Intro to Accounting: Concepts, Profit, Stakeholders

• Accounting is identifying, preparing, analysing, and communicating accounting information allowing users to make informed decisions
• The role of accounting standards and accounting concepts are important, the concepts being:

Accounting concepts

• Accounting entity
• Accrual accounting
• Going concern
• Periodic reporting
• Historic cost
• Qualitative characteristics
• Accounting measures the performance of a business, calculating the profit
• Profit equals income less expenses
• Assess the financial stability of the business through assets, liabilities, and owner's equity
• Cash flows are also important
• Nonfinancial information includes quality of staff/products, management, equipment, accounting systems, and customer satisfaction
• Stakeholders are parties affected by a business' activities, including:
• Owners/Investors
• Managers
• Creditors/Lenders
• Employees
• Unions
• Government
• General Public

Users of accounting information

• Owners and investors provide capital and are interested in their return on funds and the business's financial stability for investment safety
• Managers are divided into:
• Top Management: responsible for establishing policy
• Middle Management: responsible for carrying out policy
• Lower Management: directly supervise employees
• All levels require different accounting information
• Management needs to evaluate past decisions, maintain cash levels, and control assets/liabilities for future planning
• Creditors/lenders are interested in the financial stability of the business
• Liquidity (ability to pay debts) and security to cover advances are key factors
• Employees are interested in steady employment, fair wages, and profit-sharing schemes
• Unions act as "watch-dogs" for employees, seeking higher wages and better working conditions
• The government is interested in the economy's well-being, focusing on:
• Ability to pay taxes
• Accurate business profits for tax assessment
• Employment opportunities
• Export earnings and import costs Government uses accounting information for economic decisions
• The general public is interested in good accounting practices, social responsibility, and issues like monopoly profits and pollution

Financial Reporting in New Zealand

• The External Reporting Board (XRB) develops accounting/auditing standards
• The New Zealand Accounting Standards Board (NZASB) has delegated authority from the XRB
• Accounting standards have separate standards for for-profit and public benefit entities
• Accounting standards from XRB Board or NZASB are primary indicators of GAAP in New Zealand for entities preparing general purpose financial reports (GPFR)
• Standards specify how transactions/events are recognised, measured, and disclosed
• Large publicly listed entities and entities with public accountability legally follow XRB accounting standards
• Accounting standards ensure transparent and consistent external financial reporting
• Reporting builds trust with stakeholders like shareholders, investors, donors, funders, and customers

New Zealand Conceptual Framework

• The NZ Framework is set by the External Reporting Board (XRB)
• The NZ Framework provides a set of fundamental principles to help:
• Develop standards consistently
• Preparing financial reports
• Interpreting the standards
• Fundamental principles are basic ideas or notions on which accounting is based
• Expression of basic ideas on how accounting standards/reports should be prepared
• Accepted ways of preparing/reporting accounting information

Periodic Reporting & Accounting Entity Concepts

• Financial reports are prepared for a specified time period, normally one year, used consistently
• Deals with taxation year in NZ, from April 1st to March 31st
• Business financial dealings are kept separate from the owner(s)’ personal affairs
• Financial records prepared for an entity are regarded as separate from the individual(s) owning it
• Owner has separate relationship with the business

Historic Cost & Other Concepts

• Assets and liabilities are recorded at their actual, or original cost, at the time they were acquired
• Going Concern: Financial statements are prepared assuming the business will continue operating indefinitely, with no intention to liquidate
• Accrual Accounting: Transactions are recognised when they occur, not necessarily when payment takes place

New Zealand Framework covers

• Objectives of general purpose financial statements
• Qualitative characteristics that determine the usefulness of information
• Definition, recognition, and measurement of the elements from which financial statements are constructed
• Objective of financial statements provides information about the financial position, performance, and cash flows of an entity useful to a wide range of users in making economic decisions

Qualitative Characteristics

• Characteristics of financial information in New Zealand:
• Relevance
• Faithful representation
• Timeliness
• Verifiability
• Comparability
• Understandability
• Divided into fundamental and enhancing characteristics
• Relevance: Information makes a difference in user decisions
• Faithful representation*: Complete, neutral, and free from error
• Timeliness: Having information available to decision-makers in time to influence their decisions
• Verifiability: Knowledgeable, independent observers can agree the information is a faithful representation
• Comparability: Information can be compared with similar information about other entities or the same entity for another period
• Understandability: Presenting information clearly and concisely
• NZ IAS1: Refers to general purpose financial statements for a wide range of users
• Financial Statements include:
• Statement of Financial Position (Balance Sheet): Shows financial position at a point in time
• Statement of Comprehensive Income (includes Income Statement): Shows financial performance over a period
• Statement of Changes in Equity: Shows how equity has changed from the start to the end of the year Statement of Cash Flows: Shows business's financial health and cash generation

Income Statement

• The Income Statement uses accrual accounting to list income earned and expenses incurred for a period, calculating profit or loss
• Profit/loss equals total income minus total expenses
• Alternative names:
• Statement of Financial Performance
• Profit and Loss Statement (P&L)
• Statement of profit or loss and comprehensive income
• The Income Statement must state:
  • Name of the entity
  • Name of the statement
  • Period covered by the Income Statement
• The purpose of the Income Statement is to report revenue, income earned, expenses incurred, and the resulting profit/loss for the accounting period
• The Income Statement summarises operating activities, showing how well managers have used assets
• External users (investors/lenders) use the Income Statement to determine:
• Investment value: Is the business earning a satisfactory return on assets?
• Creditworthiness: Is the business earning enough to pay its suppliers/creditors on time?
• Income success: Is the business earning enough income relative to its size?

Income, Expenses and Profit

• A business earns revenue by selling goods/services, with income being the price customers pay
• Businesses also get interest from bank accounts Income – Expenses = Profit (or loss) for the period
• Income is increases in assets or decreases in liabilities, increasing equity (excluding contributions from equity holders)
• Expenses are decreases in assets or increases in liabilities, decreasing equity (excluding distributions to equity holders)
• Net profit for the period equals income minus expenses, which increases in owner's equity
• If expenses > income, then a net loss will result

Classifying Items in the Income Statement

• Gross profit shows profit from selling product/goods minus cost of goods sold (COGS)
• Several sections show the composition of income/expenses leading to profit
  • Income from sales = Cost of goods sold (COGS)
  • Income from services = Selling expenses (sometimes selling & distribution - SD)
  • Income from investments = Administration expenses (sometimes general & admin. expenses - A). Financial expenses (F)
• Cost of goods sold includes all costs in getting goods ready for sale
• Selling and distribution expenses include costs in selling goods/services i.e. advertising, marketing, salaries, commissions of salespeople
• Administration expenses include office salaries, stationery, postage, telephone, rent, rates, repairs to buildings, insurance premiums, other general expenses
• Financial expenses are those associated with financing the enterprise I.e interest on loans and bank overdraft
• Sales or Revenue is often separate from other incomes showing business performance from normal activities

Income Statements With Other Income (General)

• Classify the items as income, expenses, and how to categorise them in the same way as the examples
• There are variations on classifications for company income statement with common questions being:
  • "Is doubtful debts a finance expense, or a selling expense?"
  • "What about discount on sales?"
  • "Or rent on a building used for both office space and manufacturing purposes?"
• Income/expenses must be treated consistently so comparisons aren't misleading
• A company pays tax on profits
• It shows net profit before tax, tax expense, and net profit after tax
• The company tax rate is 28%
• Sole traders pay taxes personally, not through the business, shown on their tax return Information more summarised than for a sole trader Numbers reference further notes in the accounts