CPA Accounting: Role and Purpose of Accounting

• CPA Australia exam tests knowledge of accounting concepts and recording/producing financial statements
• An introduction to recording data and producing financial statements

Role and Purpose of Accounting

• Initial module considers the role/purpose of accounting and some of the fundamental concepts
• Key financial statements: statement of financial position, statement of profit or loss, and the statement of changes in equity are also introduced

Potential Statement Users

• Awareness of financial statements, who uses them, their particular information needs
• A key calculation is the accounting equation and double entry studied later

Business Entity Types

• Awareness of business entity types: retail entities and service entities
• Another method of entity classification: sole traders, partnerships, and limited liability companies

Before starting Module 1

• Attempt module questions to assess prior knowledge

Accounting

• Accounting is a way of recording, categorizing, and summarizing financial transactions

Financial Accounting

• Reporting historical financial information

Management Accounting

• Providing detailed analyses of financial information and future planning

Financial transactions

• Sales or purchase of goods or payment of expenses that are entered in ledger accounts

Financial Statements

• Transactions are summarized in financial statements

Financial Accounting Focus

• Reporting financial performance and position of a business, and satisfying information needs of external stakeholders with historical information

Management accounting Focus

• Acquiring and controlling business resources and planning for the future
• Concentrates solely on financial accounting

GAAP

• Rules govern the preparation of financial statements including company law, national accounting standards, and IFRS
• Factors shaping financial accounting concentrates on limited liability companies regulated accounts

National Legislation

• Limited liability companies are required by law to prepare and publish annual accounts, which may be regulated by national legislation

Accounting Standards

• Many countries follow national or international accounting standards

Accounting and Legal Requirments

• Accounting requirements from company law and accounting standards are what constitutes GAAP

GAAP Definition

• A set of rules governing accounting that may come from national accounting standards, IFRSs, national company legislation, statutory requirements in other countries, or stock exchange requirements

Key Accounting Concepts

• Accountants follow certain key concepts when preparing accounts and financial statements
• Procedures in common use imply acceptance of certain concepts to build up an accounting framework

The module singles out the following concepts and assumptions for discussion:

• Fair presentation
• Consistency of presentation
• Materiality concept
• Business (economic) entity assumption
• Monetary unit (money measurement) assumption
• Time period assumption
• Cost principle
• Going concern
• Accruals or matching

Qualities That Make Information Useful

• Relevance
• Faithful representation
• Comparability
• Verifiability
• Timeliness
• Understandability Relevance and faithful representation are particularly important

Fair Presentation

• Financial statements must give a fair presentation in all material respects of the financial results of the entity

Following is required for a fair presentation:

• Compliance with accounting standards
• Selection/application of appropriate accounting policies
• Presentation of information that is relevant, comparable, verifiable, timely, and understandable
• Additional disclosures

Consistency of Presentation

• Presentation and classification of items in financial statements should stay consistent period to period unless there is significant change/review
• Change in presentation requires an IFRS

Materiality Concept

• Items are considered material if omission/misstatement would influence economic decisions of users
• Error too trivial to affect user understanding is immaterial; No absolute measure of materiality applies

Business (Economic) Entity Assumption

• States that business is entity is separate, prepared on that basis, regardless of legal position

Monetary Unit (Money Measurement) Assumption

• Accounts deal with items that can be expressed in monetary terms
• Cannot include the experience and knowledge of employees

Time Period Assumption

• Statements should be prepared regularly for a particular time period

Cost Principle

• Items should be valued at cost

Historical Cost

• Items are normally valued in accounts at historical cost
• Maximizes objectivity as there documentary evidence to prove the amount paid to purchase an item or pay an expense

Replacement Cost

• Defines the amount needed to replace an item with an identical item

Net Realisable Value

• Defines the expected price that will be received on sale, less any costs incurred to get the item ready for sale.

Economic Value

• Defines a value that reflects an asset's ability to generate income
• A machine's economic value is the amount of profits it is expected to generate for the remainder of its useful life

Conceptual Frameworks

• Many countries have a conceptual framework for financial accounting and reporting, which is a documented set that underpin financial accounting and reporting

Going Concern

• The entity is normally viewed as "going concern" or will continue in operation for foreseeable future
• Entity has neither intention nor need to liquidate or need to curtail materially the scale of its operations
• An entity will continue to operate in approximately the same manner for the foreseeable future
• Assets should not be valued at their 'break-up' value without the assumption

Accruals Basis of Accounting

• Transactions are recorded as revenues or expenses are earned or incurred
• Revenue earned needs to be matched against the expenditure incurred in earning it

The Qualitative Characteristics of Financial Information

• Qualitative characteristics are the attributes that make the information useful to users for financial statements with qualitative characteristics
• Fundamental characteristics are relevance and faithful representation, whereas enhancing qualitative characteristics are comparability, verifiability, timeliness and understandability

Relevance

• Relevant information must be useful and capable of making a difference to the decisions made by users
• Predictive value, confirmatory value, or both are included

Faithful Representation

• Statements must faithfully represent the transactions/events that they purport to show that are complete, neutral. and free from material error

Substance Over Form

• Transactions are accounted for in accordance with their substance and economic reality and not merely their legal form

Comparability

• Users must be able to compare an entity's financial statements through time to identify trends and with other entities' financial statements

Verifiability

• Information is considered verifiable if knowledgeable and independent observers can broadly agree that a particular way of presenting an item is a faithful representation

Timeliness

• Information is considered timely if it is available to users in time to influence their decisions

Understandability

• Users must be able to understand financial statements.

Main Financial Statements Structure

• Principal financial statements: statement of financial position, the statement of profit or loss, and the statement of changes in equity
• The elements within these financial statements are assets, liabilities, equity (capital), income and expenses

Statement of Financial Position

• List of all the assets owned and all the liabilities owed by a business as at a particular date; A snapshot of the financial position

Assets

• Assets is something of value to a business which the business owns or has the use of (factories, equipment, cash, etc)

Non-Current assets

• Assets held and used in operations for a long time, that are acquired and retained with a view to earning profits, and not merely being turned into cash

Current Assets

• Assets held for only a short time where the are items owned by the business with intention of turning them into cash within one year, including cash/money in the bank

Liabilities

• Amount which is owed to somebody else

Current Liabilities

• Due to be repaid fairly quickly within one year

Non-Current Liabilities

• Take some years to replay

Capital or Equity

• Refers to the amounts invested in a business by the owner amounts that the business owes to the owner

Forms of Statements of Financial Position

• The statement of financial position lists assets then capital and liabilities with assets being equal to liabilities plus capital

Statement of Profit or Loss

• A record of income generated and expenses incurred over a given period

Income

• Money or other benefits that flow into a business during an accounting period

Expenses

• Money that flow out of a business during the accounting period

Form of Statement of Profit or Loss

• Period chosen depends on the purpose for which statement is produced for the financial year

Statement of Changes in Equity

• Shows the changes in the amount that the owner(s) of the business have invested in the business during a given period

Users and Statements

• Shows change in equity is a link between statements of profit or loss and the statements of financial position at the beginning and end of period

Users of Financial Statements

• There exist various groups of people who need the activity information of a business; Each group has different information needs
• The most important users of published financial statements are frequently existing and potential investors and lenders

Businesses Produce Financial Statements

• Because there are various groups of people who want to know that information

Types of Business Statements Users

• Statements users: Managers, Shareholders. Trade contacts, Providers of finance, Taxation authorities, Employees, Financial analysts and advisers, Government and their agencies, and the public

Business's Financial Activity

• Accounting information is summarized and published in financial statements to satisfy the information needs of these different groups

The Accounting Equation

• Expresses the equality between assets and liabilities (including capital as a liability)
• When business transactions are accounted for it is possible to restate the equality of assets and liabilities after every transaction

The Accounting Equation Definition

• Assets = Capital + Liabilities
• States that assets of business will all times equal its liabilities which includes capital

Drawings Definition

• Drawings are amounts of money taken out of a business by its owner

Trade Payables and Trade Receivables

• A payable is any person or business to whom a business owes money (a creditor; liability)

Trade Payable Type

• A specific type of payable is a person to whom a business owes money for debts incurred in the course of trading operations

CPA Syllabus term for payables

• 'Account payables' refers to trade payables; unless for sales tax payable or accruals

Trade Receivable

• A customer who buys goods without paying is a trade receivable and debtor (an asset)

Types of Business Entity

• Businesses exist to make a profit
• Three main types of business entity: sole trader, a partnership and a limited liability company

Trader and Partnership vs Company

• Sole traders and partnerships are not separate entities, while a limited liability company is and can issue contacts in the company's name

Trading Advantages and Disadvantages

• Legal, accounting, liability, finance, and taxation impacts whether to be one of the entity types is different

Retail Entity

• One which buys in goods and then sells the same goods on to customers

Entity Characteristics

• Operates from premises where selling takes place with large amounts of goods for resale and has a high cost of goods sold with large account payables

Service Entity

• Doesn't buy and sell goods, and instead provides a service

Entity Characteristics

• Main 'asset' is its employees, wages and salary costs account for Expenses, and low to small levels of inventory

Type of Business Form

• Business entities are classified by legal form: sole traders, partnerships, and limited liability companies
• Sole traders are those people who work for themselves and the sole trader refers to the ownership of the business

Partnerships Form

• When two or more people decide to run businesses
• Limited liability companies are incorporated to take advantage of 'limited liability' for which shareholders are responsible for amounts paid for their shares

Legal Differences

• Legally sole traders and partnerships are not separate entities while a limited liability company is legally different and can issue contracts in the company’s name

Business Concept

• Account treats all entities separate from owners

Advantage vs Disadvantage

• If things are one thing to trade as a LLC it can also be seen as other with trader or partnership (vice versa)

Disadvantages of Trading

• Companies must publish information while traders don’t

Risk Share

• Each party’s capital would serve to be considered for the business, the more capital than the single person