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Lecture week 2. Lecture Outcomes: you should be able to: 1. understand the nature of Accounting 2. list the principles and concepts 3. explain GAAP 4. explain the elements of financial statements 5. list the qualitative characteristics 6. explain & record the ACC EQ. Introduction.
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Lecture week 2 • Lecture Outcomes: you should be able to: • 1. understand the nature of Accounting • 2. list the principles and concepts • 3. explain GAAP • 4. explain the elements of financial statements • 5. list the qualitative characteristics • 6. explain & record the ACC EQ.
Introduction • The framework, provides a foundation that sets out the objectives and concepts that underlie the preparation and presentation of financial statements. We will briefly explore the concepts and principles on which the practice of accounting is based.
Principles of Accounting • The Cost Principle • The business purchases assets to produce revenue/income. The business therefore has to record these assets at the cost. E.g. if we purchase land today R100 000 in 5 years time it might be worth R500 000, yet we record it as R100 000 in our books at cost
The objectivity Principle • Another reason for using cost rather than current market values in accounting for assets is the need for a definite, factual basis valuation.
The Realization Principle • When to record revenue: Revenue is recognised when it is earned, without regard to when payment is received.
The Matching Principle • When to record expenses: Expenses are incurred for the purpose of producing revenue. The concept of offsetting expenses against revenue on the basis of “cause and effect” is called the matching principle.
The Double entry principle • With every debit there • Should be a contra credit
The entity Principle • An entity or business should be defined. All accounting practices then relate to the particular entity. Therefore it is important that the affairs of the owner are never intermingled with that of the business
Going concern assumption • The balance sheet of a business is prepared on the assumption that the business is a continuing enterprise.
GAAP • Generally Accepted Accounting Practice • A need was recognised for a set of accounting principles and practices, which would best reflect accounting information. • Almost every country has its own GAAP, and in South Africa it is broken down into various pillars.
Financial Statements should be: • Understandable - Financial Statements must be clear and show enough detail. • Relevant – Good Financial Statements should give users the information that they are looking for so that users can make decisions that concerns them. • Reliable – Financial Statements must be accurate and true. Must be free of significant errors.
Cont… • Prudent – We prepare Financial Statements as if we expect things to turn out worse rather than better • Comparable – Financial Statements must fit in with others. Users should be able to compare Financial Statements of different financial periods.
Cont… • Timely – “Don’t wait too long” Financial Statements lose relevance as time passes so they must be on time • Cost-Effective – The value of information that users get from Financial Statements should be more than the cost of preparing them.
Financial Year • A financial year is 12 consecutive months • E.g. • 1January 2006 – 31 December 2006 • 1 June 2005 – 31 May 2006 • 1 March 2003 – 28 February 2004
ASSETS • An asset is a resource from the result of a past event, which is controlled by the business and will lead to future economic benefits.
Assets are divided into 3 Groups • 1.Non-Current/ Fixed/ Long-term Assets • These assets will be used for a period of more than 12 months (one year) e.g. Vehicles, Equipment. • 2.Financial Assets • are cash, contractual rights to receive cash e.g. Investment, Fixed deposit
3.Current Assets • These assets will be converted into cash within (less than) 12months. E.g. • Bank, Inventory, Debtors
LIABILITIES • A liability is a present obligation resulting from a past event, which will lead to an outflow of future economic benefits
Liabilities are divided into 2 groups • 1. Long-term/ Non current Liabilities • - e.g. Long-term/Mortgage Loans • 2. Current Liabilities • - e.g. Creditors, Short – term loans
Owners Equity • The owner’s equity represents the owner’s claim on the assets of the business.
Owners Equity • Capital (+) Increases • Drawings (-) Decreases • Income (+) Increases • Expanses (-) Decreases • Income - Expenses = Profit
REVENUE & EXPENSE • Revenue is the price of goods sold and services rendered during a given accounting period • Expenses are the costs of goods and services used up in the process of earning revenue.
