CHAPTER 1: THE ROLE OF ACCOUNTING IN BUSINESS

* 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

•  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

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, namely

•  financial accounting

•  managerial accounting
1.2. Decision makers: The users of accounting information

•  Individuals

•  Businesses

•  Investors

•  Creditors

•  Government regulatory agencies

•  Tax authorities

•  Non-profit organisations

•  Other users, e.g. employees and labour unions

1.3 The accounting profession: Career opportunities

•  Lucrative career with many opportunities

•  Professionally qualified accountants pass the educational and experience requirements of a

•  Professional bodies recognised in Australia include

-  Institute of Chartered Accountants in Australia

-  CPA Australia

-  Institute of Public Accountants

-  Chartered Institute of Management Accountants

1.5 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

-  Objectivity

-  Professional competence and due care

-  Confidentiality

-  Professional behaviour
1.6. Types of business organisations

1.7. 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

•  Basic measurement concepts and principles include

-  Entity concept

-  Accounting period concept

-  Cost principle

-  Matching principle

-  Profit recognition principle

-  Conservatism principle

-  Going concern assumption

•  The entity concept defines the entity for which accounting data is collected

•  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

•  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 principle constrains management’s natural optimism

•  The going concern assumption assumes that the business as a whole will continue operating for the
foreseeable future

1.8 The accounting equation

It measures the resources of a business and the claims to those resources

•  Assets are a resource controlled by the entity as a result of past events and from which future
economic benefits are expected to flow to the entity

•  Liabilities are debts that are payable to outsiders called creditors

•  Equity is the residual interest in the assets of the entity after deducting all of its liabilities

•  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

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
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.

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.

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.

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.
1.10. Preparing the financial statements: The users perspective

A complete set of financial statements comprise

•  Statement of Comprehensive Income (Income Statement)

•  Statement of Changes in Equity

•  Statement of Financial Position (Balance Sheet)

•  Statement of Cash Flows

•  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

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

1.11. Using financial statements to evaluate business performance and make

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

Financial statements can be used in several ways, for example

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
 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