topic accounting 1 environment - open university...

� INTRODUCTION

Accounting plays an important role in our daily lives without us realising it. Accounting is a financial information system that helps us make better economic decisions. It is sometimes referred to as the language of business since it communicates the financial performance and well being of an organisation. We might assume that accounting is only important to businessmen or accountants. In fact, we also need accounting in our daily lives. We need financial information to make economic decisions. For example, when making a decision on buying a new car, we need to know the total net income in a month (gross income minus all expenses) to know whether we can afford to buy the car. We also need to estimate other costs that might be involved in having a car. This example is only a decision at an individual level. For a business entity, it might need to make a decision on whether to buy a new building or just rent it for operational purposes. Even though it is a higher level decision, the decision- maker still requires the necessary financial information.

TTooppiicc

11 � Accounting

Environment

LEARNING OUTCOMES By the end of this topic, you should be able to:

1. Explain the meaning, role and importance of accounting;

2. Identify the users and branches of accounting;

3. Describe the main functions of professional accounting bodiesin Malaysia; and

4. Assess the qualitative characteristics of financial information,assumptions, principles and constraints in accounting.

� TOPIC 1 ACCOUNTING ENVIRONMENT 2

In this topic, you will be introduced to the basics of financial accounting. Among them are the definition and branches of accounting, users of accounting information, professional accounting bodies in Malaysia as well as the fundamental concepts in accounting.

INTRODUCTION TO ACCOUNTING

What is accounting? Let us find the answer in this subtopic. In this subtopic we will look at the definition of accounting and who are the users of accounting information. Besides that, you will also learn what are the branches of accounting and the professional accounting bodies in Malaysia.

1.1.1 Definition of Accounting

Accounting is an information system that prepares reports on the economic activities of an entity for users to help them make better decisions. More accurately:

Economic information are information related to economic activities; whereas an entity refers to a business unit.

1.1.2 Users of Accounting Information

Users of accounting information are parties that use the accounting information for specific purposes. The information required by the users might differ between one group and another. Users of accounting information can be divided into two groups - iinternal users and eexternal users as reflected in Figure 1.1.

1.1

Accounting is a process to identify, measure, record and present the economic information of an entity to the users in order to help them make evaluations or economic decisions.

TOPIC 1 ACCOUNTING ENVIRONMENT �

3

Figure 1.1: Users of accounting information

Now, let us look at each group:

(a) IInternal users are parties that have direct access to the resources of an entity and usually involved in the management of the entity, for example the management of the company.

(b) EExternal users would be the parties who do not have direct access to the resources of the company and do not involved in the management of the entity, for example the shareholders.

The other differences between these two groups are summarised in Table 1.1.

Table 1.1: Differences between Internal Users and External Users

Differences Internal Users External Users

Types of information required

Information that can help them make planning and exercise control over the entity.

Information required are different depending on the type of decisions made.

Example:

Investor: Require information on the profitability of the company before making decision to invest.

Loan providers: Require information on the stability and liquidity of the company before making decision on giving out credit.

How does the information been obtained?

Using the status or position in the company.

Limited to what is made available by the company.

Example: Annual report published by the company.


1.1.3 Branches of Accounting

Accounting is divided into several different branches or other specialised fields. Among them are:

(a) Financial Accounting;

(b) Management Accounting;

(c) Taxation; and

(d) Auditing. These branches are not static as they evolve in time and requirement. The two most important branches taught at foundation level are financial accounting and management accounting. This financial accounting course will combine two of the most basic and important accounting branches; that are financial accounting and management accounting. Even though this course focuses on financial accounting, it is important for you to know some of the differences between these two branches. Let us look at Table 1.2.

Table 1.2: Differences between Financial Accounting and Management Accounting

Differences Financial Accounting Management Accounting Preparation of report Preparation of financial

reports of an entity for external and internal users but focus is given to the external users.

Preparation of financial and non-financial information that are required by parties in the company for planning, evaluating and controlling purposes of the operations of an entity.

Standard or Format Financial reports produced are periodically and in accordance to specified standard or format.

Report is produced at any time based on requirement and is not subject to any standard or format.

Taxation or tax accounting is concerned with the computation and management of income tax under the income tax laws. Almost every government in this world imposes various taxes on eligible individuals and corporations to raise the nationÊs revenue. Knowledge in taxation allow us to plan our tax obligations and file our tax returns with the relevant government agencies. On the other hand, auditing is a study of the systematic process in accounting that examine the reliability and credibility of the accounting information presented by an organisation. It involves reviewing and evaluating all


5

supporting documents or evidence to verify the economic transactions that are purported to have taken place in the organisation. The procedures are done in accordance with specific auditing standards to ensure that the financial information are properly prepared to represent a true and fair view of the financial information.

1.1.4 Professional Accounting Bodies in Malaysia

We also need to familiarise ourselves with the organisations that are involved in the accounting profession in Malaysia. The organisations are:

(a) MMalaysian Institute of Accountants (MIA) MIA was established under the Accountants Act 1967 as the main accounting body in the country. Overall, it functions as the core body in regulating the accounting profession. Other major functions of MIA as discussed in the Accountants Act 1967 are:

(i) To set the required qualification in order to become a member;

(ii) To provide training and education for practitioners or those who are interested in becoming accounting practitioners;

(iii) To control the accounting practices in Malaysia; and

(iv) To protect the accounting interest in Malaysia.

(b) TThe Malaysian Institute of Certified Public Accountants (MICPA) MICPA, formally known as „The Malayan Association of Certified Public Accountants‰, was established in 1958 under the Companies Ordinances. On 6 July 1964, the name was changed to „The Malaysian Association of Certified Public Accountants‰ to reflect the change of name from Malaya to Malaysia. Since February 2002, it is known as „The Malaysian Institute of Certified Public Accountants‰. Among the main objectives and functions of MICPA are:

(i) To advance the accounting theories and practices in all aspects;

(ii) To train and evaluate the competent members;

(iii) To ensure the independence of professional accountants; and

(iv) To oversee the practices and professional conducts of its members.

(c) MMalaysian Accounting Standards Board (MASB) MASB was established under the Financial Reporting Act 1997. Among the main functions of MASB are:

(i) To set and approve new accounting standards;


(ii) To revise or accept the usage of existing standards as approved accounting standards; and

(iii) To develop the conceptual accounting framework.

(d) FFinancial Reporting Foundation (FRF) FRF was established under the Financial Reporting Act 1997 together with MASB. Among the main functions of FRF are:

(i) To provide opinion to MASB on matters to be implemented;

(ii) To evaluate the performance of MASB; and

(iii) To be responsible for the overall funding of the operation of MASB, including to approve its budget.

You may want to visit the following websites for further information regarding the professional accounting bodies in Malaysia:

(a) Malaysian Institute of Accountants (MIA), www.mia.org.my

(b) The Malaysian Institute of Certified Public Accountants (MICPA), www.micpa.com.my

(c) Malaysian Accounting Standards Board (MASB), www.masb.org.my

(d) Financial Reporting Foundation (FRF), www.masb.org.my

FUNDAMENTAL ACCOUNTING CONCEPTS

Do you know what are the fundamental accounting concepts? Well, in this subtopic you will be exposed to the qualitative characteristics of accounting information and accounting assumptions. Besides that we will look at the basic principles of accounting and accounting constraints.

1.2

1. Provide examples of common decisions made by both internal and external users.

2. How does Financial Accounting and Management Accounting assist users in making decision?

EXERCISE 1.1


7

1.2.1 Qualitative Characteristics of Accounting Information

In this subtopic, you will be exposed to the qualitative characteristics of accounting information. For a start, let us look at what is qualitative characteristics of accounting information.

These characteristics are divided into two categories; pprimary and ssecondary qualities. The primary qualities of accounting information are relevant and reliable. While the secondary qualities are comparability and consistency. In summary, accounting information is only useful if it has relevance, reliability, comparability and consistency qualities. Figure 1.2 shows the summary for qualitative characteristics of accounting information.

Figure 1.2: Qualitative characteristics of accounting information

Let us discuss this further. (a) RRelevance

In everyday terms, we might describe relevant as important or being related. In accounting, relevant is described as ssomething that makes a difference in arriving at a decision. In other words, something is said to be relevant if it influences or affects the decision being made. The extent to which information is considered relevant depends on its importance in decision making and may differ between one decision maker to another. Information that is relevant to you might not be relevant to another person and vice versa.

Qualitative characteristics of accounting information refer to the characteristics that must be present in the accounting information to make it useful.


For example, suppose you are an investor and you intend to buy shares of a public listed company. What kind of information might be relevant to your needs? You might want to know the profitability and performance of the said company for the past five years, including new projects or products for the company that will be profitable in the future. This information is relevant as it will influence your decision. Suppose the information that you obtained showed that the company is experiencing continuous losses for the past five years and it does not have any new projects. Will you still proceed with the proposal to invest in the company? Probably not. Figure 1.3 shows an example of performance information of a company in order to assist investors in decision making.

Figure 1.3: Performance information of a company to assist investor in decision

making

After knowing the meaning of relevant, you must also know how certain information are said to be relevant. To become relevant, the information must have three characteristics, namely feedback value, forecast value and timeliness.

(i) FFeedback Value Relevant information must be able to assist users in substantiating or correcting early expectations matters at hand.

(ii) FForecast VValue Relevant information must be able to assist users in forecasting.

(iii) TTimeliness Relevant information must be obtained before it becomes obsolete or unusable.


9

(b) RReliability Reliability means tthat users can rely or depend on the said information to make good decisions. This characteristic is important because users might not have the time or expertise to evaluate some information. Generally, users simply depend on the information presented by the related entity and assume it to be true. This information is then used in decision making.

Reliability does not mean that the said information must be precise. This is because in accounting there are a lot of information that involves estimation and approximation that might not be precise. What is important is that the estimation and approximation made must be reliable.

Reliable information must have the following characteristics:

(i) VVerifiable This means that the accounting information could be verified objectively by another person using the same method.

(ii) OObjective Objective in this case means that the information is not biased. Information contained in the financial statements must be able to fulfill the requirements of various users and not concentrating on certain groups only.

(iii) TTrustworthy Information presented is based on the actual result of economic activities using specified methods.

(c) CComparability

Comparability means that the information can be compared whether among companies, industries or different periods. This will enable users to identify the similarities or differences that might exist in the said information. This characteristic is important because information that can be compared is more useful. Let us look at an example. Assume that you were told that the net profit of a business in the year 2011 was RM5 million. Is this information useful? This information would only be meaningful if you can compare it with the net profit of the business in the year 2010 or the net profit of other businesses in the same industry as shown in Figure 1.4. Thus, financial statements contained in the Annual Report also include information on the previous year in addition to the current year for comparison purposes.


Figure 1.4: Profitability comparison

(d) CConsistency

Consistency means that an entity must use the same accounting procedures in every period. It is for the purpose of enabling comparison to be made more effectively. In other words, a company cannot change their accounting procedure every year. This does not mean that the company cannot change the accounting procedure at all. Changes can still be made, but the company must make complete disclosure in the financial statement to explain to the users why they are making the changes and the effect of the changes towards the financial statements.

What are the important qualitative characteristics of accounting information?

SELF-CHECK 1.1

In your opinion, what will happen to a business entity if it only presents the qualitative characteristics of main accounting information in its annual report?

ACTIVITY 1.1

1. State the qualitative characteristics of accounting information.

2. Explain the meaning of comparability and provide an example to show its role in making accounting information useful.

EXERCISE 1.2


11

1.2.2 Accounting Assumptions

In this subtopic we will discuss about accounting assumptions. There are four accounting assumptions, created to aid the reporting entity and the users, which are generally accepted. They are:

(a) AAssumption of Separate Entity For the purpose of accounting, an entity is assumed to be separated from its owner and also other entities. An accounting entity is an economic entity in its own right which controls resources involving economic activities. All activities relating to the accounting entity must be separated from the owner Ês activities or other accounting entitiesÊ activities. The examples below should explain this concept clearly.

Example 1: Assume that you own a business, your personal economic activities must be kept separate from the businessÊ economic activities. If you wish to buy products for personal use, you cannot take the businessÊ money and assume that as part of the business activities. Instead, you must record it as drawings. The Drawings Account shows the money or products from the business taken by the owner for personal use. Example 2: Supposing you have just set up a business which offers computer repair services. As it is a small business and you are the sole proprietor, the businessÊ cash is deposited into your private account. Assume that on 31 December 2010, the bank balance of your account is RM5,000. Based on your record, RM1,000 is the money from your business and the balance of RM4,000 is funds for your studies.

If you did not comply with the assumption of separate entity and assume RM5,000 is the money from your business, you might make an inaccurate business decision. You might feel that your business has adequate funds while in fact only RM1,000 is the businessÊ cash. Although all the money belongs to you, from the accounting perspective, RM1,000 is for the business funds and the balance of RM4,000 is the money for your education purposes. Segregation would enable you to evaluate the financial status of the business much better and to make accurate decisions to enhance the performance of the business. If an owner has more than one business entity, each entity must be assumed as separate entity from the others.


Let us look at an example.

Assuming that Mr. Ali owns three different businesses, all three are considered to be separated from accounting perspective. Accounting records must be maintained separately; assets and liabilities for each business cannot be mixed together. Segregation would enable the owner to know the performance for each business. As a simple example, suppose that Mr. AliÊs businesses show the following result on 31 December 2010:

Table 1.3: Mr. AliÊs Business

Business Transaction (RM)

Business 1 Profit 6,000

Business 2 Loss 8,000

Business 3 Profit 12,000 If the assumption of separate entity is not complied with and all the entities are assumed as one, Mr. Ali will have an overall business profit of RM10,000 [RM6,000 + (-8,000) + RM12,000]. Based on this result, Mr. Ali might be satisfied and might not take any measures for improvement. However, by preparing separate accounts, Mr. Ali will know that Business 2 is facing problems as it is suffering a loss of RM8,000, while Business 3 is performing very well with a profit of RM12,000.

(b) AAssumption of Going Concern According to this assumption, an entity is assumed to continue to exist and in operation in the future. This assumption is important because it enables the principle of historical cost to be applied. According to the historical cost principle, all assets and liabilities must be recorded at the purchase price (original cost). For most assets, this cost would be depreciated throughout the life span of the assets to depict its usage. However, asset of property would not be depreciated as its value would always appreciate. As an example, a machine with a life span of 25 years will be depreciated for 25 years based on the assumption of going concern. With this assumption, the entity would continue to exist for a period of more than 25 years. If we assume that the entity would exist only for another 10 years in absence of this assumption, we obviously cannot use 25 years as the basis for calculating the depreciation.


13

The assumption also enables users to make decisions without any doubt or worries. Suppose you are interested to invest in a company that has consistently achieved high profits in the past few years. However, you were informed that the company would exist only for another five years. Would you still continue with your plan to invest in the said company? Generally, we will only invest when we believe the company will continue to exist in the future.

(c) AAssumption of Monetary Unit According to this assumption, all economic activities are measured and valued in currency unit. In Malaysia, the currency unit used is Malaysian Ringgit (RM). Only transactions that can be stated in currency unit will be recorded for accounting purposes. Currency unit enables the transactions to be summarised, reported and compared. Before the existence of currency, transactions were conducted by way of exchanging goods (barter system). The non-existence of currency unit had created difficulties in ascertaining the value of transactions. With a countryÊs standard currency unit, we would be able to value every product.

However, this assumption has two weaknesses, that are:

(i) It restricts the scope of accounting. Only transactions that can be measured in monetary terms will be taken into account, neglecting other factors that have impact on the business.

(ii) It assumes that the value of currency is constantly stable, whereas we know that the currency value is always changing.

(d) AAssumption of Accounting Period In the assumption of going concern, we assumed that the entity will continue to operate for an unlimited period. However, users (whether manager, shareholders, loan providers or other parties) require periodical measurements to help them making decisions. With this assumption, the lifetime of the entity is divided into a certain period for the purpose of reporting its economic activities. Normally the period selected is one year. Financial reports must be produced every accounting year.

The selected accounting period can start from 1 January and ends on 31 December, or starts from 1 July and ends on 30 June the following year, and so on depending on the operation of the company. For example, if an entity is established on 1 March, it might choose an accounting period that starts from 1 March and ends on 28 February of the following year. This accounting period can be changed if the entity feels that there is a need to do so.


Table 1.4 shows examples of accounting period.

Table 1.4: Examples of Accounting Period

Starting Date Ending Date

1 January 2010 31 December 2010

1 July 2010 30 June 2011

1 March 2010 28 February 2011 There are also companies which produce reports within a period of less than a year, for example monthly, quarterly or half yearly. These reports are known as interim reports. Interim report is normally produced to fulfill the requirement of users that might need a more up-to-date report.

1.2.3 Basic Principles of Accounting

After understanding the qualitative characteristics of information and accounting assumptions, you will be exposed to the basic principles of accounting, which are the principles used in the process to identify, measure, evaluate and report financial information. There are four basic principles that you must know as shown in Figure 1.5.

There is a company that has obtained high profits consistently for the past 5 years and would exist for a period of another 10 years. Would you invest in the company? Explain your decision.

ACTIVITY 1.2


15

Figure 1.5: Basic principles of accounting

Now, let us look at the explanation of each principle.

(a) PPrinciple of Historical Cost According to this principle, all business resources will be recorded based on historical cost, which is the original cost at time of purchase. Although the value of the resources might change in the future, no adjustment will be made to recognise the changes in the value. For example, you want to buy a piece of land for your business site. The seller set the price at RM80,000. You do not agree with the price and ask the seller to sell it at RM70,000. After negotiation, the seller agreed with the price of RM72,000. In this case, the land would be recorded at the value of RM72,000 in your financial statement. Five years later, you wish to revalue the land. The assessor informed you that the value of the land had appreciated to RM120,000. Although there is a high appreciation in value, you must still record it at the value of RM72,000, which is the original cost of the land during the purchase. The principle of historical cost is justified by its high reliability. The value recorded in the financial statement is based on the original cost at the time of purchase supported by documentation. This advantage is also a weakness for certain parties. These parties criticised the failure of the


principle to recognise any possible changes in asset value. Regardless, this principle is still adopted. Alternatively, more and more managers prefer to record their resources at fair value or current market value. Fair value is the value that is agreed by both seller and buyer at an armÊs length transaction. It is argued that this value is more relevant to reflect an organisationÊs well being since it represents the current value of its resources. For example, a parcel of land in a strategic location was bought for RM50 million 10 years ago will not be worth the same now. To record it at historical cost, which is RM50 million, would be misstating the assetÊs worth at present time. Using fair value accounting, the land might be recorded at twice the price it was originally purchased due to supply and demand of the current market.

(b) PPrinciple of Income Recognition Principle of income recognition provides guidance regarding when and how to recognise income. The three conditions that must be complied with before income is recognised are:

(i) The seller had performed the necessary actions to obtain the income (for example, providing the goods for trade or rendering services);

(ii) The amount of income can be measured objectively; and

(iii) The income can be collected.

Normally, income is recognised at the point of sale. The point of sale refers to a situation whereby ownership has been transferred from the seller to the buyer, notwithstanding whether the cash has been received or not. For an entity that offers services, the point of sale is when the service has been provided to the customer. However, in certain cases, the point of sale method is inappropriate. There are several different methods that can be used, for instance the percentage of completion and cash basis methods.

(i) PPercentage of Completion Method is normally used by companies involved in the construction industry which takes a long time to complete. For example, a housing project might take three years to complete. It would be inappropriate to recognise the revenue only after the project is completed. This is because revenue and expenses accrued throughout the duration of the project that could be determined periodically based on the degree of completion. This method is more appropriate because it complies with the accounting period principle and provides a true picture of the project development.


17

(ii) CCash Basis Method complies with the basis of cash accounting.According to this method, revenue is only recognised when cash is received. This method is applied in credit transactions when cash receipts are not assured.

(c) PPrinciple of Matching This principle matches the expense (effort) with the revenue (benefit obtained from the effort). The matching of the revenue with the expense will be done when the transaction has completed. To comply with this principle, two steps will be involved, which are:

(i) FFirst Step Recognition of the revenue for a specific period.

(ii) SSecond Step Recognition of all the expenses involved in ascertaining the revenue.

For example, when we provide services to customers, we will recognise the revenue according to the principle of income recognition. Then, we will recognise all the expenses involved in generating the revenue and match them with the revenue. The difference between the revenue and the expense will be either profit or loss. If revenue is more than expense, the difference will be net profit. However, if the revenue is less than expenses, the difference will be recognised as net loss. Figure 1.6 summarises the concept of profit and loss.

Figure 1.6: The relationship between revenue and expense

(d) PPrinciple of Full Disclosure The principle stresses for the full disclosure of all relevant information and material in the financial statement whether in the statement itself or in the notes to the accounts. This is to ensure that the users can make proper decisions. The disclosure of financial statements will be explained in detail in Topic 6.


1.2.4 Accounting Constraints

We have seen the principles that must be complied with in accounting. However, there are constraints or obstructions that might result in these principles not being complied with. The main constraints in accounting are:

(a) CCost-Benefit Relationship Before deciding on obtaining specific information, a company would normally analyse the cost involved and the benefit that may be gained from the information. If the cost of obtaining the information is very high but the benefit generated is not so much, the company might not reveal the information even though all information must be completely disclosed in accordance with the principle of full disclosure.

(b) MMateriality Materiality refers to the effect of an item towards the overall operation of the entity. An item is considered immaterial if it does not affect the decision that will be made. Materiality is often measured based on size. A transaction that involves a huge amount is normally treated as material. A

1. What is the purpose of accounting?

2. Briefly explain the main functions of Malaysian Institute of Accountants (MIA) and Malaysian Accounting Standards Board (MASB).

3. What is the importance of accounting assumptions?

4. How are the accounting period and going concern assumptions related?

5. Why is the principle of income recognition important?

6. What is meant by materiality in accounting?

7. How does the balance sheet of an entity provide a useful source of information?

8. Explain the weaknesses exist in the assumption of monetary unit.

9. Describe three conditions that must be fulfilled before revenue can be recognised.

EXERCISE 1.3


19

material transaction must be disclosed in detail, while immaterial transactions are sometimes combined or not disclosed in detail.

For example, a small amount of expense like a purchase of stamps and fares are combined into one account known as sundry expenses. Another example will be the practice of approximation. You can see examples in the annual report published by companies. Generally, companies would not record the cents value, but instead will round the figures up to the nearest ringgit (example: RM471.20 is recorded as RM471). For larger companies, it might make the approximation to the nearest hundred ringgit (example: RM525,795 is recorded as RM525,800). On the other hand, materiality may also be affected by the nature, not the size, of the transaction. For example, those transactions that might involve bribery or environmental damage in any form might be relevant to a personÊs decision making whether to invest or not to invest in a particular company.

TYPES AND OBJECTIVES OF FINANCIAL STATEMENT

After the transactions have been identified, analysed and recorded, we need to prepare a report for the users. This report is the final product of the accounting process and is known as financial statement. There are five types of financial statement that you need to know:

(a) Income Statement/Statement of Comprehensive Income;

(b) Statement of Changes in Owner Ês Equity/Statement of Changes in Equity;

(c) Balance Sheet/Statement of Financial Position ;

(d) Statement of Cash Flows; and

(e) Information on Accounting Policy and Explanatory Notes. These statements are interconnected with one another. The title for each statement must contain the reporting entityÊs name, type of statement and the reporting period covered. In this section, we will see in summary, the format for each of the four statements based on the transactions for Reen Cyber Service. We will learn about the preparation of each statement in detail in Topic 5.

1.3


Figure 1.7: Types of business

Let us take a look at Figure 1.7. Generally, businesses are divided into three types, which are sole proprietorship, partnership and company. Sole proprietorship is owned by a single owner while partnership is owned by 2 to 20 owners. Financial statements for these two types of business are not subject to the standards released by MASB. Therefore, there might be several formats used by these two types of business. Companies can be divided into private and public companies. Private companies can be owned by 2 to 50 owners. However, there are unlimited number of owners for public companies. To protect the public interest in public companies, the preparation of their financial statements is subject to the standards released by MASB, whether in the form of accounting method, disclosure and reporting format.

1.3.1 Income Statement

This statement is also known as Profit and Loss Statement wwhich lists all the revenues and expenses incurred by the entity for a specific period. The difference between the revenue and expense will result in either net profit or net loss. Excess of revenue over expense will give us net profit, while expense in excess of revenue will give us net loss. Figure 1.8 shows the income statement for Reen Cyber Service for the month ended 30 November 2010.


21

Figure 1.8: Income statement

1.3.2 Statement of Changes in Owner’s Equity

This statement shows the changes in ownerÊs equity for a specific accounting period. OwnerÊs equity will increase when the owner makes a capital investment or when the entity gains net profit. OwnerÊs equity will decrease when the owner makes drawings or when the entity incurs net loss. Figure 1.9 shows the statement of changes in ownerÊs equity for Reen Cyber Services.

Figure 1.9: Statement of changes in owner Ês equity


1.3.3 Balance Sheet

This statement is also known as the financial position statement, listing all the assets, liabilities and ownerÊs equity of the entity on a specific date. The purpose of this statement is to show the financial status of the entity on a specific date. There are two formats normally used, which are the statement format and accounts format. The accounts format places the asset on the left side with liability and ownerÊs equity on the right side (refer to Figure 1.10 and Figure 1.11).

Figure 1.10: Balance sheet in accounts format

In the statement format, the asset, liability and ownerÊs equity are listed vertically.


23

Figure 1.11: Balance sheet in statement format

1.3.4 Statement of Cash Flows

This statement reports all the cash receipts and payments of the entity in a specific period. Through this statement, the users will know the sources of cash received and why cash is paid. The difference between cash inflows and outflows will provide the final cash account balance of the entity. This balance will be the same as the cash amount shown in the Balance Sheet. In the cash flow statement, cash transactions are divided according to the type of activities, which are operating, investing and financing activities. Figure 1.12 shows the cash flow statement for Reen Cyber Services.


Figure 1.12: Statement of cash flow

Cash flows from operating activities include cash receipts and payments from a business main activities such as trading and staff salaries. Cash flows from investing activities involve cash transactions from purchases and sales of non-current assets. Cash flows from financing activities are long-term cash borrowings and repayments lenders and cash investments and withdrawals made by owner.

Discuss the issues that might arise if a business entity did not disclose the relevant information in its financial statement. Present in your tutorial.

ACTIVITY 1.3


25

1. The accounting process does NOT include:

A. Identification

B. Verification

C. Recording

D. Communication 2. Which of these is NOT a qualitative characteristic of accounting

information?

A. Materiality

B. Reliability

C. Relevant

D. Comparability 3. One example of internal user is:

A. Inland Revenue Board

B. Investor

C. Creditors

D. Management 4. Net Loss in a period will result when:

A. Liabilities exceed assets

B. Assets exceed income

C. Expenses exceed income

D. Income exceeds liabilities 5. For the purpose of simplifying accounting, the business owner

and business entity are assumed as the same.

True False

EXERCISE 1.4


6. The accounting period for all businesses must start from 1 January and ends at 31 December each year.

True False

7. The monetary unit assumption allows accounting to measure economic events for recording purpose.

True False

8. Income statement shows the net profit or loss of a business entity at a specific date.

True False

9. Fair value accounting provide a more reliable measurement of assets compared to historical cost accounting.

True False

1. Below are the assets and liabilities accounts balances for Seri Consultation Services as at 31 December 2008 including the revenue and expense incurred throughout the year 2008. On 1 January 2008, the capital of Miss Seri Devi (the owner) is RM22,200. Throughout the year, she made a cash drawings of RM6,000 but no records of it has been made.

Account AAmount (RM)

Accounts payable 1,200

Accounts receivable 18,855

Supplies 8,480

Supplies expenses 6,300

Tax expenses 4,200

Salary expenses 18,000

Sundry expenses 1,265

Rental expenses 14,400

Utility expenses 7,350

Service income 78,750

Cash 23,300

EXERCISE 1.5


27

� The users of accounting information consist of internal users and external users.

� The difference between financial accounting and management accounting are:

� Financial accounting prepares the financial report for external users while management accounting prepares the monetary and non-financial information for internal users.

Required: Based on the information given, prepare:

(a) Income Statement for the year ended 31 December 2008.

(b) Statement of Changes in Owner Ês Equity for the year ended 31 December 2008.

(c) Balance Sheet as at 31 December 2008. 2. A summary of cash flows during the period ended 30 June 2011

for Samrah Florist is provided below:

Cash receipts from: RM Customer 38,000 Owner investment 10,000 National Bank 25,000 Sales of old equipment 3,500 Cash payments from: Purchases of motor vehicles 33,000 Suppliers 15,000 Staff salaries 6,000 Utilities 1,285 Drawings by owner 500 Interest on loan 1,250 The cash balance on 1 July 2010 was RM2,170.

Required: Prepare a statement of cash flows for Samrah Florist for the year ended 30 June 2011.


� The financial reports in financial accounting is produced periodically and subject to specified format while the report for management accounting is produced according to specific needs and not subject to specified standards.

� The professional bodies involved in the accounting profession are Malaysian Institute of Accountants (MIA), The Malaysian Institute of Certified Public Accountants (MICPA), Malaysian Accounting Standards Board (MASB) and Financial Reporting Foundation (FRF).

� The assumptions and fundamental principles of accounting consist of:

� Assumption of separate entity;

� Assumption of going concern;

� Assumption of monetary unit;

� Assumption of accounting period;

� Principle of historical cost;

� Principle of income recognition;

� Principle of matching; and

� Principle of full disclosure.

� Financial statement is the final product of the accounting process and it consists of Income Statement, Statement of Changes in Owner Ês Equity, Balance Sheet and Cash Flow Statement.

Accounting Auditing External users

Fair value

Financial accounting

Full disclosure

Going concern

Historical cost

Internal users

Management accounting

Materiality

Monetary unit

Qualitative characteristics

Separate entity

Taxation

topic accounting 1 environment - open university...

Documents