ACCT10001
Accounting Reports and Analysis
Topic 1:
The Nature and Purpose of Accounting
Regulatory and Conceptual Frameworks
Presenter: Noel Boys
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Expectations
• You have downloaded and read the Subject Guide
• Topic 0: Introduction
• You have watched Lecture 0
• You will undertake the JB HiFi familiarisation exercise
• During lectures
• Watch and listen
• Use the Lecture slides and any illustrations to take notes
• Focus on UNDERSTANDING, not memory
• Adhere to the Code of Conduct
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Readings
• Chapter 1 – Introduction to accounting and business decision making
• LO 1.1 to 1.5
• Chapter 2 – Accounting in Society
• LO 2.1 to 2.3, 2.8
• Chapter 3 – Business structures (separate Supplementary recording)
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Management
Accounting
Internal
Accounting Reports
Internal
Stakeholders/
Decision Makers
Qualitative
Characteristics:
Analysis
Decision &
Action
Financial
Accounting
External
Relevance
Faithful Rep.
Comparability
Verifiabilty
Timeliness
Understandability
Budgets
Costing & Pricing
Contribution Margin
Performance reporting
Statement of profit or loss
Statement of financial position
Statement of cash flows
Statement of changes in equity
Decisions about what to
Report/disclose and in what form
Agency
Issues
External
Stakeholders/
Decision Makers
The Accounting System
Assets (A) ‐ Liabilities (L) = Equity (E)
∆E = Income – Expenses ± Transfer to/from owners
Decisions about what (Events)
to record and at what value (Attributes)
Agency
Issues
Analysis
Decision &
Action
The Economic Reality
(Events & Attributes)
of the Reporting Entity
(Sole Trader, Partnership, Company)
Time
past, present, future
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Learning objectives
By the end of this session you should be able to:
• Explain the nature and purpose of accounting
• Compare and contrast the different types of business / corporate structures
• Describe the external reporting obligations as they relate to companies
• Have a working knowledge of the Conceptual Framework
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What is Accounting?
NOT just numbers and bookkeeping
NOT black and white
NOT boring
“… can be defined as the process of identifying, measuring and
communicating economic information about an entity to a variety of users
for decision‐making purposes.”
(Birt et al, 2023)
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Users of Accounting Information
Resource providers
• investors, lenders, suppliers, employees, members, donors, government
Recipients of goods and services
• customers, beneficiaries e.g. taxpayers, community
Parties performing a review or oversight function
• regulatory agencies (ASIC, ASX, ATO), advisors, analysts, labour unions,
media, community groups
Management and governing bodies
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The information needs of users
Investors – risk and return, prospect of dividends, potential for capital growth,
management performance
Lenders – ability to repay debt, pay interest
Suppliers – ability to pay debt, likelihood of ongoing custom
Employees – ability to provide benefits, ongoing employment
Customers / Beneficiaries – fair and reasonable prices / fees / taxes, capacity to
provide ongoing supply
Regulatory agencies – compliance with reporting regulations, statistical data
Advisors and analysts – financial information for analysis
Community groups – social and environmental impact
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Summary of information needs
Financial
• Profitability (utilisation of resources to generate returns)
• Efficiency (the ability to generate cash flow)
• Liquidity (the ability to meet short‐term debts)
• Gearing / Capital structure (the debt / equity mix)
• Market performance (share‐based analysis)
Non‐financial
• Corporate governance / compliance
• Social and environmental impact (sustainability reporting)
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How Accounting provides information
Internal Users (those involved in day‐to‐day decision making and the
preparation of FS)
• details of all transactions and events, tailored reports generated from the
accounting system
External Users (stakeholders outside the entity)
• General Purpose Financial Reports
– Financial statements and notes in Company Reports
• Sustainability reports
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Components of a General Purpose Financial Report (GPFR)
• Statement(s) of Financial Performance
• Profit or Loss & Other Comprehensive Income
• Statement of Financial Position
• Statement of Cash Flows
• Statement of Changes in Equity
• Notes to the Accounts
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JB Hi‐Fi Limited
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JB Hi‐Fi Limited
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JB Hi‐Fi Limited
(continued)
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JB Hi‐Fi Limited
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Business Structures
Amongst over 2 million active businesses in Australia the most common
structures are:
• Individual (sole trader)
• Partnership
• Company
• Trust
Refer to the supplementary lecture for details regarding different types of
business structures and their reporting requirements under the Corporations
Act
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Conceptual Framework for Financial Reporting
Describes the objective of, and the concepts for, general purpose financial reporting
• The principles that underlie the preparation and presentation of GPFR
• The foundation for the development of accounting standards
The objective of general purpose financial reporting
“… to provide financial information about the reporting entity that is useful to existing
and potential investors, lenders and other creditors in making decisions relating to
providing resources to the entity.”
•
What decisions?
– buying, selling or holding equity and debt instruments (e.g. shares)
– providing or settling loans and other forms of credit
– exercising rights to vote on management’s actions
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General Purpose Financial Reports (GPFR)
Key points regarding GPFR
•
•
•
•
•
•
Many users cannot command info directly from the entity => they rely on GPFR
GPFR are not the only source of information e.g. economic data
GPFR are not designed to show the value of an entity
Management does not rely on GPFR, they can obtain their info internally (note also:
they prepare GPFR)
Other parties (regulators, public) may also be interested but GPFR not specifically
directed to their needs
GPFR are, to a large extent, based on estimates, judgments and models rather than
exact depictions
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General Purpose Financial Reports
What information does a GPFR provide?
• Economic resources and claims
• Changes in economic resources and claims
– Financial performance reflected by accrual accounting
– Financial performance reflected by past cash flows
– Changes in economic resources and claims not resulting from financial
performance
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General Purpose Financial Reports
Accrual accounting
“… depicts the effects of transactions and other events and circumstances on a
reporting entity’s economic resources and claims in the periods in which those
effects occur, even if the resulting cash receipts and payments occur in a
different period.”
• The accrual basis of accounting recognises cash and credit transactions as
well as other economic phenomena
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Qualitative Characteristics of Useful Financial Information
The characteristics that should be exhibited by information contained in GPFR in order for it
to be most useful to users
Fundamental QCs
Relevance
Faithful representation
Enhancing QCs
Comparability
Verifiability
Timeliness
Understandability
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Relevance (and Materiality)
•
Information is relevant if it is capable of making a difference to decisions made by users
• Information is capable of making a difference if it has predictive value (but not
necessarily a prediction), confirmatory value (feedback about previous evaluations or
predictions) or both
•
Information is material if omitting, misstating or obscuring it could reasonably be
expected to influence decisions that the primary users of GPFR make on the basis of
those reports, which provide information about a specific reporting entity
• Materiality is an entity‐specific aspect of relevance based on nature or magnitude, or
both, of the items to which the information relates in the context of an entity’s
financial report
• There are no quantitative thresholds specified
• Onus is on the preparer to make a judgment
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Faithful representation
Financial statements represent economic phenomena in words and numbers
To be useful, financial statements must faithfully represent the phenomena it purports to
represent
Information should seek to maximise the following qualities to the extent possible:
• Complete – all necessary info including descriptions and explanations
• Neutral – without bias, not manipulated to increase the probability that it will be
received favourably or unfavourably
• Free from error – does not mean accurate, means no errors or omissions in calculations,
processes or descriptions; a reasonable estimate may not be accurate, but it can still be
faithful
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Enhancing Qualitative Characteristics
Comparability
• information should be comparable with other entities / other reporting periods
• consistent application of accounting policies assists comparability
Verifiability
• means different knowledgeable and independent observers could reach consensus (not
necessarily complete agreement) that a particular depiction is a faithful representation
• does not necessarily mean confirmation of a single quantifiable amount (could be within
a range)
• where an item cannot be verified, disclosure of assumptions and methodology assists
users
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Enhancing Qualitative Characteristics
Timeliness
• having info available in time to be capable of influencing decisions
• generally, the older the info, the less useful it is
– however, info from prior periods useful in trend analysis
Understandability
• presenting clear and concise information
• can’t avoid some necessary complexities in FS
• assumes users have reasonable knowledge or access to someone else who does
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Basis of preparation
Reporting period
• Financial statements are prepared for a specified period of time
• The CA 2001 require reports to be prepared (at least) annually (also half‐yearly for
publicly listed companies)
• The reporting date is not prescribed (Aus fiscal year ends June 30)
Perspective adopted
• FS provide info about transaction and other events viewed from the perspective of the
reporting entity as a whole, not from the perspective of users
Going concern
• The FS are prepared on the assumption the entity will continue in operation for the
foreseeable future, with neither the intention nor need to liquidate
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The Elements of Financial Statements
GPFS portray the financial effects of transactions and events by grouping them into broad
classes according to their economic characteristics
Elements related to an entity’s financial position:
• assets, liabilities and equity
Elements related to an entity’s financial performance:
• income and expenses
NOTE: Cash flows reflect income and expenses and changes in assets, liabilities and equity
=> cash flows have no unique elements
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Definition of an Asset
A present economic resource controlled by the entity as a result of past events
An economic resource is a right that has the potential to produce economic
benefits
Rights
• A right to receive cash, goods or services from another party
• A right over a physical object (e.g. land & buildings, inventory)
• A right to use intellectual property
• In principle, each right is a separate asset, but the set of rights is accounted for as a
single asset
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Definition of an Asset
Potential to produce economic benefits
• Potential does not need to be certain, or even likely (probability may, in fact, be low)
• Economic benefit could entitle or enable the entity to:
• Receive cash flows or some other economic resource
• Produce goods or services
• Lease the resource to another entity
• Sell the resource
• Use the resource to settle debts
• The present right is the asset, not the potential future economic benefit
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Definition of an Asset
Control
• The present ability of the entity to direct the use of the economic resource and obtain
the economic benefits that may flow from it
• and prevent others from directing the use / obtaining the benefits
• The ability to enforce legal rights, including ownership, demonstrate control but
ownership is not essential
• Exposure to significant variations in the amount of economic benefits produced by an
economic resource may be an indication of control
Past events
• Most commonly an acquisition (i.e. an exchange)
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Definition of a Liability
A present obligation of the entity to transfer an economic resource as a result
of past events
Obligation
• A duty or responsibility that an entity has no practical ability to avoid
• Often established by contract or legislation and is legally enforceable by another party
• May arise from entity’s customary practices, published policies or specific statements
(constructive obligation)
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Definition of a Liability
Transfer of an economic resource
The obligation must have the potential to require the entity to transfer an economic
resource to another party
• Potential does not need to be certain, or even likely (probability may, in fact, be low)
• Obligation could require the entity to:
• Pay cash
• Deliver goods or provide services
• Transfer resources if a specified uncertain future event occurs
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Definition of a Liability
Present obligation as a result of past events
• The entity must have obtained economic benefits or taken an action that requires (or has
the potential to require) the entity to transfer an economic resource that it would
otherwise not have had to transfer
• No present obligation exists if the entity has not obtained the economic benefit, or
taken an action
• Example: employee services
• A present obligation may accumulate over time
• A present obligation can exist even if settlement cannot be enforced until some point in
the future
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Assets and Liabilities
Unit of account
• Refers to how assets and liabilities are grouped together for recognition, measurement and
disclosure purposes
• The descriptions used in financial statements for resources and obligations which have similar
economic characteristics and risks
• Relevant in providing useful information
Executory contracts
• Contracts create rights and obligations
• If entity performs its obligation first, contract gives rise to an asset
• If other entity performs its obligation first, it gives rise to a liability
• A contract that is equally unperformed gives rise to neither an asset or a liability
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Definition of Equity
The residual interest in the assets of the entity after deducting all its liabilities
• Equity = Assets less Liabilities
– Assets and liabilities already defined
• Equity does not necessarily reflect the value of the entity
• Equity is either:
– contributed by investors (contributed equity, share capital, issued capital, paid‐up
capital)
– the net result of accumulated profits of the entity (retained profits and other reserves)
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Definition of Income
Increases in assets, or decreases in liabilities, that result in increases in equity, other than
those relating to contributions from holders of equity claims
• A key characteristic of income is that it is earned
– As the performance obligation is satisfied (over time or at a point in time)
– The entity provides a good, a service or a resource
• sales, fees, rent revenue, interest revenue
– net assets will ↑
• assets (e.g. cash or receivables) will ↑ or liabilities (e.g. unearned revenue) will ↓
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Definition of Expenses
Decreases in assets, or increases in liabilities, that result in decreases in equity, other than
those relating to distributions to holders of equity claims
Assets less Liabilities = Equity
• A key characteristic of an expense is that a resource is consumed
– inventory disappears, labour is utilised, PPE is used
• cost of sales, wages, rent, depreciation
– Net assets will ↓
• assets (e.g. cash, inventory, PPE) will ↓ or liabilities (e.g. payables, provisions) will ↑
• Expense vs Expenditure vs Cost
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The links between the elements
Statement of financial position at beginning of reporting period
Assets – Liabilities = Equity
+
Statement(s) of financial performance (during the period)
Income – Expenses
+
Contributions from equity holders – Distributions to equity holders
=
Statement of financial position at end of reporting period
Assets – Liabilities = Equity
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The recognition process
The process of capturing for inclusion in the statement of financial position or the
statement(s) of financial performance an item that meets the definition of one of the
elements of financial statements
• An item can satisfy the definition of an element without necessarily being included in the
financial statements
Recognition involves depicting the item – either alone or in aggregation with other items –
in words and by a monetary amount and including that amount in one or more totals in that
financial statement
The amount at which an asset, liability or equity is recognised in the statement of financial
position is referred to as its carrying amount
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Recognition criteria
Only items that meet the definition of an element can be recognised
• Scope to present in the Notes information about an item not recognised
An asset or liability is recognised only if its recognition (and the recognition of any resulting
income, expense or change in equity) provides users with useful information
• i.e. the information about the asset, liability, resulting income, expense or change in
equity is relevant and a faithful representation
Determining what is useful is a judgement by the preparer
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Recognition criteria
Relevance
• Information about assets, liabilities, equity, income and expenses is relevant to users
• However, recognition of an asset or liability may not be relevant if:
– It is uncertain whether the asset or liability exists (existence uncertainty), or
– The asset or liability exists, but the probability of an inflow or outflow of economic
benefit is low
• Existence uncertainty and/or low probability of inflow/outflow may lead to non‐
recognition, but explanatory information may be provided in the Notes
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Recognition criteria
Faithful representation
• Recognition of an asset or liability is appropriate if it provides not only relevant
information, but is also a faithful representation of that asset or liability
• For an asset or liability to be recognised, it must be measured
• Measurement that is subject to estimation gives rise to a level of measurement
uncertainty
• If the degree of measurement uncertainty is high, consider:
– Applying the measure accompanied by explanatory Notes
– Alternative measurement options accompanied by explanatory Notes
– Non‐recognition accompanied by explanatory Notes
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Derecognition
• The removal of all or part of a recognised asset or liability from an entity’s statement of
financial position
• Occurs when the asset or liability no longer meets the definition
• For assets, when, or as the asset:
– Is consumed
– Is collected
– Is transferred
– Expires
• For liabilities, when, or as the liability is:
– Settled
– Fulfilled
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Measurement
• The quantification in monetary terms of elements recognised in financial statements
(assigning a dollar value)
• Accounting standards prescribe / provide guidance regarding measurement bases or
methods
• Historical cost – the transaction price or value at time of recognition
• Fair value – the market price (selling price)
• Value in use – the present value of future cash flows generated from use and ultimate
disposal
• Current cost – cost of an equivalent asset (replacement cost)
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Disclosure
• How a reporting entity communicates and presents information in financial statements
• Accounting standards prescribe / provide guidance regarding disclosure requirements
• Information needs to be relevant and contribute to a faithful representation
• Also enhance understandability and comparability
• Classifying information in a manner that groups similar items and separates dissimilar
items
• The right balance: aggregate information in such a way that is not obscured either by
unnecessary detail or by excessive aggregation (Notes can provide disaggregated
information)
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Where are we heading next?
To gain an understanding of the contents of financial statements and the recognition,
measurement and disclosure issues associated with key line items
To consider tools to assist financial statement analysis
Context
• External user (Financial Accounting)
• General Purpose Financial Reports (GPFR) prepared by companies in accordance with
Accounting Standards
– Other types of entities (e.g. SMEs and non‐reporting entities) prepare reports on a
(slightly) different basis (same principles but reduced reporting regime)
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