Chapter 1 The Role Of Accounting

What is the Purpose of Accounting? Why do we do it? What is Accounting?

What is the Purpose of Accounting? Accounting is the collection and recording of financial data, and the reporting, analysis and interpretation of financial information. But what is the PURPOSE of the above definition?

What is the Purpose of Accounting? The purpose is to provide business owners with accurate financial information that will assist them in making decisions about the activities of their firm. Whilst the owners may not always make the ‘right’ decisions, the information provided should assist in making more ‘informed’ decisions to improve the performance of the business.

Users of Accounting Information Whilst the owners of a trading business (owned by one person) would be interested in Accounting information, other parties which deal with the trading business would be interested in the information presented.

Users of Accounting Information These parties are; - Debtors - Creditors - Banks and other financial institutions - Employees - Prospective owners - Australian Tax Office (ATO)

*Financial Data vs Financial Information* Financial information is financial data which has been sorted, classified and summarised into a more useable and understandable form which is able to be presented to the owner/s. Financial data are raw facts and figures which is financially based from original documents, e.g. Receipts, cheque butts, etc.

The Accounting Process Collecting Source Documents Recording Reporting Advice

Accounting Principles Accounting principles are the basic rules of accounting, which have become acceptable producers over time Together with accounting standards, form a set of rules that allow accounting records and reports to be prepared in a similar way, regardless of the type of business under examination or the form of ownership.

Accounting Principles CHER @ MCG Consistency Historical Cost Entity Reporting Period Monetary Unit Conservatism Going Concern

Consistency The accounting methods used by the business should be applied consistently from one reporting period to another. This allows valid comparisons of performance to be made.

Consistency By consistently applying the same accounting techniques, comparisons of performance can be made over time If constant changes were allowed comparisons would be extremely difficult, if not impossible. Link to comparability- as the demand for consistency is made so that comparisons of results are meaningful

Historical Cost All transactions are recorded at their original value. Therefore, items are shown in the accounting records at their historical (original) price.

Historical Cost Assets are NOT valued at what they could be sold for at the present time This method is quite objective because it relies on evidence from documents such as invoices and receipts Deals with facts and NOT opinions (link to reliability)

Historical Cost NOTE: some exceptions to this rule, land normally appreciates in value and may be revalued in some circumstances This will be covered later in the course.

Entity Personal transactions of the owner(s) should be kept separate from those of the business. If this principle were not followed it would be impossible to evaluate the performance of the business.

Entity Therefore, for accounting purposes, the business is always viewed as a separate entity, regardless of where the firm is a sole trader, a partnership or a company. The business must be a separate accounting entity from its owner and from other entities. If the owner contributes personal assets to the business, it should be recorded as a ‘capital contribution’.

Reporting Period The ongoing life of a business is broken into regular intervals of time for the preparation of financial reports. These regular intervals are referred to as ‘Reporting Periods’

Reporting Period These intervals allow accountants to assume that business operations have been frozen momentarily so that a profit or loss figure can be determined These periods may be a week, month, quarter or a full year, but must not be longer due to taxation requirements

Monetary Unit Measure and record financial events To understand the meaning of the reported information it is necessary to use a common unit of measurement. Australian dollars are used as this measure Reports are expressed in dollar value

Conservatism It is acknowledged that gains will not be recognised until earned and losses will be recognised as soon as they are likely to occur. This principle is followed so as not to overstate assets and revenues and not understate liabilities and expenses.

Going Concern It is assumed that the business will be ongoing, i.e. the business will have an indefinite life. The purpose of this rule is so that a distinction can be made between assets, which will provide benefit to future reporting periods, and expenses that are totally consumed within one reporting period

Going Concern By following this rule accountant can report long-term assets in a balance sheet. Otherwise they would all have to be written off as expenses in their year of purchase Link to historical cost Going concern principles also allows accountants to cater for transactions that overlap two consecutive years, as is the case with many credit transactions

Qualitative Characteristics The basic objective of general purpose financial reports is to provide relevant and reliable information to users of reports to allow them to make financial decisions. For accounting information to be valuable; it must satisfy the following requirements, known as qualitative characteristics.

Qualitative Characteristics CURR Comparability Understandability Relevance Reliability

Comparability Users must be able to compare the financial reports of an entity through time to identify trends in the entity’s financial position and performance. Users must also be able to compare the financial reports of different entities to evaluate their relative financial position, financial performance and cash flows. Hence, the measurement and display of the financial effect of like transactions and other events must be carried out in a consistent way throughout an entity and over time and in a consistent way for different entities.

Comparability Therefore, the measurement and display of the financial effect of like transactions and other events must be carried out in a consistent way throughout an entity and over time and in a consistent way for different entities.

Understandability An essential quality of the information provided in financial reports is that it is readily understandable by users. For this purpose, users are assumed to have a reasonable knowledge of business, economic activities and accounting, and a willingness to study the information with reasonable diligence.

Relevance To be useful, information must be relevant to the decision- making needs of users. Information has the quality of relevance when it influences the economic decisions of users by helping them evaluate past, present or future events or confirming, or correcting, their past evaluation. If information is likely to influence a financial decision by a user of a report it is deemed to be relevant

Reliability Information has the quality of reliability when it is free from material error and bias and can be depended upon by users to represent faithfully that which it either purports to represent or could reasonably be expected to represent. To be reliable, the information contained in financial reports must be neutral, that is, free from bias.