Introduction

Financial & Accounting Information in Context

● What’s the purpose of Accounting?

○ Record keeping or bookkeeping
○ Economic transactions of a business
○ Useful for internal and external decision makers

● Who needs accounting information? (internal/external)

○ Managers
○ Owners/Potential owners
○ Debt investors/Potential debt investors
○ Employees
○ Government – e.g. IRD

Do you need accounting information?

● Business and personal decisions require accounting

Websites – Where to find financial information?

● All publicly listed companies today have their own websites (e.g. Auckland
International Airport / The Warehouse)

● The easiest way to access financial information about those companies is to go to

their websites and look for the information online

● One can locate the company website by using “GOOGLE”

○ www.google.com

Balance Sheets
● Forms part of the financial statement of an organisation and prepared at the end of
each period.
● The assets = Liabilities + Equity
○ Equity is what the owners share of the business
● It is a record of everything the business owns (assets) and owes( Liabilities) and the
owners have whatever is left over
● The balance sheet below has assets a list of assets and then they deduct the
liabilities to receive net asset
○ Net asset is equal to total equity because Asset - Liability = Owner's equity.
 ○ If the formula is A = L + OE then A - L = OE
● This balance sheet has both the group and parent company
○ Here the parent company owns subsidiaries
○ The group represents the parent and all the subsidiaries
● Assets has current and non-current asset
○ Current assets are things that can be converted to cash in the current period
○ Non-current assets are those that have a longer life in the business such as
investments, intangible assets, property plant and equipment.
■ These things are used for more than one period
● Liabilities are also divided into current liabilities and non current liabilities
○ Current liabilities are payments that need to be paid back within the same
year
○ Non current liabilities are those which can be paid in more than a year's time
● Equity is made up of a lot of things
○ Contributed equity which is the amount that the shareholders have actually
paid to the company
○ Reserves typically arise through revaluations
○ Retained earnings: when the organisation makes a profit each year it doesn'’
pay it all out to the owner and some of that income is retained
The Accounting Equation

● Assets = Liabilities + Owner’s Equity

● A= L + OE
● The equation must always balance
● Double entry accounting
○ Every transaction will affect both sides of the equation to balance it or it will
effect a positive or negative that balance out on one side of the equation

The Accounting Model and its Elements

 ● Simplified Accounting (Balance Sheet) Equation
○ Assets (A) = Liabilities (L) + Owner’s Equity (OE)
○ A0 = L0 + OE0
■ A0 represent the assets at the beginning of the year
■ L0 represents the liabilities at the beginning of the year
■ OE0 represents the owner's equity at the beginning of the year

○ The way the A,L and OE are transformed from the beginning of the year to
the end of the year has to do with the economic transactions that take place

• Expanded Accounting (Balance Sheet) Equation

○ Revenue (R), Expenses (E), Distributions (D), Revaluation (Revaln), Owner’s
contribution (OC)
■ Revenue is the sales the organization makes, the income that comes in
■ Expenses are the things that are paid for in order to generate revenue
■ Distributions in a company would be dividends which are payments to
our shareholders or owners (sole trader)
■ Revaluation is where the company periodically revalues its assets and
if this occurs then they will have a revelation amount
■ The owner's may also contribute more capital during the year

● EOY (end of year) A1 = L1 + {OE0 + [(R1 – E1) + Revaln1 + OC1 – D1]}

○ Assets at the end of the year are equal to the liabilities at the end of the year
+ Owner's equity + Profit which is revenue - expenses and adding on any
revaluations or any new contributions of capital and then track any
distributions made to the shareholders
● A1 = L1 + {OE0 + [Profit1 + Revaln1 + OC1 – D1]}
● A1 = L1 + {OE0 + Change in OE1}
● A1 = L1 + OE1

Transaction

1. Investment by Shareholders.
a. Ray and Barbara Neal decide to open a computer programming service
named Softbyte. On September 1, 2011, they invest $15,000 cash in exchange
for capital shares.
b. This is a single transaction but it has two sides
i. One side is the business receives some cash which is the asset
ii. The business receives some shares which is the equity
c. Both the sides still equal
2. Purchase of Equipment for Cash.
a. Softbyte purchases computer equipment for $7,000 cash.
b. The cash reduces by 7000 but the equipment increases by 7000 which is an
asset
c. This is a positive and a negative on the same side of the equation

3. Purchase of Supplies on Credit.

a. Softbyte purchases $1,600 of computer paper and other supplies, expected
to last several months, on credit.
b. Supplies represent computer paper, stationary etc. and the expectation is that
they will last for several month and this helps us recognise this as an asset
c. This will be brought on credit which means that the company isn't paying
cash for it and is being invoiced by the supplier and the invoice is then
generated into an accounts payable which is the debt
d. 1600 of supplies gives the company debt of 1600
e. A = L + OE has increased and it has increased by the amount of the new debt
that the business has
i. This is because the business is now being financed with debt and
equity so the total value of the business has gone up but for the
shareholders their amount is still the original amount they contributed
4. Services Provided for Cash.
a. Softbyte receives $1,200 cash from customers for programming services
provided.
b. This is the generation of revenue and this is because it is the result of services
being performed but also the cash of the business has gone up from the
assets which balances out the two as well alongside increasing the company's
value

5. Purchase of Advertising on Credit.

a. Softbyte receives a bill for $250 from the Daily News for current advertising,
but postpones payment until a later date.
b. On credit affects accounts payable and adds to the debt and liabilities
c. However, the amount will only be an asset if it generates some future benefit
and since the advertisement is being run currently, it will not be worth
anything in the future
d. This is how we define expense which is something we incur to generate
revenue and we only generate revenue in this period and so the company has
250 in expense and also 250 in accounts payable under liabilities
e. This is balanced out because revenue - expense whereas accounts payable
comes under liabilities therefore they get balanced out

6. Services Provided for Cash and Credit.

a. Softbyte provides $3,500 of programming services for customers, receiving
cash of $1,500 while billing the balance of $2,000.
b. Here 2000 is owed to the business and that is called accounts receivable
which comes under asset
c. The money earned of 3500 goes directly to revenue and balances out both
the sides
7. Payment of Expenses.
a. Softbyte pays the following September expenses in cash: store rent $600,
salaries of employees $900, and utilities $200.
b. None of these are assets as these are things that have already been used in
the business so that means that they expenditure
c. Therefore the total of 1700 will be negative in cash under asset and also
under expenditure

8. Payment of Accounts Payable.

a. Softbyte pays its $250 Daily News bill in cash. [In Transaction (5)]
b. Here it has already been recognised as an expense previously but what does
happen here is that it is recognised as an expense that has been reduced
since it has been paid off which means that the accounts payable has reduced
c. In the beginning of the transaction there was a recognition of the expense
and debt but in this transaction the debt is reduced as the payment is made
which reduces the cash and the liabilities (accounts payable)

9. Receipt of Cash on Account.

a. Softbyte receives $600 in cash from customers who had been billed for
services [in Transaction (6)].
 b. Since the revenue has already been recognised in the previous transaction, it
isn't recognized again
c. Cash is being received so that gets added and the accounts receivable gets
deducted as the customer no longer owes the money

10. Dividends.
a. The corporation pays a dividend of $1,300 in cash.
b. Cash goes down
c. A new column gets added to equity of distribution where 1300 is reduced
since it is paid out of the account
d. However, this doesn't affect share capital because mostly organisations pay
dividends and that forms part of the retained earnings

Basic concepts and terms used in accounting

These help with identifying, measuring, and recording:

● Entity concept.
○ There are accounting entities, legal entities and it is important to know
whether the business is a separate entity or not.
○ In Accounting separate businesses are recognised as separate entities
○ Eg. Sole trader keeps the business account separate from the personal
account making the business an independent entity

● Monetary unit concept.

○ Things in accounting are recognised in money terms

● Historical cost concept.

Entity concept
 ● An entity is considered to be separate from its owners and from any other business.

○ True for all forms of business: companies, sole traders, and partnerships.
■ Whether they have legal entity status or not, from an accounting POV
they are an entity

○ Implication? The owners’ personal assets and liabilities do not appear on the
entity’s financial statements.

● Each business is an entity and has its own accounting system and records.

Monetary unit concept

● All recordable economic events, including transactions, and the financial statements
that summarise such events, are recorded in terms of money.
● The monetary unit used depends on the national currency of the country in which
the business operates.
● In New Zealand, all transactions in foreign currencies are converted to NZ dollars.

Historical cost concept

● A business records its transactions based on the amount exchanged at the time the
transaction occurred.

● Transactions are recorded at the amount that is paid for things

○ Doesn't make a difference for items purchased in past year or two but old
companies have assets in the book from years ago and if it hasn't been
revalued it will be sitting at the value that the company had originally paid for
it and not the current value

● Therefore, when looking at the accounting sheet it is important to remember that

some amounts are in the current dollars whereas others are in the historic dollars

● In most cases thereafter, the values shown on the financial statements are based on
that original cost.
○ E.g., the land is not re-valued to market value.
○ E.g., merchandise inventory is not re-valued to its selling price, unless below
cost.
Accounting Principles and Concepts

Several accounting principles and concepts assist with the recording of transactions:

1. Accounting period.
a. The period to which the accounts apply eg. monthly, quarterly, yearly etc.

2. Accrual accounting (vs. Cash accounting)

a. Affects how we record transactions and expenses

3. Recording revenues.

4. Matching principle.

Accrual Accounting
● Under accrual accounting, transactions are recorded when they occur.
○ Sometimes accrual-basis and cash-basis accounting result in recording an
event in the same way and period.

○ But often the cash inflow or outflow occurs in a period different from when
accrual accounting would recognise the revenue or expense.

Revenue Recognition

The revenue recognition principle determines when revenue is recorded and reported.
● Under this principle, which is an integral part of accrual accounting, revenue is
recognised, or recorded, in the period in which both of the following conditions are
met:
○ The revenue has been earned. (The earnings process is complete).
○ The collection of cash is reasonably assured.
○ (The price charged is collectable).

● Revenue is recorded when these two conditions are met, regardless of when cash is
received.
○ The receipt of cash is not required to record revenue.

● In effect, this means revenue is recognised when the product is delivered or the
service provided,
○ Even if the customer had pre-paid earlier, or
○ Even if the customer has not yet paid a cent.
Matching Principle – Expenses

● Expense recognition is the process of identifying an expense with a particular time

period.

● Under accrual accounting, expenses are recognised following the matching principle,
which requires that expenses be recorded and reported in the same period as the
revenue that it helped to generate.

● Expenses for an accounting period should include only those costs used to earn
revenue that was recognised in the accounting period.

● Thus, the key to expense recognition is matching the expense with revenue.

Timing - Example

Cash vs Accrual Accounting

So, under accrual accounting, which Revenues and Expenses belong in a given accounting
period?

● Revenue Recognition Rule

○ Include only the Revenues earned during the period.
● When earned? Usually…
○ When sale takes place
○ When service is performed

Expense Recognition Rules:

● Given a payment or an increase to a liability, recognise an expense if there is no
reliably measurable future benefit.
 Examples?
● Given an expenditure previously recorded as an asset, recognise an expense (and
reduce the asset) to the extent future benefit has been consumed or lost during the
accounting period at hand.
● Examples?

And how does cash accounting determine Revenue and Expense recognition?

Why might the profit for a period be different under the two systems?
 Tutorial

Equity consists of different types of accounts including shares, drawings and capital
contribution

Cash vs Accural

● Cash accounting is when cash goes in and out of your account and is recorded as a
transaction
● Accrual is when the transaction is recorded when it happens regardless of when the
actual cash is taken or received.

Tutorial Worksheet 1
TBL

● Debit greater than credit is called a debit balance

● Same for credit