Topic 2 - Accounting & Business

Topic

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Accounting and Business

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Learning Outcomes: At the end of this topic, students should be able to: 1. Explain the nature and types of business. 2. Defined assets, liabilities, owner’s equity, revenue and expenses. 3. Discuss on the differentiation of cash and accrual accounting. 4. Explain accounting assumptions, principles and constraints. 12/08/09

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Business Entity Forms Proprietorship Proprietorship

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Partnership Partnership

Corporation Corporation

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Exh. 1.8

Characteristics of Businesses Cha ra cte ristics P roprie torshipP a rtne rshipCorpora tion Busine ss e ntity ye s ye s ye s Le ga l e ntity no no ye s Lim ite d lia bility no no ye s Unlim ite d life no no * ye s * Busine ss ta x e d no no ye s One ow ne r a llow e d ye s no ye s

**Proprietorships Proprietorshipsand and partnerships partnerships that thatare are set set up up as asLLC’s LLC’s provide providelimited limitedliability. liability. 12/08/09

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Corporation  Governed by: Companies Act 1965,

Memorandum of Association & Article of Association

 Owners of a corporation are called

shareholders (or stockholders).

 When a corporation issues only one class of

stock, we call it common stock (or capital stock).

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DEFINITIONS  Definitions of Income ,Expenses Assets,

Liabilities and Equity, based on MASB Framework for the Preparation Presentation of Financial Statement.  Refer to FRS101 Presentation of Financial

Statements at www.masb.org.my

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INCOME  Income is increases in economic benefits

during the period in the form of inflows or enhancements of assets or decreases of liabilities that result in increases in equity, other than those relating to contributions from equity participants.  Income includes both revenue and gains.

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INCOME…  REVENUE - the gross inflow of economic benefits

during the period arising in the course of the ordinary activities of an enterprise when those inflows result in increases in equity, other than increases relating to contributions from equity participants. 

increases assets results from the sales of goods and services, fees, interest, dividends, royalties, grants and rent.

 GAINS - increase assets might arise from the

disposal of assets, or the revaluation of financial instruments, investment property and agricultural assets, among other things

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EXPENSES  Expenses are decreases in economic benefits during

the period in the form of outflows or depletions of assets or increases of liabilities that result in decreases in equity, other than those relating to distributions to equity participants.  Expenses include both expenses and losses.

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ASSETS  Probable future economic benefit obtained or controlled

by a particular entity as a result of past transactions or events  E.g.: 1. 2. 3. 4. 5.

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Cash, Accounts and notes receivable Inventories Prepaid items Property, plant, and equipment

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Assets Cash Cash Accounts Accounts Receivable Receivable

Vehicles Vehicles

Store Store Supplies Supplies 12/08/09

Resources Resources owned owned or or controlled controlled by by aa company company

Notes Notes Receivable Receivable

Land Land

Buildings Buildings Equipment Equipment

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LIABILITY  Probable future sacrifice of economical benefit

arising from a present obligation of a particular entity to transfer assets or provide services to other entities in the future as a result of past transactions or events.  “Obligation” includes legal, moral, social, and

implied commitments.

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Liabilities Accounts Accounts Payable Payable

Notes Notes Payable Payable

Creditors’ Creditors’ claims claims on on assets assets Taxes Taxes Payable Payable 12/08/09

Wages Wages Payable Payable 13

OWNER’S EQUITY  Residual interest in the assets of an entity that remains after deducting its liabilities.



E.g.: (corporation)  Share capital – ordinary and preferred shares  Reserves – share premium, revaluation reserve, etc.  Retained earnings – is the amount of the undistributed earnings of past periods.

ASSET – LIABILITY = EQUITY

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Equity Owner Owner Withdrawals Withdrawals

Owner Owner Investments Investments

Owner’s Owner’s claims claims on on assets assets Revenues Revenues 12/08/09

Expenses Expenses 15

Classification of Assets and Liabilities 

How to Classify Items on the Balance Sheet 1. Current (one year or less) 2. Non-current (more than 1 year)

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CURRENT ASSETS 

those assets that; 

 



Are either expected to be realised in, or intended for sale or consumption in, the normal course of entity’s operating cycle; Held primarily for trading purposes; Expected to be realised within 12 months after the balance sheet date;

E.g.: 1. 2. 3. 4. 12/08/09

Accounts and notes receivable Inventories Prepaid items Cash 17

Operating Cycle  the time between the acquisition of assets for processing and

their realisation in cash or cash equivalents.  When the entity's normal operating cycle is not clearly

identifiable, its duration is assumed to be twelve months.

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Operating Cycle Cash Collect ions

Purch ases Inventories

Receivables 12/08/09

Sale s

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NON-CURRENT ASSETS 

All other assets that do not meet the current assets’ criteria.



E.g.:  Investments  Property, plant, and equipment (PPE)  Deferred income taxes





PPE - properties of a tangible and relatively permanent nature that are used in the normal business operations. Intangible assets - long-term rights and privileges of a nonphysical nature acquired for use in business operations. E.g.: goodwill, patent, copyright, etc.

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CURRENT LIABILITIES 

Liabilities are classified as CURRENT if they are:  Expected to be settled in the entity’s normal operating cycle or less than 12 months.  Held for trading.  it is due to be settled within twelve months after the balance sheet date



E.g.: 1. accounts payable, 2. notes payable, 3. accrued expenses

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NON-CURRENT LIABILITIES  All other liabilities that do not meet the current

liabilities’ criteria.  E.g.:    

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Long-term debt Long-term lease obligations Deferred income tax liability Pension obligations

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Timing Issue: Cash-Basis Accounting Vs Accrual-Basis Accounting

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Cash-Basis Accounting  Revenues are recognized when cash is

received.  Expenses are recognized when cash is paid.  Cash-basis accounting is not in accordance with generally accepted accounting principles (GAAP).  Use by public sector (government). But most of the public sector is moving towards the application of accrual basis. 12/08/09

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Accrual-Basis Accounting Transactions recorded in the periods in which the events occur Revenues are recognized when earned, rather than when cash is received. Expenses are recognized when incurred, rather than when paid. Accrual-basis accounting is applied accordance with generally accepted accounting principles (GAAP). Use by private entities

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The Operating Guidelines of Accounting ASSUMPTIONS

PRINCIPLES

CONSTRAINTS

Economic entity

Historical costs

Conservatism

Monetary unit

Revenue recognition

Materiality

Going concern

Matching

Time period

Full disclosure

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Accounting Assumptions Now

Future

Economic Entity The business is accounted for separately from other business entities, including its owner

Going-Concern Principle Reflects assumption that the business will continue operating instead of being closed or sold

Monetary Unit Principle Express transactions and events in monetary, or money, units

Time Period The economic life of business can be divided into artificial time period for the purpose of financial reporting

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Accounting Assumptions… Economic entity:  Defines the scope of the business  Identifies which transactions should be recorded Going Concern  Allow to record assets at historical cost Monetary Unit:  Provides a common unit of measure  Permit to add & subtract items on FS 12/08/09

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Time Period Assumption

Time Interval / Periodicity assumption

•Final accounts are prepared at regular intervals (monthly, quarterly, Annually) •Known as accounting period / financial year.

Examples of annual accounting period: •Calendar year : 1/1/2008 – 31/12/2008 •Fiscal year:1/7/2006-30/6/2007 12/08/09

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Accounting Principles Revenue Recognition 1. Recognize revenue when it is Historical Cost earned. Accounting information is based 2. Proceeds need not be in cash. on actual cost. 3. Measure revenue by cash received plus cash value of items received.

Matching Expenses are matched against revenues, and recorded in the same period in which the related 12/08/09 revenues are earned

Full Disclosure Report enough information for users to make knowledgeable decisions about the company 30

Accounting Principles

Matching Principle

Full Disclosure Principle 12/08/09

Profit is recognized by matching the income of the period with all expenses incurred in earning suc income.

Financial statements should provid sufficient / relevant information to influence users decision making (e.g Acctg policies, methods, Changes in policy) 31

Accounting Constraints

Conservatism Income and assets be reported at their lowest reasonable amounts (i.e. minimizing the assets and understating the income)

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Materiality Accountants are required to accurately account for significant items and transactions

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Accounting Constraints

Materiality Principle

Conservatism Principle

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An item is said to be “material” if it is sufficiently important to affect our judgment of the true position of the firm.

When in doubt, choose the solution that will be least likely to overstate assets and income. In easy word, Income and asset are reported at their lowest reasonable amounts. 33

Material  Omissions or misstatements of items are material if they could,

individually or collectively, influence the economic decisions of users taken on the basis of the financial statements.

 Materiality depends on the size and nature of the omission or

misstatement judged in the surrounding circumstances.

 The size or nature of the item, or a combination of both, could

be the determining factor.

(FRS101)

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