Chapter 1

The role of accounting in business

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 Learning objectives

• Define the main types of accounting

• Describe how decision makers use accounting information
• Describe professional career opportunities in accounting
• Describe how accounting is regulated in Australia
• Explain the role of ethics and sustainability in accounting
• Identify the three main types of business organisations

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 Learning objectives

• Describe the basic accounting principles and their

applications in business
• Describe the accounting equation and its function
• Apply the accounting equation to analyse transactions
• List the different financial statements and demonstrate how
they are prepared and used
• Use financial statements to evaluate business performance
and make decisions

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 1.1. Defining accounting
Accounting encompasses the information system that
• measures business activity
• processes the data into reports
• communicates the results to decision makers

It is divided into two main types:

1. Financial accounting: provide information for ________
decision markers, such as outside investors and lenders.
2. Managerial accounting: focuses on information for
________ decision markers, such as business
____________
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 1.2. Decision makers: The users of
accounting information
• Business owners
• Investors
• Creditors
• Government regulatory agencies
• Tax authorities
• Non-profit organizations
• Other users, e.g. employees and labour unions

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 1.3. Accounting regulation

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 1.4. Corporate social responsibility
• Financial reports prepared by accountants play a central part in
informing financial decisions
• The ICAA and CPAA have a joint code of ethics for
professional accountants as part of their professional
standards
• It includes the following principles
- Integrity ===> to be honest, fair and sincere
- Objectivity ===> to avoid conflicts of self-interest and bias
- Professional competence and due care
- Confidentiality
- Professional behavior ===> compliance with the law

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 1.5. Accounting measurements:
Concepts and principles
• The primary objective of external financial reporting is to
provide useful information for making investment and
lending decisions

• Useful information must be relevant, valid and reliable

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 1.7. Accounting measurements:
Concepts and principles
• Basic measurement concepts and principles include
- Entity concept
- Accounting period concept
- Cost principle (revalue => fair value (~ market value))
- Matching principle
- Profit recognition principle
- Conservatism principle
- Going concern assumption

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 1.7. Accounting measurements:
Concepts and principles
• The entity concept: an accounting entity is an organization that stand apart
from other organization and individuals as a separate economic unit for the
purpose of some decision.
• The accounting period concept defines the unit of time for which
accounting data is collected
• The cost principle states that accounting measures are based
upon transaction costs
• The matching principle relates inputs and outputs of goods and
services to one another

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 1.7. Accounting measurements:
Concepts and principles
• The profit recognition principle states that profit should be
recognized when the sales and any other revenues or gains
relating to the relevant activity are earned and can be reliably
measured
• The conservatism (or prudence) principle constrains
management’s natural optimists.
• The going concern assumption assumes that the business as a
whole will continue operating for the foreseeable future

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 Quick Check
1. Accounting standards in Australia are formulated by the:

a. Australian Accounting Standards Board (AASB)

b. CPA Australia (CPAA)

c. The Institute of Chartered Accountants in Australia (ICAA)

d. Australian Securities and Investments Commission (ASIC)

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 Quick Check
2. Which concept or principle is based on the belief that
accountants should record transactions at amounts that can be
verified?

a entity concept

b cost principle

c matching principle

d going concern concept

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 Quick Check
3. The accounting principle that states recording expenses and
revenues in the same period in which they occur:

a/ Historical cost

b/ Matching

c/ Revenue recognition

d/ Going-concern

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 Quick Check
4. Accounting is the information system that:

a measures business activity

b communicates the results to decision makers

c processes data into reports

d all of the above

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 Quick Check
5. Which of the following is least likely to be a user of a business'
financial information?

a Australian Taxation Office

b customers

c creditors

d investors

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 Quick Check
6. Which of the following accounting principles allows for an
organization’s activities to be divided into specific time
periods such as a month, a quarter or a year?

a/ Revenue Recognition Principle

b/ Matching Principle

c/ Accounting Period Principle

d/ Business Entity Principle

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 Quick Check
7. T&T Corporation completed a project for a client. The $8,000
fee for this project was billed to the client in 2014, but will be
collected in 2015. Is this revenue recorded in 2014? Which
principle could have been applied?
a/ Historical cost
b/ Matching
c/ Profit recognition
d/ Going-concern

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 1.8. The accounting equation
It measures the resources of a business and the claims to those
resources

Assets Liabilities Equity

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 2.1. The account, the ledger and the
journal
Assets
An asset is a resource controlled by an entity as a result of past
events that is expected to provide future economic benefits to the
entity in the future

• Cash • Land
• Accounts receivable • Buildings
• Inventories • Plant and equipment

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 2.1. The account, the ledger and the
journal
Liabilities
A liability is a 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
• Accounts payable
• Loan payable/ borrowing
• Accrued liabilities (salary payable, interest payable, tax
payable, etc.)

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 2.1. The account, the ledger and the
journal
Owners’ equity
The financial estimate of owners’ claims to the value in a business
is called owners’ equity. It is the residual interest in the assets of
an entity after deducting all liabilities
•Capital

•Drawings (Dividend)
•Income => equity increase
• Revenue => equity increase
• Expenses => equity decrease
(Revenue/ Income – Expenses = Profit/ Loss)

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 1.8. The accounting equation
• Income refers to all increases in equity other than
investments by owners
• Revenue is that part of income arising from ordinary
activities
• Expenses decrease equity by using up assets or increasing
liabilities in order to deliver goods or services to customers

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 1.9. Accounting for business
transactions
• Accounts record the impact of events that are considered to
affect the value of entities’ assets and liabilities
• A transaction is an event that involves at least two parties
exchanging resources
• Each transaction affects at least two accounts
• Some transactions affect only one side of the equation; some
affect both sides

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 1.9. Accounting for business
transactions
Transaction 1: Starting the business
On 1 May 201N, Sheena Bright invests $30,000 of her own
money to start the business by depositing this amount in a bank
account title ‘Smart Touch’.
Transaction 2: Purchase of land
Smart Touch purchases land for an office location, paying cash
of $20,000.
Transaction 3: Purchase of office supplies
Smart Touch buys stationery and other office supplies,
agreeing to pay $500 within 30 days.
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 1.9. Accounting for business
transactions
Transaction 4: Earning of service revenue
Smart Touch earns service revenue by providing training
services for clients. Sheena Bright earns $5,500 revenue and
collects this amount in cash.
Transaction 5: Earning of service revenue on credit
Smart Touch performs services for clients who don’t pay
immediately. In return for its training service, Smart Touch
receives clients’ promises to pay $3,000 within one month.

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 1.9. Accounting for business
transactions
Transaction 6: Payment of expenses
During the month, S.T pay $3,300 in cash expenses: lease
expense on a computer, $600; office rent, $1,100; employee
salary (part-time assistant), $1,200; electricity and gas, $400
Transaction 7: Payment of account
S.T pays $300 (pay on account) to the store where it purchased
$500 worth of office supplies in transaction 3.
Transaction 8: Personal transaction
Sheena Bright remodels her home at a cost of $40,000, paying
cash from personal funds.
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 1.9. Accounting for business
transactions
Transaction 9: Collection on account
The business collects $1,000 from the client in transaction 5.
Transaction 10: Sale of land
S.T sells some land owned by the agency. The sale price of
$9,000 (in cash) is equal to the cost of land to Smart Touch.
Transaction 11: Withdrawal of cash
Bright withdraws $2,000 cash from the business for personal
use.

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 1.9. Accounting for business
transactions
Assets Liabilities Owners´ Type of
equity owners‘equity
transaction
Cash Land Office Accounts Accounts Sheena
supplies receivable payable Bright, capital
(1) +30 000 (1) +30 000 Owner
investment
(2) -20 000 (2) +20 000

(3) +500 (3) +500

(4) +5 500 (4) 5 500 Service revenue

(5) +3 000 (5) +3 000 Service revenue

(6) -600 (6) -600 Expenses

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 1.9. Accounting for business
transactions
Assets Liabilities Owners´ Type of
equity owners‘equity
transaction

Cash Land Office Accounts Accounts Sheena

supplies receivable payable Bright,
capital
(6) – 1 100 (6)-1 100 Expense

(6) – 1 200 (6) – 1 200 Expense

(6) -400 (6) -400 Expense

(7) -300 (7) -300

(9) +1 000 (9) -1 000

(10) +9 000 (10) -9 000

(11) -2 000 (11) -2 000 Drawings

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 Quick Check
8. Fossil sells fashion wristwatches and leather goods. At the
end of a recent year, Fossil's total assets added up to $363
million and owners'equity was $228 million, How much did
Fossil owe its creditors?

a. cannot determine from the data given

b. $363 million

c. $135 million

d. $228 million
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 Quick Check
9. Assume that Fossil sold watches at a profit of $48 000 to a
department store on credit. How would this transaction affect
Fossil's accounting equation?

a increase both assets and liabilities by $48 000

b increase both assets and owners' equity by $48 000

c increase both liabilities and owners' equity by $48 000

d no effect on the accounting equation because the effects cancel out

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 Quick Check
10. Consider the overall effects on Fossil of selling watches on
credit for $64,000 and paying expenses totalling $25,000. What is
Fossil's profit or loss?

a profit of $39,000

b loss of $39,000

c profit of $64,000

d loss of $64,000

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 Quick Check
11. How would this transaction affect the entity’s accounting
equation with a event: the entity officially opened for business
on 15th Jan, 201X.

A increase both asset and owners’ equity

B increase both asset and liability

C increase asset and decrease owners’ equity

D no effect
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 Quick Check
12. The accounting equation can be written as:
a) Assets - Liabilities = Owner’s equity
b) Assets + Liabilities = Owner’s equity
c) Liabilities = Owner’s equity – Asset
d) Liabilities – Assets = Owner’s equity

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 Quick Check
13. A company borrows 10,000,000 VND from the bank, which of
the following accounts will be affected?
a)Accounts payable – Cash in bank
b)Cash – Loan payable
c)Petty Cash – Loan payable
d)Accounts receivable – Cash in bank

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 Quick Check
14. A company purchases goods on credit for 500,000 VND.
Which elements of the accounting equation will change due to
this transaction?
a) Assets and Liabilities
b) Liabilities only
c) Assets only
d) Assets, liabilities and owner’s equity

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 Quick Check
15. Which of the following would be classified as a
non–current asset (fixed asset)?
a) Cash on hand
b) Accounts receivable
c) Accounts payable
d) Machinery and equipment

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1.10. Preparing the financial statements:
The users perspective
A complete set of financial statements comprise
• Statement of Profit or loss and other comprehensive
Income (Income Statement or P/L Statement)
• Statement of Changes in Equity
• Statement of Financial Position (Balance Sheet)
• Statement of Cash Flows
• Note
(IAS1 – Presentation of Financial Statement)

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 1.10. Preparing the financial statements:
The users perspective
• The Statement of Comprehensive Income presents a summary of
an entity’s income and expenses and all changes in equity, other
than new owner investments and drawings, for a specific period of
time
• The Statement of Changes in Equity shows the changes in
owners’ equity during a specific time period
• The Statement of Financial Position lists all the entity’s assets,
liabilities and owners´ equity as at a specific date
• The Statement of Cash Flows reports the cash coming in and the
amount of cash going out during a period
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1.10. Preparing the financial statements:
The users perspective
Each financial statement should have a heading showing
• the name of the business
• the name of the financial statement
• date or time period covered by the statement

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 1.11. Using financial statements to
evaluate business performance and
make decisions
Financial statements can be used in several ways, for example
• The Statement of Comprehensive Income provides
information about profitability for a particular period
• The Statement of Changes in Equity informs users about how
much of the earnings were kept and reinvested in the company

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 1.11. Using financial statements to
evaluate business performance and make
decisions
Financial statements can be used in several ways, for example
• The Statement of Financial Position provides valuable
information to financial statement users about the economic
resources the company owns (assets) as well as the debts the
company owes (liabilities).
• The Statement of Cash Flows provides information about
three types of business activities

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 1.11. Using financial statements to
evaluate business performance and make
decisions
Statement of Profit or Loss and other comprehensive income
SMART TOUCH LEARNING
Statement of Profit or Loss and other comprehensive income
For the month ended 31 May 201N
Revenue
Service revenue $8 500
Expenses
Salary expense $1 200
Rent expense, office 1 100
Lease expense, computer 600
Electricity and gas expense 400
Total expenses 3 300
Profit $5 200
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 1.11. Using financial statements to
evaluate business performance and make
decisions
• Statement of changes in equity
SMART TOUCH LEARNING
Statement of changes in equity
For the month ended 31 May 201N
Sheena Bright, capital, 1 May 201N $0
Add: Investment by owner 30 000
Profit for the month 5 200
35 200
Less: Drawings by owner (2 000)

Sheena Bright, capital, 31 May 201N $33 200

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 1.11. Using financial statements to
evaluate business performance and make
decisions
• Statement of Financial Position

SMART TOUCH LEARNING

Statement of Financial Position
As at 31 May 201N

Assets Liabilities
Cash $19 900 Accounts payable $200
Accounts Receivable 2 000
Office supplies 500 Owners’equity
Land 11 000 Sheena Bright, capital 33 200

Total Assets $33 400 Total Liabilities and $33 400

Owners’ equity

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 Quick Check
12. The balance sheet reports:

a financial position on a specific date

b results of operations on a specific date

c financial position for a specific period

d results of operations for a specific period

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 Quick Check
13. The Statement of profit or loss reports:

a financial position on a specific date

b results of operations on a specific date

c financial position for a specific period

d results of operations for a specific period

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 Summary: Chapter 1
• Accounting is typically divided into financial accounting and
managerial accounting
• Different users review a company’s financial statements for different
reasons
• There are several measurement concepts and principles
• The accounting equation measures the resources of a business and
the claims to those resources
• Transactions are events involving at least two parties exchanging
resources
• A complete set of financial statements consists of four financial
statements

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 Tasks
Textbook: Chapter 1
• Quick Check
• Starters: S1-7; S1-12
• Exercises: E1-1, E1-6, E1-7, E1-8, E1-9, E1-13,
E1-14 (Req. 1&2) , E1-15 (req 1)

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 The end of Chapter 1
The role of accounting in business

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