Notes - Validation 2

Different Types and Characteristics of Business Undertakings:

A manufacturing business is any company that uses raw materials or components such as wood, metal, clay or cloth, to create finished goods. Manufacturing businesses make most of the products a business uses, including electronic devices, furniture, medical equipment or aircrafts.

A trading company is a commercial business entity that buys and sells various goods (Inventory). A commercial business entity is a legally recognized organization that engages in commercial activities with the aim of earning profits. The inventory they sell mainly consists of products purchased by the business with the intention of re-selling these products at a profit. For example, a book shop, computer store and furniture store. There are two types of trading businesses: a retailer, which is a business that sells the inventory to the public, and a wholesaler which is a business that purchases inventory from a manufacturer and sells this inventory to a retailer.

A service providing business is a company that provides a service to the costumer for a “fee”. For example, a solicitor, a business, an accountant or a hairdresser. Service businesses often appeal to customers because its saves time, provide specialized skills, or offer a higher quality of work compared to what customers could do themselves. Services are often produced and consumed at the same time, requiring the presence of the customer, unlike a trading and a manufacturing type of business.  

Concepts & Conventions of Financial Accounting:

Accounting Principles are a set of rules for making entries in an accounting system and preparing accounting reports. The accounting equation states that a company’s total assets are equal to the sum of its liabilities and the owner’s/shareholder’s equity. This straightforward relationship between assets, liabilities, and equity is considered to be the foundation of the double-entry accounting system. The accounting equation ensures that the balance sheet remains balanced. That is, each entry made on the debit side has a corresponding entry/s on the credit side, this is referred to as a double-entry - a recording process that had originally emerged in the Italian Renaissance period.  For example, if the owner/s were to borrow $15000 from the bank, this would increase their assets (cash at bank) and increase their liabilities (debt to bank) by $15000. Assets represent the valuable resources controlled by a company and the liabilities represent its obligations. Both liabilities and the owner’s/shareholders’ equity represent how the assets of a company are financed. Financing through debt shows as a liability since this can make the business appear riskier to investors and lenders, potentially leading to higher borrowing costs in the future. The accounting cycle is the series of steps that accountants follow to track and manage a business's financial transactions throughout a financial period. These six steps include Financial Transaction, General Journal, General Lodger, Trial Balance, Financial Statements and Analysis. There are two types of evidence for any financial transaction; source documents, which can refer to receipts, tax invoices, deposit slips, or anything else that proves that a transaction occurred, and a general journal which documents or journalizes each daily transaction in date order. When a financial event occurs, it must be recorded this is called a transaction. General Ledger is made up of several individual accounts (Asset, Liability & Equity accounts), these are then balanced at the end of the financial period.

Accounting Principles & Conventions:

Accounting Entity: The accounting entity assumption is when a business’s assets and liabilities are kept separate from the owner’s personal assets and liabilities. The personal action of the owner is not recorded in the accounting system of a business (personal withdrawals are not recorded). Whether or not a business is a legal entity (incorporated body registered under law), it will always be an accounting entity. For example, a mortgage on the family home made by the owner/s, will not be recorded in the business’s financial records.

Monetary: The monetary unit principle states that business transactions should only be recorded if they can be expressed in terms of a currency. Essentially anything that is non-quantifiable should not be recorded in the business’ financial accounts. Non-monetary aspects are factors such as the quality of customer service, employee morale, or the reputation of a company. According to the monetary principle, when business transactions or events occur, they are first converted into money and then recorded in the financial accounts of a business. In Australia, all financial reports are to be presented in Australian currency (dollars). By using the monetary principle, it makes it easier for companies to compare financial statements, regardless of location. Although there are limitations to this as the monetary unit principle assumes the purchasing power of the currency remains stable over time, which is not always the case due to inflation. For example, in a company, twice a year the CEO gives a highly valued lecture to all employees about morale and motivation in the work environment. This lecture cannot be recorded in the business financial accounts as it cannot be measured in terms of money.

Historical Cost: The historical cost principle is an accounting principle that requires a business to record assets at their original purchase price, and this value is not changed as time passes. This can be an advantage as it prevents over-valuation of an asset and is especially useful when an asset appreciation is due to unpredictable market conditions. Although it can also be a disadvantage as it doesn’t account for inflation or deflation, and it is misleading as it doesn’t give an accurate indication of a company’s ability to continue to operate at a specific level because its assets were undervalued. For example, a company purchased a building and the land it sits on for $60,000 in 1975. In 2025 that property may be reasonably valued at $375,000. Listing the land at the original cost on the balance sheet does not reflect that gain in value. The company is therefore valued at less than its assets are actually worth today. In general, the more time that has passed since the original purchase date, the less accurate historical cost is as a value measure—though this only applies to non-depreciating assets.

Materiality: The materiality principle in accounting dictates that only information that is likely to influence the economic decisions of users (like investors or creditors) should be reported in financial statements, ensuring that significant data is disclosed. The principle aims to provide users of financial statements with information that is relevant and useful for decision-making, while avoiding cluttering the statements with insignificant details. Relatively large amounts, regarding assets, are material, while relatively small amounts are not material (or immaterial). For example, a small error in a company's expense account might be considered immaterial, while a large misstatement in revenue or assets would be material, as it could affect the economic decision of investors or creditors.

Accounting Period: The accounting period assumption is that the life of a business is divided into intervals of time known as the accounting periods. The length of an accounting period can be, for example, six months or twelve months. In Australia the ATO (Tax Authority) accounting period is from 1 July to 30 June each year. It's used to create financial statements (like income statements, balance sheets, and cash flow statements) that show a company's financial performance and position over a specific time frame. This can enable business to create budgets and forecasts based on historical performance, identifying trends and areas for improvement. Accounting periods are also used for tax reporting purposes, as businesses need to report their income and expenses for specific periods to tax authorities. For example, an Australian bushiness reports their financial transactions from 1^st of July to the 30^{th of} June of the following year, on a balance sheet.

Going Concern: The going concern concept in accounting assumes a business will continue operating for the foreseeable future, typically at least 12 months, without liquidation. Financial statements are prepared on the assumption that the business will continue operating, allowing for the recognition of long-term assets and liabilities.  Assets are recorded and valued based on their expected future use, not their liquidation value, as the business is expected to continue operating. If there's reason to believe that a business is unlikely to continue operating, the going concern assumption may not be appropriate, and financial statements may need to be prepared on a liquidation basis. Negative trends that lead to no longer being a going concern include denial of credit, continued losses, and lawsuits. For example, a company is in a tough financial situation and is struggling to pay its debt, and as there is reason to expect the unlikeliness of continuity, the company is no longer a going concern.

Elements of a Financial Statement:

An asset is a resource that the business owns with the expectation that it will generate future economic benefit, such as cash, property, equipment, or intellectual property. There are three types of assets; (a) tangible assets such as real estate or inventory; (b) intangible assets such as patent (exclusive legal right for an invention), copyrights, trademarks and brand recognition, and (c) financial assets, which includes cash, accounts receivable, investments, etc. Assets can be categorized as current (due within 12 months) or non-current (due beyond 12 months). A liability is something that is owed by a business. A liability is the future outflow of money from the business, meaning a liability is money, or a service owed by a business. Common liabilities include outstanding loans, accounts payable (money owed to suppliers), wages payable, taxes payable, and deferred revenues (payments received for future goods or services).  Liabilities can be categorized as current (due within 12 months) or non-current (due in more than 12 months). Equity is the money or resources contributed to the business by the owner of the company. The amount of money invested into the business by the owner is usually referred to as capital or owner’s equity. For example, the owner/s contributed office equipment to their business. This would be referred to as the owner’s equity.

Features of the GST:

A New Tax System (Goods and Services Tax) Act 1999 legislates for 10% GST is to be collected, at the point of sale, whether a cash or credit transaction, on most goods and services supplied or consumed in Australia. 

GST Effects on Supply:

Reporting & Accounting for GST:

Business Activity Statements (BAS): A Business Activity Statement (BAS) is a government form that all businesses must lodge to the Australian Tax Office (ATO). It’s a summary of all the business taxes owed to or from the government during a specific period. A BAS is important as it calculates and informs the ATO, how much GST is owed to either the ATO or the business. This from is accompanied during the payment of GST to the ATO.

Impact of GST Legal Requirements on Small Businesses:

The businesses who must register for GST with the Australian Tax Office (ATO) are small businesses with a turnover of more than $75 000 per annum; those who provide taxi travel as part of their business, regardless of their turnover; not-for-profit organisations with a turnover of more than $150,000 per annum and sole traders and partnerships with an annual turnover less than $75 000, registration is optional. For example, a sole trader who provides hairdressing services, and has an annual turnover of $50,000, the owner would not have to apply for GST. Legislation requires all businesses registered for GST to inform the ATO of the value of the GST they have collected and paid out. A registered business must do this by completing a Business Activity Statement (BAS) which is submitted to the ATO. Most small businesses submit a BAS monthly or quarterly (three monthly).

An Australian Business Number (ABN) is an 11-digit number that identifies a business to the Australian government, other businesses, and the public. On application for registration, the business’s ABN is issued as evidence that a business is registered for GST. The ABN also serves as the GST registration number and when printed on a business's stationery, informs trading partners that they are obliged to pay GST on the tax invoice and that they can claim credits for amounts they pay to the business.

When preparing the BAS, the net amount owing to the ATO is calculated by deducting the GST Out from the GST In and the net amount owing is remitted (paid). A business can pay GST with either of two methods; (a) they can pay using the cash method if the business’s annual turnover is less than $2 million and the business lodges their tax return based on declaring income when the company banks it and expenses when they pay for it out of the bank account. Or (b) the accrual method which can be done if the business’s annual turnover is less than $2 million and if the company lodges the business’s tax return based on declaring income when it is invoiced and expenses when the business has been invoiced.

Preparation of a Simplified Classified financial statements for a Sole Trader:

 A balance sheet is a financial statement that provides a snapshot of a company's financial position at a specific point in time, showing its assets, liabilities, and equity, adhering to the fundamental accounting equation: Assets = Liabilities + Equity. Its purpose is to provide a clear picture of a company's financial health and position at a specific moment. This allows investors, creditors, and management to use balance sheets to assess a company's financial stability, liquidity, and overall performance. Stability refers to the comparison of the business’s total liabilities against equity in order to asses the “gearing position” of the business. Excessive borrowing to finance a business can be problematic as it leads to high interest payments, negatively impacts cash flow, and can make a business appear riskier to investors and lenders, potentially leading to higher borrowing costs in the future. Liquidity refers to a business’s ability to pay its short-term debts when they are fall due. This is done by comparing current assets to current liabilities. The business would aim to have more current assets then current liabilities, as otherwise it runs the risk of not being able to pay its debts when they fall due.