TOPIC 1

The Role of Accounting

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LEARNING OUTCOME

After studying this chapter, you should be able to: -

LO 1 – Explain the purpose of accounting.
LO 2 – Identify and explain the various stages in the
accounting process.
LO 3 - Identifying the users of accounting information
and the financial information they may require
LO 4 – Define and apply the accounting assumptions.
LO 5 – Identify and define the elements of financial
statements.

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 LESSON PLAN
LECTURE 1A
- Concept 1 – Purpose of Accounting
– Accounting Process
– Users of Accounting Information
– Types of Business

LECTURE 1B
- Concept 2 – Accounting Assumptions
- – Financial Statements & Elements of
Financial Statements
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 PURPOSE OF ACCOUNTING

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 THE PURPOSE OF ACCOUNTING
Provide financial information that will assist users (of financial
statements) in making decisions about the activities of their firm

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WHAT IS ACCOUNTING

Accounting is the process of

1. Identifying
2. Collecting
3. Recording
4. Reporting
5. interpreting financial information.

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 THE ACCOUNTING PROCESS
The accounting process involves collecting source documents,
recording financial data and then reporting financial information, and
subsequently advising the owner on an appropriate course of action

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SOURCE DOCUMENTS

Source documents are papers/records that show the nature

of a transaction & provides all information needed to
account for a transaction done by a business.

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 Common Types of Source
Documents

• Cash Sales Slip

• Sales Invoice
• Purchase Invoice
• Cheque Copies
• Cash Receipts
• Daily Summary
• Bank Advices

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RECORDS
• Data from source documents is recorded
• Involves sorting, classifying & summarizing data in
source documents
• Common accounting records:-
• Journals
• Ledgers
• Inventory cards

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 REPORTS

• Output stage
• Reporting to users in a understandable form
• 3 types of reports:-
• Cash Flow Statements
• Income Statements
• Balance Sheet

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 ADVICE

• Need for cash – reports on cash inflow and cash outflow

• Profits made from trading activities
• Amount of assets and liabilities owing at one point in time.

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 QUIZ
THE ACCOUNTING PROCESS
Identify the accounting process in the correct order

Records Reports Provides Advice Source

Document

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 USERS OF FINANCIAL
INFORMATION
Internal
Managers who plan, organize and run a
business
Marketing managers
Production supervisors
Finance directors
Company officers

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 USERS OF FINANCIAL
INFORMATION
External
• Investors
• Creditors
• Others

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 CLASS DISCUSSION 1

1. What are the questions asked by internal

users?

2. What are the questions asked by

external users?

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 CLASS DISCUSSION 1

What are the questions asked by internal

users?

Melbourne Institute of Business and Technology Pty Ltd trading as Deakin College
CRICOS Provider Codes: Deakin College 01590J, Deakin University 00113B
 CLASS DISCUSSION 1

What are the questions asked by external

users?

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 TYPES OF BUSINESSES
(FOR PROFIT)

Objective of business is to earn a profit.

Profits used to :-
1. Create jobs for employees and pay wages.
2. Reinvested in R&D, equipment upgrade,
facilities expansion and many activities that
make business competitive.
3. Shared with shareholders as dividends.

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 TYPES OF BUSINESSES
(FOR PROFIT)

1. Manufacturing.
2. Retail(or merchandising).
3. Service.

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 TYPES OF BUSINESSES
(FOR PROFIT)
1. Manufacturing.

• A manufacturing business is a for-profit business that is

designed to make a specific product or products.
• Manufacturers specialize in procuring components in the
most basic form (often called direct or raw materials) and
transforming the components into a finished product that is
often drastically different from the original components.
• Examples of products made by manufacturing firms include
automobiles, clothes, cell phones, computers, and many
other products that are used every day by millions of
consumers.
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 MANUFACTURING
BUSINESS
Mr. Willie Wonka owns a chocolate factory. The raw material
used in this factory is cocoa, milk, labour and machinery and
the end product after conversion is a bar of chocolate.

Sales – Chocolate bars

Cost of sales – cost of making chocolate

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 TYPES OF BUSINESSES
(FOR PROFIT)
2. Retail(or merchandising).
• Manufacturing businesses and retail (or merchandising) businesses
are for-profit businesses that sell products to consumers.
• A retail business(or merchandising business), that purchases products
(called inventory) and then resells the products without altering them
—that is, the products are sold directly to the consumer in the same
condition (production state) as purchased.
• Examples of retail firms - Automobile dealerships, clothes, cell
phones, and computers.
• Garry Warren Smith buys Mazda cars from Japan and sells to
customers.
• Woolworths buys chocolates from Cadburys and sells chocolates to
you!
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 TYPES OF BUSINESSES
(FOR PROFIT)
3. Service.
• Service businesses are businesses that provide services to
customers.
• A major difference between manufacturing and retail firms and
service firms is that service firms do not have a tangible product that
is sold to customers.
• Instead, a service business does not sell tangible products to
customers but rather provides intangible benefits (services) to
customers.
• A service business can be either a for-profit or a not-for profit
• Examples of service-oriented businesses include hotels, cab services,
entertainment, and tax preparers.
• Sheraton hotel, 13CABS, H&R Block tax services.
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 CONCLUSION – CLASS
1A
We have covered today : -
Concept 1 – Purpose of Accounting
– The Accounting Process
– Users of Accounting Information
In the next class we will cover : -
Concept 2 – The Accounting Assumptions
– The Financial Statements & Elements of
Financial Statements

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 CONCEPT 2

ACCOUNTING PRINCIPLES
& ASSUMPTIONS
THE FINANCIAL STATEMENTS & ELEMENTS OF
FINANCIAL STATEMENTS

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 ACCOUNTING ASSUMPTIONS

• Entity – the business is assumed to be separate

from the owner and other businesses, and its
records should be kept on that basis
• Going Concern – the life of the business is
assumed to be continuous, and its records are
kept on that basis

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 ACCOUNTING ASSUMPTIONS

• Reporting Period – the life of the business must

be divided into periods of time to allow reports to
be prepared
• Historical Cost – the recording of a transaction at
its original cost or value, as this value is verifiable by
reference to the source document

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 ACCOUNTING PRINCIPLES

• Conservatism – losses should be recorded when

probable but gains should only be recorded when
certain, so that liabilities and expenses are not
understated and assets and revenues are not
overstated
• Consistency – accounting methods should be applied
in a consistent manner to ensure that reports are
comparable between periods
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 ACCOUNTING ASSUMPTIONS

Monetary Unit –
all items must be
recorded and
reported in a
common unit of
measurement; that
is, Australian dollars

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 ACCOUNTING ASSUMPTIONS
Accrual – the
assumption that
revenues are
recognised when
earned and expenses
are recognised when
incurred. So profit is
revenue earned less
expenses incurred
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 FINANCIAL STATEMENTS &
ELEMENTS OF FINANCIAL
STATEMENTS

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 FINANCIAL
STATEMENTS

The four general-purpose

financial reports are the:
• Cash Flow Statement
• Income Statement
• Statement of changes in
equity
•Balance Sheet

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 PURPOSE OF THE
FINANCIAL STATEMENTS
Reports on the firm’s cash inflows and outflows, and the change in
Cash flow statement its cash balance over a period

Reports on the firm’s ability to earn a profit from its trading activities
Income statement

Reports on the firm’s assets and liabilities at a particular point in

Balance sheet time.

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THE ELEMENTS OF
FINANCIAL STATEMENTS

ASSET

LIABILITY
Assets (A)
Liabilities (L)
OWNER’S EQUITY
Equity (E)
REVENUE Revenue (R)
PROFITS(+)/LOSSES(-) Expenses (X)
EXPENSES

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QUIZ 1
IDENTIFYING ELEMENTS
What elements of the Financial
Statements are these?

ASSET LIABILITY OWNER’S EQUITY REVENUE EXPENSES

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THE ELEMENTS OF
FINANCIAL STATEMENTS

Assets Some Asset Examples:

• Cash at bank
• Resources controlled by the • Inventory
entity
• Accounts receivable
• Result of past transactions or • GST paid
events • Prepayments
• Provide a future economic benefit • Investments in shares
• Land and buildings

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 THE ELEMENTS OF
FINANCIAL STATEMENTS

Liabilities Some Liability Examples:

• Results in a future economic sacrifice • Bank overdraft

• Owed to an external party

• Accounts payable
• Accrued expenses
• Current debts and obligations
• GST collected
• Loans
• Mortgages

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THE ELEMENTS OF
FINANCIAL STATEMENTS

Owner’s equity
• Residual interest in the assets of the entity, after
deducting all its liabilities.
• Represents the owner’s claim on the (net) assets of
the entity. Capital Revenue
Contribution
s s

Expenses Drawings

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THE ELEMENTS OF
FINANCIAL STATEMENTS
Revenue
• The value of transactions with the Some Revenue
customers or clients of the examples
business. • Sales revenue
• Amounts earned from the sale of
• Fee income from
goods or services
providing
services
• Interest revenue
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• Commissions
THE ELEMENTS OF
FINANCIAL STATEMENTS

Expenses Some Expense examples

• Costs incurred in running the • Cost of goods sold
business in order to earn • Depreciation
income. • Interest
• value of goods consumed • Rent
• value of services “used up” • Utilities

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 CLASS DISCUSSION 2

Is wages paid or to be paid to employees

considered as an asset? Why?

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 CLASS DISCUSSION 3
Is money expected to be paid next year for
advertising considered as a liability? Why?

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 CLASS DISCUSSION 4
Is capital contributed by the owners
considered as revenue? Why?

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 CLASS DISCUSSION 5
Define Drawings

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 CLASS DISCUSSION 6
Can drawings be an expense? Why

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INCOME STATEMENT

• Reports operating success or failure for a period.

• Summarizes revenues and expenses for period:

month, quarter, or year.

• If revenue > expense = Net Income.

• If revenue < expense = Net Loss.

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INCOME STATEMENT EXAMPLE

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STATEMENT OF CHANGES IN EQUITY

Reconciles the owners’ equity amount stated

at the beginning of the time period, with the
owners’ equity amount determined at the end
of the time period.

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 STATEMENT OF CHANGES
IN EQUITY
Includes

1. Beginning equity

2. Plus net income amount (from income statement)

3. Minus owner withdrawals

4. Plus contributions received by business

5. Ending Owner Equity (Cost Value Basis)

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STATEMENT OF CHANGES IN
EQUITY EXAMPLE

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 BALANCE SHEET

Reports assets and claims to assets.

Claims of creditors, liabilities.

Claims of owners, stockholders’ equity.

Assets = Liabilities + Stockholders’ Equity

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BALANCE SHEET EXAMPLE

© Cambridge University Press 2012

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 BALANCE SHEET - ASSETS

Resources owned by the business

• Cash
• Accounts receivable (Debtors)
• Inventories (Stock)
• Building
• Furniture and fixtures
• Equipment
• Supplies
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BALANCE SHEET - LIABILITIES
Obligations or debts of business

• Notes payable
• Accounts payable (Creditors)
• Interest payable
• Salaries payable
• Unearned revenue

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BALANCE SHEET – OWNERS’ EQUITY

• Ownership claims on assets

• Paid-in capital

Common stock

• Retained earnings

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 QUIZ 2
Match the following items on the
left to the appropriate Financial
Statements.

INCOME BALANCE
STATEMENT SHEET

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BASIC ACCOUNTING
EQUATION

Assets = Liabilities + Owner’s Equity

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 H5P QUIZ 3

Using your knowledge of the accounting

equation, solve the missing values in the
following table

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