Foundations of Accounting

Foundations of accounting

Contents

Key to the resources

Introduction

Summary

This learning guide is based on the following resource:
Textbook
Duncan A (2006) Introductory Accounting, National Core Accounting Publications, Bondi

Key to the resources

Resource / Textbook
1 / Chapter 1Foundations of accounting
2 / Chapter 1, Section 1.2
3 / Chapter 1

self-testing exercises 2 and 4
end of chapter exercises 7, 8 and 27

4 / Chapter 1, Section 1.3
5 / Chapter 1

self-testing exercises 1 and 3
end of chapter exercise 17

6 / Chapter 1, section 1.4
7 / Chapter 1, end of chapter exercise 20
8 / Chapter 1, section 1.5
9 / Chapter 1, end of chapter exercise 22
10 / Chapter 1, section 1.6

Introduction

Accounting is the process of collection, processing and communication of financial information relating to a business.

Studies of accounting will therefore be directed towards the recording, classifying and reporting of the transactions of a business. A transaction is a unit of activity of a business. Later studies of accounting will consider the wider fields of taxation, corporations law and auditing.

In accounting, there are two important aims:

1to measure the operating performance (profit or loss) of the business, usually at least on an annual basis, by the preparation of an income statement

2to identify the financial position of the business on an ongoing basis in terms of its assets and liabilities, by the preparation of a balance sheet.

Before we commence with the practical aspects of recording, it is essential that there is an understanding of the fundamentals on which accounting practices are based and have been developed. This will necessitate the recognition of the underlying principles, the conventions and doctrines of accounting, relevant terms and definitions, the significance of accounting standards and the documentation supporting financial records.

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Definitions of relevant terms

A number of terms are basic to all accounting processes and it is essential that a knowledge and understanding of them is achieved.

At this stage, the following must be understood:

assets / things of value which belong to the business and which will provide benefit in the future, eg motor vehicles, inventory
liabilities / amounts owing by the business which have to be repaid in the future, eg accounts payable, bank overdraft, mortgage
owner’s equity / the financial interest that the owner (proprietor) has in the business representing any capital contribution (resources) by the owner and any profits retained in the business
revenue / income generated by the activities of the business, eg sales, fees income
expenses / outlays incurred which benefit the business in the short term (essentially 12 months or less), eg wages, insurance
income statement / a statement of financial performance prepared to measure the operating results of the business by offsetting expenses against revenue to arrive at the profit (or loss) for a period
balance sheet / a statement of financial position, ie the assets, liabilities and owner’s equity at a point of time, usually the end of the period for which the income statement is prepared

Assets and liabilities are also given a classification into current and non-current:

current assets / cash or assets which are convertible into cash within 12 months of the reporting date, eg inventory, accounts receivable
non-current assets / assets that will provide (future) benefit to the business beyond the current reporting date, eg delivery vehicles
current liabilities / amounts owing by the business which are payable within 12 months of the reporting date, eg accounts payable (suppliers), bank overdraft
non-current liabilities / amounts owing by the business which are payable more than 12 months after the reporting date, eg bank loan, mortgage
accounting equation / ‘assets = equities’ or ‘assets = liabilities + owner’s equity’; the basis of the double-entry bookkeeping system
proprietorship equation / ‘owner’s equity (proprietorship) = assets – liabilities’;assets – liabilities is commonly referred to as net assets
In accordance with the Accounting entity convention, the owner’s equity, ie the proprietor’s capital, is the amount owing by the business to the owner.
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Complete the exercises indicated.

Conventions and doctrines of accounting

The conventions and doctrines are the underlying principles of accounting practice.

The conventions are recognised as being essential rules or practices accepted unequivocally, ie without question, by the accounting profession.

The doctrines are recognised as being desirable rules or practices. Their acceptance, in general terms, is essential but in application may be varied according to the circumstances and the professional judgment of the accountant. The development of accounting standards has generally provided direction to accountants in this regard and they have eliminated to a fair extent much of the uncertainty that existed as to appropriateness and adequacy.

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Complete the exercises indicated.

Accounting standards

An awareness of the development and existence of accounting standards is necessary without, at this stage, any learning of the standards themselves. The variety of circumstances for which separate standards have been developed should be noted.

The requirements of the standards should serve as direction for accountants in satisfying the practical requirements of the accounting conventions and doctrines and as a protection against legal actions for negligence in performance of duties.

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Complete the exercises indicated.

Types of business ownership

Our accounting in the early stages will concentrate on the processes relevant to sole-trader (sole-proprietor) businesses. The advantages and disadvantages of other common forms of business ownership, ie partnerships and incorporated companies, should be recognised.

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/ Now go to Resource 9
Complete the exercises indicated.

Accounting source documents

The importance of proper documentation in the accounting processes cannot be overstated. The relevance of this documentation, not only as the basis of recording transactions but also its rolein substantiating evidence for audit and tax investigation purposes, has to be appreciated.

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Foundations of accounting—summary

What is accounting?

Accounting is a process for the collection, processing and communication of financial information.

What is bookkeeping?

Bookkeeping is that part of accounting concerned with the recording, classifying and summarisingof the transactions of a business.

What is a transaction?

A transaction is any unit of activity of a business.

What is the double-entry system of bookkeeping?

The double-entry system of bookkeeping operates such that every transaction is entered in the ledger as a debit to one account and as a creditto another account for an equal value.

What are accounting standards

Theyare pronouncements issued by the Australian Accounting Standards Board primarily designed to improve the quality and consistency of accounting reporting.

What are ‘generally accepted accounting principles’ (GAAP)?

Theyare the fundamental or basic rules and methods which govern accounting practice—the accounting conventions and doctrines.

What are accounting conventions?

These are the fundamental or basic rules:

Accounting Entity Conventionrecognises that, for accounting purposes, the business is considered separate and distinct from the owner of the business—the transactions are recorded from the point of view of the business.
Monetary Convention recognises that, to be recorded in the books, the transactions of the business have to be given a money value.
Going Concern (or Continuity of Activity) Convention recognises that, when a business is formed, it is intended to continue indefinitely.
Accounting Period Convention recognises that the assumed endless life of the business is divided into equal time (accounting) periods, ie financial years.

What are the accounting doctrines?

They are theaccepted methods and practices:

Doctrine of Consistencyrequires that there should be consistent application of the accounting principles in the preparation of the financial statements.
Doctrine of Disclosurerequires that there should be full disclosure of all material information in the preparation of the financial statements.
Doctrine of Materialityrecognises as material any information which is likely to influence any decision made on the basis of the financial statements.

What are financial statements?

The financial statements of a business are its income statement and its balance sheet.

An income statement (or revenue statement or profit andloss)is prepared so as to arrive at theprofit or lossfrom business operations for a period. Its preparation involves thematching of expenses againstincome. An expense(eg wages, electricity) is an outlay that benefits the business in the shortterm (ie 12 months or less). Incomeis the return to the business (eg sales, fees) which is generated by business operations.
A balance sheet (or statement of financial position)is a statement of the assets and liabilitiesof a business at a point of time, usually at the end of a financial period as the end date of the income statement.

Summary

In this learning guide you have looked at the underlying principles, the conventions and doctrines of accounting, relevant terms and definitions, the significance of accounting standards and the documentation supporting financial records.

Foundations of accounting1