2022
VCE Accounting
Unit 1 Revision for Semester Exam
The Role of Accounting
Accounting: the process of recording and reporting on financial events, and proving useful information for
decision making
Ethics: moral decision making. Should take into account social, environmental and financial decision
making
Elements
Assets: Economic resources under control of an entity, which have the potential to produce economic
benefit (within 12 months - CA / for more than 12 months - NCA)
Liabilities: Obligations to transfer economic resources to another entity (within the 12 months – CL / in
more than 12 months - NCL)
Owners’ Equity: Residual value of the assets of an entity after deducting its liabilities
Capital (Contribution), Drawings, Profits
Revenue: Increases in assets, or decreases in liabilities, that result in an increase in Owner’s Equity.
Expense: Decreases in assets, or increases in liabilities, that result in a decrease in Owner’s Equity
Accounting for Small Business
Accounting process: Business/source documents → Records → Reports → Advice
Qualitative Characteristics
T.U.R.F.C.V
Timeliness: Information is to be provided to users as quickly as possible so that it remains useful for
decision making
Understandability: Financial information should be presented clearly and concisely, so that users can
easily understand it
Relevance: Information to be useful in helping users make decisions
Faithful representation: Financial information must accurately reflect economic events
Comparability: Ability to compare similar types of accounting information effectively with other entities, or
over different reporting periods
Verifiability: Information is to be supported by evidence that can be used to check its accuracy
1. How can the business owner to verify the accuracy of the records?
2. Why does the business owner keep the source documents for three years?
Accounting Assumptions
P.A.G.E
Period: Financial activities are recorded and reported on for a particular period of time
Accrual basis: Recording revenue when earned, and expenses when incurred
Going concern: A business will continue to operate, and isn’t expected to end in the near future
Entity: Business must keep its records separate from its owner
Balance Sheet for Small Business
Balance sheet: indicates the current position of the firm
Accounting Equation: A = L + OE
OE = A - L
Equities: Liabilities + Owner’s Equity
Accounts receivable: credit customers who have been provided with goods or services but have not yet
paid for these items. That is, they owe the business money. Classified as a current asset
Accounts payable: suppliers who have provided our business with goods or services but have not yet paid
for these items. The business still owes the supplier money. As this represents a present obligation, it
qualifies as a current liability.
Liquidity: The ability of a business to meet its short-term debts
Working capital = Current Assets – Current Liabilities
Working Capital Ratio (WCR) =
Current Assets
Current Liabilities
For example, A WCR of 3:1 will mean that there is $3 of current assets, to cover its current liabilities and
would be satisfactory. Less than 1:1 would not be.
Single Entry Accounting
Cash Source Documents: Cheque butts, EFT Receipt, Cash Receipt
Credit Source Document: Invoice
Other Source Documents: Credit Note, Purchase order, Delivery Docket, Statement of Account, Bank
Statement
Establishing a Small Business
Reasons to go into business:
 Independence
 Income
 Passion


Freedom
Capital gains
Reasons for business failure:
 Insufficient capital
 Poor Management
 Ineffective financial advice


Poor demand
Inability to compete in marketplace
Unlimited Liability: situation where the owner of a business is responsible for any debts that are
remaining after a business goes bankrupt
Sole Proprietorship: business owned by a single person, which is easy to set up and the owner has full
control & receipt of profits. However, the starting capital is limited and it comes with unlimited liability.
Partnership: business owned by a small number of people, which is easy to set up, more starting capital is
available, and responsibility/expertise can be shared. However, profits must be split and it has unlimited
liability.
Company: Large business owned by shareholders, who do not make decisions in the running of the
business. Shareholders have limited liability, share most of their profits with the numerous other
shareholders, and have far greater access to capital. Shareholders earn money by either receiving a slice
of the profit, known as a dividend, or by selling their shares for a profit.
Investment Opportunities
Savings Account: Bank account through which you receive interest revenue. Secure, but low returns.
Constant and immediate access
Term Deposit: Bank accounts which receive a higher return than a regular bank account, with the proviso
that the funds cannot be accessed for an extended period. Secure investment
Government bonds: The lending of money from the public to the government, in return for interest.
Cannot be accessed for several years, and considered a safe investment
Company shares: Investing by buying a small slice of a company. Shares are seen as a risky investment,
however with high returns. Profit can come via dividends or by selling shares at a profit
Debentures: A loan by the public to a company so they can raise capital. Interest is high, with a medium
risk
Property: Safe investment, however an expensive investment. Profit via sale of property or rental income
Recording Cash Flows
Cash Receipt: Any time a business receives cash, and their bank account goes up, we refer to it as a cash
receipt. These can include: cash sales, receiving interest, receiving money owed from credit customers,
loans and capital contributions. These transactions are recorded in the Cash Receipts Journal (CRJ)
Cash payment: Any time a business pays cash, and their bank account goes down, we refer to it as a
cash payment These can include: buying inventory or non current assets, paying for services (electricity,
wages), interest on loans, paying back suppliers and drawings. These transactions are recorded in the
Cash Payments Journal (CPJ)
Statement of Receipts and Payments: The report will give a summary of all payments and receipts, as
well as the subsequent affect on the bank balance
Excess of Receipts over Payments: Subtotal of cash receipts less the subtotal of cash payments
GST: Goods & Services Tax. 10% on most purchases, and is collected by businesses on sales, and paid
on purchases. At the end of a period, if the business paid more than it collects during that time it will have a
GST Asset which will be paid to them via the ATO. If the business receives more than it pays, it will have
GST liability to be paid to the ATO
Income Statements
After completing an Income Statement, the net profit amount will be included in the Owner’s Equity section
of the Balance sheet. It will be added to the Capital balance.
Credit Transactions
Credit transaction: goods and services are supplied immediately but are paid at a later date. Source
document is always an invoice. Credit purchases are recorded in the Purchases Journal (PJ), Credit
sales are recorded in the Sales Journal (SJ)
Credit terms: The period of time a customer has to repay the amount owed, is called the credit terms. An
example would be “5/7, n/30”. This means that the customer has 30 days to pay the full amount, but for
every dollar paid in the first 7 days, they will receive a 5% discount
Both accounts payable and accounts receivable have their own individual records too
When experiencing slow accounts receivable payments, improvement techniques include:
 Reminder notices / calls
 Legal action
 Timely invoicing
 Removal of credit facilities
 Debt collection
 interest
Accounts Receivable Schedule: A summary of the accounts receivable
Financing Small Business
Internal Finance: owner’s capital or retained profit (profit made each period that is kept in the business for
expansion or operation funds, rather than withdrawn by the owner
External Finance: Trade credit, overdraft, Loan, leasing
Gearing: The amount of the business that is funded by loans or borrowed funds, instead of capital
Cash Flow Statements
Cash flow statement: Reports on the movements of cash in and out of a business during a reporting
period
Operating Activities: Cash flows that relate to the day to day operations of the business
Investing Activities: Cash flows that result from the purchase or the sale of non-current assets
Financing Activities: Cash flows that relate to changes in the financial structure of the business. Includes
drawings, capital contributions, new loans and the payment of the principle of old loans. Does not include
interest expense.
Evaluating performance
We compare the results against previous periods to see if the business is improving or worsening. It gives a
good indication of whether corrective action needs to be made. Looking at one year alone can give a false
indication of the business’s current performance
A business will produce a budget before an accounting period to indicate how much profit it expects to
earn, and also how much it intends to spend on each expense. Once a period concludes, its actual
performance can be compared to the budget to see whether it over or underperformed. Either way,
conclusions can be made as to what improvements are needed, or if overperforming the budget, how to
continue this trend
Businesses in a competitive market should compare their performance necessary to similar businesses.
Many industries have their average performance statistics public. Comparing to the industry can give an
indication of if the business is over or under performing. However, consideration should be given to the fact
that every business is different, operating with a different set of circumstances
Profitability: the ability of the business to earn profit. It is measured by comparing profit against a base
such as sales, assets or owner’s equity. Profitability is not a measure of how much profit is earnt, but
instead a business’s capacity to earn profit. A firm’s ability to earn profit is dependent on its ability to earn
revenue and control expenses
Calculates the percentage of Sales revenue that is retained as net profit, and is a profitability indicator.
Used to assess a business’s ability to control expenses
A 10% NPM would mean that 10% of sales is retained as net profit after deducting expenses, or 90% of
sales revenue is spent as expenses. 10c of every $1 the business earns is kept as net profit. The better the
business is at earning revenue, or controlling its expenses, the higher the Net Profit Margin
The main measure of profitability for the investor. The profit earnt per dollar of capital invested. How
effective the business was in using the owner’s funds to generate profit
A 25% ROI would mean that for every $1 the owner has invested in the business, he is earning 25c of profit
Otherwise known as Return On Assets. Assesses profitability from a manager’s point of view. The profit
earnt per dollar of asset controlled by the business. How effective the business was in using its assets to
generate profit.
A 10% ROA would mean that for every $1 of assets the business owns, it is generating 10c of profit
A liquidity indicator, assessing the ability of the business to meet its short term debts. Indicates how much
current assets are on hand to cover our current liabilities
Business A has $1.25 of current assets for every $1 of current liabilities, however Business B has only 95c
of current assets to cover every $1 of current liabilities. We would suggest that Business A has a sufficient
WCR, especially when comparing to a similar business, however Business B has insufficient WCR due to
its lack of current assets to cover its current liabilities
Debt ratio is a performance indicator, however is also a stability indicator. Stability is the ability of the firm
to meet its long term debts, and hence continue business. Measures the percentage of a firm’s assets that
are financed by liabilities (known as gearing). Shows how reliant a business is on debt to purchase assets.
The higher the ratio, the higher the reliance on borrowed funds and risk, but also the higher the amount of
funds that will flow to the owner. Also, higher the debt ratio, the higher the interest expense that will be paid
Business A has a very low risk of not repaying its debts, with a low reliance on borrowed funds. However,
less profit will flow to the owner. Business B has a much higher gearing and risk, due to its more balanced
reliance on both borrowed funds and capital. It will have much higher interest expense, and lower profits
flowing to the owner.
There are numerous other ways to judge the performance of a business, and these are known as nonfinancial indicators. Successful businesses combine both financial and non-financial indicators when
making decisions.
They include:
• Jobs completed
• Website traffic
• Tracking of
• Number of
• Repeat
postcodes
complaints
customers
• Customer
• Referrals
satisfaction
• Hours worked
surveys
Internal Control
Internal Control: It is important for businesses to protect assets, including their cash, from theft, loss and
damage. Both physical and accounting measures can be put in place to protect against this. Includes:
separation of duties, rotation of duties, random checks, accurate record keeping and physical protection of
assets (alarms, cameras, security)
Two-fold effect of transactions
Explain the effects of transactions on the accounting equation
Paid Monthly Loan 1,000
Assets: decrease by 1,000 Liabilities: decrease by 1,000 Owner’s equity: no effect
Purchase equipment which worth 5,000
Assets: increase by new equipment bought in worth 5,000, decrease by cash paid 5,000
Every transaction in accounting has an impact on at least two items of the balance sheet
Both sides of the balance sheet must remain balanced, and therefore the net effect on assets has to be
equal to the net effect on the equities
Any time a revenue increases, such as an increase in sales, this leads to an increase in Owner’s Equity.
This is because revenue increases profit, which at the end of the period goes to the owner
Any time an expense increases, such as an increase in wages, this leads to a decrease in Owner’s Equity.
This is because expenses decrease profit, which at the end of the period goes to the owner
Increases to GST received lead to a higher GST liability, as this is owed to the GST. Increases to GST paid
will lower any GST liability that exists, or lead to a GST asset. Regardless of it is an asset or liability to the
period, in the Balance Sheet it will now be referred to as GST Clearing
Cost of Goods Sold is the value of inventory that is sold plus any associated costs that are incurred in the
process of bringing inventory into a condition or location ready for sale
• The main component of COGS is Cost of Sales, which represents the cost price of inventory that
has been sold
• It also includes the following:
• Cartage in / freight in / delivery in
• Customs Duties
• Import Duties
• It does not include the delivery to customers
When selling inventory, 2 different pairs of double entries need to be made:
• The revenue (sale price) at which the stock was sold to the customer
• The cost of goods sold (cost price) at which the inventory has left the store or warehouse
When purchased, inventory must be recorded at its cost price to satisfy verifiability
Elements
Asset
Owner's
Equity
Liability
Current
Non-current
Current
Non-current
Inventory
Vehicle
Loan
Cash at Bank
Machinery
Loan
Bank
Overdraft
Accounts
Receivable
GST Clearing
Shop Fittings GST Clearing
Furniture
Premises
Equipment
Accounts
Payable
Capital
Drawings (-)
Net Profit
Computer
Balance
Sheet?
Yes
Yes
Yes
Income
Statement?
No
No
No
Revenue
Expense
Credit Sales
Cash Sales
Electricity
Wages
Fees
Advertising
Insurance
Interest
Cost of Sales
Cartage In
Delivery
Freight In
Customs Duties
Buying expenses
Import Duties
Office Expenses
No
No
Balance
Sheet?
Yes
Yes
Income
Statement?
Ethics
Ensure that you write about financial, social and environmental effects of any decision or query being
asked.
Financial should include any effect on the businesses balance sheet or income statement.
Social should include impacts on society as a whole, and potential reputation shifts
Environmental should include situations such as pollution and recycling
Theory Questions
When answering theory questions always follow IDL when possible
Identify – state the Qualitative Characteristic or Accounting Assumption if you have been asked to do so
Define – Define the QC or AA, or element, if the question has asked for it
Link – Always ensure you link it back to the question. Utilise the business’s name and owner’s name, and
explicitly answer what is being asked. Do not ‘beat around the bush’ or use the ‘dump truck’ method