week 3 - elements of accounting

• Elements

  • assets
  • liabilities
  • equity
  • income
  • expenses
• Assets

  • a present economic resource controlled by (the entity) as a result of (past events) an economic resource is a right that has the potential to produce (economic benefits)
  • "controlled" - usually means owned. exception is lease, eg leasing equipment, cars, machines
• Liabilities

  • "a (present obligation) of the entity to transfer (an economic resource) as a result of (past events)"
  • Present obligation means a duty to act or perform in a certain way in the future.
  • Transfer of an economic resource could involve cash settlement, or the provision of goods or services.
  • A past event must have already occurred, the intention to do something in future is not adequate.
• Equity

  • "the residual interest in the assets of the entity after deducting all its liabilities"
  • "what's left of the assets, after liabilities are taken away"
  • This simply means what is left over after taking liabilities away from assets: Equity = Assets – liabilities
  • Equity is dependent on the definitions and measurement of assets and liabilities.
• Income / revenue

  • ‘increases in assets, or decreases in liabilities, that result in increases in equity, excluding contributions from holders of equity claims’
  • owners contributing capital can never be considered income
  • most common: sales revenue. less common: gains (eg. selling NCA for profit)
  • the timing of income recognition is important
• Expenses

  • decreases in assets, or increases in liabilities, that result in decreases in equity, excluding distributions to holders of equity claims (ie. drawings & paying owners' dividends)
• recognition criteria

  • even though an item fits into a criteria, deciding WHEN it should be recorded is crucial
  • an item meeting the definition should be recorded if it is RELEVANT or FAITHFULLY REPRESENTED
  • e recognition criteria apply to assets, liabilities, income and expenses (not equity)
  • because equity is just a calculation (A-L)
• Relevance ( probable)

  • recording an item may be irrelevant if:
  • 1)It is uncertain whether an asset or liability exists
  • 2) An asset or liability exists, but the probability of an inflow or outflow of economic benefits is low. (eg. a new car that won't turn on, don't record, useless)
  • don't record if: not sure asset will provide benefit, not sure liability requires repayment, not sure that revenue has been earned, not sure that expense has incurred
• Faithful representation

  • recognition should be truthful, honest, representative of what firm's trying to show, affected by uncertainty of estimates.
  • If the level of uncertainty in estimating a value is high, the estimate may not be a faithful representation, and therefore not useful to users.
  • If an acceptable estimate cannot be found, an item should not be recorded
• Recognition v Disclosure

  • recognised: if included in financial statements (ie. meets definition and recognition criteria)
  • disclosed (revealed): if included in notes of financial statements (ie. meets the definition but NOT the recognition criteria)
  • recognised = certain. disclosed = uncertain
• asset

  1. an economic resource
  2. controlled by the entity
  3. potential to produce economic benefit
• liability

  • present obligation
  • involves transfer of economic resource
  • due to past events
• income

  • increase in assets / decrease in liabilites
  • increase in equity
  • not a contribution from owner
• expense

  • increase in liabilities / decrease in assets
  • decrease in equity
  • not drawings
• reports

  • income statement : income, expenses
  • balance sheet: assets, liabilities, owners equity
  • statement of changes in equity: owners equity
  • statement of cash flows: cash (one type of asset)
• cash accounting

  • Records incomes and expenses at the TIME the cash is received or paid
  • eg. if someone buys an item on credit in june, paying in july, the cash will be recorded in july
• accrual accounting

  • Records incomes and expenses when they are earned or incurred, regardless of the cash movement
  • income is recognised when earned, regardless of whether cash had already been received or is yet to be received.
  • Expenses are recognised when they are incurred, regardless of whether cash has been paid already, or is still owing.
• when recording transaction BEFORE cash movements

  • selling inventory to customers on credit (ACC. rec)
  • purchasing inventory from suppliers on credit (ACC. pay)
• when recording transaction AFTER cash movement

  • early payment - an asset
  • eg. prepaid rent, purchasing rent before the expense has incurred(ie. before the time period for rent)

  or

  • early sales - a liability
  • eg. unearned income, selling inventory before the revenue was earned