Financial Analytics for

Managerial Decisions

Week 1 -
Introduction to the course and the balance sheet
1.0.0 Week Introduction:
BALANCE SHEET: The balance sheet is a listing of a company’s assets and liabilities, as
well as the owner's equity at a point in time. This financial statement provides a snapshot of
the resources a company has under its control to operate the business, together with how
the company has financed these resources.

There are two sides/sections to the balance sheet:

● The assets side of the balance sheet is concerned with the resources that the
company owns, or has under its control, that will provide future economic benefits to
the company.
● The other side of the balance sheet explains how a company has financed the assets
of the company, either via liabilities or the owner’s capital or retained earnings.

ASSETS and LIABILITIES are usually classified into current and non-current categories in
the balance sheet.

EQUITY is usually categorised into share capital, retained earnings and reserve.

The accounting equation below and the principles of the double-entry system keep the
balance sheet in balance:

Assets = Liabilities + Owner's equity

1.1.0 Activity: Explain the importance of financial analytics and
its relationship with accounting and finance
The tasks designed here are based on the readings posted on Canvas and sections 1.1, 1.2 and 1.4
from Chapter 1 of Birt et al. 2019, Accounting, Business Reporting for Decision Making, 7th edn.,
John Wiley & Sons.
1.1.1 Why is financial analytics important and what is its relationship
with accounting and finance?

Financial analytics is a field that draws insights from a business’s financial data. It helps to
gain in-depth knowledge of the business’s financial situation and takes actions to improve its
performance. Financial analytics is important for managers to make effective and
sustainable business decisions.

Accounting comprises financial accounting and management accounting:

1. Financial accounting deals with identifying, measuring and communicating relevant
business transactions that have happened in the past.
● Primarily focused on the historical performance of a business. It involves
identifying, measuring, and reporting financial transactions that have already
taken place. The output is usually in the form of financial statements (income
statement, balance sheet, cash flow statement) that are shared with external
stakeholders like investors, creditors, regulators, and tax authorities.

2. Management accounting is concerned more with the planning and controlling of the
current and short term business activities.
● Focuses on internal decision-making for a business. It is more concerned with
planning, budgeting, and controlling current and short-term operations.
Management accounting helps managers make informed decisions through
techniques like cost analysis, variance analysis, and performance metrics. It's
not subject to the same strict external reporting standards as financial
accounting, as it's used internally.

Finance focuses on long term issues such as capital investment decisions, management of
funding sources etc. and is, therefore, oriented towards the future.
● While both accounting branches focus on recording and analysing past and current
activities, finance is forward-looking. It deals with managing the company’s capital
structure, investment decisions, and how to fund future operations. Finance is
concerned with long-term strategies, including capital investments (like expanding a
business or acquiring assets), risk management, and securing funding from various
sources (equity, debt, etc.).
1.1.1 VIDEO: The importance of Financial Analytics

FINANCIAL ANALYSIS helps users to evaluate an entity’s past financial information and
form an opinion as to the entity’s future financial health.

The types of analysis can include:

- the comparison of financial results over periods
- the comparison with a competitor of the entire industry sector.
The analysis of financial information reveals how an entity is doing relative to various
benchmarks.

The analysis of cost and pricing information helps the managers to make important
decisions.
- How many products to produce to break even?, how to set up a competitive price for
the products?…)
1.1.1 VIDEO: The difference between Accounting and Finance

Accountants: primarily concerned with the goal that is historical-looking.

● The goal is to create a set of financial statements that accurately represents the
financial standing of a company at some moment in time.
● They look at the economic transactions that have occurred up to this point.
They look at how much cash is in the bank today and ask “how did we get here?”
They create a set of financial statements that accurately represents that.

Finance: the goal is future-looking

● “This is how much cash we have in the bank today, this is how we got there, what are
our assumptions about what’s going to happen in the future?”
● They take those assumptions and that informs the business decisions we make
about how we’re going to use the cash today.

RISK

Accounting: concerned with the risk of Finance: what’s the variance between my
material misstatement of the financial assumption about the future and what
statements - (somehow something is not actually ends up happening - (risk of
being accurately represented). incorrect assumptions).

1.1.2 Discussion: The importance of accounting information for

managers, creditors and customers

Accounting information is structured to assist a variety of users that are broadly classified as
internal and external (stakeholders).

External stakeholders: we have investors, which include shareholders, bondholders and

lenders, as well as creditors, customers, government authorities, regulatory bodies and
many more. They all use this information for decision-making that suits their purposes.

Managers are classified as internal users of accounting information.

Different stakeholders use accounting information for different purposes, including the
following:
● Investors are concerned with future profitability, cash flows, dividends, interest and
principal repayments.
● Government authorities (e.g. ATO) use accounting information to establish the
accuracy in determining tax liabilities or assets.
● Regulatory bodies (e.g. ASIC) ensure compliance with the accounting standards, the
Corporations Act 2001 (Cwlth), taxation laws and others.
1.1.2 Discussion: “Reflect and share your thoughts on why managers,
creditors and customers need accounting information.”

MY ANSWER

Managers need to create budgets, predict future revenues and expenses, and plan
resource allocation. By looking at the accounting information, it helps them to decide where
to focus investments, reduce costs or reallocate resources in order to achieve short and
long-term business goals.

Creditors need to evaluate if a company is able to repay its loans or debts.

They use the company’s accounting information to understand whether the company is
making enough cash from their operations to be able to cover the debt obligations.

Customers are looking for consistency of products and services. By looking at the
accounting information, customers assess the risk of entering into long-term contracts.
This is essential in industries where customers are relying on ongoing service or support.
1.2.0 Activity: The accounting standards - Their rigidity and
flexibility
This activity addresses learning outcomes 3 and 4 for the week. The tasks designed here are based
on sections 1.3, from Chapter 1 and sections 2.1, 2.2 and 2.3 of Chapter 2 from Birt et al. 2019,
Accounting, Business Reporting for Decision Making, 7th edn., John Wiley & Sons.
1.2.1 The relevance of accounting standards for financial accounting

The UK-based International Accounting Standard Board (IASB) issues the International
Financial Reporting Standards (IFRS). Most countries worldwide have adopted IFRS for
publicly listed companies.

The US-based Financial Accounting Standards Board (FASB) have the Generally Accepted
Accounting Principle (US-GAAP), but there is a drive to converge IFRS with US-GAAP.

In Australia, the Australian Accounting Standards Board (AASB) is responsible for issuing
Australian versions of the international accounting standards. Since 1 January 2005, AASB
has subscribed to IFRS. As such, IFRS provides the underlying basis for the accounting
standards and practices in Australia.

Another role of the AASB is to provide critical inputs for further development of IFRS.
Following the standards is mandatory and is enforced through regulatory bodies and the
Corporations Act, which stipulates that all the disclosing entities, public companies and large
proprietary companies must apply AASB standards (i.e. IFRS) in preparing their reports.
Accounting bodies such as Chartered Accountants Australia and New Zealand (CAANZ),
Certified Practising Accountants Australia (CPA) and the Institute of Public Accountants (IPA)
ensure implementation of accounting standards through their members who are accounting
professionals.

The development of accounting standards is lengthy and rigorous and must follow due
process. Also, the implementation of these standards is a complex and costly exercise for
firms.

“Reflect why are converging accounting standards so important for

stakeholders and managers?”

MY ANSWER

Converged accounting standards simplify financial reporting and make the company more
attractive to global investors. Stakeholders have more confidence in financial information
that adheres to a recognized standard and which aligns with global norms. Not only does
this eliminate confusion or misrepresentation that could arise from using different
accounting frameworks, it makes it easier to assess risk and return on investment.

Converged accounting standards promote consistency, transparency and comparability

and help assure stakeholders that the financial information provided is reliable. This is
crucial for companies/managers looking to build trust with stakeholders.

Converged accounting standards reduce the need for multiple financial reports that
managers would otherwise need to tailor to adhere to different regions while also reducing
the cost of maintaining different sets of financial reports. In addition, converging standards
align with global regulatory requirements, which pose fewer risks of penalties or
compliance issues when operating across different regions.
TEACHER’S ANSWER

In this era of globalisation where worldwide economies are converging and companies are
becoming multinational, standardisation of accounting practices and high-quality financial
reporting promotes transparency, accountability, comparability and efficiency for investors
in financial markets.

For multinational companies, universal standards significantly reduce reporting and

regulatory costs. Also, cross-border investments are enormous, and companies may
approach any financial market for raising capital. Following international accounting
standards allows potential investors to understand a business’s prospects well.

1.2.2 Distinguish between the financial and management accounting

Financial accounting
Financial accounting is concerned with the preparation and presentation of financial
statements. General purpose financial statements (GPFSs) are prepared to meet the
common information needs of a wide range of users (both internal and external) who are
unable to command special reports to suit their own needs (stakeholders). This information
is governed by generally accepted accounting standards (GAAP) which provide accounting
standards for preparing statements.

The main financial statements are as follows:

● The balance sheet - shows what an entity owns and what it owns at a specific date.
● The income statement - shows an entity’s profit or loss for a specific period.
● The cash flow statement - reports an entity’s cash inflows and outflows.

Management accounting
Management Accounting is about preparing internal reports to suit the needs of the
management (internal users) which may require any level of detail. As a result, they are not
regulated by standards like financial accounting (for stakeholders). It is predominately about
planning and decision making for future events and analysing past events.

Core activities include:

● Formulating plans and budgets
● Providing information to be used in monitoring and control within the entity.
1.2.2 VIDEO: The difference between Financial and Management
Accounting

Financial Accounting
- Preparation and presentation of financial statements
GPFS (General Purpose Financial Statements) → GAAP (Generally Accepted Accounting Principles)
- Allow users to make economic decisions about the entity.

Financial Statements
- A set of statements (balance sheet, income statement, cash-flow statement, changes of equity statement)
- Directed towards the common information needs of a wide range of users (both internal
and external)

● Financial statements consist of:

- Statement of cash-flows - (flow of funds → cash inflows/outflows)
- Statement of financial position - (balance sheet → what business owns and owes)
- Statement of profit or loss - (income statement → profit/loss performance)

FOR COMPANIES
- The statement of profit or loss and other comprehensive income
- The statement of changes in equity
Capital account: amount initially invested by stakeholders (did they put more money in?)
Profit/Loss statement: profit/loss belonging to stakeholder.

Management Accounting
- No regulatory body, not regulated by rules
- Economic information for internal users
- Predominantly about planning and decision making for future events

● Core activities include: (can include as much/as little detail as required)

- Formulating plans and budgets
- Providing information to be used in monitoring and control within the entity
- Can also include QUALITATIVE aspects about the business, unlike Fin.Acc.

Financial Accounting Management Accounting

- Historical picture of past operations - Can be both a historical record and a
- Bound by GAAP, Corporations Act, ASX.. projection for future activities
- External: ATO, investors, suppliers, - Less formal and without prescribed rules
consumers, banks, employees… - Internal - managers in the entity
- Quantitative in nature - concerning the - Both quantitative and qualitative - more
whole entity detailed

Quantitative financial data include numbers you can measure, such as revenue, expenses,
profit margins and taxes.

Qualitative financial data help you determine the intangible impact of different transactions
on your business.
Benefits of a Business Plan
The business plan provides a clear, formal statement of direction and purpose.
● Allows management and employees to work towards defined goals in the daily
operations of the business.
● The business entity in evaluating the business.

Operation of the Business

Accounting information provides managers and owners with the tools they require to:
● Make decisions regarding the daily running of the business entity.
● Evaluate whether the goals set by the business entity in the planning process are
being achieved.

Cost-Volume-Profit Analysis
Understanding how profits will change in response to changes in sales volumes, costs and
prices.

Evaluation of the Business Plan

Accounting information provides management with the tools necessary to:
● Evaluate the business plan
● Encourage the management and owners to review all aspects of the operations.

- Management can make changes to the entity’s operating activities to ensure that they keep
on track with the original business plan.
1.3.0 Activity: The balance sheet and the accounting equation
This activity addresses Learning Outcomes 5, 6 and 7 for the week. The tasks designed here are
based on the sections: 2.3 from Chapter 2, 4.1 to 4.5, 4.7 and 4.9 from Chapter 4, and 5.2 to 5.8 from
Chapter 5 of Birt et al. 2019, Accounting, Business Reporting for Decision Making, 7th edn., John
Wiley & Sons. It is also based on the additional contents provided in the activity itself.
1.3.1 The role of the conceptual framework

The adoption of IFRS by the AASB in 2005 also entailed that its Framework for Preparation
and Presentation of Financial Statements be adopted. In 2010, it was revised and titled the
Conceptual Framework. The objective of the Conceptual Framework is to “provide
information about the financial position, financial performance and cash flows of an entity
that is useful to a wide range of users in making economic decisions” (IFRS 2010). As per
the framework, GPFSs are designed with the following characteristics.

Fundamental qualitative characteristics

Relevance (Users use this information for predictive purposes)

Information should have predictive and confirmatory value for users.

Faithful Representation (Information is reliable and not misleading)

Implies that financial information faithfully represents the phenomena it purports to
represent.

Enhancing qualitative characteristics

Comparability (compared with previous years, or compared with competitors)

Can compare aspects of the entity at one time and over time, and between entities at one
time and over time.

Verifiability (reliability of the information)

Assures that the information faithfully represents what it suggests that it is representing.

Timeliness (must be released to stakeholders in time)

Information is available to all stakeholders in time for decision-making purposes.

Understandability (clear guidelines in presentation of information and depth of information)

Implies that preparers of information have classified, characterised and presented the
information clearly and concisely - in the most understandable manner for users.

1.3.1 VIDEO: Regulatory bodies and the role of the Conceptual

Framework

Regulatory Bodies and Compliance

● (ASIC) Australian Securities and Investments Commission - Corporations Act 2001
● (ASX) Australian Securities Exchange
● (ACCC) Australian Competition and Consumer Commision
● (RBA) Reserve Bank of Australia
● (APRA) Australian Prudential Regulation Authority - (finance institution)
● (ATO) Australian Taxation Office
Australian and International Accounting Standards
● Prior to 2005, Australian Accounting Standards were largely developed by the
Australian Accounting Standards Board (AASB)
● Since 1. January 2005, Australian entities have complied with International Financial
Reporting Standards (IFRS). The adoption of IFRS has ensured compliance with
internationally agreed principles, standards and codes of best practice, resulting in
the issue of various new standards and the amendment of many existing Australian
standards.
● The AASB provides input into current International Accounting Standards Board
(IASB) projects by issuing exposure drafts of amended Australian Accounting
Standards that incorporate the relevant clauses and requirements of IFRS.

The functions and responsibilities of the AASB include:

- Issuing Australian Accounting Standards
- Significantly influencing the development of IFRS (such as providing significant input
to the development of standards relating to the global financial crisis)
- Promoting globally consistent application and interpretation of accounting standards.

A disclosing entity (large, listed companies that have stakeholders outside the business who rely on annual
is an entity that issues securities that are quoted on a stock market or
reports/financial statements)
made available to the public via a prospectus.

The Corporations Act (legal force) stipulates that disclosing entities, public companies and large
proprietary companies must apply Australian Accounting Standards in preparing their
financial reports.

For other reporting entities (i.e. non-disclosing entities), preparers and auditors of general
purpose financial statements (GPFS) have a professional obligation to apply the accounting
standards.

In Australia, there are two main professional accounting associations:

1. CPA Australia
2. Chartered Accountants Australia and New Zealand (CAANZ)
CPA Australia and CAANZ play important roles in regulating Australian companies through
stringent regulation of their members and through their input into the standard setting
process.

CYCLE

Accounting Standards → through Corporations Act

Professional bodies → ensure that the businesses prepare their financial report in
accordance with the requirements.
Role of the Conceptual Framework

Conceptual Framework: a set of guidelines which helps us in preparation of financial

statements, as well as which guides the standards for future developments.

Original Conceptual Framework contained Statements of Accounting Concepts (SACs):

● Assisted in preparation and presentation of financial statements
● Assisted standard setters in developing future accounting standards

Since 2005 have adopted IASB framework:

● Applies to all disclosing entities
● Users rely on general purpose financial statements (GPFS)

In 2010, the IASB issued a revised document titled Conceptual Framework for Financial
Reporting (Conceptual Framework).
This document has since been superseded, with the revised Conceptual Framework (issued
in March 2018) becoming effective for annual reporting periods beginning on or after 1.
January 2020.

In 2018, the AASB was working on replacing the existing AASB Framework for the
Preparation and Presentation of Financial Statements with the revised Conceptual
Framework.

Objective of Financial Reporting

According to paragraph 1.2 of the Conceptual Framework general purpose financial
reporting provides a reporting entity’s financial information in a way that is of use to ‘existing
and potential investors, lenders and other creditors in making decisions about providing
resources to the entity.’

The financial reports are prepared with the assumption that its users have a ‘reasonable
knowledge’ (paragraph 2.36 of Conceptual Framework) of the business and its economic
activities.

SUMMARY
● Many regulatory bodies involved in how the business is reporting its annual reports.
● AASB has subscribed to IFRS - moving towards standardisation of the accounting
standards.
● Reporting styles - Conceptual Framework - prescribes exactly how we want to
present the information and tells us to follow the (GPFS) general purpose financial
statement (balance sheet, income statement, cash-flow statement, changes of equity statement)
● Implementation of requirements:
- once the Australian Accounting Standards are issued, we ensure that businesses
follow those standards → through Corporations Act (legal force)
→ through professional bodies (CPA Australia/CAANZ)
(professional associations of accounting bodies)
They maintain the books accordingly
1.3.2 The elements of the balance sheet

The Conceptual Framework provides the definitions and recognition criteria for the elements
of a balance sheet and other financial statements.

The balance sheet shows what an entity owns and owes at a specific date. The statements
lists all of the company’s assets, liabilities and equity components at one point in time.

Definitions

Asset
A resource controlled by the entity as a result of past events, from which future economic
benefits are expected to flow to the entity.
Examples include: property, plant and machinery, cash at hand, inventory, and so on.
Assets may further be classified as current and non-current.

Liability
A present obligation of the entity arising from past events, the settlement of which is
expected to result in an outflow of resources embodying economic benefits from the entity.
Examples include: loans, accounts payable and so on.
Liabilities may also be further classified as current and non-current.

Equity
The residual interest in the assets of the entity after all its liabilities have been deducted.
Examples include: owners’ funds, capital, retained earnings and net profit.

Recognition Criteria

It is a process of recording items in the financial statement with a monetary value assigned
to them. Apart from the definition, these items should also satisfy the recognition criteria to
be recognised in the accounting books.

Probable

● Asset: It is more than likely that the future economic benefit embodied in the asset
will eventuate.
● Liability: It is more than likely that the future sacrifice of economic benefits will be
required.

Reliably measured

● Whether the value/cost/amount of the asset/liability can be measured reliably

● Involves the use of estimates

Uncertainty

● Does the asset/liability even exist?

An example of how one might use the recognition criteria is in consideration of an under-trial
lawsuit with low probability of economic outflow for the business. This should not be
recognised as a liability or expense yet. The business may certainly disclose that as a
contingent liability in disclosures, but it is difficult to measure the extent of the outflow in
monetary terms.

1.3.2 VIDEO: Key elements of the balance sheet

Nature and purpose of the statement of financial position

The Statement of Financial Position is a financial statement that details the entity’s assets,
liabilities and equity as at a particular point in time - the end of the reporting period.

ACCOUNTING ELEMENTS
Assets = Liabilities + Equity
ASSETS ↓ ↓ ↓
LIABILITIES Balance Sheet What you own What you owe What you get
EQUITY capital
profits
INCOME Income Statement
losses
EXPENSES

● Income statements and cash-flow statements are prepared on the basis of activities
that have happened throughout the year - income statement of any recording or
sales (total sales for the entire year), cash flow from any operating activities (cash
flows generated throughout the year)
● Balance sheets - snapshot of assets, liabilities, equity on one particular date (closing
date of the reporting period - in Australia it is the 30.june) - this shown in the title.
The definition of assets
An asset is formally defined in the Conceptual Framework as:
‘A present economic resource controlled by the entity as a result of past
events’, from which future economic benefits are expected to flow to the entity.

The essential characteristics of an asset are:

● It is a present economic resource.
● The resource is controlled by the entity.
● The resource is a result of a past event.
● Future economic benefits are expected to flow to the entity from the resource.

The definition of liabilities

A liability is formally defined in the Conceptual Framework as:
‘a present obligation of the entity to transfer an economic resource as a result of
past events’, the settlement of which is expected to result in an outflow from the
entity of resources embodying economic benefits.

The essential characteristics of a liability are:

● It’s a present obligation.
● The obligation is a result of past events.
● The obligation is to transfer an economic resource.
● An outflow of resources embodying economic benefits is expected to flow from the
entity as a result of settling the present obligation.

The definition and nature of equity

Equity is defined in the Conceptual Framework (para. 4.4(c)) as:
‘The residual interest in the assets of the entity after deducting all its liabilities’.

Equity cannot be defined independently of assets and liabilities.

EQUITY = ASSETS - LIABILITIES

Equity comprises various items, including capital contributed by owners (shareholders) and
profits retained in the entity.

Recognition (in acc: “ready to record transactions in your books”) - Assets, Liabilities and Equity
The term recognition refers to recording items in the financial statements with a monetary
value assigned to them. Satisfying the definition criteria is only part of the process in
recording an item on the balance sheet. The recognition criteria must also be satisfied.

Factors to consider when making a recognition decision are:

● Uncertainty (should be low of that if it is an asset or liability)
● Probability (should be high - that it will happen)
● Measurement uncertainty/reliably measured (should be able to reliably measure in monetary terms)
Recognition of an asset:
● Uncertainty
- Does the asset even exist?

● Probable
- It is more than likely that the future economic benefits will flow from the asset
to the business controlling it.

Example:
Credit sales = 30 days credit (cash will come to you in 30 days period)
- this account is called ‘Accounts Receivables’ - this account keeps
track of the money that we are yet to receive from customers.

Accounts Receivable - can be classified as an asset

- However, if the customer is problematic and you do not think
they will pay you for the goods, then suggest making an
account called Doubtful Debts, or if we have to write it off then
that is an expense to the business and not an asset.

● Reliably measured ($ value)

- The value of the asset can be measured reliably.
- Involves the use of estimates

Recognition of a liability
● Uncertainty
- Does the liability even exist?

● Probable
- It is more than likely that the future economic benefits will flow from the
business to another entity. (outflow)
Example: Unpaid Salaries Accounts - this is a liability account

● Reliably Measured ($ value)

- The value of the liability can be measured reliably
Example: You know how much salaries you have to pay
- If needed, we can use estimates here as well
 NA = Net Assets

“30.sept 2019” - particular point in time, it is not for the whole year
Narrative form balance sheet style - everything is put vertically
Assets
- current (short-term) - less than or equal to 12 months in books, e.g. account receivable
- non-current (long-term assets) - will be in the books for more than a year
Liabilities
- current (short-term liability/debt) - expected to clear these in less than or equal to 12
months,
e.g. accounts payable (to your suppliers)
- non-current (long-term liability/debt) - will be in the books for more than a year
e.g. bank loans
OWNER’S EQUITY
- Capital - what owners/stakeholders have invested in the business
- Profit - what owners/stakeholders earned after all liabilities are paid
The Format and the Presentation of a Balance Sheet
The Balance Sheet of an organisation enlists its Assets, Liabilities and Equity.

It may be presented in the T-Format or the Narrative format with the latter being a standard
for larger or listed organisations.

VIDEO: Formatting and Presentation of the Balance Sheet

Two main formats of the balance sheet:

1. T-format:
- assets on LHS and liabilities and equity on RHS
- often used for smaller entities
2. Narrative format:
- Assets, liabilities and equity presented vertically

● Comparative information allows users to see how a firm's financial position has
changed between the previous and current periods.
- The information presented in the balance sheets are in comparative form (and
the information remains consistent year after year meaning you can study the
performance of this year compared to the previous years.)

Format and presentation of the statement of financial position

● Statements of financial position may also report:
○ Parent entity financial statements (for controller)
○ Consolidated financial statements (for group)
- The parent entity will merge the financial statements of its subsidiaries
in their annual report = (overall group performance).
● A group:
○ Refers to the parent entity and all its subsidiaries
○ Is often referred to as the economic entity.
Presentation and disclosure of elements on the statement of financial position
Accounting standards exist that prescribe the presentation, classification and disclosure
requirements for assets, liabilities and equity on the statement of financial position.
Even though not legally required, some entities with no public accountability voluntarily adopt
similar classification, presentation and disclosure practices as required by IFRS.

Current and non-current assets and liabilities

- Distinction between current and non-current classification is based on timing (one
reporting period that is being analysed).
- If the economic benefits (of asset) or outflow of resources (liability) are expected to
be realised within the next 12 months, the asset or liability is categorised as current.
- If economic benefits (of asset) or outflow of resources (liability) are expected beyond
the next reporting period, the classification is non-current.

Assets are classified according to their nature or function. Classifications can reflect:
- Liquidity (usually current assets) (can be converted into cash in a very short period of time)
- Marketability (current assets)
- Physical characteristics (assets can be classified as tangible/intangible)
- Expected timing of future economic benefits (current <12 months/non-current >12 months)
- Purpose (current - working capital routing running, non-current - production of goods/services)

Asset classes include:

- Cash and cash equivalents (term deposits in bank)
- Trade receivables (account receivables - customers yet to pay within 12 months)
- Inventories (stock business trades on, warehouse/store “lager”)
- Non-current assets held for sale (tradable non-current assets)
- Investments accounted for using equity method (investment in other businesses- stakes)
- Financial assets (buying shares of other company)
- Property, plant and equipment (non-current investments)
- Deferred tax assets
- Agricultural/biological assets (cattle, grapevines)
- Intangible assets (goodwill)
Liabilities
Liabilities are classified according to their nature. Classifications may be based on:
- Liquidity (current - unpaid salaries)
- Level of security guarantee ((cheaper) secured -mortgage or backup/(expensive) unsecured debt -no
mortgage or backup
- Expected timing of the future sacrifice (current- short term/non-current - long term)
- Source
- Conditions attached to the liabilities

Classes of liabilities include:

- Trade and other payables (current liability - money we are yet to pay to entities - unpaid salaries, suppliers)
- Borrowings (current/non-current)
- Tax liabilities (deferred tax liability)
- Provisions (uncertainty of timing of sacrifice, upcoming liability = ‘warranties’)
- Financial liabilities (investment in derivative product (contract which has value based on some underlying
financial product- risk hedging purposes = ‘investment in currencies’)
- Secured debts (situation where the company issued the debt, it was backed up by the assets of the company.)

Presentation and disclosure of equity

Depending on the entity structure, the terminology and equity classifications appearing on
the statement of financial position will vary between entities.
- Sole proprietorships and partnerships will have profit/loss and drawings contributing
directly to equity.
- Companies will have retained earnings and reserves
Classification of equity
- Share capital:
Amount invested by the shareholders = paid-up share capital, contributed capital

- Retained earnings:
Generated profits/losses (annual) = Cumulative profits that have not been distributed
(meaning we haven’t given dividends (we didn’t give money to the shareholders)

● Investors put money into the company and companies generate profit.
From the profit we pay dividends to the shareholders/investors.
We don’t pay 100% dividend because you need money for further
investments. The part of profit which is retained back into the business, is
called retained earnings and each year we keep adding to those retained
earnings.

- Reserves
A component of equity that takes many forms
- General reserves, capital reserves…
- Money kept aside for further investment purposes
- Creating a reserve on the side in case you need money.

- Non-controlling interests (minority interest):

Presented in the consolidated accounts only if the parent entity does not own 100%
of the subsidiary entity.
- In statements we show the non-controlling interests when we are
consolidating .
- This is the stake that belongs to the other shareholders (not you)

- Contributed equity - shareholders putting money in

- Reserves & retained earnings - putting money in reserves and retained earnings
- JB Hi-Fi doesn’t have any non-controlling interest in their subsidiary - they own 100% of that,
they don’t have other stakeholders there.

- Increase in capital from 2017 to 2018 (they must have raised more capital)
- Increase in reserves (they are keeping aside more money)
- Retained earnings have increased (after paying dividends) - meaning a profitable year
The following is the snapshot of the balance sheet of Jb Hi-fi Ltd for the year 2018. It is
presented in the narrative format. Note that the Total Assets is equal to the sum of Total
Liabilities and Equity. Alternatively, Total Assets – Total Liabilities = Equity or Net Assets.
That happens because of the accounting equation and the principle of dual entry system
which is discussed ahead in the module.
1.3.3 Apply definition and recognition criteria for balance sheet
elements

Transaction Account Element Recognised Reason

in Balance
Sheet?

Signed a contract to Plant and Asset No Correct, Though it can be reliably

purchase machinery next machinery (Non-current) measured and the probability is
month worth $500,000 yet high, it is not a past event yet but
to be paid. an incomplete acquisition and
lacks control of an asset.

Unpaid invoices for raw Accounts Liability Yes Correct, It is an obligation from
materials purchased payable (Current) the past activity, the settlement
will result in cash outflow, it can
be reliably measured and the
probability of payment is very
high.

Application for a bank loan Loan Liability No Correct, Not yet a past event,
yet to be approved (Non-current) approved amount is not certain
yet, the probability is uncertain.

Credit sales Accounts Asset (Current) Yes Correct, It is a result of some past
receivable activity, benefits are expected to
flow to the business when paid, it
is reliably measured and
probability is high.
1.3.4 Applying the accounting equation

Example
The following is an example of XYZ Ltd.’s Balance sheet in the T-Format

The accounting equation

The accounting equation suggests that Total assets (A) = Liabilities (L) + Owner’s equity
(OE), which is shown in the above example. Both the sides of the balance sheet have a total
of $800,000.
This equation (A = L + OE) may also be rearranged as OE = A – L, which highlights that the
owners have a residual interest in the business after paying off all the liabilities as suggested
in the definition of 'equity' above.
The right-hand side lists the sources of funds, and the left-hand side provides the utilisation
of funds. So, when money is raised from the investors or owners it is employed in the
business in some form and, therefore, the two sides should match intuitively. The key
principle that makes this equation functional is the dual-accounting system also known as
the double entry system. In principle, the double entry system mandates that every business
transaction affects at least two accounts and the accounts debited will also lead to an equal
amount credited in other accounts in the transaction. Note that:

Increase Decrease

Debit Assets, expenses Liabilities, Equity, Income

Credit Liabilities, Equity, Income Assets, Expenses

As an example of a double entry system, imagine that a company takes a loan of $100,000
from its bank. As a result, the company's cash account (assets) increases by $100,000 and
the loan account (liability) also increases by $100,000. To record the transaction, the cash
a/c is debited (increase in assets) and the loan a/c is credited (increase in liability). Please
note that the dual entry system keeps the accounting equation in balance.
In our example, the accounting equation remained in balance because both sides of the
balance sheet – assets and liabilities – were each increased by $100,000.
VIDEO: Connecting Assets, Liabilities and Owner’s Equity with the
Accounting Equation

Definition and recognition of elements of financial statements:

● Assets: are present economic resources (ec. resources - they have certain value today, or can be
used to produce more value for future purposes), resulting from past events, and are controlled
(many times you do not own the assets but you have the privilege to control those assets) by the entity (para.
4.3)
○ Examples of assets for JB Hi-Fi Ltd are plant and equipment, cash,
inventories, goodwill and intangible assets.

Example: we bought a trust = we got a loan - the title of the truck belongs to the finance
company but we do have the right to control/use this asset. - we can list this item as an asset
on the balance sheet because we ‘control’ the truck.

*** A plant asset is an asset with a useful life of more than one year that is used in producing revenues in a
business's operations. Plant assets are also known as fixed assets.
*** Goodwill is the value of the business that exceeds its assets minus the liabilities. It represents the
non-physical assets, such as the value created by a solid customer base, brand recognition or excellence of
management. Business goodwill is usually associated with business acquisitions.

● Liabilities: are present obligations (at some point we have to pay back or settle these obligations -
When we settle this obligation, it will result in transfer of some economic resources through the third party.) ‘to
transfer an economic resource as a result of past events’ (para. 4.26)
○ Examples of liabilities for JB Hi-Fi Ltd are borrowings, trade payables, and
current tax payable.

● Equity: is the residual interest in the assets of the entity after deducting its liabilities.
○ Examples of equity for JB Hi-Fi Ltd are capital contributions, dividends,
reserves and retained earnings.

Total assets = total liability + total owner’s equity

- The business has total assets and the investors have claims on those assets.
- Two types of investors: (L) we can borrow money or (E) we can put in money
- We raise capital from investors and we invest in assets.

Residual interest: Equity = assets - liabilities

- From all the assets that you have, once you settle all obligations (L), whatever
is left in the business belongs to the owner's equity.

● Income: is an increase in an asset, or a decrease in a liability, which results in an

increase in equity, ‘other than those relating to contributions from holders of equity
claims’ (other than owner’s contribution to capital - this is not counted as an income) (para. 4.68)
○ Examples of income for JB Hi-Fi Ltd are revenue, interest and dividend
income from investments in other entities.
Asset ↑ or Liability ↓ = Equity ↑
***General speaking, equity can increase by capital or by the operations of the business.
In income, equity can only increase because of the operations, not by fresh injections of funds by the owners.
 ● Expense: is a decrease in an asset, or an increase in a liability, which results in a
decrease in equity ‘other than those relating to distributions to holders of equity
claims’ (para 4.69).
○ Examples of expenses for JB Hi-Fi Ltd are sales and marketing expenses,
rent expense, finance costs and salaries.
Asset ↓ or Liability ↑ = Equity ↓

VIDEO: Accounting Equation in action

ASSETS = LIABILITIES + EQUITY

A=L+E
(OWN) = (OWE) + (OWNER)

Two types of investors:

1. Own money (equity)
2. Borrowed money (liability) } these are sources of capital

= Then you invest that money (own/borrowed) in assets to generate income in the business

● Assets = resources controlled by entity.

● Liabilities = external sources of funds.
● Equity = need to be funded by owners and lenders: the liabilities and equity
represent the claims against the entity’s assets.

Dual entry system: each and every transaction that we record in the books affects at least
two accounts.

EXAMPLE: Valerie’s Vases needs $350,000 of assets to do business. Valerie only has
$200,000 to contribute as equity; therefore her business needs to borrow additional funds of
$150,000 from a bank which will become a liability of the business.

Assets = Liability + Equity

$350,000 = $150,000 + $200,000

The concept of duality:

The accounting equation must be kept in balance after a transaction is entered.
i.e. Assets MUST = Liabilities + Equity
In order to keep the equation in balance, a transaction must be recorded at least twice.
A transaction has a dual effect on the equation:
- Cash movement effect
- Money paid or received (cash account)
- Money going to be paid or received (accounts payable/receivable)
- Category of the transaction effect
- What is the nature of the transaction?
- Purchase an asset = asset account
- Receipt of money from sale = revenue account
Concept of Duality Example:
- The purchase of a delivery truck via a loan.
● Cash effect - loan payable (liability ↑)
○ Payment will be made in the future
● Category effect - motor vehicle (asset ↑)
○ This is the purchase of a delivery truck to support the business
while the business generates revenue. (The truck is an economic
resource as it will help generate income)

A=L+E
Truck ↑ = Loan ↑

The expanded accounting equation

- Income produces an increase in equity
- Expenses result in decreases in equity

PROFIT/LOSS is ADDED TO/SUBTRACTED FROM opening equity on the statement of

financial position.

ASSETS = LIABILITIES + EQUITY + INCOME - EXPENSES

Example 1 - capital contribution:

Owner contributes $20,000 in cash to start a business:
1. Keywords ‘cash’ and ‘owner’
2. Cash increases $20,000 (asset)
3. Owner increases capital (equity)

Assets (A) = Liabilities (L) + Equity (E)

↑Cash $20,000 = $0 + ↑Capital $20,000

Example 2 - purchase of an asset with cash:

Firm purchases new iPad for $500 and pays by cash:
1. Keywords ‘cash’ and ‘iPad’
2. Cash decreases $500 (asset)
3. New iPad purchased $500 (asset)

Assets (A) = Liabilities (L) + Equity (E)

↓Cash $500
↑Office equipment
Example 3 - income earned:
BCS sends an invoice to Tassie Tennis for providing tennis coaching services totalling $3000
1. Keywords ‘invoice’ and ‘services’
2. Accounts receivables (AR) increases $3000 (asset)
3. Fees revenue increases $3000 (income)

Assets (A) = Liabilities (L) + Equity (E) + Income (I) - Expenses (E)
↑Accounts ↑Coaching
receivables Fees
$3000 $3000

Using the accounting equation to solve for missing figures

The accounting equation can also help us solve for missing figures because the assets side
must always equal the claims side.

Example:
T. Curtis has current assets of $34,000, current liabilities of $8,000, non-current liabilities of
$80,000 and equity of $160,000. What is the amount of non-current assets?

Current Assets Non-current Current Non-current Equity

Assets Liabilities Liabilities

$34,000 $214,000 $8,000 $80,000 $160,000

Rules of debits and credits

The expanded accounting equation:
Assets = Liabilities + Equity + Income - Expenses
Moving expenses to the other side:
Assets + Expenses = Liabilities + Equity + Income

The accounting worksheet

- Summarises the duality associated with each business transaction.
- All business transactions of the entity can be entered into the worksheet.
- Then the individual columns of the worksheet can be totalled and used as the basis
for preparing financial statements.
Transaction Assets Liabilities Equity Explanation

Obtaining loan to Increase Increase Unchanged Correct, Cash a/c (current asset) and loan
purchase equipment a/c (non-current liability) both increase.
for $55,000

The owners take Decrease Unchanged Decrease Correct, Inventory a/c (current asset) and
$6,000 in inventory for capital a/c (equity) both decrease.
personal use

A trade receivable Unchanged Unchanged Unchanged Correct, Cash a/c (current asset) increases
owing $8,000 makes a and accounts receivable a/c decreases by
part payment of $4,000 each. It is a change in the type of
$4,000 current account. Total assets are
unchanged.

Inventory is Increase Increase Unchanged Correct, Inventory a/c (current asset)

purchased for increases by $10,000, cash a/c (current
$10,000, paying asset) decreases by $6,000 and accounts
$6,000 cash and the payable (current liability) increases by
balance on credit $4,000.

Impairing a building Decrease Unchanged Decrease Correct, Building a/c (non-current asset)
from its acquisition decreases and equity decreases due to loss
cost less in the value of an asset.
accumulated
depreciation of
$100,000 to its
recoverable amount
of $85,000

Inventory with a cost Unchanged Unchanged Unchanged Correct, as inventory is measured at the
price of $45,000 has lower of cost and net realisable value, the
net realisable value of value of inventory remains to be $45 000 (no
$60,000 effect on inventory).

Current Non- Total Current Non- Total Share Retained Total

assets current assets liabilities current liabilities capital earnings equity
($) assets ($) ($) liabilities ($) ($) ($) ($)
($) ($)

35,000 46,000 81,000 9,000 28,000 37,000 30,000 14,000 44,000

57,000 84,000 141,000 29,000 52,000 81,000 53,000 7,000 60,000

159,000 136,000 295,000 55,000 102,000 157,000 122,000 16,000 138,000

15,900 24,000 39,900 6,900 16,000 22,900 14,800 2,200 17,000

46,941 82,186 129,127 28,255 40,500 68,755 48,750 11,622 60,372

1.3.5 Learning the measurement of assets and liabilities

Measurement of assets and liabilities

The dollar value assigned to assets and liabilities is called their carrying amounts or book
values. Although it is common to leave assets at their historical cost (or cost adjusted for
depreciation), entities are also permitted (and sometimes required) to revalue certain items
to fair value. Accounts receivable are measured as the gross receivables minus allowance
for doubtful debts. Inventory needs to be recorded at the lower of historical cost and net
realisable value. Non-current assets with limited life must be depreciated. All depreciable
assets are carried at their historical cost (or fair value) minus accumulated depreciation. The
following sample balance sheet of XYZ Ltd in T format reflects the measurement of accounts
(a/c) receivable and plant and equipment.

VIDEO: Measurements of Assets and Liabilities

Accounting policy choices, estimates and judgements

Accounting choices applied to the recognition and measurement of elements in the financial
statements are referred to as accounting policies.

There are numerous accounting rules that permit choices (i.e. alternative methods of costing
inventory; method for calculating depreciation (wear and tear of the asset, year after year this asset loses its
value); the treatment of development expenditure (money spend on research should be immediately expensed
- or development of an asset for development) as an asset (known as capitalisation) or as an expense).

This is why an analysis of an entity’s accounting policies is important.

Measurement of various assets and liabilities
The dollar value assigned to assets and liabilities is called their carrying amounts or book
values (reported values - ultimate figure that goes into the reports (balance sheet)).

Alternative measurement systems include:

- Historical cost (e.g. original cost)
Is an entry value (entry value: when you are buying the asset for yourself) as it reflects the value in
the market in which the entity acquires the asset or incurs the liability. = cost of acquisition
of that asset

- Current cost
Is also an entry value. It reflects the cash or cash equivalents that would have to be
paid to replace the asset (if you were to replace this asset today how much would you pay in cash or cash
equivalents?), or the undiscounted amount of cash or cash equivalents that would be
required to settle the obligation at measurement date.

- Fair value/market value

Is defined as the price that would be received to sell an asset or paid to transfer a
liability in an orderly transaction between market participants at the measurement
date. (instead of looking at the cost perspective we are looking at the value perspective - if I were to sell this asset
today, how much would I receive as of price, as a value for that asset in the marketplace? = what is the value of
selling this asset today?)

- Value-in-use/present value
Represents the present value of the cash flows that an entity expects to derive from
the continuing use of an asset and its ultimate disposal. (I’m not selling this asset, but I continue
to use this asset in the future = what is the present value of economic benefits we will receive by continuously using
this asset?) If we work out the present value of those future expected benefits (the cash flows) then that
becomes the value of that asset (time value of money principle (TVM)).

- Fulfilment value
Applies to liabilities and is the present value of the cash flows that an entity expects
to incur to satisfy a liability. (liabilities for a continuous cash outflow for a foreseeable future = what is the
value of those payments that you have to keep making in terms to keep up with their obligations? How much you
would have to pay today to clear that liability)

Measuring receivables (account receivables account = customers who are yet to pay us (from credit sales))
- The carrying amount of receivables is the expected cash to be received
- Thus the amount owing must be reduced by the amount expected to be uncollectable
using an account called allowance for doubtful debts
- On the statement of financial position, receivables are usually shown at their net
amount:
Net amount = gross value - allowance for doubtful debts
The details for the gross value and allowance disclosed in notes.
(Gross value: total accounts receivable that you have in your books)
Measuring inventory (cost price)
- Carrying value of inventory must be the lower of its cost price or net realisable
value.
- Measuring inventory at cost requires a cost flow assumption because inventory can
be purchased at different times at different cost prices.
- 2 cost assumptions permitted under IRFSs:
○ First-in, first-out (FIFO)
○ Weighted average

Carrying amount = lower of cost price OR net realisable value

Two ways to estimate Cost price: FIFO OR Weighted average cost method

Net realisable value = expected selling value/price of this asset today (minus) all
associated costs to sell that asset (marketing…etc).

Inventory Valuation Example

What is the price of 9000 units sold?

What is the price of 5000 units that you’re left with in your books
Inventory valuation - FIFO
- The entry that got in first, sold first

Inventory - weighted average cost

- Weighted average cost per turn
- Total amount (divided by) units = average unit price
Measuring inventory: (net realisable value) (What is the value I would receive in the market if I sell today?)
The net realisable value of inventory is:
- The expected selling price
- Less the expected costs associated with getting the inventory to a sellable state
- Plus the costs of marketing, selling and distribution

Expected selling price (minus) all cost associated in order to get it ready + cost of marketing,
sales/distribution

Measuring non-current assets:

- All assets with limited useful lives must be depreciated
- Land is not depreciated (because it tends to increase in time)
- Depreciation is the allocation of the depreciable amount of the life of the asset
- On statement of financial position, depreciable assets are carried at their cost (or fair
value) less accumulated depreciation.

● We estimate the amount of wear and tear of that asset during the reporting periods
and charge that as a depreciation expense for that period.

Notable exceptions of measuring non-current assets

- Goodwill (an intangible asset that's created when one company acquires another company for a price greater
than its net asset value.) cannot be revalued upwards and must be tested at least annually
for impairment (loss in the value of an asset).
- Identifiable intangibles (patents/licences) can be revalued upwards only if an
active and liquid market exists.
- Financial instruments (shares/short-term securities in market) are measured at their fair value
- Agricultural assets are measured at their value less costs to sell (net amount = value
(minus) cost to sell)

Measuring non-current assets - IMPAIRMENT TEST

Carrying amount of non-current assets at cost must be no more than their recoverable
amount.
- Recoverable amount is higher of expected fair value minus costs to sell, and value
in use.
- Value in use refers to the present value of expected future cash flows associated
with the use and subsequent disposal of the asset.

Higher of = fair value / value in use = recoverable amount

● Any impairment loss (an expense - meaning the value of the asset has gone down)
must be recognised immediately.

IMPAIRMENT LOSS
=
CARRYING AMT - RECOVERABLE AMT
SUMMARY:
- conservative approach:
Current asset (inventory) or non-current asset - we need to ensure that we are not using a
carrying amount, which is more than net realisable value for inventory or which is more
than the recoverable amount for non-current assets.
1.3.6 Understanding business and personal transactions and
business events
Business Transactions
Business transactions are the external exchange of something of value between 2 or
more entities and affect the assets, liabilities and equity items in an entity.
A business transaction is recorded when:

○ it can be reliably measured in monetary terms

○ it occurs at arm’s length

Under the entity concept, every entity must keep records of its business
transactions separate from any personal transactions of the owners.
Examples:

○ contribution of capital by owners

○ payment of wages
○ receipt of bank interest
○ payment of GST
○ purchase of digital camera for business

Personal Transactions
Personal transactions are transactions of the owners, partners or shareholders. They
are unrelated to the operation of the business.
Examples:

○ purchase of digital camera for personal use by the business owner

○ sale of shares in personal name by the owner

Business Events
Business events are occurrences that will probably affect the entity in some way but
may not have an immediate monetary effect or cannot be measured reliably.
They are not recorded as business transactions until an exchange of goods occurs
between the entity and an outside entity.
They are much wider in scope than business transactions
Examples:

○ change of a company CEO

○ resignation of an employee
VIDEO: Accounting process and identifying transactions

The Accounting Process

Accounting is the process of identifying, measuring and communicating economic
information about an entity to a variety of users for decision making purposes.\

Record → Report → Decision making

Identifying business transactions

Business transactions are the external exchange of something of value (goods, services…etc)
between 2 or more entities (one of which is your business).

- This transaction affects the assets, liabilities or equity items in an entity. (if there is no
impact then it is not a business transaction yet)

A business transaction is recorded when:

● It can be reliably measured in monetary terms (clear measurement of $ value)
● It occurs at arm’s length

Under the entity concept, every entity must keep records of its business transactions
separate from any personal transactions of the owners.

Examples of business transactions

- Contribution of capital by owners
- Payment of wages
- Receipt of bank interest
- Payment of GST
- Purchase of digital camera
- Payment of accounts payable
- Depreciating office equipment
- Sale of goods to customer
- Provision of services to client
- Purchase of accounting software
- Withdrawal of capital
- Repayment of short-term loan to financial institution
- Cash purchases of office supplies
- Payment of advertising
Business and personal transactions and business events

Personal transactions:
- Transactions of the owners, partners or shareholders
- Are unrelated to the operation of the business

Business events (think of lawsuits)

- Occurrences that will probably affect the entity in some way
- Not recorded as business transactions until an exchange of goods occurs between
the entity and an outside entity.

Accounting and its role in decision making

Accounting information is designed to meet the needs of both internal and external users.
Accounting information is extremely valuable to an entity’s owner or management (internal
users)

External users (stakeholders) are parties outside the entity who use information to make
decisions about the entity. Stakeholders can include:
- Shareholders (both current and prospective)
- Customers
- Suppliers and banks
- Employees
- Government authorities (ATO, ASIC…)
For the following case scenario, identify and explain if each activity qualifies to be a
business transaction. Submit your answer to reveal feedback.

On Monday morning, Andy negotiates a new loan contract with his banker for his business.
Later in the noon, he meets a potential client and offers and explains the available discounts
on his products. When he returns to his office in the evening, he finds an invoice for using
the internet at his workplace.

MY ANSWER

Negotiating a Loan Contract:

This is not a business transaction because a transaction requires an exchange of value
(money, goods, services), and in this case there is no financial impact yet.
Until the loan is finalised, money is received or payment terms are set, it’s just a
negotiation.

Meeting with a Potential Client:

This meeting can be classified as a marketing effort or business development but not a
business transaction as there has been no exchange of money, goods, or services.

Receiving an Invoice for Internet Usage:

This is a business transaction because he received an invoice which represents the
internet usage as a completed service that has created a liability (the amount due) which
affects the financial records of the business.

TEACHER’S ANSWER

a) Meeting a banker for a loan contract is a negotiation. No exchange has taken

place. Hence, it is not a business transaction.
b) Meeting a potential client is just a discussion; it’s not a business transaction
until the scheme is implemented to the debtor’s account.
c) Receiving an internet bill is a business transaction as the business has used
the internet and has received an invoice informing them of the charges.
1.3.7 The accounting errors and the limitations of accounting
information
The accounting errors
There are plenty of possible accounting errors in the process of recording accounting
information. Some of them may be classified as:

1. Single Entry Error Concept of duality must be applied to every transaction. The
balance sheet will not balance if only one part of the transaction is entered.

2. Transposition Error Occurs when 2 of the digits are transposed: Example: payment of
$5340 cash is recorded as $5430 decrease in profit: difference of $90. A
transposition error is always divisible by 9.

3. Incorrect Entry Recording 2 increases or 2 decreases on one side. Or, recording an

increase to one side and a decrease to the other side. Example: the owner withdraws
cash of $3000 and records the transaction as an increase in cash and a decrease in
equity. Asset side will be $6000 higher than the claims side.

The errors which violate the accounting equation principle are relatively easy to track and
are easily fixed eventually. There are, however, more complex scenarios where the
accounting equation is followed while recording the transactions. Yet, the accounting data
may not be accurate or reflect the real picture of the business. It is worthwhile that you
conduct your independent research around all such possible errors and their impact on the
financial statements and analysis.

Limitations of accounting information

● Time lag in the distribution of information to users, therefore affecting its accuracy
● Historical information based on past data and is often outdated
● The subjectivity of information refers to choices involved in the inclusion of items to
be reported and the choice of accounting policies to adopt
● Costs of providing information:
○ Information costs - Costs involved in gathering, summarising and producing
info contained in the financial report
○ Release of competitive information - Information in the financial report may
contain proprietary information that could be used by competitors to
strengthen their market position

You must contemplate the impact of these limitations on the financial analysis.
VIDEO: The limitations of accounting information

1. Single entry error: (balance sheet is not balanced)

- Concept of duality must be applied to every transaction
- Worksheet will not balance if only one part of transaction is entered

2. Transposition error: (error in figures)

- Occurs when 2 of the digits are transposed:
- E.g. payment of $5340 is recorded as $5430 decrease in profit:
= difference of $90
- A transposition error is always divisible by 9.

3. Incorrect entry:
- Recording 2 increases or 2 decreases on one side.
- Or, recording an increase to one side and a decrease to the other side.
- E.g. the owner withdraws cash of $3000 and records the transaction
as an increase in cash and a decrease in equity. Asset side will be
$6000 higher than the claims side.

Other error possibilities:

- Omission error - forgetting to record that transaction all together.
- Recording a sale twice

Limitations of accounting information

● Time lag in the distribution of information to users, therefore affecting its accuracy
● Historical information (we don’t get the projections of the annual reports, just the
historical overview) based on past data and is often outdated.
● Subjectivity of information refers to choice involved in inclusion of items to be
reported and choice of accounting policies to adopt.
● Costs of providing information:
○ Information costs - Costs involved in gathering, summarising and producing
info contained in the financial report
○ Release of competitive information - Information in the financial report may
contain proprietary information that could be used by competitors to
strengthen their market position
Summary of topic
● Process of accounting concerns identifying, measuring and communicating economic
information for decision making
● Users of accounting information may be external or internal
● Management accounting concerns the needs of internal users, while financial
accounting focuses on reports for external users
● Entities have become larger, more diversified and multinational
● The main sources of company regulation are the Corporations Act, the ASX listing
rules, and the influence of the accounting profession
● IASB’s Framework is applicable to all Australian reporting entities
● Business transactions are occurrences that affect the assets, liabilities and equity
items in an entity
● Business transactions are an exchange of goods that occurs between the entity and
an outside entity
● The accounting equation:
Assets = Liabilities + Equity
● Limitations of accounting relate to the time lag, historical nature of information and
costs associated with releasing accounting information