Financial Reporting
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Lecture Outline
Financial Accounting Financial Statements
Defined Income Statement
Characteristics Balance Sheet
Cash vs. Accrual
Accounting
Defined
Benefits
Limitations
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Annual Report
Financial statements
are contained within an
organisations ANNUAL
REPORT
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Annual Report
Contents
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Annual Report
Contents
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Financial Accounting
Communication of financial information to external
users. Specifically;
Financial Performance
Financial Position
Without financial accounting, the economy could not
operate effectively.
no-one would know whether it was safe to invest or lend
money to an entity.
If no one invested or lent money, organisations could not
grow.
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Annual Reports
External User Primary Interest
Investors Profits
Lenders: Ability to repay loan
Suppliers: Ability to pay debt
Government (A.S.I.C): Compliance
Employees/Unions: Job Security, Profits
Customers: Continued Supply
Environmental Groups: Env. Performance
General Public: Social Obligations
A.S.I.C: Australian Securities & Investments Commission
Indonesian Capital Market Supervisory Agency
Securities Commission (Malaysia)
Monetary Authority of Singapore
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Financial Reporting
In Australia
Financial Year Begins: 1 July
Financial Year Ends: 30 June
Current Financial Year
1 July 2007 – 30 June 2008
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Financial Reporting
Reporting entities in Australia must prepare
financial statements as at the following dates:
31 December (semi annual – 6 months)
30 June (annual – 12 months)
Reporting entities are organisations that have
‘users’
1. public companies,
2. large partnerships,
3. large private companies
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Methods of Accounting
Two Types of Accounting:
1. Cash Accounting
2. Accrual Accounting
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Cash Accounting
A simple system of accounting concerned
only with cash inflows and cash outflows.
Recognise revenue when cash is RECEIVED
Recognise expenses when cash is PAID
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Accrual Accounting
Revenue recognised when EARNED.
When services are provided or goods are sold.
Savings in outflow (i.e. discount)
When payment is received is irrelevant.
Expenses recognised when INCURRED.
When, for example, the electricity, water and telephone
are actually used.
When payment is made is irrelevant.
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Recognition Rules
CASH ACCRUAL
Revenue Received Earned
Expenses Paid Incurred
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Cash vs. Accrual: Edwards Painting
Business
Which method best reflects what actually
occurred?
Month 1
Edward painted houses and earned $19,000 on credit
(customers have not yet paid). An employee worked
with Edward but his wages for the month have not
been paid.
Month 2
Didn’t Work. Received $19,000 from customers.
Month 3
Didn’t work. Paid $4,000 to employee.
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Solution - Cash Profit
1 2 3
Revenue 0 19,000 0
Expenses 0 0 4,000
Profit 0 19,000 (4,000)
Profit/Loss = Revenue - Expenses
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Solution - Accrual Profit
1 2 3
Revenue 19,000 0 0
Expenses 4,000 0 0
Profit 15,000 0 0
Profit/Loss = Revenue - Expenses
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Prepaid Expense
On the 28th of June you pay $1,000 rent for the
month of July.
30/6/07 Period A 30/6/08 Period B 30/6/09
Paid Incurred
The Rent is an expense of period B.
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Accrued Expense
At 30 June wages of $500 is owing (the
employee worked for you during June).
30/6/07 Period A 30/6/08 Period B 30/6/09
Incurred Paid
The wages is an expense of period A.
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Unearned Revenue
On the 29th June a customer pays you $20 to mow
his lawn in July.
30/6/07 Period A 30/6/08 Period B 30/6/09
Received Earned
The $20 is revenue for the period B.
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Accounts Receivable
You mow a customers lawn on 26th June for $20,
but do not receive payment until 2 July.
30/6/07 Period A 30/6/08 Period B 30/6/09
Earned Received
The $20 is revenue in period A.
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Cash vs. Accrual
Cash Accrual
Complexity Low High
Cost Low High
Quality of Low High
information
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Cash Vs. Accrual
Accrual accounting offers greater accountability and
is therefore the better system of accounting when;
Separation between ownership and management.
There are other users interested in the performance of the
organisation (i.e. lenders).
Where there is no separation (i.e. sole trader) then it
may be appropriate to use cash accounting.
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Accrual Accounting
Allows the preparation of:
1) Balance sheet.
Statement showing the financial position of a business at
a given point in time.
2) Income statement.
Statement showing the profit made by a business for a
given period (i.e. 12 months, 6 months, 3 months, 1
month).
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Financial Accounting
Elements
Financial Accounting contains five elements.
These are:
1. Assets Balance
2. Liabilities Sheet
3. Equity
4. Revenues Income
5. Expenses Statement
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Assets
First Test – Is an item an asset?
Must possess future economic benefit
Must help an organisation make money (private sector)
or provide a service (public sector).
Control
Organisation must have the ability to deny or regulate
access.
Result of a past transaction or event
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Assets
Second Two – Can the asset be ‘recognised’
Can the assets value be reliably measured?
Historical cost: Original price paid for the asset
Fair Value: Market value of asset today.
Present value: Present value of cash flows asset
will generate.
It must be probable that economic benefits will
occur?
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Current Assets
Assets the business estimates it will hold for less
than 12 months from the reporting date.
Cash
Accounts receivable (money owed by customers)
Short term investments (term deposits)
Inventory (goods sold to customers)
Prepaid expenses (to be addressed in a future topic)
GST Outlay (to be addressed in a future topic)
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Non Current Assets
Assets the business estimates it will hold for
more than 12 months from the reporting date
Buildings
Land
Machinery
Motor Vehicles
Long Term Investments
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Liability
First Test – Does a liability exist?
Present obligation to sacrifice economic benefit.
Result of a past transaction or event
Second Test – Can we recognise the liability?
Reliable Measurement
It must be probable that sacrifice of economic benefits will
occur.
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Current Liability
Liabilities that are payable within 12 months of the
reporting date.
Accounts payable (money owed to suppliers)
Short term loan (a loan that must be repaid within 12 months)
Bank Overdraft (short term loan available to business)
Accrued expenses (to be addressed in a future topic)
Unearned revenue (to be addressed in a future topic)
GST Collections (to be addressed in a future topic)
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Non Current Liability
Liabilities which are not due within 12 months
of the reporting date.
Long Term Loan
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Equity
Residual interest in the assets after liabilities have
been deducted.
Capital A [Amount invested by Partner A]
Capital B [Amount invested by Partner B]
Retained Profits A [Partner A’s share of profit]
Retained Profits B [Partner B’s share of profit]
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Income Statement
Revenue
An inflow of assets (usually cash) as a result
of providing goods or services.
Savings in outflow are also considered to be revenues
(i.e. Discount received)
Expenses
Loss or consumption of economic benefits.
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Revenue
Revenues (if earned Not Revenues in the
within the current current period.
Cash obtained from a loan.
period). Cash received from selling
Fees from providing a an asset.
service. Any gain you make on
Cash from the sale of the sale is revenue.
goods. Cash received for goods
Discount Received. and services to be provided
in a future period.
Interest on investments Cash received for goods
and services provided in a
previous period.
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Expenses
Expenses (if incurred in Non Expenses
current period). Repayment of Loan
Discount Allowed Principle.
Wages Purchase of Assets
Electricity Payment made for
Rent expenses to be incurred
in a future period.
Telephone Payment made for
Depreciation expense expenses incurred in a
Doubtful Debts previous period.
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Accounting Equation
Assets - Liabilities = Owners Equity
A - L = OE
Principle of Duality
Every transaction has two opposite and equal
components.
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Accounting Equation
Assets - Liabilities = Owners Equity
97,900 - 61,200 = 36,700
The owner invests $15,000 into the business.
+15,000 + 15,000
112,900 - 61,200 = 51,700
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Accounting Equation
112,900 - 61,200 = 51,700
The business borrowed $90,000.
+90,000 + 90,000
202,900 - 151,200 = 51,700
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Accounting Entity Principle
The personal assets and liabilities of the
owner(s) must be kept separate from those of
the business.
Owner Business
Assets Liab. Assets Liab.
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