Basic Principles of Accounting and Finance

What Is Accounting?

Accounting - an information system that measures business activities, processes information and communicates financial information.

Users of Financial Information

• External Users - make decisions about the entity

1. Creditors - before making a loan, creditors determine a businesses ability to meet scheduled payments. This determination is based upon the businesses financial information.
2. Individuals - use accounting information to manage bank affairs, evaluate job prospects and make investments.
3. Investors - evaluate the return on capital they can expect to receive from accounting information.

• Internal Users - make decisions for the entity

1. Business Managers - use accounting information to set goals for their orgs, to evaluate progress towards these goals and to take corrective action if necessary.

Fields of Accounting

• Financial Accounting - Focuses on information for people outside the firm, including creditors, government agencies and the general public.
• Management Accounting - Focuses on information for internal decision makers, including top executives, department heads or university deans.

Standards of Professional Conduct

Standards of Ethical Conduct of Individual Companies In light of the collapses of HIH and One Tel, companies are increasing seeing their responsibilities to stakeholders in a broader ethical context.

• KPMG: “ensuring good ethical conduct reduces corporate risk and enhances corporate reputation.”.
• Key to ethics is honest disclosure
• Ethical standards exist to ensure that accounting information is honest and accurate. Thus, users of accounting information are able to rely on this information for decision-making.

Codes of Professional Conduct - have been established in many large accounting organizations”

• Lists obligations/duties of employees
• Requires employees to conduct themselves in certain ways
• Binding

ICAA and CPPA's Joint “Code of Professional Conduct” contains common prescriptions and places common obligations on the members of both professional bodies

• Purpose is maintaining and enhancing their credibility, professionalism and quality
• Lays down minimum standards of conduct

Types of Business Organizations

Proprietorships

• Single owner who is often the manager
• Each proprietorship is distinct from the proprietor

Advantages

• Total undivided attention
• Low levels of bureaucracy, allowing changes to be made quickly

Disadvantages

• Unlimited liability
• Capital is harder to find

Partnerships

• Joins two or more individuals together as co-owners
• Accounting records treat it as a separate entity, distinct from personal affairs of each partner

Advantages

• Skills and abilities of the partners will strengthen the companies foundation and knowledge
• Significantly broadens access to capital by increasing ability to borrow needed funds

Disadvantages

• Unlimited liability
• Possibility of personality or authority conflicts

Companies

• A business owned by shareholders, people whom own shares of ownership in the business
• A company is a legal, individual entity

Advantages

• Limited liability of shareholders
• Relative ease of ownership transference

Disadvantages

• Separation of ownership and control
• Extensive government regulations

Generally Accepted Accounting Principles

Primary Objective of Financial Reporting - To provide information useful for making investment and lending decisions.

The Entity Concept

• Defines the entity for which accounting data are collected
• An accounting entity is an organization or section of an organization that stands apart from other organizations and individuals as a separate economic unit for the purpose of some decision
• Sharp boundaries are drawn around each entity so as not to confuse its affairs with those of other entities and thus bring info that is not relevant to the decision being made
• Important also because allows a separation to be made between the owners of the business and the business itself

The Time Period Concept

• Defines the unit of time for which accounting data is collected and the financial reports prepared
• In Australia, many businesses prepare their statements for the financial year from July one to June 30 the following year
• As a result of this concept, there is a production of yearly financial reports and the calculation of periodic profit

The Cost Principle

• Assets and services acquired should be recorded at their actual cost

The Reliability (Objectivity) Principle

• Information must be reasonably accurate
• Information must be free from bias
• Information must report what actually happened
• Individuals would arrive at similar conclusions using the same data

The Matching Principle

• MP relates the inputs and outputs of a business to one another
• The cost of inputs used up to produce outputs are treated as expenses and subtracted from revenues associated with those outputs in calculating profit for their period

The Profit Recognition Principle

• Profit should be recognized when the revenues related to the relevant activity is “earned”
• Revenues are “earned” when goods and services are sold or otherwise disposed of and all the other expenses to be matched with them can be identified
• Therefore you do not wait for cash to be received or paid before recognizing profit

The Conservatism Principle

• Constrains management's natural optimism, as this could find its way into the reported assets and profits
• “Anticipate no profits, but anticipate all losses.”.
• Recognizing expected loss before expected revenues

The Going Concern Principle

• The entity will continue to operate in the future

Australian Accounting Standards