Topic 1 - Introduction to Financial Accounting & Key Financial Statements

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This article is a topic within the subject Accounting 1A.

Contents

Required Reading

Trotman, K. & Gibbins, M., 2009 Financial Accounting: An Integrated Approach, 4th edition, Melbourne: Thomson Nelson ITP pp. 1-30.

What is Accounting?

Accounting is the process of identifying, measuring, recording & communicating economic information to assists users to make decisions. There are 2 types of accounting:

  1. Financial Accounting, which refers to the preparation of financial information for external decision makers or users and,
  2. Management Accounting, which refers to the preparation of financial information for internal decision makers

Financial accounting is the main focus of this course.

Accounting is integral to society and it is used by all enterprises - businesses, government, charities, universities etc.

Financial Accounting

Financial accounting is used to measure a firm's position (balance sheet) and performance over a period of time (income statement). Position and performance generally correlate. As you will find out, accounting is a web of interconnections.

  • Financial Performance: Generating new resources from day to day operations over a period of time (Revenue, costs, expenses, profit)
  • Financial Position: The Enterprises set of financial resources & obligations at a point of time (A/L/E)
  • Financial Statements: Reports describing financial performance & position (summaries)

Financial Accounting Users

  • Owners, Investors & Analysts
    • Financial Accounting is an aid in deciding whether to buy, sell or hold
  • Creditors - Banks, Bondholders, Suppliers, Employees
    • They have lent money or are owed money in return for supplying something of value to the firm. They must decide whether to lend/supply on the probability of being repaid. If the firm is in difficulty, creditors can take control of the enterprise.
  • Managers
    • Use FA information for planning, controlling & organizing activities of the entity.
    • Salaries are often derived from financial performance & position.
  • Employees & Trade Unions
    • Interested in the ability of the firm to pay wages & super.
    • Employees can assess job security
  • Government
    • Rules & Regulations - Monitoring actions of the firm
    • Ensuring firms pay the correct amount of tax
  • Competitors
    • Better understand the competitor’s operations in order to out-compete them
  • Customers
    • Important to make sure the entity is financially sound if you pay in advance / depend on warranty
  • Accounting Researchers
    • University academics, who study to better understand accounting & to contribute to its improvement

Accrual Accounting

Under accrual accounting, the impact of transactions on the financial statements is recognised in the time periods during which revenue and expenses occur (rather than when cash or paid or received).

  • Revenue is generally from the sale of G&S (inventory) e.g. $45,000 from selling 15,000 chocolates
    • Interest received on cash/investments, dividends from shares, rent from owned premises
  • Expenses: The costs of services & resources consumed in the process of generating revenue
    • Examples: Labour, electricity, travel, depreciation

Cash Accounting

Cash Accounting involves recording revenue and expenses at the time cash is paid or received.

  • Accountants know when cash has been paid/received & the exact amount
  • Often, the timing of cash flows is in a different accounting period to the substance of the transaction (e.g. Selling inventory on credit)

Although Cash Accounting is accurate, Accrual is thought to be more relevant as it accounts for transactions. For example, if I sold 500 Chocolates for $1 each to a buyer who used a credit card, under accrual I would recognise $500 of revenue but under cash I would only recognise revenue once I had been paid in cash. Often accrual accounting involves judgement, we will get to this later in the course.

Financial Accounting Assumptions

  • Financial Reports are prepared Accrual Basis
    • The effects of transactions/other events are recognised, regardless of whether cash is paid or received at the time
  • Going Concern
    • Financial statements are prepared on the premise that the organization will continue as a going concern in the foreseeable future
  • Accounting Entity
    • Separate & distinguishable from its owners, not necessarily different legal entities e.g. Sole trader
  • Accounting Period
    • The life of the business is divided into discrete time periods evaluate performance e.g. annually
  • Monetary
    • Transactions are to be measured in a common denominator e.g. AUD
  • Historical Cost
    • Assets are recorded at cost e.g. inventory, property can be revaluated  higher D&A expense

End

This is the end of this topic. Click Accounting 1A to go back to the main subject page for Accounting 1A

References

Textbook refers to Trotman, K. & Gibbins, M., 2009 Financial Accounting: An Integrated Approach, 4th edition, Melbourne: Thomson Nelson ITP

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