topic 2 accounting business
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Accounting andBusiness
Topic
2
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Learning Outcomes:
At the end of this topic, students
should be able to:
1. Explain the nature and types of business.
2. Defined assets, liabilities, owners equity,revenue and expenses.
3. Discuss on the differentiation of cash and
accrual accounting.4. Explain accounting assumptions, principles
and constraints.
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Business Entity Forms
Proprietorship Partnership Corporation
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Characteristics Proprietorship Partnership Corporation
Business entity yes yes yes
Legal entity no no yes
Limited liability no no yes
Unlimited life no no yes
Business taxed no no yes
One owner allowed yes no yes
*
* Proprietorships and partnerships that are set up as LLCs
provide limited liability.
Characteristics of Businesses
Exh.
1.8
*
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Corporation
Governed by: Companies Act 1965,Memorandum of Association & Article ofAssociation
Owners of a corporation are calledshareholders (or stockholders).
When a corporation issues only one class ofstock, we call it common stock (or capitalstock).
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Definitions of Income ,Expenses Assets,Liabilities and Equity, based on MASBFramework for the Preparation Presentation ofFinancial Statement.
Refer to FRS101 Presentation of FinancialStatementsat www.masb.org.my
DEFINITIONS
http://www.masb.org.my/http://www.masb.org.my/ -
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INCOME
Income is increases in economic benefitsduring the period in the form of inflows orenhancements of assets or decreases of
liabilities that result in increases in equity,other than those relating to contributions fromequity participants.
Income includes both revenue and gains.
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INCOME
REVENUE - the gross inflow of economic benefitsduring the period arising in the course of theordinary activities of an enterprise when thoseinflows result in increases in equity, other thanincreases relating to contributions from equity
participants. increases assets results from the sales of
goods and services, fees, interest, dividends,royalties, grants and rent.
GAINS - increase assets might arise from thedisposal of assets, or the revaluation of financialinstruments, investment property and agriculturalassets, among other things
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EXPENSES
Expenses are decreases in economic benefits duringthe period in the form of outflows or depletions ofassets or increases of liabilities that result indecreases in equity, other than those relating to
distributions to equity participants.
Expenses include both expenses and losses.
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Probable future economic benefit obtained or controlledby a particular entity as a result of past transactions orevents
E.g.:1.Cash,
2.Accounts and notes receivable
3.Inventories
4.Prepaid items
5.Property, plant, and equipment
ASSETS
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Land
Equipment
Buildings
Cash
Vehicles
StoreSupplies
NotesReceivable
AccountsReceivable
Resourcesowned orcontrolled
by a
company
Assets
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Probable future sacrifice of economicalbenefit arising from a present obligation of aparticular entity to transfer assets or provide
services to other entities in the future as aresult of past transactions or events.
Obligation includes legal, moral, social, and
implied commitments.
LIABILITY
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TaxesPayable
WagesPayable
NotesPayable
AccountsPayable
Creditors
claims onassets
Liabilities
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OWNERS EQUITY
Residual interest in the assets of an entity that remainsafter deducting its liabilities.
E.g.: (corporation)
Share capital ordinary and preferred shares
Reserves share premium, revaluationreserve, etc.
Retained earnings is the amount of theundistributed earnings of past periods.
ASSET LIABILITY = EQUITY
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Ownersclaims
on
assets
Revenues
OwnerInvestments
OwnerWithdrawals
Expenses
Equity
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Classification of
Assets and Liabilities
How to Classify Items on the Balance Sheet
1. Current (one year or less)
2. Non-current (more than 1 year)
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those assets that; Are either expected to be realised in, or intended for
sale or consumption in, the normal course of entitys
operating cycle;
Held primarily for trading purposes; Expected to be realised within 12months after the
balance sheet date; or
E.g.:
1. Accounts and notes receivable2. Inventories
3. Prepaid items
4. Cash
CURRENT ASSETS
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Operating Cycle
the time between the acquisition of assets for processing andtheir realisation in cash or cash equivalents.
When the entity's normal operating cycle is not clearly
identifiable, its duration is assumed to be twelve months.
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Operating Cycle
Receivables
Cash
Inventories
PurchasesCollections
Sale
s
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All other assets that do not meet the currentassets criteria.
E.g.:
Investments
Property, plant, and equipment (PPE)
Deferred income taxes
PPE - properties of a tangible and relatively permanentnature that are used in the normal business operations.
Intangible assets - long-term rights and privileges of anonphysical nature acquired for use in businessoperations. E.g.: goodwill, patent, copyright, etc.
NON-CURRENT ASSETS
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Liabilities are classified as CURRENT if they are:
Expected to be settled in the entitys normal
operating cycle or less than 12 months.
Held for trading.
it is due to be settled within twelve months afterthe balance sheet date
E.g.:1. accounts payable,
2. notes payable,
3. accrued expenses
CURRENT LIABILITIES
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NON-CURRENT LIABILITIES
All other liabilities that do not meet the currentliabilities criteria.
E.g.:
Long-term debt
Long-term lease obligations
Deferred income tax liability
Pension obligations
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Timing Issue:
Cash-Basis AccountingVs
Accrual-Basis Accounting
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Cash-Basis Accounting
Revenues are recognized when cash isreceived.
Expenses are recognized when cash is paid.
Cash-basis accounting is not in accordancewith generally accepted accounting principles(GAAP).
Use by public sector (government). But mostof the public sector is moving towards theapplication of accrual basis.
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Transactions recorded in the periods in which the
events occur
Revenues are recognized when earned, rather than
when cash is received.
Expenses are recognized when incurred, rather
than when paid.
Accrual-basis accounting is applied accordancewith generally accepted accounting principles
(GAAP).
Use by private entities
Accrual-Basis Accounting
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The Operating Guidelines of
Accounting
ASSUMPTIONS PRINCIPLES CONSTRAINTS
Economic entity Historical costs Conservatism
Monetary unit Revenue recognition Materiality
Going concern Matching
Time period Full disclosure
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Accounting Assumptions
Economic Entity
The business is accounted forseparately from other business
entities, including its owner
Monetary Unit PrincipleExpress transactions and events in
monetary, or money, units
Now Future
Going-Concern PrincipleReflects assumption that the
business will continue operatinginstead of being closed or sold
Time PeriodThe economic life of business can bedivided into artificial time period forthe purpose of financial reporting
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Accounting Assumptions
Economic entity:
Defines the scope of the business
Identifies which transactions should be recorded
Going Concern
Allow to record assets at historical cost
Monetary Unit:
Provides a common unit of measure
Permit to add & subtract items on FS
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Time Period Assumption
Time Interval
/ Periodicity
assumption
Final accounts are prepared
at regular intervals (monthly, quarterly,
Annually)
Known as accounting period /financial year.
Examples of annual accounting period:
Calendar year : 1/1/2008
31/12/2008
Fiscal year:1/7/2006-30/6/2007
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Historical CostAccounting information is based
on actual cost.
Revenue Recognition1. Recognize revenue when it is
earned.
2. Proceeds need not be in cash.3. Measure revenue by cash
received plus cash value of itemsreceived.
MatchingExpenses are matched against
revenues, and recorded in thesame period in which the related
revenues are earned
Accounting Principles
Full DisclosureReport enough information forusers to make knowledgeabledecisions about the company
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Accounting Principles
Matching
Principle
Full
Disclosure
Principle
Profit is recognized by matching
the income of the period with all
expenses incurred in earning such
income.
Financial statements should provide
sufficient / relevant information
to influence users decision making,
(e.g Acctg policies, methods,
Changes in policy)
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Accounting Constraints
ConservatismIncome and assets be reported at
their lowest reasonable amounts (i.e.minimizing the assets andunderstating the income) Materiality
Accountants are required to
accurately account for significantitems and transactions
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Accounting Constraints
Materiality
Principle
ConservatismPrinciple
An item is said to be material
if it is sufficiently important
to affect our judgment of the
true position of the firm.
When in doubt, choose the solution
that will be least likely to overstate
assets and income. In easy word,
Income and asset are reported at
their lowest reasonable amounts.
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Material
Omissions or misstatements of items are material if they could,individually or collectively, influence the economic decisions ofusers taken on the basis of the financial statements.
Materiality depends on the size and nature of the omission ormisstatement judged in the surrounding circumstances.
The size or nature of the item, or a combination of both, couldbe the determining factor.
(FRS101)
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