LECTURER HANDOUTS CHAPTER 2: BASIC ACCOUNTING CONCEPT AA015

2.0 BASIC ACCOUNTING CONCEPTS

2.1 GENERALLY ACCEPTED ACCOUNTING

Describe the meaning and the importance of Generally Accepted Accounting Principles
(GAAP)

● The accounting profession has developed standards that are generally accepted and
universally practiced. This common set of standards is called generally accepted
accounting principles (GAAP). These standards indicate how to report economic events.
● The different opinions among accountants can be solved by referring to GAAP.
● It covers conventions, concepts, regulations, procedures and the guidelines standards.
● It is important because the Financial Statements must be completed and easy to
understand by others in order to make a comparison or to make any economic decision.

2.2 ACCOUNTING CONCEPTS

CONCEPT EXAMPLE SOLUTION

1. Historical Cost
✔ The acquired assets and The company purchased a car The amount that should be
services by a company from a supplier at a cost price of recorded is the cost i.e.
should be recorded at their RM20,000 on 21 August 2016. RM20,000 because this cost is
actual cost. The market value increases up a reliable measure.
✔ The cost is a reliable to RM25,000 on the next day.
measure and can be Which amount should be
approved and the company recorded by the company?
should continue reporting Why?
the historical cost of an
asset over its useful life.
2. Monetary
Measurement A transaction occurred in the The transaction must be
Assumption organization but the value recorded in the monetary unit
cannot be determined because and the value assumed stable
✔ Money is the common of inflation. and did not change with the
denominator in business. inflation situation.
Monetary measurement is a
principle that assumes
business transactions or
events can be measured
and expressed in terms
of monetary units and they
are stable and dependable.
In other words, the language
of business and finance is
money.

1
 LECTURER HANDOUTS CHAPTER 2: BASIC ACCOUNTING CONCEPT
3. Economic Entity
✔ The business and its owner
are two different entities.
✔ The activities of the
business must be kept
separated and distinctively
from the activities of the
owner and of all other
economic entities such as
the creditors, suppliers,
customers etc.
✔ The entity needs to be
evaluated separately from
the owner, can hold
properties and debts under
its own name.
4. Going Concern
✔ The business will continue
to operate long enough to
carry out its’ existing
objectives. It means that the
entity will remain in
operation for the
foreseeable future.
✔ Most resources such as
supplies, land, building and
equipment are acquired to
be used rather than to sell.
5. Consistency
✔ Consistency means that a
company uses the same
accounting principles and
methods from year to year.
✔ When financial information
has been reported on a
consistent basis, the
financial statements permit
Sally Salleh, owner of Sally’s
Boutique, must keep her
personal living costs separate
from the expenses of the
business. Whatever she took
from the boutique must be
declared as withdrawal or also
known as drawings.
The company purchases a car
with a cost of RM20,000 with
the estimated useful life for 10
years. It is suggested that the
car should be depreciated for 5
years because the business is
expected to make a clearance in
a short period.
The company uses a straight
line method in depreciating the
fixed asset of the company. The
company decides to change to a
declining balance method.
2
AA015
-
The suggestion is rejected
because it contradicts the
Going Concern Concept. The
vehicle should be recorded at
the value of RM20,000 and
must be depreciated for 10
years because the trade must
be assumed to operate for the
period that cannot be expected
It does not comply with the
consistency concept because
the method should be used
from year to year. Any changes
should be disclosed in the
notes to the financial
statements.
 LECTURER HANDOUTS CHAPTER 2: BASIC ACCOUNTING CONCEPT
meaningful analysis of
trends within a company.
6. Accounting Period
✔ Time period covered by
financial statements is
known as the accounting
period.
✔ Time period assumption
means business activities
can be divided into specific
periods such as a month, a
quarter and a year in order
to enable comparison of
business performance over
time.
7. Materiality
✔ Materiality relates to an
item’s impact on a firm’s
overall financial condition
and operations. An item is
material when it is likely to
influence the decision of a
reasonably prudent investor
or creditor. To determine the
materiality of an amount, the
accountant usually
compares it with such items
as total assets, total
liabilities and net income.
8. Revenue Recognition
✔ Revenue is recognized in
the period they are earned.
✔ When the merchandise has
arrived to the buyer or when
services are rendered
although cash has not been
received.
✔ Criteria to recognize a
The company was established
on 1 January 2013. The trade
closes the business account
every 12 months on 31
December every year. Explain
the concept involved.
A company purchases
calculator at cost RM20 and it
will depreciate for 5 years over
its useful life. Give your opinion.
Azmal is a pottery entrepreneur.
He has received reservations of
porcelain vases on 1st of Jan,
2017 and has received a
payment of RM1,000. The
booking was sent on 1st of Feb.
When should the sales for the
100 units of porcelain vase be
recognized? Give your opinion.
3
AA015
It is a normal condition when
the trade follows the
Accounting Period where the
financial statements will be
held every 12 months.
a Although the proper
accounting would depreciate
the calculator over its useful
life, this cost is considered
immaterial. It will not make a
material difference on total
assets and net income. So the
cost of the calculator is best
declared as a supply (current
asset) rather than an
equipment (fixed asset).
Azmal needs to recognize sales
revenue of RM1,000 on 1st of
Feb because of the change of
ownership on that date.
 LECTURER HANDOUTS CHAPTER 2: BASIC ACCOUNTING CONCEPT AA015
revenue: -
o there is a change of
ownership/title.
o buyers are willing to pay.
o the stability of the
currency.
o buyers are able to pay.

9. Expense Recognition
Tina has recorded expenses of Yes, Tina adheres to the
✔ Expenses are recorded in RM2,000 for utilities used in concept of expense recognition
the accounting period in December 2016, although as an expense of the current
which it has been involved payment will only be made in period should be recorded in
for a business revenue. January 2017. Is she doing the the current accounting period.
✔ Expenses are recognized right thing?
when they are incurred even
if payment has not yet been
made.
✔ The goal - to find out the
actual amount of revenue
and expenditure for a
financial period.

10. Full Disclosure

✔ The company should report
the sufficient information (ie:
relevant, reliable,
comparable) so that the
external parties can make a
reasonable decision.
Farida Ent. has made changes
in the stock valuation method
used. The company did not
disclose the information in the
financial statements for the
accounting period.
The situation does not comply
with the concept of full
disclosure where a change is
made and it should be reported
in the notes to the accounts.
The aim is to inform the user of
changes in the financial
statements.

11. Objectivity
✔ All accounting data should
be valid and has reliable
evidence to support
transactions occurred.
✔ The goal - to prevent
accountants from giving
subjective and inaccurate
opinion.
KZB Co. issues only receipts for
cash transactions, but for the
return of goods from sales
transactions, no source
document is issued. Give your
opinion.
The Company does not comply
with the concept of objectivity
for the return of goods from
sales transactions. For all
transactions which need to be
confirmed with the release of
the source document. In
addition to the evidence it can
also facilitate the recording.

4
 LECTURER HANDOUTS CHAPTER 2: BASIC ACCOUNTING CONCEPT AA015

12. Fair Value Measurement

✔ FAIR VALUE MEASUREMENT states that assets and liabilities should be reported at fair value
when it comes to the point of selling assets or settling liabilities.
✔ FAS No. 157 defines fair value as the price that would be received to sell an asset or paid to
transfer a liability (i.e., the “exit price”) in an orderly transaction between market participants at
the measurement date.

2.3 ACCOUNTING EQUATION

Accounting Equation for service businesses

ASSETS = LIABILITIES + OWNER’S EQUITY

ASSETS = LIABILITIES + (CAPITAL + REVENUES – EXPENSES – OWNER’S

WITHDRAWAL)

2.4 DEFINE ASSETS, LIABILITIES AND OWNER’S EQUITY

ASSETS
● Wealth /resources owned by the business.

1. Non-Current Assets 2. Current Assets Account

● Assets that have a life of more than one year.

i. Tangible/fixed ii. Intangible assets iii. Long-term ❖ Exists in one accounting

assets investments period and can be
– cannot be seen - fixed converted into cash within a
– can be seen physically. deposits for year.
physically. more than a ❖ Constantly changing form
Example:- and value.
year, the

5
 LECTURER HANDOUTS CHAPTER 2: BASIC ACCOUNTING CONCEPT AA015
Example:- Buildings, Trademarks, patents, purchase of ❖ Example :- Inventory,
Vehicles, Equipment Copyrights. bonds. Accounts Receivable, Cash
and Bank .

LIABILITY
● Debt / business obligation to be paid by a business entity to another party.

1. Non-Current Liabilities ( > 1 year) 1. Current Liabilities (< 1 year)

❖ Debt due in less than a year.

❖ Debt to be settled within a period exceeding one
❖ Example:- Account payable,
year.
Expense payables, Unearned
❖ Example:- Long-term loans , Mortgage Revenue.

OWNER’S EQUITY
● Owner’s claims on the business. They include:

● Capital invested by the owner into the business.

● The net profit from the business activities.

Owner’s claims on the business. They include:

❖ Capital
▪ Capital invested by the owner into the business.
▪ The net profit from the business activities.
❖ Drawing / Withdrawals
▪ Owner takes assets (cash or merchandise) for his own use.
▪ This will reduce the value of owners' equity.
❖ Profit

6
 LECTURER HANDOUTS CHAPTER 2: BASIC ACCOUNTING CONCEPT AA015
▪ Expenses
• This will reduce the owner’s equity.
▪ Revenues
• This will add value to the owner’s equity.

Revenues
● Income from the sale of goods or services to customers.
● It is based on the concept of revenue recognition.

● 2 types of revenue:-

✔ Operating Revenue – from business main activities

Example:- Sales, Service Revenue

✔ Non-Operating Revenue – from a side activity

Example:- Interest income, Rental income, Gains on Sales of fixed assets.

Expenses
● An expense is the money spent or cost incurred in an entity’s effort to generate
revenue.
● Expenses use up assets or create liabilities in the course of operating a business.
Expenses decrease equity.

2 types of Expenses:

✔ Operating Expenses
Example: Utilities , Sales Commissions, Delivery Expense

✔ Non-Operating Expenses
Example: Interest Expense, Property Taxes on the Administrative Office Building

7
 LECTURER HANDOUTS CHAPTER 2: BASIC ACCOUNTING CONCEPT AA015
Analyse the effects of business transactions on accounting equation

Transaction Analysis

EXAMPLE ASSETS = LIABILITIES + OWNER’S EQUITY

J. Scott, the owner, The accounts involved are:

contributed
RM20,000 cash to (1) Cash (asset) increases
start the business. (2) J. Scott, Capital (equity) increases

Purchased supplies The accounts involved are:

paying RM1,000
cash. (1) Cash (asset) decreases
(2) Supplies (asset) increases

Purchased The accounts involved are:

equipment for
RM15,000 cash. (1) Cash (asset) decreases
(2) Equipment (asset) increases

Purchased Supplies The accounts involved are:

of RM200 and
Equipment of (1) Supplies (asset) increases
RM1,000 on (2) Equipment (asset) increases
account. (3) Accounts Payable (liability) increases

Borrowed RM4,000 The accounts involved are:

cash from 1st
American Bank on a (1) Cash (asset) increases
Notes Payable. (2) Notes payable (liability) increases

Rendered The accounts involved are:

consulting services
receiving RM3,000 (1) Cash (asset) increases
cash. (2) Revenues (equity) increases

8
 LECTURER HANDOUTS CHAPTER 2: BASIC ACCOUNTING CONCEPT AA015
Paid salaries of The accounts involved are:
RM800 to
employees. (1) Cash (asset) decreases
(2) Salaries expense (equity) decreases

J. Scott withdrew The accounts involved are:

RM500 from the
business for (1) Cash (asset) decreases
personal use. (2) J. Scott, Withdrawals (equity) decreases

J. Scott Transaction Analysis

ASSETS = LIABILITIES OWNER’S Notes

EQUITY
Cash Supplies Equipment Accounts Notes
Payable Payable
1 20,000 20,000 capital
2 (1,000) 1,000
3 (15,000) 15,000
4 200 1,000 1,200
5 4,000 4,000
6 3,000 3,000 Revenues
7 (800) (800) Salaries
Expenses
8 (500) (500) Drawing
9,700 1,200 16,000 1,200 4,000 21,700
26,900 = 26,900

Let’s prepare the Financial Statements reflecting the transactions we have recorded.

1. Statement of Comprehensive Income/ Profit or Loss

The Statement of Profit or Loss (SOPL) describes a company’s revenues and expenses
along with the resulting profit or loss over a period of time due to earnings activities.

9
 LECTURER HANDOUTS CHAPTER 2: BASIC ACCOUNTING CONCEPT AA015

2. Statement of Owner’s Equity

The Statement of Owner’s Equity explains changes in equity from profit (or loss) and
from owner investments and withdrawals for a period of time

3. Statement of Financial Position

The Statement of Financial Position (SOFP) describes a company’s financial position at
a point in time.

4. Statement of Cash Flows

2.5 Double-Entry System

Accounting uses the double-entry system, which means that we record the dual effects of each
transaction. As a result, every transaction affects at least two accounts. It would be incomplete
to record only the giving side, or only the receiving side, of a transaction.

2.6 RULES OF DEBIT AND CREDIT DEBIT = The left side of the

Account Record Debit/Credit CREDIT

Normal = The right side of t
Balance
ASSET DEBIT The following T-account:
EXPENSE DEBIT
DRAWINGS CREDIT Title of A
LIABILITY CREDIT CREDIT
EQUITY DEBIT CRE
REVENUE DEBIT

10
LECTURER HANDOUTS CHAPTER 2: BASIC ACCOUNTING CONCEPT AA015

11