Test 6

• Liability a present obligation of the entity to transfer an economic resource as a result of past events
• Income increases in assets OR decreases in liabilities, that result in increases in equity, other than those relating to contributions from holders of equity
• Expenses decrease in assets or increase in liabilities, that result in decreases in equity, other than those relating to distributions to holders of equity
• Financial statements:

  These are the:

  1. Income Statement
  2. Balance Sheet
• The Income statement shows how much profit/loss was earned during a period (usually one year)
• The Balance sheet shows what the company owns and owes at a specific point in time (usually end of financial year). It also includes shareholder's equity which represents the value of the shares owned by investors.
• Expense


  Decreases in assets OR increases in liabilities, that result in decreases in equity, other than those relating to distributions to holders of equity claims
• Asset recognition criteria


  • Contained in the Framework
  • Two conditions must be met before recognition
• Asset recognition criteria


  1. Is the information RELEVANT?

  2. Is there a Faithful Representation of its value?
• Relevant information


  Important enough to make a difference in decisions made by users of the reports
• Liability recognition criteria


  • Contained in the Framework
  • Two conditions must be met before recognition
• Liability recognition criteria


  1. Is the information RELEVANT?

  2. Is there a Faithful Representation of the value of the obligation?
• According to the Conceptual Framework, an asset or liability may not be recognised if it is uncertain whether or not the asset or liability exists
• According to the Conceptual Framework, an asset or liability may not be recognised if the probability of an inflow or outflow of economic benefits is low
• Faithful Representation


  Value can be determined with a degree of certainty; must be complete, neutral (free from bias), and free from error
• Measurement methods for Faithful Representation

  • Historical cost
  • Value in use
  • Current value
• The recognition of income and expenses is dependent on the recognition criteria for assets and liabilities
• Income recognition


  1. Recognised when it is EARNED

  2. Increase in an asset or decrease in a liability occurs
• Income recognition scenarios


  • Services - when the job is completed
  • Trading - when inventory is passed on to the customer
• Cash can be received before, during, or after it is earned
• Expense recognition


  1. Recognised when it is INCURRED

  2. Decrease in an asset or increase in a liability occurs

  3. Resource is consumed or expired
• Cash can be paid before, during, or after it is incurred
• Accrual Accounting


  Income is recognised when it is earned
• Income recognition


  When the right to receive cash is recognised
• Income is recognised


  When a job or service is completed or when inventory is sold and passed to a customer
• Expenses recognition


  When they are incurred
• Cash Accounting


  Income is recognised when cash is received from customers; expenses are recognised when cash is paid
• Balance day adjustments are entries made on BALANCE DAY to adjust cash received from income and cash paid for expenses
• Adjusting entries


  Made to income and expense accounts at the end of the accounting period
• Adjusting entries ensure that the recognition criteria are followed for assets, liabilities, income and expenses
• Prepaid expenses are resources that are paid for in this period but are consumed in the next accounting period
• Prepaid expenses


  Treated as an asset when paid because they represent a future benefit
• Prepaid expenses


  • Rent
  • Insurance
  • Advertising
• If adjusting entry is not carried out, the assets will be overstated and expenses understated meaning profit will be overstated
• Income in advance


  Income received in cash this accounting period but not earned until next period
• Income in advance is treated as a liability because the business has not done the work yet to earn the income
• If adjusting entry is not carried out, the liabilities will be overstated and income understated meaning profit will be understated
• Accrued Expenses


  Expense incurred in this accounting period but has not yet been paid
• If adjusting entry not carried out for accrued expenses, profit will be overstated and liabilities will be understated
• Accrued Income


  Income earned in this accounting period but has not yet been received