Topic

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Accounting and Business

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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Exh. 1.8

Characteristics of Businesses
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.
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Corporation
Governed by: Companies Act 1965,

Memorandum of Association & Article of Association

Owners of a corporation are called

shareholders (or stockholders).

When a corporation issues only one class of

stock, we call it common stock (or capital stock).

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DEFINITIONS
Definitions of Income ,Expenses Assets,

Liabilities and Equity, based on MASB Framework for the Preparation Presentation of Financial Statement.
Refer to FRS101 Presentation of Financial

Statements at www.masb.org.my

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INCOME
Income is increases in economic benefits

during the period in the form of inflows or enhancements of assets or decreases of liabilities that result in increases in equity, other than those relating to contributions from equity participants.
Income includes both revenue and gains.

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INCOME
REVENUE - the gross inflow of economic benefits

during the period arising in the course of the ordinary activities of an enterprise when those inflows result in increases in equity, other than increases 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 the

disposal of assets, or the revaluation of financial instruments, investment property and agricultural assets, among other things
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EXPENSES
Expenses are decreases in economic benefits during

the period in the form of outflows or depletions of assets or increases of liabilities that result in decreases in equity, other than those relating to distributions to equity participants.
Expenses include both expenses and losses.

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ASSETS
Probable future economic benefit obtained or controlled

by a particular entity as a result of past transactions or events

E.g.:

1.Cash, 2.Accounts and notes receivable 3.Inventories 4.Prepaid items 5.Property, plant, and equipment
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Assets
Cash Accounts Receivable Notes Receivable

Vehicles

Resources owned or controlled by a company

Land

Store Supplies
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Buildings

Equipment

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LIABILITY
Probable future sacrifice of economical

benefit arising from a present obligation of a particular entity to transfer assets or provide services to other entities in the future as a result of past transactions or events.
Obligation includes legal, moral, social, and

implied commitments.

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Liabilities
Accounts Payable Notes Payable

Creditors claims on assets

Taxes Payable
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Wages Payable
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OWNERS EQUITY
Residual interest in the assets of an entity that remains

after deducting its liabilities.

E.g.: (corporation)

Share capital ordinary and preferred shares Reserves share premium, revaluation reserve, etc. Retained earnings is the amount of the undistributed earnings of past periods.

ASSET LIABILITY = EQUITY

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Equity
Owner Investments Owner Withdrawals

Owners claims on assets

Revenues
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Expenses
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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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CURRENT ASSETS

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 12 months after the balance sheet date; or

1. 2. 3. 4. Accounts and notes receivable Inventories Prepaid items Cash
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E.g.:

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Operating Cycle
the time between the acquisition of assets for processing and

their 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
Cash Collections

Purchases

Receivables
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Inventories
Sale s
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NON-CURRENT ASSETS

All other assets that do not meet the current assets criteria.
E.g.: Investments Property, plant, and equipment (PPE) Deferred income taxes

PPE - properties of a tangible and relatively permanent nature that are used in the normal business operations. Intangible assets - long-term rights and privileges of a nonphysical nature acquired for use in business operations. E.g.: goodwill, patent, copyright, etc.
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CURRENT LIABILITIES

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 after the balance sheet date
E.g.: 1. accounts payable, 2. notes payable, 3. accrued expenses

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NON-CURRENT LIABILITIES
All other liabilities that do not meet the current

liabilities criteria. E.g.:

Long-term debt Long-term lease obligations Deferred income tax liability Pension obligations

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Timing Issue:
Cash-Basis Accounting Vs Accrual-Basis Accounting

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Cash-Basis Accounting
Revenues are recognized when cash is

received. Expenses are recognized when cash is paid. Cash-basis accounting is not in accordance with generally accepted accounting principles (GAAP). Use by public sector (government). But most of the public sector is moving towards the application of accrual basis.
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Accrual-Basis Accounting
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 accordance with generally accepted accounting principles (GAAP).
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Use by private entities

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The Operating Guidelines of Accounting

ASSUMPTIONS
Economic entity Monetary unit

PRINCIPLES
Historical costs Revenue recognition

CONSTRAINTS
Conservatism Materiality

Going concern

Matching

Time period

Full disclosure

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Accounting Assumptions
Now Future

Economic Entity The business is accounted for separately from other business entities, including its owner

Going-Concern Principle Reflects assumption that the business will continue operating instead of being closed or sold

Monetary Unit Principle Express transactions and events in monetary, or money, units
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Time Period The economic life of business can be divided into artificial time period for the 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

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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Time Interval / Periodicity assumption

Accounting Principles
Revenue Recognition 1. Recognize revenue when it is Historical Cost earned. Accounting information is based 2. Proceeds need not be in cash. on actual cost. 3. Measure revenue by cash received plus cash value of items received.
Full Disclosure Report enough information for users to make knowledgeable decisions about the company
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Matching Expenses are matched against revenues, and recorded in the same period in which the related 4/18/2012 revenues are earned

Accounting Principles
Profit is recognized by matching the income of the period with all expenses incurred in earning such income.

Matching Principle

Full Disclosure Principle

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

Conservatism Income and assets be reported at their lowest reasonable amounts (i.e. minimizing the assets and understating the income)

Materiality Accountants are required to accurately account for significant items and transactions

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Accounting Constraints
An item is said to be material if it is sufficiently important to affect our judgment of the true position of the firm.

Materiality Principle

Conservatism Principle

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 of users taken on the basis of the financial statements.
Materiality depends on the size and nature of the omission or

misstatement judged in the surrounding circumstances.

The size or nature of the item, or a combination of both, could

be the determining factor. (FRS101)

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