ACCOUNTING ELEMENTS. Assets

ACCOUNTING ELEMENTS Assets Liabilities Owner s Equity Revenue Expenses An asset is 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. A liability is a present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits. Embodying economic benefits because outflows will not always be cash. The residual interest in the assets of the entity after deducting all its liabilities. Revenue is inflows of economic benefits or savings in outflows in the form of increases in assets or decreases in liabilities that lead to an increase in owner s equity, except capital contributions. Savings in outflows and decreases in liabilities relates to Discount Revenue from Creditors and Prepaid revenues that have now been earned and trade-in allowance on credit purchase of NCA. Expenses are outflows of economic benefits or reductions in inflows in the form of decreases in assets or increases in liabilities that lead to a decrease in owner s equity, except drawings. Reductions in inflows relates to Discount Expenses & Bad Debts (Debtors). Increases in liabilities relates to accrued expenses. Remember when answering questions relating to revenues and expenses only use that part of the definition that relates to the particular item. REVENUES Inflows of economic benefits (increases in assets) Cash sales (Bank) Credit Sales (Debtors) Accrued interest revenue Cash proceeds from disposal of NCA Savings in outflows (decreases in liabilities) Discount revenue (Creditors) Revenues previously prepaid (receipts in advance do not have to be refunded) Trade-in received from sundry creditor EXPENSES Outflows of economic benefits (decreases in assets or increases in liabilities) Cash expenses (Bank) Accrued expenses (Liabilities) Prepaid rent expense used up Reductions in inflows (decreases in assets) Discount expense (Debtors) Bad debts (Debtors) Sales returns (Debtors) The School For Excellence 2011 The Essentials Year 12 Accounting Book 1 Page 4

SAMPLE QUESTIONS Q. Explain why prepaid revenue is a current liability? It is a present obligation that is expected to result in an outflow of economic benefits in the next 12 months. The outflow will occur when goods are delivered (stock) or a cash refund is given if the contract is cancelled. Q. When the goods are delivered why do we record the revenue? The revenue has been earned in the reporting period when the goods are delivered. It is a savings in outflow in the form of a decrease in liabilities that leads to an increase in Owner s Equity. The savings occurs because we no longer have to refund the money to the customer. Q. Explain why a gain on disposal of a non-current asset is revenue? The outflow of economic benefits (the carrying cost) is less than the inflow of economic benefits from the cash proceeds from disposal. Q. Explain why interest owing on a term deposit is revenue? The interest owing has been earned in the period and leads to an inflow of economic benefits in the form of an increase in assets (accrued interest). Q. Explain how you would treat a sales return in a profit statement. A sales return is deducted from sales because it has the same effect as an expense. It causes a reduction in inflows in the form of a decrease in assets (debtors) that leads to a decrease in Owner s Equity. Q. Explain why product costs are not expensed until the stock is sold. The product costs are added to the cost of stock as they represent future economic benefit that is controlled by the business in the next 12 months. The School For Excellence 2011 The Essentials Year 12 Accounting Book 1 Page 5

ACCOUNTING PRINCIPLES ENTITY The business must be a separate accounting entity from its owner and from other entities. This includes multiple businesses as they are each a separate accounting entity in their own right so informed decisions can be made. It is important to identify for whom we are preparing financial reports. The isolation of drawings in the Owner s Equity section is an example of this principle. MONETARY UNIT In order to record financial events and understand the meaning of reported information it is necessary to use a common unit of measurement: The Australian dollar. GOING CONCERN It is assumed that the business will be ongoing. 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. QUESTION 1 Explain how the Going Concern Principle is reflected in the reporting of depreciable Non-Current Assets in the Balance Sheet. Motor Vehicle 50,000 Less: Accumulated Depreciation 15,000 35,000 HISTORICAL COST Transactions are recorded at their original value (as this is reliable). Items are shown in the accounting records at their original price. CONSISTENCY The accounting methods used by the business should be applied consistently from one reporting period to another to enable meaningful comparisons to be made. The School For Excellence 2011 The Essentials Year 12 Accounting Book 1 Page 6

QUESTION 2 The owner wants to change the depreciation % on his assets to reduce his expenses in the next period. Explain why this is breaching an accounting principle. 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 will avoid overstating assets and revenue and understating liabilities/expenses. QUESTION 3 The stock on hand of 28000 could be sold for 60000. The owner wants to record this revenue and related profit in this reporting period. Explain why is this not an acceptable accounting practice? QUESTION 4 Explain why the application of the lower of cost and net realisable value is using the principle of Conservatism. QUESTION 5 Explain why treating a deposit as prepaid revenue is an example of Conservatism. The School For Excellence 2011 The Essentials Year 12 Accounting Book 1 Page 7

REPORTING PERIOD The ongoing life of a business is broken into regular intervals of time for the preparation of accounting reports. Profit is calculated by matching revenue earned against expenses incurred in a particular reporting period for the purposes of decision-making. QUESTION 6 The owner has recommended to the accountant that he should not worry about including any interest revenue as it will not be received from the bank until the next reporting period. Explain why the owner is incorrect. RELEVANCE QUALITATIVE CHARACTERISTICS 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. The relevance of information is affected by its nature and materiality. Information is material if its omission or misstatement could influence the economic decisions of users taken on the basis of the financial report. Materiality provides a cut-off point which information must have if it is to be useful. QUESTION 7 Identify and explain a qualitative characteristic that would assist with the decision to add 0.20 delivery cost to a particular stock item or treat the total cost of 400 as a Period Cost. The School For Excellence 2011 The Essentials Year 12 Accounting Book 1 Page 8

QUESTION 8 Explain why the use of net realisable value is an acceptable accounting practice even though there is not verifiable evidence. RELIABILITY Reports must reflect what they say without bias or undue influence. This is achieved when reports are prepared from verifiable evidence, such as source documents. 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. However, information about complex matters should be included in the financial report because of its relevance to the economic decision-making needs of users, and should not be excluded merely on the grounds that it may be too difficult for certain users to understand. The business is currently facing a law suit for selling genetically modified seeds to unsuspecting customers. The lawyer estimates potential damages at 100,000. The owner believes that this should be ignored until the case is resolved. He also believes that the issue is too confusing for investors and other users of the financial information. QUESTION 9 Explain with reference to two qualitative characteristics why this information should be reported. Can you also identify an Accounting Principle that would apply to this situation? The School For Excellence 2011 The Essentials Year 12 Accounting Book 1 Page 9

COMPARABILITY For reports to be useful there is a need to use similar accounting methods, both over time and between different businesses in order to effectively compare results when making decisions. 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. QUESTION 10 Explain the link between the Accounting Principle of Consistency and the Qualitative Characteristic of Comparability. To answer questions on Principles, Elements and Qualitative characteristics use the IDL approach. IDENTIFY the principle / characteristic / item. DEFINE in textbook terms. LINK to the specifics of the question, i.e. answer the question! LINKS between Principles and Qualitative Characteristics: PRINCIPLES Historical Cost Consistency Going Concern Reporting Period Accounting Entity Conservatism Monetary QUALITATIVE CHARACTERISTICS Reliability Comparability Relevance/Understandability Relevance Relevance Relevance Understandability Principles relate to the recording of financial information and Qualitative characteristics relate to the reporting of information. The School For Excellence 2011 The Essentials Year 12 Accounting Book 1 Page 10

UNIT 4 ACCOUNTING Do students need to be able to calculate financial indicators/ratios for analysis and interpretation in the November examination? In order for students to best answer analysis questions in the November examination, they should have an understanding of what the financial indicators listed below involve and the formulas attached to them. Students will be expected to know how financial indicators are calculated, but in the examination setting students will not be expected to make those calculations. DO NOT ASSUME THAT RATIO FORMULAS WILL BE PROVIDED IN THE EXAM Recording of the GST in the Statement of Cash Flows for the purchase of a non-current asset: The GST will be reported as an operating outflow. For example, if a motor vehicle were purchased for 20 000 cash, with GST of 2000. The 20 000 would be an investing outflow, with the 2000 GST being reported as an operating outflow. In a Budgeted Statement of Cash Flows how are prepayments, payments of an expense, repayment of a loan and payment of interest treated? When preparing cash budgets, the distinction should be made between the payments of an expense and the prepayment of an expense. Distinction should also be made between the repayment of a loan and the payment of interest on the loan. How are sales and purchase returns treated? To be consistent with the First-In, First-Out (FIFO) assumption, sales returns should be recorded at the most recent cost price. The cost of purchase returns will be identified as the FIFO assumption only applies to the selling of stock. Sundry Debtors or Sundry Creditors are not part of the Debtor/Creditor Control system so they do not require an additional entry into a Subsidiary Ledger. The School For Excellence 2011 The Essentials Year 12 Accounting Book 1 Page 11

SECTION 2: SALES & PURCHASE RETURNS

TREATMENT OF SALES RETURNS AND ALLOWANCES AND PURCHASE RETURNS A trading firm can purchase and sell goods on credit. There are situations that require businesses to issue credit notes (the opposite effect to invoices). Credit notes cancel out previous transactions. The entries for returns must be completed in the General Journal because they cannot be accommodated in the special journals and they should only occur infrequently. Because general journals are specifically mentioned in the Study Design you can assume that you would only be recording returns on credit transactions and not cash refunds. Returns may occur due to: 1. Faulty or damaged goods. 2. Excess supply. 3. Wrong price. 4. Wrong size or type. 5. Wrong colour or design. CREDIT SALE SALES RETURN Debtors Control Debit Sales Returns Debit Credit Sales Credit GST Clearing Debit GST Clearing Credit Debtors Control Credit Cost of Sales Debit Stock Control Debit Stock Control Credit Cost of Sales Credit CREDIT PURCHASE PURCHASE RETURN Stock Control Debit Creditors Control Debit GST Clearing Debit Stock Control Credit Creditors Control Credit GST Clearing Credit The Sales Returns and Purchase Returns entries are the EXACT opposite to Sales and Purchases. The only minor exception is that we Debit an account called SALES RETURNS rather than Credit Sales. We use a separate account called SALES RETURNS because it is important for any business to be aware of any issues/problems with the quality of their products. This figure will become an important Key Performance Indicator for the business. It can be used to indicate the level of customer satisfaction with your product. Always remember to record the individual debtor or creditor in the Subsidiary Ledger. The School For Excellence 2011 The Essentials Year 12 Accounting Book 1 Page 12

PROFORMA LEDGERS DEBTORS CONTROL Date Cross Reference Date Cross Reference Sales/GST Clearing Sales Returns/GST clearing Bank/Discount Expense Bad Debts SALES Date Cross Reference Date Cross Reference Debtors Control SALES RETURNS Date Cross Reference Date Cross Reference Debtors Control STOCK CONTROL Date Cross Reference Date Cross Reference Creditors Control Cost of Sales (sales return) Creditors Control (purchase return) Cost of Sales Cost of Sales CREDITORS CONTROL Date Cross Reference Date Cross Reference Bank/Discount Revenue Stock Control/GST (purchase ret) Stock Control/GST clearing GST CLEARING Date Cross Reference Date Cross Reference Creditors Control Creditors Control (purchase ret) Bank Debtors Control (sales return) Bank Debtors Control The words in brackets are for instructional purpose only. Do not show these in your ledgers! COST OF SALES Date Cross Reference Date Cross Reference Stock Control Stock Control (sales return) Stock Control The School For Excellence 2011 The Essentials Year 12 Accounting Book 1 Page 13

Documents not recorded by Diggers Inc. Spuds Galore Credit Note CN 4 ABN 344 567 789 DIGGERS INC. Credit Note 6 ABN 370 444 111 Date: 30 th December 2012 Credit To: Diggers Inc Nicola potatoes 50 @ 10 per bag = 500 Plus GST 50 Total Credit 550 Goods returned due to spoilage Date: 20th December 2012 Credit to: MACRO Organic Stores Nicola Potatoes 50 @ 20 per bag = 1,000 Plus GST 100 Total Credit 1,100 Goods returned due to spoilage All Nicola potatoes are marked-up by 100% * Assume GST Clearing is a Liability Account Document CN 4 Purchase Return Item Account Name Increase Decrease No Effect Amount Assets Stock Control Decrease 500 Liabilities GST Clearing Increase 50 Creditors Control Decrease 550 Owner s Equity No effect The School For Excellence 2011 The Essentials Year 12 Accounting Book 1 Page 14

Document Credit Note 6 Sales Return Item Account Name Increase Decrease No Effect Amount Assets Debtors Control Decrease 1100 Stock Control Increase 500 Liabilities GST Clearing Decrease 100 Owner s Equity Gross Profit Sales returns (up 1000) Cost of Sales (down 500) Decrease 500 Date 2012 Debit 20 th Dec Sales Returns 1000 Particulars General Ledger Subsidiary Ledger GST Clearing 100 Credit Debtor MACRO Organic Stores 1100 Debit Credit Debtors Control 1100 Stock Control 500 Cost of Sales 500 Sales Return as per Credit Note No. 6 Sales Returns 6 entries 30th Dec Creditors Control 550 Creditor Spuds Galore 550 Stock Control 500 GST Clearing 50 Purchase return per Credit Note CN 4 Purchase Returns 4 entries The School For Excellence 2011 The Essentials Year 12 Accounting Book 1 Page 15

Item: Date 2012 Nicola Potatoes Details Qty IN OUT BAL Cost Total 1 Dec Balance 700 8.00 5600 5 Dec Rec 1-25 400 8.00 3200 300 8.00 2400 8 Dec Rec 26-34 200 8.00 1600 100 8.00 800 10 Dec Inv SG 40 500 9.00 4500 15 Dec Rec 35-50 18 Dec INV SG 50 600 10.00 6000 22 Dec INV 26 20 Dec 30 Dec CN No. 6 Sales Return CN No. 4 Purchase Return Qty 100 200 300 200 Cost 8.00 9.00 9.00 10.00 Total Qty 100 500 Cost 8.00 9.00 Total 800 4500 800 1800 300 9.00 2700 300 9.00 2700 600 10.00 6000 2700 2000 400 10.00 4000 50 10.00 500 400 10.00 4000 50 10.00 500 350 10.00 3500 Effect on Stock Cards of Returns Sales Returns will reduce/cancel a cost of sales entry (record in In column). Cost of Sales = Qty times cost price in the OUT column LESS sales returns in the IN Column. Only use transactions with an invoice or receipt number in the OUT column. 3200+1600+800+1800+2700+2000-500 = 11600 Do not use memo s in your calculation as they will not relate to sales Purchase returns will reduce/cancel a purchase (record in Out column). They have no effect on profit. Creditors Decrease 500 and Stock Control Decrease 500. No change in Owner s Equity A sales return is recorded using FIFO whereas the purchase return is recorded using identified cost. This is because the FIFO system only relates to the selling of stock not buying. Stock is assumed to be sold in the order that it is purchased. Therefore FIFO will be applied in reverse to a sales return. The most recent stock transaction in the out column will assume to be the first returned. The credit note does not identify the cost price (confidential information to customers). The customer receives the refund based on the selling price. This is known. A purchase return is identified because we know the amount paid for the stock. We therefore know the actual refund/credit that we are entitled to from our suppliers. Our suppliers would not want their refund based on an assumption. The School For Excellence 2011 The Essentials Year 12 Accounting Book 1 Page 16