Studied by 4 peopleAccounting terms
Assets
A present economic resource controlled by the entity (as a result of past events) that has the potential to produce future economic benefits.
Eg : Spare parts, Cash, Equipment, Accounts Receivable
Liability
A present obligation of the entity (as a result of past events) to transfer an economic resource.
Eg : Bank overdraft, Loans, Mortgage, Accounts Payable
Current VS Non-Current Asset
Current - to be converted to cash, sold or cosumed within 12 months. Eg : GST Receivable, Supplies
Non-Current - not held for resale and expected to be used for more than 12 months. Eg : Vehicles, Tools
Current VS Non-Current Liability
Current - transfer will occur within 12 months. Eg : Loan, GST Payable
Non-Current - transfer will occur after 12 months. Eg : Mortgage,Loans
Owner’s Equity
The residual interest in the assets of the entity after the liabilities are deducted. (informal - what the business owes the owner).
The Accoutinting Equation
Assets = Liabilities + Owner’s Equity
Transactions and the Accounting equation
Every transaction will afect at least 2 items in the accounting equation.
After the changes, the accounting equation must still balance.
Accounting Assumptions
Assumptions which govern the way Accounting information is recorded.
P : Period assumption
A : Accrual basis
G : Going concern
E : acounting Entity
Accounting Entity
The records of the assets, liabilities and business activities of the entity are kept completely seperate from those of the owner of the entity as well as from those of other entities.
Going Concern
The business wil continue to operate in the future, and its records will be kept on this basis.
Period
Reports are prepared for a particular period of time, such as a month or year, in order to obtain comparability of results.
Accrual Basis
Revenues are recognised when earned and expenses when incurred. Profit is calculated as revenue earned in a particular period less expenses incurred in that period.
Qualitative Characteristics
Are the ‘generally accepted rules’ that govern the way Accounting information is recorded.
T : Timeliness
U : Understandability
R : Relevance
F : Faithful representation
C : Comparability
V : Verifiability
Relevance
Financial information must be capable of making a difference to the decisions made by users of the report.
Faithful representation
Financial information should be a faithful representation of the real-world economic event it claims to represent : complete, free from material error and neutral (without bias).
Verifiability
Financial information should allow different knowledgable and independent observers to reach a consensus that an event is faithfully represented.
Comparability
Financial information should be able to be compared with similar information about other entities and with similar information about the same entity for another period or another date.
Timeliness
Financial information should be available to decision makers in time to be capable of influencing their decisions.
Understandability
FInancial information should be understandable or comprehensible to knowledgable users and presented clearly and concisely.
The Balance Sheet
An accounting report that details a firm’s financial positions at a particular point in time by reporting assets, liabilities and owner’s equity.
Debt Ratio
Measures the proportion of the firm’s assets that are funded by external sources.
Dangers - High Debt Ratio indicates a high reliance on liabilities, and consequently a high risk of financial collapse. Furthermore, a high Debt Ratio may actually prevent a business from being able to access more borrowed funds.
Benefits - Borrowing does give the business access to funds to purchase assets that it may not have been able to afford by only trying to raise funds internally. Furthermore a high Debt Ratio means a higher return for the owner, as he or she has less capital invested, but still earns all the profits.
Small Business
A business in which the owner and manager is the same person and which employs fewer than 20 people.
Reasons for becoming an Owner
Profit Motive
Desire for freedom/independence
Identifiying a market opportunity
Unemployment
External Support Resources
Accountant - are experts in providing advice and direction on ownership structures, pricing policies, tax minimisation, superannuation obligations, tax obligations regarding pay-as-you-go tax and GST and strategies for improving business performance.
Lawyers - to assist them in any form of legal matter in ownership structure such as a partnership or proprietary company, representation in civil cases, registering for necessary licenses or assistance with the lodging of a registered trademark.
Bank Managers - can provide specific advice regarding business finance and suggest alternatives in terms of financing options.
Sole Proprietorship
A business owned by a single individual, operating their business in their own right under their own name or a registered business name.
Advantages : Easy and cheap to set up, owner has full control over decision making, owner receives all profit and has full access to capital, simple to sell or wind up.
Disadvantages : Owner has unlimited liability and is thus responsible for debts and liabilities incurred, business has limited life if the owner dies the business is in danger, limited access to captial, skills may be limited, may have to endure long hours and stress.
Partnership
A business owned by two or more persons in business together with a view to making a profit.
Advantages : Relatively cheap to set up, relatively simple to wind up and reclaim individual investment in the business, greater access to capital and skills, tax advantages when partners are married.
Disadvantages : Control over decision is shared among partners, owners have unlimited liability and are thus personally responsible for debts and liabilities incurred by the business, the partnership has a limited life – if one of the partners die or be declared insane the partnership is dissolved, profit are shared among partners.
Proprietary Company (Ptd Ltd) / Private Company
A business that exists as a separate legal entity that is entitled to do business in its own right.
Advantages : Limited liabilities, greater ability to attract capital to the business as there is limited liabilities, life of the business is ongoing due to it being owned by a seperate legal entity.
Disadvantages : Establishment cost are high, there may be difficulty attracting additonal capital because a proprietary company cannot publicly advertise for funds, higher compliance costs, degree of regulation is much higher than that imposed on sole proprietorships or partnerships.
Public Company (Ltd)
A large business structure that is also incorporated, so it also has its own legal existence but derives the ‘Public’ name because it can publicly raise funds by advertising and selling shares through the Australian Securities Exchange (ASX).
Advantages : Limited liabilities, greater ability to attract capital as they can publicly advertise, greater transferability of ownership (selling of shares), life of business is ongoing due to being a seperate legal entity.
Disadvantages : Establishment costs, ongoing administration and compliance costs are high, much more scrutiny, greater seperation between ownership and control, greater statutory obligations with the possibility of fines and penalties if not met, greater disclosure requirements.
Reasons for success and failure
Success - High demand for product or service, ;ocation that is visible and easily accessible for customers, thorough business plan, sufficient starting capital, ppropriate personal qualities.
Failure- Competition for other small or large businesses, poor location, insufficient start-up capital, poor marketing, poor management skills, poor customer relations .
Ethical Considerations
There is a close relationship between the ethical performance of a business and whether or not it is meeting its legal requirements. Ethical considerations go beyond following legal requirements and reducing legal risk, as a firm with sound ethical practices will build strong goodwill for their business in the form of a strong customer base, loyalty and growing profits.
Treatment of employees
The business should ensure employees have safe working conditions and are paid correctly. Poor treament can lead to the business becoming hated by the public and employees working less efficient,
Products Sold
The business should ensure that:
– products are sourced from suppliers that provide safe working conditions and fair wages.
– products meet minimum required safety standards. There are mandatory standards that exist to ensure information and safety features exist for consumers. If a business deals with foods or perishable items, proper food handling and storage needs to take place.
– products are of a particular quality and do what has been advertised.
– products are purchased from local suppliers and the suppliers support the local community or economy.
Type of service
Ensure that customers are sold only what they require and not forced or charged for purchasing unwanted extras.
Impact on society environment
Privacy considerations/packaging considerations/disposal of waste/products which have a positive social impact.
Methods of Accounting and financial reporting
If a business chose not to follow these and other ethical considerations but instead chose to try to cut costs or profiteer, and was subsequently caught out, then the impact would be:
1. damage to the business’s reputation leading to a decline in sales, profits and market share
2. large costs in the forms of fines and other penalties for breaches of the law.
Internal sources of finances
Funds generated by and within the firm.
Capital Contribution
Internal source of finance consisting of cash (or other assets) contributed to the business from the personal assets of the owner.
Advantage - no set repayment date, no interest charge.
Disadvantage - limited to resources of owner.
Retained earnings
Internal source of finance consisting of funds generated from business profits that are not taken as drawings by the owner.
Advantage - no set repayment date, no interest charge.
Disadvantage - limited to previous profits (may be none).
External sources of finances
Funds generated from sources outside of the business.
Trade Credit
An internal source of finance offered by suppliers that allows its customers to purchase goods or services immediately and then pay at a later date.
Advantage - allows immediate access to goods/services, allows businesses to generate sales before payment is required, no interest charge if credit terms are met, discounts are available from some suppliers for early payment.
Disadvantage - trade credit can only be used with purchases with that supplier.
Bank overdraft
An external source of finance provided by a bank that allows the account holder to withdraw more than their current.
Advantage - readily accesible, flexible - can be used for a variety of purposes.
Disadvantage - high interest charge, can be recalled on short notice.
Term Loan
External finance provided by banks and other lenders for a specific purpose and repaid over time.
Advantage - makes possible the purchase of expensive assets, flexible, secured loans attract a lower interest rate.
Disdvantage - interest charge, requires commitment by business to make repayment for term of the loan, principal and interest repayments can put pressure on cash flows.
Mortgage
A specific type of term loan that is secured against property.
Lease
A written agreement that grants to the lessee the right to use a particular asset for a specified period of time in return for periodic payments to the lessor.
Advantage - reduces intial outlay to acquire assets, allows assets to be up to date, reduces maintenance and repair costs.
Disadvantage - no ownership of asset, requires commitment for the term of the lease.
Interest-only loan
Loan that requires the borrower to make regular interest payments before repaying the entire principal in one lump sum on the last day of the loan period.
Principle and Interest Loan
Loan that requires the borrower to make regular repayments of both the principal and interest over the life of the loan.
Return on Owner’s Investment (ROI)
A profitability indicator that measures how effectively a business has used the owner’s capital to earn profit.
Guidelines for seeking external finance
The term of the finance should match the life of the asset. Short-term assets should be purchased using short-term finance, and long- term assets should be purchased using long-term finance.
The cost of interest must be considered. The interest rate is equivalent to the cost of using borrowed funds, and the borrower must be able to repay both the principal (the amount borrowed) and the interest charges.
The conditions of the loan should be tailored to suit the borrower. The longer the term, the lower the instalments but the higher the total interest charges.
Consider the impact on the Debt Ratio and the firm’s ability to borrow further.
Accounting process
Source Documents
Records
Reports
Advice
Source documents
Source documents have two separate yet related functions:
They provide the verifiable evidence of the details of a transaction, thus ensuring that the information in the Accounting reports provides a Faithful representation and the Verifability of Accounting reports by authenticating each transaction.
They provide the evidence that is required by the Australian Tax Office relating to the firm’s income tax and Goods and Services Tax obligations.
Cash Receipts
Can refer to both the transaction that occurs when cash is received from another entity, as well as the source document that verifies that transaction.
Cheques
A document informing the bank, the drawee, to transfer funds from the account of the drawer to the bank and account of the payee. The drawer actually hands the cheque to the payee, who then presents it at their own bank. It is a sensible business practice to nominate the payee and cross it not negotiable. A cheque that is marked ‘Not negotiable’ can only be deposited into the account of the nominated payee.
Bank Statements
Statements provided by a business’s bank that shows all cash transactions in and out of a particular bank account for a specified period. They provide two useful functions:
Provide a list of all transactions that can be used as a point of comparison to ensure all transactions are legitimate and to provide a balance of the account at the end of a specified period.
Identify transactions that you may have been unaware of such as direct debits, direct credits or direct deposits from other entities.
Credit Transactions
When goods or services are sold or purchased on credit, the source document will be an invoice. Because GST is recognised and reported at the time of purchase or sale, the invoice must also show all the information necessary for it to be classified as a tax invoice.
Sales Invoice
A source document that verifies a credit sale of inventory
The seller or supplier is also the business that issues the invoice and so will have its name at the top of the invoice. Conversely, the purchaser or customer is named in the middle of the invoice. The original is sent to the customer with the copy being retained by the seller for its recording purposes.
Credit Note
A document that evidences that there is a reduction in the amount owed by a customer
Purchase Invoice
a source document that verifies a credit purchase (usually of inventory).
The seller or supplier is the business that issues the invoice, so will have its name at the top of the invoice. Tthe customer has its named in the middle of the invoice. The original is sent to the customer, the copy is retained by the seller for its recording purposes.
Statement of Account
A statement provided to credit customers to give details of transactions that have occurred over a specific period of time and the resulting balance owing at the end of that period.
Delivery Docket
a document used to verify that the goods received are the goods ordered.
Shipping and order confirmation
a document that indicates that an order has been dispatched (sent) and can be expected at some point.
Memo
a source document used to verify internal transactions.
Journals
an Accounting record that classifies and summarises transactions during a particular reporting period.
Cash Journals
Cash transactions are recorded in one of two journals:
Cash Receipts Journal, which summarises all cash received by the business (from other entities) during a particular reporting period
a Cash Payments Journal, which summarises all cash paid by the business (to other entities) during a particular reporting period.
Statement of Receipts and Payments
an Accounting report that lists cash receipts and payments during a reporting period, the change in the bank balance, and the opening and closing bank balance.
Cash Flow Statement
an Accounting report that reports all cash flows during a reporting period, classified as Operating, Investing and Financing activities.
Operating activities - cash flows related to day-to- day trading activities
Investing activities - cash flows related to the purchase and sale of non- current assets
Financing activities - cash flows related to changes in the financial structure of the firm
Uses of Cash Flow Statement
The specific benefits of preparing a Cash Flow Statement are:
to aid decision-making about the firm’s cash activities by detailing the sources and uses of cash in a particular period
to assess whether or not the business is meeting its cash targets by comparing the Cash Flow Statement against budgeted (or expected) cash flows, which will highlight problems and allow for corrective action to be taken
to assist in planning for future cash activities by providing a basis for the next budgeted Cash Flow Statement, which will set targets for the future
to identify whether or not the business is generating enough cash from its Operating activities to fund its Investing and Financing activities.
GST Payable
GST owed by the business to the ATO when the amount of GST the business has received on its fees is greater than the GST it has paid to its suppliers.
GST Settlement
a payment made to the ATO by a small business to settle GST payable (operating outflow).
GST Receivable
GST owed to the business by the ATO when the amount of GST the business has paid to its suppliers is greater than the GST it has received on its fees.
GST Refund
a cash receipt from the ATO to clear GST receivable (operating inflow).
Cash Flow Cover
a liquidity indicator that assesses the firm’s ability of the business’s Operating Cash Flow to meet its short-term debts as they fall due.
Internal control mechanisms
the procedures and strategies used to protect the firm’s assets from theft, damage and misuse.
Physical Safeguards
These prevent unauthorised people from accessing a particular asset through barriers such as fences, padlocks or locked storerooms, and for cash, in particular, through the use of safes, lock-boxes and lockable cash drawers. If people cannot touch the asset, they have less chance of misusing or misappropriating it.
Preventive safeguards
These involve dissuading misuse or theft of assets through the threat of apprehension. Systems such as alarms and security cameras (open, hidden and even dummy) work on the premise that people are less likely to attempt theft if they are concerned they will be caught.
Separation of duties
This involves ensuring that no one employee (except the owner) has complete control over a particular type of asset, so their actions are open to scrutiny by another employee. The more people involved in the process, the less chance there is of collusion occurring.
Rotation of duties
This involves ensuring that tasks are not always performed by the same employee, so that their actions are open to scrutiny by the next employee who performs that task. (This has the added benefit of multi-skilling employees, who can then perform a number of tasks.)
Careful hiring practices
These involve effective screening and assessment of potential employees to ensure that only the most trustworthy and responsible candidates are employed. This should reduce the need to rely on other internal control mechanisms.
Effective employee training
This involves ensuring that staff are skilled in the use and management of the assets they are required to use or supervise, reducing the likelihood that assets are damaged through misuse. This is particularly the case for equipment, but also protects another of the firm’s assets its staff.
Cash Control
the procedures and strategies used to protect the firm’s cash.
Accounts Receivable
a customer who owes a debt to the business for goods or services sold to them on credit.
Accounts Payable
the business owes a debt to the suppliers for goods or services sold to them on credit.
Credit Purchases
a transaction that involves the acquisition of materials or supplies (or other goods) from a supplier who does not require payment until a later date.
Inventory of materials is valued at the supplier’s price, and the GST on credit purchases reduces the GST payable.
Purchases Journal
an Accounting record that summarises all transactions involving the purchase of materials or supplies on credit.
Accounts Payable formula
With total credit purchases recorded in the Purchases Journal, and total payments to Accounts Payable recorded in the Cash Payments Journal, we can calculate the total balance owed to Accounts Payable at the end of the reporting period.
Sales Journal
an Accounting record that summarises all transactions involving the sale/performing of services on credit during a reporting period.
Credit Fees
a transaction that involves the provision of a service to a customer who is not required to pay until a later date.
As a result, any GST charged on credit fees is therefore owed back to the ATO, increasing the GST payable.
Accounts Receivable Formula
Using the summaries from the Sales Journal and Cash Receipts Journal, we can calculate the total balance owed by Accounts Receivable at the end of the reporting period.
Profit
Profit = Revenue - Expenses
Revenue
an increase in assets or reduction in liabilities that leads to an increase in owner’s equity (except for a Capital contribution).
Expenses
a decrease in assets (or increase in liabilities) that reduces owner’s equity (except for Drawings).
Income Statement
an Accounting report that details the revenue earned and expenses incurred during the reporting period.
Cost of materials used
the business needs to calculate how much of its materials were actually consumed or ‘used up’ within the Period. Under the Accrual basis assumption, this amount incurred will be reported as an expense.
Cash vs Profit
A net increase in cash position (net decrease) measures the difference between cash inflows and cash outflows.
A Net Profit (or Loss) measures the difference between revenue and expenses.
Reporting a Net Profit or Loss in the Balance Sheet
A Net Profit represents a net increase in owner’s equity, whereas a Net Loss represents a net decrease in owner’s equity, both as a result of business operations. This must then be reported in the owner’s equity section of the Balance Sheet. Must show the initial Capital balance, as well as any Capital contribution, Net Profit or Loss, and Drawings to show how the capital at end was determined.
Uses of Income Statement
Aid decision-making about the firm’s operations by measuring the firm’s performance. Detailing revenue and expenses (and ultimately profit) allows the owner to identify where changes may be necessary.
Assess whether the business is meeting its revenue and expense targets by comparing the Income Statement against budgeted (or expected) performance
Assist in planning for future service activities by providing a basis for the next budgeted Income Statement, which will set targets for the future. This may include setting targets to achieve a certain level of fees, staffing requirements or advertising expenditure.
Assess the performance of management in operating the business, primarily relating to generating sales and controlling expenses.
Strategies to increase revenue
Decrease prices - Decreasing prices can make the business’s service appear more competitive leading to a higher volume of sales.
Employ effective marketing - Advertising could be engaged more effectively by ensuring it targets the prospective customer base specifically desired. The best method of conveying a business’s service needs to be determined; for example, print, radio, internet or a mix that will provide the most reach. Marketing material must accurately represent the qualities of the service offered to maintain a business’s ethics and reputation.
Improve their service - Improving the service already offered with additional services as part of the standard package and being more customer-friendly can improve customer satisfaction and word of mouth.
Strategies to decrease expenses
Change supplier - Finding an alternative supplier who can provide cheaper materials could result in a reduction in Cost of materials used. Also looking at different providers of electricity, mobile and internet services can expose cost savings via different plans.
Buy in bulk - Purchasing in large quantities can allow a business to achieve a reduced cost price per unit of materials thus decreasing cost of materials used. Also, it could potentially cut delivery costs if a business reduced the number of purchases and deliveries per month by making one large purchase rather than many small ones.
Liquidity
the ability of the business to meet its short-term debts as they fall due.
Stability
the ability of the business to meet its debts and continue its operations in the long term.
Price Setting Strategies
• recommended retail price - a selling price that is recommended by the manufacturer or wholesaler
• competitors’ prices - prices charged by businesses competing in the same market
• market reaction - the response of customers in a particular marketplace to price levels for a particular good or service
• quotes - a method of determining a selling price by estimating the costs involved with a particular job, and then adding on a certain amount to provide for profit
• percentage mark-up
• cost-volume-profit analysis.
Note
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