Introduction to Accounting

M B G Wimalarathna

[FCA, FCMA, MCIM, FMAAT, MCPM, (MBA–PIM/USJ)]

USQ UNIVERSITY OF SOUTHERN QUEENSLAND

MBA - ACC5502

Accounting & Financial Management / S1 / 2015

Surface

Accounting is a formal process which basically analyzes financial & non-financial information of the particular entity and present them in a formal manner in order to take (economic) decision(s).

Further, accounting is a structured system which entails series of activities; identifying, measuring, recording & presenting (communicating) various business transactions/events in order to serve the different needs of different stakeholders.

Discussion: Book Keeping Vs Accounting

Identify: various business

transactions

Measure: the identified

transactions

Record: the measured

transactions

Present: the recorded

transactions

Note: Every entity includes an Accounting System as a key component of its internal control system. (degree of importance)

Control environment Control procedures

Accounting system

Relationship between Accounting & Auditing

Auditing (external) is basically provides an assurance (reliability) on financial statements prepared by the entity. External audit does not necessarily provide an absolute assurance on accuracy of the financial statements compiled by the entity, it provides true and fair view due to many practical reasons. Even though, the audit opinion is treated as high level assurance. Why entity’s tend to conduct annual audit? Mandatory and/or other benefits. Discussion: Difference between External & Internal Auditing

Accounting Information and Decision Making

As we have identified in above, main duty of the Accountant (Key Management) is to produce information for the users (existing/prospective) to make their decisions. (mostly economic decisions)

Types of users

Internal

Inter

External

Related

Internal - Key management

Inter-related - Financial Institutions (Banks)

- Key customers

- Key suppliers

- Employees (Unions)

External - Shareholders (sometimes internal)

- Government

- Public at large

Note: All of the above parties commonly called as “Stakeholders”. Stakeholders are the individual/ group of people/ party who are interested on operations & results of the entity and change their decisions based on such results (get affected).

Stakeholder Accounting information need and decision making

Investor Information to determine the future profitability of the entity, to assess

the future cash flows for dividends and the possibility of capital growth of

investment.

Banks Information to determine whether entity has the ability to repay a loan.

Suppliers Information to determine an entity’s ability to repay debt associated with

purchase.

Employees Information concerning job security, the potential to pay or awards and

bonuses, and promotional opportunities down the track.

Customers Information regarding the continuity of the entity and the ability to

provide the appropriate goods and services.

Government

authorities

Information to determine the amount of tax that should be paid and any

future taxation liabilities or taxation assets.

Regulatory bodies Information to determine if the entity is abiding by regulations such as

the Corporations Act and Australian taxation law.

Community Information to determine whether the entity is contributing positively to

the general welfare and economic growth of the local community.

Special interest

groups

Information to determine whether the entity has considered

environmental, social or industrial aspects during its operations.

Group of Stakeholders with their distinctive needs Stakeholder Category Information which is need and respective decision making

Investors/OSHs Profit at current. Possibility for growth of profit. Cash flows and its ability to enhance for dividends and capital gain. Going concern.

Key management NA. Profit and its trend. Cash flows and its volatility. Recent trend in industry and markets. Emerging risks and mitigating acts. Communication all what matters to all what want.

Financial Institutions Ability to repay the borrowings with interest. Going concern. NA.

Key suppliers Cash flows. LT relationship. Changes in ownership. Going concern. Key changes in markets and production.

Employees Profit at current and its possibility to grow. NA. Changes in internal policies/procedures/structures. Cash flows.

Key customers Profit. Cash flows. NA. Going concern. LT relationship. Dramatic changes in industry/sector/production.

Government (IRD) Abiding by laws and ability to pay taxes on time.

Community at large Main revenue streams. Profitability. Ownership and its key changes. Industry trend in CSR.

Regulatory bodies Recent structural/ownership changes. Nature of operational activities and its changes. NA. Cash flows. Going concern.

Special interest group Conformity with general requirements. What intended has delivered.

Financial Accounting Vs. Management Accounting Scope of the Financial accounting defines from the view point of the external (third) party while management accounting analyzes information from the view point of the entity’s key management (internal).

Management Accounting Financial Accounting

Key Mgt./Board of Directors Investor

Financial Accounting Management Accounting

Regulations Bound by GAAP. GAAP are represented by accounting

standards, the Corporations Act, and relevant rules of the

accounting association and other organizations such as the

ASX.

Much less formal and without any

prescribed rules. The reports are

constructed to be of use to the

management.

Timeliness Information is often outdated by the time the report is

distributed to the users. The financial reports present a

historical picture of the past operations of the entity.

Management reports can be both a

historical record and a projection,

e.g. a budget.

Level of detail Most financial reports are of a quantitative nature. The

reports represent the entity as a whole, consolidating income

and expenses from different segments of the business.

Much more detailed and can be

tailored to suit the needs of

management. Of both a quantitative

and qualitative nature.

Main users Prepared to suit a variety of users including management,

suppliers, consumers, employees, banks, taxation authorities,

interested groups, investors, and prospective investors.

Main users are the key management

of the entity; hence the term

management accounting.

Environment of Accounting

The environment of accounting is a well established scope within which the entities’ overall accounting function will be carried out.

Recent corporate collapses and episodes of insider trading urge the need to have a strictly monitored environment for accounting. This further confirmed and re-iterate with the concept of globalization of accounting.

This helps to protect the interests of different stakeholders and promotes investment in business and economic activities through confidence.

Government frequently intervene by forming/establishing rules, regulations and various principles to serve this requirement. Certified Professional Accountant (CPA) Australia ICAA The National Institute of Accountants (NIA) NZICA

Sources of Regulation

Following key institutions basically involved in forming suitable environment for accounting.

Australian Securities and Investment Commission (ASIC) ASIC basically acts as the company watchdog and enforces company and financial services laws to protect consumers, investors and creditors. Role of ASIC Uphold the law uniformly, effectively and quickly.

Promote confident and informed participation in the financial system by

investors and consumers.

Make information about companies and other bodies available to the public.

Improve the performance of the financial system and the entities within it.

ASIC establish the corporation Act (2001) which treated as main source of regulation to control business entities. Act includes such sections as the definition of a disclosing entity; the accounting requirements of a disclosing entity; exemptions by ASIC; a small business guide; the basic features of a company; registering a company; company powers; annual financial reporting to members and the appointment of an auditor; and specific offence, including false or misleading statements, and obstructing hindering ASIC. Two important sections of the act are s.292, which outlines the entities that must prepare annual financial reports and director’s reports; and s. 296, which stipulates that financial reports must comply with accounting standards.

Australian Securities Exchange (ASX)

ASX provides in-depth market data and information to a variety of users. It operates as the primary Australian exchange for shares, derivatives and fixed interest securities such as debentures.

ASX regulates entities through its business rules and listing rules.

Australian Competition and Consumer Commission (ACCC)

ACCC acts by covering anti competitive behavior and unfair market practices, mergers and acquisition of companies, product safety and liability.

The primary role of the commission is the protection of the consumers.

Reserve Bank of Australia (RBA) RBA is responsible for the stability of the Australian financial system and for setting monetary policy.

Australian Prudential Regulation Authority (APRA)

APRA oversees financial institutions and is responsible for ensuring that financial institutions can honor their commitments.

Australian Taxation Office (ATO)

ATO collects taxes and responsible for overseeing all self-managed superannuation funds.

Australian Accounting Standards Board (AASB)

AASB is responsible for the development of accounting standards for application to reporting entities under the corporation Act.

Functions/responsibilities of the AASB

Participating in IASB research projects Providing AASB staff to the IASB to work on selected projects Establishing and maintaining good relationships with other

standard setters such as New Zealand standard setter.

Financial Reporting Council (FRC)

FRC is responsible for overseeing the standard setting process in Australia. The FRC is made up of key stakeholders from the business community, the professional accounting bodies, government and regulatory agencies.

The FRC was also responsible for promoting the Australian adoption of IFRSs and monitors the operation of AASBs to assess their relevance and effectiveness in achieving their objectives.

Development of Accounting Standards

Following are the key steps involved in the event of establishing a new accounting standard.

Emerging issues are identified through submissions and other materials from interested parties. An emerging issue could be an exposure draft issued the IASB, or by a regulatory change in Australia that has consequences for standard setting.

When an emerging issue is added to the AASB’s work program, the AASB usually invites people with expertise to participate in the process to investigate different opinions, current practices and viewpoints on the issue.

An early version of the standard for comment, known as an exposure draft, is prepared and sent to selected entities, user groups, individuals, academics and practitioners for comment. This original draft is reviewed and may be amended after considering the views of the different parties.

The actual exposure draft is issued, inviting comment from all interested parties over a period of usually three months. This is available for downloading from the AASB website.

The accounting standard is finalized by reviewing the submissions from the exposure draft and the final standard is then prepared.

Key Professional Accounting Associations

Organisation Areas of expertise

CPA Australia (Certified Practising

Accountants)

Covers accountants working in industry,

commerce, government, academia and private

practice

Institute of Chartered Accountants in

Australia (ICAA)

Covers mainly public practice members (Auditors)

National Institute of Accountants (NIA) Covers accountants working in industry,

commerce, government, academia and private

practice

Australian Institute of Company Directors

(AICD)

Promotes knowledge and skills of directors

Charted Secretaries of Australia (CSA) Develops and improves good governance practices

for company secretaries

Chartered Institute of Management

Accountants (CIMA)

UK-based organization with branches in Australia

that specialises in management accounting

Financial Planning Association of Australia

(FPA)

Financial planning

Insolvency Practitioners Association of

Australia

Bankruptcy and insolvency

Taxation Institute of Australia Membership organization for tax agents

AASB Framework

A reporting entity is identified by reference to users who are dependent on general purpose financial reports for making and evaluating resource allocation decisions.

General purpose financial reports are financial reports intended to meet the information needs common to users who are unable to command the preparation of reports tailored to suit their information needs.

The current AASB framework includes following key 03 areas. The objective of financial reporting The Objective of financial reports is to provide information about the financial position, financial performance & cash flows of an entity that is useful to a wide range of users in making economic decisions. The users include present & potential all stakeholders.

The qualitative characteristics that determined the usefulness of information in financial reports

Key qualitative characteristic of financial reports will be as follows. Relevance – Information should have predictive and confirmatory

value for users in making and evaluating economic decisions. Relevance shall be affected by nature and materiality of information.

Reliability/Verifiability – The information must be without buyers or due error & must faithfully represent transactions & events.

Faithful representation – The financial information will be complete, neutral and free from error.

Comparability – The users of financial reports must be able to compare aspects of an entity at one time and over time, and between entities at one time & overtime.

Timeliness – Accounting information (financial and non-financial) is available to all stakeholders in time for decision making purpose. (how much applicable to financial accounting?)

Ability to Understand – The information should present in the most understandable manner to users without sacrificing relevance or reliabilities.

The definition, recognition and requirement of the elements

from which financial statements are constructed

Following elements should be identified in line with the definitions provided by the accounting standards.

Assets – A resource control by the entity as a result of past events & from which future economics benefits are expected to flow to the entity. E.g. PPE, Investments, Goodwill, Debtors, Inventory, Cash in hand & etc.

Liabilities – A Present obligations of the entity arising from past events & settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits. E.g. Long term & short term Loan, accrued expenses, provisions & etc.

Equity – The residual interest in the assets of the entity after deducting its liabilities. Equity will increase through contributions made by owners & through the excesses of the entity’s income over its expenditures & decrease vice versa. E.g. Share capital, capital reserve & revenue reserve (retain earnings)

Income – Inflows or other enhancements of assets or decreases of liabilities that result in an increase in equity during the reporting period. E.g. Sale of goods/services, interest on investments, dividends, service fee, grants, gain from sale of assets, discount received and etc.

Expenses – Decrease in economic benefits in the form of outflows or depressions of assets or incurrence of liabilities that result in a decreasing equity during the reporting period. E.g. Cost of sales, salaries & wages, power & electricity, rent, depreciation, interest, bad debts, telephone and etc.

Limitations of Accounting Information

A particular user should consider the limitations surrounding accounting information prior to use and make a decision on such information.

Time lag

Use historical information

Subjectivity of information

Potential costs - Information cost

- Release information to competitors

Evolution of Accounting Profession of accounting and most of its key attributes are evolving as a result of the effect of the following variables/factors/phenomena. Globalization Technological change Demographic change Social impact Trend of merge/consolidation With rapid changes in the recent past, following new career opportunities are emerged within the profession. Fund Accountant Internal Auditor Forensic Accountant Payroll Manager/Accountant Business Analyst