Financial Accounting

Accounting

The process of identifying, measuring, recording, and communicating economic information to assist users in making informed decisions.

Accounting Entity Assumption

The assumption that the business entity is separate and distinct from its owner(s). Only the financial transactions of the business are recorded, not the owner's personal ones.

Balance Sheet Equation

The foundational formula for a balance sheet: Assets = Liabilities + Equity. It must always balance after every transaction.

Accrual Basis Assumption

The assumption that the effects of transactions are recognised when they occur (when the event happens), not when cash is received or paid. This provides more useful information for decision-making.

Assets

Present economic resources controlled by the entity as a result of past events. A resource is a right that has the potential to produce economic benefits (e.g., cash, equipment, inventory).

Company / Corporation

A type of business entity that is owned by shareholders, is a separate legal and accounting entity, and offers limited liability to its owners.

Comparability and Consistency

An enhancing qualitative characteristic that allows users to identify and understand similarities and differences between two sets of economic data (over time or between different entities).

Cost Constraint

The principle that the benefits of providing financial information must justify the costs of providing and using it.

Decision Making Process

Four Steps Involved in making a decision

1. Identify the Situation

2. Gather relevant information

3. Assess the consequences of alternatives

4. Choose a course of action.

Double Entry Accounting

The system of accounting where every transaction affects at least two components of the accounting equation (Assets, Liabilities, or Equity), ensuring the equation remains balanced.

Equity

The residual interest of the owner(s) in the assets of the entity after deducting liabilities (Assets - Liabilities = Equity). Also known as capital, net assets, or accumulated surplus.

Expenses

Decreases in economic benefits (outflows or incurrences of liabilities) that result in decreases in equity, excluding distributions to equity participants.

External Users

Users of accounting information who are outside the entity (e.g., shareholders, lenders, potential investors, creditors, customers, government). They rely on General Purpose Financial Statements.

Faithful Representation

A fundamental qualitative characteristic meaning that information presented is complete, neutral (without bias), and free from material error. It reflects economic substance over legal form.

Fundamental Qualitative Characteristics

• Relevance

• Faithful Representation

• Comparability and Consistency

• Verifiability

• Timeliness

• Understandable

• Materiality

• Cost Constraints

Financial Accounting

The area of accounting concerned with reporting financial information to external users. It involves preparing General Purpose Financial Statements that must comply with accounting standards and be audited.

Financing Activities

A category of cash flows in the Statement of Cash Flows related to raising funds for the entity, such as borrowing money, receiving owner investments, or making payments to owners (drawings/dividends).

General Purpose Financial Statments

Financial statements (Income Statement, Balance Sheet, etc.) designed to meet the common information needs of a wide range of external users. They are standardised and comply with accounting standards.

Going Concern Assumption

The assumption that an entity will continue to operate in the future (for the foreseeable future) unless there is evidence to the contrary. Assets are not reported at their liquidation (forced sale) value.

Income

Increases in economic benefits (inflows or enhancements of assets, or decreases in liabilities) that result in increases in equity, excluding contributions from equity participants.

Internal Users

Users of accounting information who are inside the entity (e.g., managers, CEOs). They use Special Purpose Financial Statements and reports for management decision-making.

Investing Activities

A category of cash flows in the Statement of Cash Flows related to the acquisition and disposal of long-term assets (e.g., purchasing equipment, land, or buildings).

Liabilities

Present obligations of the entity arising from past events. Settlement is expected to result in an outflow of resources from the entity (e.g., accounts payable, loans).

Management Accounting

The area of accounting concerned with providing financial and other information to internal management. It produces on-demand, special-purpose reports tailored to specific decision needs, and is not subject to accounting standards.

Materiality

The concept that information is material if its omission or misstatement could influence the economic decisions of users. It helps determine if information is relevant and can vary by entity.

Operating Activities

A category of cash flows in the Statement of Cash Flows related to the primary revenue-generating activities of the business (e.g., cash received from customers, payments to suppliers and employees).

Partnership

A type of business entity owned by two or more partners. It is simple to set up, is a separate accounting entity, but is not a separate legal entity.

Relevance

A fundamental qualitative characteristic meaning that information is capable of making a difference in the decisions made by users. It must be able to influence economic decisions.

Reporting Period

The division of the life of an entity into equal time intervals (e.g., months, quarters, years) to measure and report on financial performance and position for that specific period.

Sole Proprietorship / Sole Trader

A type of business entity owned by one person. It is simple to set up, is a separate accounting entity, but the owner has unlimited liability.

Special Purpose Financial Statements

Financial reports tailored for internal users (management) to assist with specific decisions. They are not required to comply with accounting standards or be externally audited.

Statement of Cash Flows

A financial statement that reports on the cash inflows and outflows of an entity over a specific time period, categorised into Operating, Investing, and Financing activities.

Statement of Changes in Equity

A financial statement that reports the changes in the owner's equity over a specific time period, detailing the beginning balance, profit/loss, additional investments, and drawings.

Statement of Financial Performance (income statement)

A financial statement that reports the financial performance of an entity over a specific time period by showing Income and Expenses to calculate Profit or Loss.

Statement of Financial Position (balance sheet)

A financial statement that reports the financial position of an entity at a specific point in time, presenting its Assets, Liabilities, and Equity.

Timeliness

An enhancing qualitative characteristic meaning that users have access to information early enough to influence their decisions.

Understandability

An enhancing qualitative characteristic meaning that information is presented clearly and concisely, with the expectation that users have a reasonable knowledge of business and will study the information with reasonable diligence.

Verifiability

An enhancing qualitative characteristic meaning that different, independent observers can reach a consensus that information faithfully represents what it claims to represent.

Areas of Accounting Practice

1. Public Accounting: offering services to the public for a fee, taxation

2. Commercial Accounting: accountants employed within a business entity, budgeting

3. Public Sector and Not-for-profit: accountants working for governments, NGOs and charities

External Transactions

Transactions that involve an outside party and an exchange of economic resources and/or obligations (e.g. sale of inventory, purchase of supplies).

Internal Transactions

Transactions that involve the transformation of economic resources (e.g., use of office supplies).

Non-transactional Events

Events not usually recorded but may be in the future (e.g., receiving an order from a customer).

Source Documents

Prepared for every external transaction to support entries in accounting records; an important element in the control system (e.g., tax invoice, purchase order, cash register tape, credit card slip).

Interim Statements

Statements prepared for external users before the end of the annual period.

The Accounting Cycle

The steps and procedures, culminating in the preparation of financial statements.

Ledger Account

Where the effect of transactions is recorded. Contains three basic parts: title, place for recording increases, and place for recording decreases.

T-account

An account format that is a convenient way to show individual accounts and illustrate the effects of transactions. Still used in practice for quick calculations.

Running Balance Accounts

An account format that provides all T-account information plus a balance after each transaction. Used in formal accounting systems.

Asset Accounts

Accounts representing resources expected to provide future economic benefits

• Cash at bank

• Accounts receivable

• GST outlays

• Prepaid expenses

• Land

• Buildings

• Plant and equipment

Liability Accounts

Accounts representing obligations (e.g., accounts payable, unearned income, GST payable/receivable, mortgage payable).

Equity Account Transaction Types

Four main types of transactions

• Investments of assets by owner

• Withdrawal of assets by owner

• Income earned

• Expenses incurred

Equity Account Types

1. Capital

2. Drawings (For withdrawals)

Revenue vs Gain

Revenue is income that arises in the course of ordinary activities of an entity, through provision of services or sales. Gain is income that does not arise from ordinary activities, usually non-recurring or sporadic in nature.

P/L

Profit	When total income exceeds total expenses.
Loss	When total expenses exceed total income.

General Ledger

Collection of all the individual accounts of an entity. Organised in the order they appear in the balance sheet and income statement. Each account has a specific ID number.

Chart of Accounts

A listing of ledger account titles and related numbers used as a reference point when analysing transactions. Reveals type of organisation, nature of activities, and sources of incomes/expenses.

Transaction Analysis

Determining what type of accounts are affected (assets, liabilities, equity) and by how much each item must be increased/decreased, ensuring the accounting equation remains in balance.

Debit

An instruction detailing that the balance needs to be recorded ‘on the left-hand side’ of the ledger.

Credit

An instruction detailing that the balance needs to be recorded ‘on the right-hand side’ of the ledger.

Double-Entry Accounting Rules

Balance Sheet - Assets increase with debits and decrease with credits. Liabilities and Equity increase with credits and decrease with debits.

Performance - Income increases with credits and decreases with debits. Expenses increase with debits and decrease with debits.

General Journal

A two-column journal containing two columns for entering dollar amounts. Provides a complete, chronological record of transactions with debits/credits shown together.

Posting

Transferring amounts entered in the journal to the proper ledger accounts. Classifies the effects of transactions on individual accounts.

Journal to Ledger Process

Step 1. Analyse the transactions to identify affected accounts.

Step 2. Record transaction in general journal.

Step 3. Post journal entry to general ledger

Computerised Posting

Posting is automated and maintains the double-entry system. A journal proof summary is checked before posting to ensure general ledger remains in balance (debits = credits).

Trial Balance

A list of all accounts in general ledger order with their current balances. Debit balances in one column, credit balances in another. Totals of both columns must be equal.

Limitations of Trial Balance

May balance but still contain errors. If it doesn't balance, there is definitely an error (but doesn't indicate what). If the difference is divisible by 9, it may indicate a transposition or slide error.

Correcting Errors

Correcting Errors (Before Posting)	Cross out the error with a single line and insert the correct amount.
Correcting Errors (After Posting)	Must be corrected with a journal entry. Errors should not be erased or whited out to avoid the impression of concealment or fraud.

Dollar Signs and Decimals

Dollar signs are used in financial statements/reports. Dollar amounts in journals/ledgers are entered and columns are ruled. Decimal points are not necessary.

GST Registration

Optional if turnover < $75,000. Required if turnover > $75,000.

Business Activity Statement (BAS)

Must be completed for each tax period. Payments due to ATO within 28 days of the end of the tax period. Can report monthly, quarterly, or yearly.

GST Accounts

Registered businesses use "GST Receivable" (amounts received) and "GST Payable" (amounts paid). In practice, often combined into one liability account called "GST Net Payable".

Financial Capital

Capital is synonymous with the net assets (equity) of the entity. Profit exists only after maintaining the dollar value (purchasing power) of equity at the beginning of the period.

Physical Capital

Capital is viewed as the operating capability of the entity’s assets. Profit exists only after setting aside enough capital to maintain the operating capability of its assets.