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Topic

Accounting and

2 Business

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Learning Outcomes:
At the end of this topic, students
should be able to:
1. Explain the nature and types of business.
2. Defined assets, liabilities, owner’s equity,
revenue and expenses.
3. Discuss on the differentiation of cash and
accrual accounting.
4. Explain accounting assumptions, principles
and constraints.
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Business Entity Forms

Proprietorship
Proprietorship Partnership
Partnership Corporation
Corporation

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Exh.
1.8

Characteristics of Businesses

Cha ra cte ristics P roprie torshipP a rtne rshipCorpora tion


Busine ss e ntity ye s ye s ye s
Le ga l e ntity no no ye s
Lim ite d lia bility no no ye s
Unlim ite d life no * no * ye s
Busine ss ta x e d no no ye s
One ow ne r a llow e d ye s no ye s

**Proprietorships
Proprietorshipsandand partnerships
partnerships that
thatare
are set
set up
up as
asLLC’s
LLC’s
provide
providelimited
limitedliability.
liability.
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Corporation
 Governed by: Companies Act 1965,
Memorandum of Association & Article of
Association

 Owners of a corporation are called


shareholders (or stockholders).

 When a corporation issues only one class of


stock, we call it common stock (or capital stock).

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DEFINITIONS
 Definitions of Income ,Expenses Assets,
Liabilities and Equity, based on MASB
Framework for the Preparation Presentation of
Financial Statement.

 Refer to FRS101 Presentation of Financial


Statements at www.masb.org.my

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INCOME
 Income is increases in economic benefits
during the period in the form of inflows or
enhancements of assets or decreases of
liabilities that result in increases in equity,
other than those relating to contributions from
equity participants.

 Income includes both revenue and gains.

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INCOME…
 REVENUE - the gross inflow of economic benefits
during the period arising in the course of the
ordinary activities of an enterprise when those
inflows result in increases in equity, other than
increases relating to contributions from equity
participants.
 increases assets results from the sales of
goods and services, fees, interest, dividends,
royalties, grants and rent.

 GAINS - increase assets might arise from the


disposal of assets, or the revaluation of financial
instruments, investment property and agricultural
assets, among other things
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EXPENSES
 Expenses are decreases in economic benefits during
the period in the form of outflows or depletions of
assets or increases of liabilities that result in
decreases in equity, other than those relating to
distributions to equity participants.

 Expenses include both expenses and losses.

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ASSETS
 Probable future economic benefit obtained or controlled
by a particular entity as a result of past transactions or
events
 E.g.:
1. Cash,
2. Accounts and notes receivable
3. Inventories
4. Prepaid items
5. Property, plant, and equipment

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Assets

Cash
Cash
Accounts
Accounts Notes
Notes
Receivable
Receivable Receivable
Receivable
Resources
Resources
owned
owned oror
Vehicles controlled
controlled
Vehicles Land
by
by aa Land
company
company
Store
Store Buildings
Buildings
Supplies
Supplies
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Equipment 11
LIABILITY
 Probable future sacrifice of economical benefit
arising from a present obligation of a particular
entity to transfer assets or provide services to
other entities in the future as a result of past
transactions or events.

 “Obligation” includes legal, moral, social, and


implied commitments.

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Liabilities

Accounts
Accounts Notes
Notes
Payable
Payable Payable
Payable

Creditors’
Creditors’
claims
claims on
on
assets
assets
Taxes
Taxes Wages
Wages
Payable
Payable Payable
Payable
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OWNER’S EQUITY
 Residual interest in the assets of an entity that remains after deducting its liabilities.


E.g.: (corporation)
 Share capital – ordinary and preferred shares

 Reserves – share premium, revaluation reserve, etc.

 Retained earnings – is the amount of the undistributed earnings of past periods.

ASSET – LIABILITY = EQUITY

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Equity

Owner
Owner Owner
Owner
Investments
Investments Withdrawals
Withdrawals

Owner’s
Owner’s
claims
claims
on
on
assets
assets
Revenues
Revenues Expenses
Expenses
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Classification of
Assets and Liabilities
 How to Classify Items on the Balance Sheet

1. Current (one year or less)


2. Non-current (more than 1 year)

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CURRENT ASSETS
 those assets that;
 Are either expected to be realised in, or intended for
sale or consumption in, the normal course of entity’s
operating cycle;
 Held primarily for trading purposes;
 Expected to be realised within 12 months after the
balance sheet date;
 E.g.:
1. Accounts and notes receivable
2. Inventories
3. Prepaid items
4. Cash
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Operating Cycle
 the time between the acquisition of assets for processing and
their realisation in cash or cash equivalents.

 When the entity's normal operating cycle is not clearly


identifiable, its duration is assumed to be twelve months.

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Operating Cycle
Cash

Collect Purch
ions ases

Receivables Inventories

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Sale 19

s
NON-CURRENT ASSETS
 All other assets that do not meet the current
assets’ criteria.
 E.g.:
 Investments
 Property, plant, and equipment (PPE)
 Deferred income taxes
 PPE - properties of a tangible and relatively permanent
nature that are used in the normal business operations.
 Intangible assets - long-term rights and privileges of a
nonphysical nature acquired for use in business
operations. E.g.: goodwill, patent, copyright, etc.

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CURRENT LIABILITIES
 Liabilities are classified as CURRENT if they are:
 Expected to be settled in the entity’s normal
operating cycle or less than 12 months.
 Held for trading.
 it is due to be settled within twelve months after
the balance sheet date
 E.g.:
1. accounts payable,
2. notes payable,
3. accrued expenses

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NON-CURRENT LIABILITIES
 All other liabilities that do not meet the current
liabilities’ criteria.
 E.g.:
 Long-term debt
 Long-term lease obligations
 Deferred income tax liability
 Pension obligations

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Timing Issue:

Cash-Basis Accounting
Vs
Accrual-Basis Accounting

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Cash-Basis Accounting
 Revenues are recognized when cash is
received.
 Expenses are recognized when cash is paid.
 Cash-basis accounting is not in accordance
with generally accepted accounting principles
(GAAP).
 Use by public sector (government). But most of
the public sector is moving towards the
application of accrual basis.

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Accrual-Basis Accounting
Transactions recorded in the periods in which
the events occur
Revenues are recognized when earned,
rather than when cash is received.
Expenses are recognized when incurred,
rather than when paid.
Accrual-basis accounting is applied
accordance with generally accepted
accounting principles (GAAP).
Use by private entities
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The Operating Guidelines of
Accounting
ASSUMPTIONS PRINCIPLES CONSTRAINTS
Economic entity Historical costs Conservatism

Monetary unit Revenue recognition Materiality

Going concern Matching

Time period Full disclosure

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Accounting Assumptions

Now Future
Economic Entity Going-Concern Principle
The business is accounted for Reflects assumption that the
separately from other business business will continue operating
entities, including its owner instead of being closed or sold

Monetary Unit Principle Time Period


Express transactions and events in The economic life of business can be
monetary, or money, units divided into artificial time period for
the purpose of financial reporting
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Accounting Assumptions…
Economic entity:
 Defines the scope of the business
 Identifies which transactions should be recorded

Going Concern
 Allow to record assets at historical cost

Monetary Unit:
 Provides a common unit of measure
 Permit to add & subtract items on FS

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Time Period Assumption

•Final accounts are prepared


Time Interval at regular intervals (monthly, quarterly,
/ Periodicity Annually)
assumption •Known as accounting period /
financial year.

Examples of annual accounting period:


•Calendar year : 1/1/2008 – 31/12/2008

•Fiscal year:1/7/2006-30/6/2007

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Accounting Principles

Revenue Recognition
1. Recognize revenue when it is
Historical Cost
earned.
Accounting information is based
2. Proceeds need not be in cash.
on actual cost.
3. Measure revenue by cash
received plus cash value of items
received.

Full Disclosure
Matching
Report enough information for
Expenses are matched against
users to make knowledgeable
revenues, and recorded in the
decisions about the company
same period in which the related
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Accounting Principles

Profit is recognized by matching


Matching the income of the period with all
Principle expenses incurred in earning suc
income.

Full Financial statements should provid


Disclosure sufficient / relevant information
Principle to influence users decision making
(e.g Acctg policies, methods,
Changes in policy)
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Accounting Constraints

Conservatism
Income and assets be reported at
their lowest reasonable amounts (i.e.
minimizing the assets and
understating the income) Materiality
Accountants are required to
accurately account for significant
items and transactions

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Accounting Constraints

An item is said to be “material”


Materiality if it is sufficiently important
Principle to affect our judgment of the
true position of the firm.

When in doubt, choose the solution


Conservatism
that will be least likely to overstate
Principle
assets and income. In easy word,
Income and asset are reported at
their lowest reasonable amounts.
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Material
 Omissions or misstatements of items are material if they could,
individually or collectively, influence the economic decisions of
users taken on the basis of the financial statements.

 Materiality depends on the size and nature of the omission or


misstatement judged in the surrounding circumstances.

 The size or nature of the item, or a combination of both, could


be the determining factor.

(FRS101)

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