explain the application of internal control principles for handling cash - Prepare a bank reconciliation Cash & Credit Transactions In summary, examples of transactions with inflows of cash include: - Revenue from cash sales of goods and services - Collection of cash from credit sales - Cash proceeds from divestment of assets - Cash received from business owners through issuance of shares - Cash received from borrowings Examples of transactions that cause outflows of cash include: - Cash payment for purchases of inventory - Cash payment for investment in assets such as property, plant and equipment - Cash payment for business expenses such as payroll and rent - Payment to business owners in the form of dividend or return of capital - Interest and loan payments to financial institution Cash is the most desirable asset because it is readily convertible into any other asset. Credit & Electronic Banking - Many business transactions now utilise electronic payment methods - Credit cards are a common form of payment for goods and services - EFTPOS and credit card transactions provide benefits to businesses due to reduction in staff costs and less risk associated with cash handling - Electronic funds transfer - provides nearly instant payment and reduces transaction costs Bank Reconciliation - The use of a bank contributed significantly to good internal control over cash by: - Minimising the amount of cash that must be kept on hand - Providing a double record of all bank transactions: - One by the business - One by the bank - Helping a company safeguard its cash by using a bank as a depository and clearing house for cheques received and written - Reconciling the bank account involves comparing the bank’s records and the firm’s bank ledger account - Lack of agreement between firm’s books and bank statement can result for two main reasons: - - Timing differences - Timing differences occur when the parties record the same transaction in different periods: - Unpresented cheque: lag between when the cheque is written and dated and the date it is paid by the bank - Outstanding deposits: lag between when receipts are recorded by the business and when recorded by the bank Errors - Errors by either party in recording transactions Reconciliation Procedure To prepare a bank reconciliation you require: - Last bank reconciliation - Cash receipts and cash payments journals - Cash at bank ledger balance - Bank statement for the period since last reconciliation Steps in the Reconciliation Procedure 1. Compare current bank statement to: a. Previous month’s bank reconciliation b. Current month’s cash receipts and cash payments journal 2. Identify ‘unticked’ items on bank statement a. Adjust cash-book for dishonoured cheques and direct deposits and own errors b. Examine cash journals and unticked items (outstanding deposits and unpresented cheques) i. List in bank reconciliation c. Unticked items from opening reconciliation are carried forward to current bank reconciliation 3. Total cash journal and post to Cash at Bank ledger 4. Complete bank reconciliation a. Outstanding deposits increase the bank account b. Unpresented cheques decrease the bank account Bank Rec Format Example of a Bank Reconciliation WEEK 10 - COMPILATION OF FINANCIAL STATEMENTS Learning Objectives - Use a worksheet to prepare the financial statements Prepare an adjusted trial balance and financial statements Describe the difference between current and noncurrent assets and liabilities Expanded Accounting Cycle Including Adjusting Entries The Adjusted Trial Balance & Financial Statements - The adjusted trial balance is prepared after all adjusting entries have been made - It is used to prove the equality of total debit balances and total credit balances after the adjusting entries have been made - The adjusted trial basis is the main basis for preparation of the financial statements Trial Balance & Adjusted Trial Balance Compared Statement of Profit or Loss - Income Statement - Purpose is to report the entity’s success or failure over a period of time - Lists the entity’s income (revenue and gains) - Lists the entity’s expenses - Income less expenses = profit (loss) - Prepared first to determine profit or loss - Reflects entity’s performance for the period - The statement prepared from revenue and expense accounts Statement of Changes in Equity - Current period profit (or loss) and dividends paid transferred to retained profits account - Statement of changes in equity - Profit (loss) must be added to (subtracted from) equity - Capital contributions and drawings/dividends also recorded - Shows details of movements in equity - Equity balance is reported in balance sheet Statement of Financial Positions - Statement of financial position prepared from asset, liability, equity and balance of retained earnings accounts - Reflects entity’s financial position as at the end of the period - Three major categories of accounts - Assets - Liabilities - Equity - Statement users find it useful if assets and liabilities are further classified WEEK 12 - PARTNERSHIPS Learning Objectives 1. 2. 3. 4. 5. Define a partnership and major attributes of a partnership State the advantages and main characteristics of the partnership structure of a business Explain the purpose of a partnership agreement and describe its typical content Describe the special features applicable to accounting for partnerships Explain the accounting entries for the formation of a partnership Partnership Defined - Partnership Act - The relationship that ‘subsists between persons carrying on a business in common with a view to profit’ - Necessary attributes 1. Must be an agreement (written or verbal) 2. View to earning a profit 3. Co-ownership of the business Advantages - Pooling of capital resources and multiple skills of individual partners - Formed at little or no cost - Subject to little regulation/supervision - Partners may be able to operate with more flexibility because not subject to control of a board of directors - May be tax advantages Characteristics - Mutual agency - Each partner acts as agent for the partnership - Each partner has authority to act on behalf of the partnership - Unlimited liability - Each partner personally responsible for all debts of the business - No limit to liability - Personal assets are exposed - Unattractive to wealthy individuals - Limited life - Ended if member dies, withdraws or retires, or becomes incapacitated - Ended on the admission of a new member - Ended via bankruptcy - Ended if formation purpose is over - Transfer of partnership interest - Capital interest is personal asset Partnership Agreement Agreement covers: - Name, location and nature - Name, investment and duties of each partner - Sharing of profits and losses Administrative details/day to day operations Withdrawals (drawings) Dispute resolution Admission/withdrawal of partners Partnership liquidation Accounting for Partnerships Method 1: Fluctuating Capital Accounts - Capital account credited when assets are invested in the partnership - Drawings account debited with withdrawal of assets or personal expenses - Drawings account closed to capital - P&L summary closed to Profit Distribution and allocated to Capital accounts - In agreed ratio, usually as per agreement Accounting for Partnerships Method 2: Fixed Capital Accounts - Capital account credited with asset investments and debited with withdrawals of capital - Drawings account debited with withdrawal of assets or personal expenses - Drawings account closed to Retained Profits - P&L summary closed to Profit Distribution and allocated to Retained Profits accounts - Commonly used in practice Accounting for the Formation of a Partnership - First step is to agree on carrying amount and fair value of assets to be contributed and liabilities to be assumed by the partnership - Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at measurement date - Assuming that the partners agree to have capital balances equal to the fair value of net assets contributed and that GST is not applicable the initial entry would be:
