CH 1 Introduction To Accounting

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Financial Accounting 1
© Oxford Fajar Sdn. Bhd. (008974-T), 2013 1– 1
CHAPTER 1
Introduction to Accounting
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Overview
 Introduction to Accounting
 The Basic Accounting Terminology and Rules
 Historical Development and the Conceptual
Framework.
 Generally Accepted Accounting Principles
(GAAP)
 Types of Business Entity
 Conceptual Framework
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 Modern accounting originated by Pacioli in

Venice, Italy, at the end of the fifteenth
century.
 A good number of rules related to accounting
were developed and are known as accounting
principles or accounting practices.
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(CON’T)
 Different accounting bodies in each country is

responsible for keeping their accounting
practices advanced and updated.
 For example, in USA, the American Institute of
Certified Public Accountants plays a noticeable
role. The Malaysian Institute of Accountants is
responsible for the same in Malaysia.
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Basic Accounting Terminology
 Book keeping
 Accounting/account/accountants
 Identify an economic activity
 Recording the related transactions
 Communicating in the form of financial
statements or also known as accounting reports
such as income statement and balance sheet
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Nature Of Accounting
Accounting is an information system that

identifies, records, and communicates
the economic events (transactions)
of an entity to interested users to permit informed
judgements and decisions.
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Financial Accounting 1 7
The Accounting Process
Identifying Economic Activity
Recording
Communicating
Figure 1.1 The accounting process
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Users of Accounting
Information
Figure 1.2 Internal and external users of accounting information.

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Branches of Accounting
Branches of Accounting
Auditing Taxation Forensic Accounting
Financial Cost and Management Government

Accounting Accounting Accounting
Figure 1.3 Branches of accounting
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Types of Accounting
 Financial accounting is the process of such as

preparing financial statements, such as
statements of comprehensive income and
statement of financial position from the
happenings of the business transactions.
 Management accounting includes activities
to gather and prepare information intended for
management, for the purposes of planning,
controlling, decision-making, performance
evaluation and managing the organization as
a whole.
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Types of Accounting (con’t)
 Cost accounting is the process of gathering

the operating cost information which will help
managers in identifying, measuring and
controlling expenditure
 Auditing is the activity of examining the
accounts.
 Tax accountants are responsible for
calculating individual or business tax
for the purpose of tax assessment.
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Types of Accounting (con’t)
 Government accounting is also known as

public sector accounting. Government
accounting includes accounting for legislative
bodies and government departments.
 Forensic accounting is the latest branch of
accounting which involves the application of
knowledge and accounting standards in the
court of law.
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Basic Accounting Rules
 Boundary Rules
– Separate entity
– Accounting period
– Ongoing concern
 Measurement Rules
– Money measurement
– Historical cost
– Realization
– Matching
– Duality
– Materiality
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Basic Accounting Rules
 Ethical Rules
– Conservatism (prudence)
– Consistency
– Objectivity
– Relevance
– Integrity
– Confidentiality
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Generally Accepted Accounting
Principles (GAAP)
 GAAP is defined as a set of standards or rules
used by accounting professionals to prepare
accounting information for external parties.
 GAAP started in US when the United States
Steel Corporation became the first company to
issue financial statements and auditors’ report.
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Development of Accounting
Standards
 Before 1971, Malaysia accounting standards were based on the
United Kingdom’s Statements of Standard Accounting Practice
(SSAPs).
 In 1993, the Securities Commission (SC) was created to protect
the interest of investors by ensuring full and fair disclosure.
– SC identified the need to develop accounting standards for the
local capital market to ensure a high level of financial reporting
and disclosure from the corporate sector.
 Accounting standards are applicable to all financial statements
whose purpose is to give a true and fair view of the financial
position and profit and loss for the period.
 Before 1997, the professional bodies themselves (MACPA & MIA)
produce the accounting standards which were applicable to their
own members.
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Standards – cont’
 In 1997, Malaysian Accounting Standards Board
(MASB) was created as the sole authority to set legally
binding accounting & financial reporting standards in
Malaysia.
 MASB was established under Financial Reporting Act 1997 as
an independent authority to develop and issue accounting &
financial reporting standards in Malaysia.
 Continually develop ,improve, review, revise or adopt accounting
standards and to contribute to the international development of
financial reporting. Develop a conceptual framework for the
purpose of evaluating proposed standards.
 Determine the scope and application of standards.
 Provide guidance on how items should be presented in accounts
/ financial reports.
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 MASB previously produced the accounting

standards known as Financial Reporting Standard
(FRS)
 The standards are similar with the International
Financial Reporting Standards (IFRS) produced by
International Accounting Standards Board (IASB).
 MASB on 19 November 2011 issued a new MASB
approved accounting framework, the Malaysian
Financial Reporting Standards (MFRS Framework).
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 The issuance finalises MASB Exposure Draft 75
IFRS-compliant Financial Reporting Standards
exposed in June 2011 and is made in conjunction
with the Board’s plan to converge with International
Financial Reporting Standards (IFRSs) in 2012.
 Convergence with IFRS needs no further
introduction as after the convergence
announcement was made back in 2008, various
initiatives have been done to instill awareness
amongst numerous stakeholders and other affected
parties.
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The MFRS Framework
 The MFRS Framework comprises Standards as issued by the

International Accounting Standards Board (IASB) that are
effective on 1 January 2012.
 It also comprises new/revised Standards recently issued by
the IASB that will be effective after 1 January 2012 such as
Standards on financial instruments, consolidation, joint
arrangements, fair value measurement and employee
benefits, amongst others.
 The adoption of the MFRS Framework is a significant
milestone for the capital market as entities will be able to
assert that their financial statements are in full compliance with
IFRSs as it is a fully IFRS-compliant framework and equivalent
to IFRSs.
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The MFRS Framework
 The MFRS Framework is to be applied by all Entities Other Than

Private Entities for annual periods beginning on or after 1 January
2012, with the exception of entities that are within the scope of
MFRS 141 Agriculture (MFRS 141) and IC Interpretation 15
Agreements for Construction of Real Estate (IC 15), including its
parent, significant investor and venturer (herein called
‘Transitioning Entities’).
 Transitioning Entities will be allowed to defer adoption of the new
MFRS Framework for an additional one year. Consequently,
adoption of the MFRS Framework by Transitioning Entities will be
mandatory for annual periods beginning on or after 1 January
2013.
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Accounting Conceptual
Framework
Professor Dr. Hamzah Ismail outlines four requirements

of conceptual framework which are as follows:
1. To limit what to be included in financial statements.
2. To prepare the accounting field to face new
challenges.
3. To rationalize accounting practices.
4. To give opportunity to the organization to choose
the measurements and disclosure methods.
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What is a conceptual framework?
…a
… a coherent
coherent system
system of
of interrelated
interrelated
objectives
objectives and
and fundamentals
fundamentals that that is
is
expected
expected toto lead
lead to
to consistent
consistent
standards
standards and
and that
that prescribes
prescribes thethe
nature,
nature, function
function and
and limits
limits of
of financial
financial
accounting
accounting andand reporting.
reporting.
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Conceptual Framework
The Need for a Conceptual Framework

 To assist the MASB in the development of future
MFRSs/FRSs and in its review of existing MFRSs/FRSs;
 To assist preparers of financial statements in applying
MFRSs/FRSs and in dealing with topics that have yet to
form the subject of a MFRSs/FRSs;
 To assist auditors in forming an opinion on whether
financial statements comply with MFRSs/FRSs;
 To assist users of financial statements in interpreting the
information contained in financial statements prepared in
compliance with MFRSs/FRSs; and
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Need of Conceptual Framework-
cont
 To provide those who are interested in the
work of the MASB with information about its
approach to the formulation of MFRSs/FRSs.
 The Board recognises that in a limited number
of cases there may be a conflict between the
Conceptual Framework and a MFRS/FRS. In
those cases where there is a conflict, the
requirements of the MFRS/FRS prevail over
those of the Conceptual Framework.
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Benefits
o Consistent, logical reporting requirements

o Greater compliance
o Enhanced accountability
o Fewer specific standards
o Enhanced understandability of reporting
requirements
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Conceptual Framework
The Framework comprised of four levels:

First Level = Basic Objectives of General Purpose
Financial Statements
Second Level = The reporting entity (to be added)
Third level = Qualitative Characteristics of Useful
Financial Information
Forth Level = Underlying Assumptions, Elements of
Financial Statements, Recognition and Measurement of
the Elements, Concepts of Capital and Capital
Maintenance.
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Fundamental Qualitative
Characteristics - Relevance
 The fundamental qualitative characteristics are
relevance and faithful representation.
Relevance
 Relevant financial information is capable of making a
difference in the decisions made by users.
Information may be capable of making a difference
in a decision even if some users choose not to take
advantage of it or are already aware of it from other
sources.
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Relevance – continued.
Relevance – Relevant information will help the users of

information to evaluate past, present or future events.
Predictive value – if it can be used as an input to processes
employed by users to predict future outcomes.
Confirmatory value - if it provides feedback about
(confirms or changes) previous evaluations.
Materiality – information is material if its omission or
misstatement could influence the economic decisions of
users of the financial statements. Materiality is an
entity-specific aspect of relevance based on the nature
or magnitude, or both, of the items to which the
information relates in the context of an individual entity’s
financial report.
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Faithful representation
 To be useful, financial information must not

only represent relevant phenomena, but it
must also faithfully represent the phenomena
that it purports to represent.
 To be a perfectly faithful representation, a
depiction would have three characteristics.
It would be complete, neutral and free from
error.
 Of course, perfection is seldom, if ever,
achievable.
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Faithful representation –
continued.
 A complete depiction includes all information
necessary for a user to understand the phenomenon
being depicted, including all necessary descriptions
and explanations.
 A neutral depiction is without bias in the selection or
presentation of financial information. A neutral
depiction is not slanted, weighted, emphasised,
deemphasised or otherwise manipulated to increase
the probability that financial information will be
received favourably or unfavourably by users.
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Faithful representation –
continued
 Free from error means there are no errors
or omissions in the description of the
phenomenon, and the process used to produce
the reported information has been selected
and applied with no errors in the process.
 Substance over form – we should present
the accounting information in accordance
with their substance and economic reality and
not merely their legal form.
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Enhancing qualitative
characteristics
 Comparability, verifiability, timeliness and
understandability are qualitative
characteristics that enhance the usefulness
of information that is relevant and faithfully
represented.
 The enhancing qualitative characteristics may
also help determine which of two ways should
be used to depict a phenomenon if both are
considered equally relevant and faithfully
represented.
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Comparability
 Comparability is the qualitative characteristic that

enables users to identify and understand similarities
in, and differences among, items. Unlike the other
qualitative characteristics, comparability does not
relate to a single item.
 A comparison requires at least two items.
Information that is measured and reported in a
similar manner for different companies is considered
comparable. Users must also be able to compare the
FS of an entity through time in order to identify
trends in its financial position & performance
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Consistency
 Although related to comparability, is not the same.

 Consistency refers to the use of the same methods
for the same items, either from period to period
within a reporting entity or in a single period across
entities.
 Comparability is the goal; consistency helps to
achieve that goal.
 When a company applies the same accounting
treatment to similar events from period to period eg.
Depreciation method and stock valuation method.
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Verifiability
 Verifiability helps assure users that information

faithfully represents the economic phenomena it
purports to represent.
 Verification can be direct or indirect. Direct
verification means verifying an amount or other
representation through direct observation, for
example, by counting cash. Indirect verification means
checking the inputs to a model, formula or other
technique and recalculating the outputs using the same
methodology.
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Timeliness
 Timeliness means having information available to

decision-makers in time to be capable of influencing
their decisions.
 Generally, the older the information is the less
useful it is.
 However, some information may continue to be timely
long after the end of a reporting period because, for
example, some users may need to identify and assess
trends.
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Understandability
 Classifying, characterising and presenting

information clearly and concisely makes it
understandable.
 Some phenomena are inherently complex and
cannot be made easy to understand. Excluding
information about those phenomena from
financial reports might make the information in
those financial reports easier to understand.
 However, those reports would be incomplete and
therefore potentially misleading
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Underlying ASSUMPTION –
Going concern
 The financial statements are normally prepared on

the assumption that an entity is a going concern and
will continue in operation for the foreseeable future.
 Hence, it is assumed that the entity has neither the
intention nor the need to liquidate or curtail
materially the scale of its operations; if such an
intention or need exists, the financial statements
may have to be prepared on a different basis and, if
so, the basis used is disclosed.
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Underlying ASSUMPTION –
Accrual basis
 The accruals concept requires revenue and expenses

to be recognised and recorded when earned or
incurred, and not when cash is received or paid.
 It makes a distinction between the receipt of cash

and the right to receive cash, and payment of cash
and the obligation to pay cash.
 Determining the expenses used up to obtain the

revenue is referred to as matching expenses against
revenues.
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Accrual basis - cont
 Revenue earned during an accounting period has to
be matched with expenses incurred to
derive/measure the net profit/loss without regard
to the date of receipt or payment.
 This assumption requires that adjustments are made
to some figures in the trial balance before the
financial statements can be prepared.
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Accounting Concepts
Economic Entity – company keeps its activity

separate from its owners and other businesses.
Monetary Unit/Money measurement concept -
money is the common denominator as it is relevant,
simple, universally available, understandable and
useful
Periodicity/Time interval concept - company can
divide its economic activities into time periods & FS
are prepared at regular interval of one year – also
have interim statement.
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Accounting Concepts
Historical Cost – the price, established by the

exchange transaction, is the “cost”.
Issues:
Historical cost provides a reliable benchmark for
measuring historical trends.
Fair value information may be more useful e.g. current
value, realisable (setlement) value or present value.
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Realisation Concept
 Profit and gains can only be taken into account when realisation has
occurred and that realisation occurs only when the ultimate cash
realised is capable of being assessed with reasonable certainty.
 Revenue Recognition - generally occurs (1) when realized or
realizable and (2) when earned.
1) Realises revenue when it exchanges product (goods or services) or
other assets for cash or claims to cash. Revenues are realisable when
assets received or held are readily convertible into cash or claims to
cash.
2) Revenues are earned when the company substantially accomplishes
what it must do to be entitled to the benefits represented by the
revenue.
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Types of Business Entity
 Sole Proprietorship
 Partnership
 Company
– Private Limited Company
– Public Limited Company
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Strengths of Sole Proprietorship
Sole proprietorship is a business owned by only on

individual. Its incorporation procedures are simple
where it only needs to register with the Registrar of
Business in the Companies Commission of
Malaysia (CCM). The strengths of a sole
proprietorship are:
– Easily formed and dissolved and low incorporation
cost
– Can solely enjoy the profit as there is no need to
share with others
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Strengths of Sole Proprietorship
(Con’t)
– Have full authority to run the business

– Does not depend on other people
– Not many regulations to adhere to
– Not charged with special income tax
– Can be easily dissolved and the cost involved
is small
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Weaknesses of Sole Proprietorship
– Unlimited liability
– Limited capital
– Owner needs to give full commitment to
the business
– Limited life
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Strengths of Partnership
– Easily formed
– Can bring in other expertise
– Have the opportunity to increase the capital
– Not many regulations to adhere to
– Not charged with special income tax
– Partners can work together for the benefit of
the business
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Weaknesses of Proprietorship
– Unlimited liability although at least a partner

has unlimited liability.
– Profits need to be shared among the partners
– Possibility of misunderstanding among the
partners
– Rules to dissolve the partnership depend on
certain conditions
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Private Limited Company
 The number of shareholders is between 2 and

50 persons only.
 The shares can only be sold to other individuals
by invitation and is circulated among members.
 The company cannot be listed in the Malaysian
Stock Exchange.
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Public Limited Company
(Con’t)
 The number of shareholders is a minimum of

7 persons to an unlimited amount of person.
 The shares can be sold to any member of
the public.
 The company can be listed in the Malaysian
Stock Exchange.
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 Modern accounting originated by Pacioli in

All Rights Reserved

 Different accounting bodies in each country is

All Rights Reserved

All Rights Reserved

Accounting is an information system that

All Rights Reserved

Identifying Economic Activity

Figure 1.1 The accounting process

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Figure 1.2 Internal and external users of accounting information.

Auditing Taxation Forensic Accounting

Financial Cost and Management Government

Figure 1.3 Branches of accounting

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 Financial accounting is the process of such as

 Cost accounting is the process of gathering

All Rights Reserved

 Government accounting is also known as

All Rights Reserved

All Rights Reserved

All Rights Reserved

All Rights Reserved

 MASB previously produced the accounting

All Rights Reserved

All Rights Reserved

 The MFRS Framework comprises Standards as issued by the

All Rights Reserved

 The MFRS Framework is to be applied by all Entities Other Than

All Rights Reserved

Professor Dr. Hamzah Ismail outlines four requirements

All Rights Reserved

All Rights Reserved

The Need for a Conceptual Framework

All Rights Reserved

All Rights Reserved

o Consistent, logical reporting requirements

All Rights Reserved

The Framework comprised of four levels:

All Rights Reserved

Relevance – Relevant information will help the users of

 To be useful, financial information must not

All Rights Reserved

All Rights Reserved

 Comparability is the qualitative characteristic that

All Rights Reserved

 Although related to comparability, is not the same.

All Rights Reserved

 Verifiability helps assure users that information

All Rights Reserved

 Timeliness means having information available to

All Rights Reserved

 Classifying, characterising and presenting

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 The financial statements are normally prepared on

All Rights Reserved

 The accruals concept requires revenue and expenses

 It makes a distinction between the receipt of cash

 Determining the expenses used up to obtain the

All Rights Reserved