Accounting Concepts Standard
Term
Statement of Accounting
Policies
Definition
Shows the assumptions, rules and valuation methods
followed in preparing the accounts and how financial
elements have been measured.
Applying it
Income statement
Measures income, expenses and the profit for the
reporting period.
Informs the owner if the business is profitable, tells IRD
if the correct amount of income tax is being paid.
Balance Sheet
Measures the assets, liabilities and equity (or net
worth) at one point in time.
Cash Flow Statement
Shows where cash has come from and how it has been
spent over the period and the change in the bank
balance.
Assets and liabilities are classified and changes in equity
shown.
Useful to measure business liquidity and financial
structure, ability to borrow more debt
Total cash receipts – Total cash payments + Opening bank
balance = Closing bank balance.
Bob’s Builders
Statement of Accounting Policies
Name and Nature:
Financial Statements have been prepared for Bob’s
Builders a sole proprietorship building business.
Measurement Basis:
The measurement base adopted is historical cost.
Property Plant and Equipment:
Property, plant and equipment are recorded at their
original purchase price.
Depreciation
The cost less residual value of property, plant and
equipment (except for land) is depreciated over their
estimated useful lives.
Income
The increase in economic benefit in the form of
inflows, or enhancements of assets of decreases in
liabilities that result in increases in equity other than
owner’s contribution.
In order to define income you need to be able to
repeat the three essential characteristics of income:



An increase/ inflow in economic benefit which
increases assets;
An increase in equity;
It is not based on owners contributions
NB: If it is a community organisation do not use third
point.
The sales in a trading business, or the fees, commission,
takings and service revenue of a service business – the
amount earned by the business from their main income
generating activity.
Businesses may also earn revenue from investing in shares
(dividends received), term investments (interest received)
or assets like buildings (rent received).
E.g. Explain how sales of Pizzas for Poppas Pizza meets the
definition of income:
 The bank asset increases (or overdraft decreases)
when sales revenue is received.
 Sales income of Poppa’s Pizzas increases the net
profit, which increases the equity.
 The increase in equity is not the result of a
contribution by the owner.
Expenses:
Expenses are consumptions or losses of service
potential or future economic benefits in the form of
reductions in assets or increases in liabilities of the
entity other than those relating to distributions to the
owners that result in a decrease in equity during the
reporting period.
In order to define expenses you need to be able to
repeat the three essential characteristics of an
expense:



Capital Expenditure
Revenue Expenditure
Distribution Expenses:
A loss in service potential or economic benefit;
A decrease in equity;
It is not based on owner’s drawings.
Decrease in economic benefit – the money paid is an
outflow which decreases the bank account which is an
asset (or increases the bank overdraft liability) OR
(accounts payable liability increases if it is a credit
transaction).
Decrease in equity – equity decreases as the net profit is
decreased.
Not owners drawings – the decrease in the asset (bank) OR
the increase in the liability (bank overdraft) is not the
result of any distribution to the owner.
E.g. explain how Poppa’s Pizza electricity bill meets the
definition of an expense:
 The bank asset decreases (or bank overdraft
increases) when the electricity bill is paid
 The electricity bill decreases the net profit which in
turn decreases the equity; and
 It is not a distribution to the owner.
Capital expenditure includes:
 the purchase of a non current asset;
 costs incurred in transporting & installing the asset to
get it ready for the business to use;
 any improvements to an asset to extend its useful life.
NB It’s an expense.
NB: If it is a community organisation do not use third
point.
Spending that will benefit the business beyond the
current year. The purchase of an asset e.g. delivery
van, tools, a building, a computer. These are reported
in the balance sheet.
Capital expenditure does NOT affect equity.
Spending that benefits the business in the current
period that is treated as an expense and decreases
profit and equity
The expenses directly related to selling inventory
Examples of Distribution expenses include advertising,
(goods) or delivering a service – the costs incurred in
sales wages, petrol, shop electricity and depreciation on
transferring ownership to the consumer and for the
shop fittings.
promotion, storage, selling and delivery of inventory for
sale.
Administrative Expenses:
The costs associated with the administration of the
entity as a whole.
Finance Costs:
The expenses incurred in borrowing funds. Finance
costs are limited to different types of interest paid.
Assets:
The resources controlled by the entity as a result of
past events, from which future economic benefits are
expected to flow to the entity.
Past = past events
Present = controlled by the entity
Future = future economic benefits
In order to define assets you need to be able to
describe the three essential characteristics of an
asset.
Current Assets
Non-current assets
An asset is current if it is:
 expected to be realised in or is intended for sale or
consumption in, the entities normal operating cycle
(the next 12 months);
 held primarily for the purposes of being traded;
 expected to be realised within 12 months of the
balance sheet date; or
 cash or cash equivalent.
All other assets are classified as non-current.
An asset which will remain in the business for more
Examples of Administrative expenses include office
salaries, rent, insurance, depreciation on equipment,
telephone, discounts allowed (to debtors), bad debts
Examples of Finance costs include interest on overdraft,
interest on loan, and interest on mortgage.
Past: the asset (name the asset) was purchased in the
past.
Present: only the entity has control of the asset (show
how and state the name of the entity and the asset)
Future: the asset (name the asset) will be used in the
future to provide an inflow of economic benefit to the
entity (state how).
e.g. Poppas Pizza delivery van:
The delivery van was purchased in the past.
Only Poppa’s Pizza can use the delivery van to deliver
pizzas.
Poppa’s Pizzas will benefit from the delivery van as it will
be used to deliver pizzas and earn income for the
business in the future.
An asset expected to be turned into cash, sold or used up,
within one year after the date of the balance sheet.
than one year after the date of the Balance Sheet.
Property, plant and equipment
Property, plant and equipment are reported in the note
to the balance sheet. They are tangible items that:
 are held for use in the production or supply of
goods or services, for rental to others, or for
administrative purposes, and
 are expected to be used during more than one
period.
Intangible assets
Assets that have no physical characteristics but
provide service potential or economic benefits in the
future e.g. goodwill.
Investment Assets
Cash assets that provide service potential or economic
benefits in the future, but may not readily accessible
e.g. term investments.
Physical assets owned by the business e.g. land buildings
and machinery
Assets held to earn interest or dividend income and
perhaps a capital gain in the case of shares.
Depreciation
The loss or consumption of the service potential or
future economic benefit of an asset.
- Over time assets wear out or become obsolete,
they provide less benefit as time goes by.
- Depreciation is treated as an expense.
Annual depreciation rate is reported in the Income
Statement and the accumulated depreciation to date
is reported in the Balance Sheet.
Straight line depreciation is used in level 1 NCEA
calculated by:
Historical cost – Residual Value
Estimated useful life
-
Historical cost is the original purchase price of the
asset.
Residual value is what the asset can be sold for at the
end of its useful life.
Estimated useful life is how long the asset will be used.
By the entity.
Explain why Poppa’s Pizza depreciates the delivery van
each year:
Poppas Pizza depreciates the delivery van in order to
represent the loss, or consumption of the service potential
of future economic benefit. (defined)
Depreciation is classified as an expense because it
represents the loss or consumption of the service
potential or future economic benefit, in the form of the
reduction in the delivery van that results in a decrease in
equity other than a distribution to the owner. (applied)
Liabilities:
The present obligation of the entity arising from past
events, the settlement of which is expected to result
in an outflow from the entity of resources embodying
economic benefits.
Past = past events
Present = the entity is now obligated
Future = assets will need to be sacrificed in the future
In order to define liabilities you need to be able to
describe the three essential characteristics of a
liability.
Current Liability
Non-current liabilities
Equity
A liability is classified as current when:
 it is expected to be settled in the entities normal
operating cycle; or
 it is held primarily for the purposes of being traded
(12 months); or
 it is due to be settled within 12 months after the
Balance Sheet date; or
 The entity does not have an unconditional right to
defer settlement for at least 12 months after the
balance sheet date.
All other liabilities shall be classified as non-current.
A liability which will take more than one year to repay.
The residual interest in the assets of the entity after
deducting all its liabilities.
Assets less liabilities of an entity at a point in time e.g.
on balance day. Equity = Assets – Liabilities
In a community organisation the equity section is known
as the accumulated fund.
Past: the liability (state the name of the liability) was
taken out/ raised in the past.
Present: the entity is now obligated or required to pay
someone for providing it with a good or service.
Future: an asset will need to be sacrificed in the future in
order to repay a debt to an outside party.
E.g. Poppa’s Pizza buys a new oven on hire purchase
The hire purchase was taken out in the past.
Poppa’s Pizza is currently obligated to repay the hire
purchase for the new oven.
In the future, money from the bank asset will be used in
order to repay the hire purchase.
Liabilities expected to be repaid or settled within one year
after the date of the Balance Sheet.
Equity will increase when income has been earned by the
business or the owner has invested cash or assets into the
business.
Equity will decrease when the business pays its daily
running expenses or the owner takes cash or assets out of
the business in the form of drawings.
General Accounting Principles:
The Accounting Entity Notion
or Accounting Entity concept
The accounting entity notion ensures that the financial
affairs of the business are kept separate from the
financial affairs of the owner.
Fully explain how the accounting entity concept is applied
when Bob records this cheque for his personal telephone
bill in the accounting records of Bob’s Builders.
To define you must illustrate the necessity of keeping
personal and business finances separate.
Bob Builders will record the payment of Bob’s personal
telephone bill as drawings to keep the business expenses
separate from his personal expenses.
To apply you need to add the example stated in the
question and illustrate that it is a financial transaction
of the owner and not the business by referring to it as
drawings.
Monetary measurement or
Monetary concept
The monetary concept states that all transactions,
assets, liabilities, income and expenses are recorded in
a common dollar unit such as the New Zealand dollar.
E.g. Bob the builder imported to nail guns from Germany.
Explain how the monetary concept is applied in recording
the nail guns in the accounting records of Bob’s Builders.
To define state the concept.
The nail guns are recorded in New Zealand currency in
the accounting records.
To apply add the definition to the example stated in
the question.
Going Concern Concept
The going concern concept states that for accounting
purposes it is assumed that the business will continue
to operate into the foreseeable future.
To define state the concept.
To apply:
It is assumed that Bob’s Builders will continue to trade
and operate (as a builder) into the foreseeable future.
To apply you need to add the name of the business and
that it will be business as usual
Reporting period concept
The reporting period concept states that the
continuing life of the business is divided into time
periods of equal length to enable comparisons of net
profit between periods.
To define refer to the business life and even time
periods.
To apply add to the definition a clear financial reason
for the regular preparation of statements and give the
date (if given).
To apply:
The life of the business is divided into yearly periods,
from 1 July to 30 June, to make it possible to prepare
financial statements so that the financial performance
and financial position can be measured on a regular
basis.
Accrual Basis
Transactions are reported in the financial statements
of the period to which they relate.
DO NOT use the word “record” you must use “report”
Historical Cost
The historical cost concept states that assets are
recorded at their original purchase cost to the
business.
To apply use the definition and include the name of the
asset and the $amount.
To apply:
$400 wages owing at balance date. The $400 is reported
in the Income Statement as the expense has been
consumed in the period or relates to this period. It is
reported as a liability (accrued expenses $400) at balance
date.
Bob’s Builders Nail gun is shown in the Balance Sheet as
“nail gun $1500 (cost)’. What does this mean?
To apply:
The nail gun has been recorded at its original purchase
cost of $1500.
To apply:
Specialised areas of accounting:
Accounting clerks/technicians
Financial Accounting
Cost Accounting
Taxation Accounting
Management Accounting
Chartered Accountant
Auditing
Record and prepare accounts and statements, provide
financial and management information.
Preparing, analysing and interpreting financial reports
to help end users make informed decisions.
Calculating and controlling the costs of producing
goods and services through preparation of budgets
and production planning.
Preparing tax returns and providing taxation advice.
Coordinating the flow of financial information from
the business operation and measuring business
performance.
Fully qualified member of the NZ institute of
chartered accountants who provides financial and
strategic planning advice.
Carried out by chartered accountant who verifies
that financial statements are a “true and fair view” of
financial performance and position.
You need to be able to identify the appropriate
accounting specialist to complete a particular task.
Comparing Sole Proprietors to Community Organisations
Feature
Ownership
Sole Proprietor
One owner
Finance
Owner invests capital
Loans from bank or family
Mortgage over private property
Unlimited liability – owner is personally for business
debts
Owner makes decisions, receives all profits, sets
work hours
Liability
Advantages
Disadvantages
Difficult to get time off.
Unlimited liability – your personal assets can be sold
to help recover business debts.
Difficult to raise funds for expansion.
Community Organisation
Not incorporated 2+ members
Incorporated 15+ members
Members pay subscriptions
If incorporated can issue debentures to members
Not incorporated – unlimited liability for club debts
Incorporated – limited liability for club debts
Not Incorporated – Ability to participate in
sports/recreation, meet community needs or provide a
service.
Incorporated – Able to issue debentures to raise funds for
club expansion. Limited liability – members personal assets
protected.
Not Incorporated – unlimited liability
Incorporated – costly to set up, needs to be audited each
year.