ACCG1000 Week 2 - Financial Accounting for Business

Week 2: Financial Accounting for Business

Transaction Analysis

• Overview: Transaction analysis involves understanding how business transactions affect the accounting equation (Assets = Liabilities + Owner’s Equity).
• Elements of Financial Statements: Includes Assets, Liabilities, Owner’s Equity (ALOIE), Income, and Expenses.
• Accounting Concepts and Principles: Guides how financial information is recorded and reported.
• Qualitative Characteristics of Accounting Information: Ensures that accounting information is useful for decision-making.

Reminders for Week 2

• Tutorials commence this week.
• Actively participate and engage with peers and tutors.
• Assessment timeline is available on iLearn.
• Student Consultation schedule available on iLearn.

Assessment Timeline

• Assessments are due in Weeks 8, 10, and 12.

Prescribed Textbook

• Accounting: Reporting, Analysis and Decision Making, 7th Edition by Carlon, McAlpine, Lee, Mitrione, Kirk, and Wong.
• Includes a Student Solution Manual and Accounting 101 Study Notes.

Recap of Week 1

• Outline of the unit.
• What is Accounting?
• Branches of Accounting.
• Accounting Stakeholders.
• Impact on society.
• Role of Accountants in Business.
• Accounting Careers.
• Forms of Business Structures.

Week 2 Overview: Transaction Analysis & ALOIE

• Introduction to the accounting cycle.
• Introduction to common accounts used in recording transactions and events related to ALOIE (Assets, Liabilities, Owner's Equity, Income, Expenses).
• Introduction to transaction analysis and the accounting equation.
• Introduction to double-entry accounting.
• Accounting concepts and principles.
• Qualitative characteristics of accounting information.

The Accounting Cycle

1. Analyse transactions.
2. Journalise transactions.
3. Post to ledger accounts.
4. Prepare Adjusting Journal Entries.
5. Prepare Closing Journal Entries.
6. Prepare Financial Statements.

The Recording Process

• Preparing General Journal Entries (Week 3).
• Posting Journal Entries to General Ledger (Week 4).
• Trial Balance (unadjusted) (Week 4).
• Adjusting Journal Entries (Week 5).
• Post Adjusting Journal Entries to General Ledger (Week 5).
• Adjusted Trial Balance (Week 5).
• Closing Journal Entries (Week 6).
• Post Closing Journal Entries to General Ledger (Week 6).
• Post-Closing Trial Balance (Week 6).
• Preparing Financial Statements (Week 7).

Accounting Transactions & Events

• A transaction is an external exchange of something of value between two or more entities (e.g., purchase of office equipment, sale of goods or services).
• Accounting transactions and events are occurrences that must be recorded/recognized because they affect the assets, liabilities, or equity items of a business.
• Evidence of a transaction comes in the form of a “source document” (e.g., purchase order, EFT on bank statement, cash register tape, sales invoice).
• Not all transactions and events are recorded (e.g., hiring a new employee).

Five Financial Elements - ALOIE

Definition of Assets

• An asset is a present economic resource controlled by the entity as a result of past events. An economic resource is a right that has the potential to provide economic benefits.
• Examples of Assets:
  • Cash at bank
  • Inventory
  • Plant and equipment
  • Buildings
  • Accounts receivable
  • Prepaid expenses

Definition of Liabilities

• A liability is a present obligation of the entity to transfer an economic resource as a result of past events.
• Examples of Liabilities:
  • Accounts payable
  • Loan payable
  • Interest payable
  • Revenue received in advance (Unearned revenue)

Definition of Owner’s Equity

• Equity is the residual interest in the assets of the entity after deducting all its liabilities.
• Equity increases with owner’s contribution (capital) and income.
  • Capital (the owner’s share of the business, i.e., Owner’s Capital).
  • Income (Amounts received/receivable from selling goods or services).
• Equity decreases with expenses and drawings (dividends if it is a Company).
  • Expenses (costs that a business incurs to generate income).
  • Drawings or withdrawals (owners takes out of business for personal use).
  • Dividends (distribution of profits to shareholders).

Definition of Income

• Income is increases in assets, or decreases in liabilities, that result in increases in equity, other than those relating to contributions from holders of equity claims.
• Examples of Income:
  • Sales revenue
  • Service revenue
  • Interest income

Definition of Expense

• Expenses are decreases in assets, or increases in liabilities, that result in decreases in equity, other than those relating to distributions to holders of equity claims.
• Examples of Expenses:
  • Wages expense
  • Rent expense
• Profit: When total income exceeds total expenses.
• Loss: When total expenses exceed total income.

The Accounting Equation

• The accounting equation measures the resources of a business and the claims to those resources.
• Basic Accounting Equation: $Assets = Liabilities + Owner’s Equity$
• Expanded Accounting Equation: $Assets = Liabilities + Owner’s Capital + Income – Expenses – Drawings$

How to Analyse Transactions

• Accounting is based on a “Double-Entry” system, which records the “dual effect” of a business transaction.
• Each transaction affects TWO or more accounts.
• The pattern of recording the dual effect is based on the accounting equation.
• For every transaction, the amount on the left side of the equation must EQUAL to the amount on the right side of the equation.
• Accounting Equation: $Assets = Liabilities + Owner’s Equity$

Transaction Analysis Examples

• Example 1: David Healy starts a business – David’s Car Wash by contributing capital of $30,000 in cash.
  • $Assets = Liabilities + Equity$
  • $Cash = David, Capital$
  • +$30,000 = +$30,000
• Example 2: David’s Car Wash borrows $5,000 from a bank.
  • $Assets = Liabilities + Equity$
  • $Cash = Bank Loan$
  • +$5,000 = +$5,000
• Example 3: David’s Car Wash purchases office equipment by paying $8,000 in cash.
  • $Assets = Liabilities + Equity$
  • $Office Equipment - Cash = 0$
  • +$8,000 - $8,000 = 0
• Example 4: David’s Car Wash receives $15,000 in cash for services performed.
  • $Assets = Liabilities + Equity$
  • $Cash = Income$
  • +$15,000 = +$15,000
• Example 5: David’s Car Wash pays $2,000 in cash for office rent.
  • $Assets = Liabilities + Equity$
  • $Cash = Expenses$
  • -$2,000 = -$2,000
• Example 6: David Healy withdraws $1,000 cash from the business for his personal use.
  • $Assets = Liabilities + Equity$
  • $Cash = Drawings$
  • -$1,000 = -$1,000

Net Effect of Transactions

• What is the net effect of all these transactions on the net worth of David’s Car Wash?
• Assets $47,000 = Liabilities ($5,000) + Equity ($42,000)

Double-Entry Accounting

• Accounting is based on a “Double-Entry” system, which records the dual effect of a business transaction.
• Each transaction affects TWO or more accounts.
• At least ONE account is DEBITED and ONE account is CREDITED.
• Debits must EQUAL to Credits (Debits = Credits).

The “T” Account

• Set up accounts before recording transactions.
• Each account consists of three parts:
  1. Account Name
  2. Debit Side (Left)
  3. Credit Side (Right)

Debit and Credit Rules

• The account category determines how increases and decreases in the account are recorded as debits and credits.
• The pattern of recording debits and credits is based on the accounting equation.
• Debit and Credit Rules Table:     | Account Category | Increase | Decrease |     | :--------------- | :------- | :------- |     | Asset | Debit | Credit |     | Liabilities | Credit | Debit |     | Owner’s Equity | Credit | Debit |     | Income | Credit | Debit |     | Expenses | Debit | Credit |     | Drawings | Debit | Credit |     | Dividends | Debit | Credit |

Expanded Accounting Equation with Debits and Credits

$Assets + Expenses = Liabilities + Equity + Revenues$

Examples of Transaction Effects

Accounting Concepts & Principles

• Going Concern Principle: The business will remain in operation for the foreseeable future.
• The Accounting Period Concept: The life of a business is divided into artificial periods. Profit is determined for particular periods of time in order to be comparable.
• Accounting Entity Concept: Identify clearly the boundaries of the entity being accounted for. Personal transactions of the owner must remain separate from the transactions of the entity.
• Accrual Basis Accounting: The effects of transactions are recognised when they occur, NOT when the cash is received/paid.
• Cash-Basis Accounting: Records transactions and events only at the time of receipt/payment of cash, i.e., no payables or receivables.
• Cost Principle: States that all assets are initially recorded in the accounts at their purchase price or cost. Numerous departures from the cost principle are permitted by accounting standards (e.g., assets revaluations).

Qualitative Characteristics of Accounting Information

Fundamental Qualitative Characteristics

1. Relevance: Information is considered relevant if it is capable of making a difference to the decisions made by users.
2. Faithful Representation: Information is a faithful representation of the economic phenomena it purports to represent if it is complete, neutral, and free from material error.

Enhancing Qualitative Characteristics

1. Comparability: Users can identify similarities and differences between two sets of economic data.
2. Verifiability: Information is verifiable if it represents the economic phenomena without bias or material error.
3. Timeliness: Whether the information is available to users before it ceases to be relevant.
4. Understandability: Users who have reasonable knowledge of business and accounting can comprehend its meaning.

Week 2 Lecture Takeaways

• ALOIE & Transaction Analysis
• Accounting Cycle
• Accounting Concepts & Principles
• Double-Entry Debits (DR) = Credits (CR)
• The Accounting Equation
• Qualitative Characteristics

Coming up in Week 3

• Week 3 Tutorial: Discuss Transaction Analysis, Elements of Financial Statements, Accounting Concepts & Principles & Qualitative Characteristics of Accounting Information
• Week 3 Lecture: Financial Accounting for Business: Preparing General Journal Entries