Year 11 Accounting Accounting Concepts

Reference Page 17 of the booklet

What are Accounting Concepts? Accounting Concepts are the accounting ‘theory’ used in preparing accounting information, such as Balance Sheet, Income Statement.

What are the accounting concepts we will learn this year? ACCOUNTING CONCEPTS Accounting EntityMonetary ConceptHistorical Cost Going Concern Period Reporting Accrual Basis

Accounting Entity Concept Thinking Time!!!!!! Will you include your house (which is an asset) in your business’s Balance Sheet as an asset? Why??????

Accounting Entity Concept - Definition Accounting Entity Concept states that: The financial (money) affairs of the OWNER should be SEPARATE from the financial (money) affairs of the BUSINESS.

Why Accounting Entity is Important? Accounting Entity Concept ensures that: All the information contained in the financial statements SOLELY reflect entity’s transactions ONLY. NOT BOTH OWNER AND ENTITY’S TRANSACTIONS.

Review Question So will you still include your house in your business’s Balance Sheet as Buildings? NO! NO! NO! because The Concept states that the financial affairs of the OWNER (i.e. ) should be separated from the financial affairs of the BUSINESS (i.e. ) ACCOUNTING ENTITY Owner’s house Buildings

Monetary Concept Thinking Time!!!!!!!! Can you tell me which one ‘worth’ the most, and Why? THE PIGOR THE GOAT

Monetary Concept - Definition The Monetary Concept states that: All transactions in financial statements must be measured in DOLLAR In New Zealand, the common measurement unit will be NEW ZEALAND DOLLAR

Monetary Concept Can you tell me which one ‘worth’ the most, and Why? THE PIG NZ$ THE GOAT NZ$0.05

Why Monetary Concept is important? Monetary Concept helps us to compare the value of different items easily because we use DOLLAR to measure the items.

Monetary Concept Q & A Time Q:If you are the owner of a shop, will you include yourself in the Balance Sheet as an asset? A:No, the Monetary Concept states that all transactions in financial statements are measured in dollars. As owner cannot be measured in dollars, therefore owner cannot be shown on Balance Sheet.

Monetary Concept Q & A Q:Your business bought a computer from Australia cost A$1,000. Do you show the amount of computer as A$1,000 or NZ$1,099 in the Balance Sheet? Why? A:NZ$1,099 because according to the monetary concept, the common unit of measurement in New Zealand is New Zealand Dollars.

HISTORICAL COST Historical Cost states that: Assets are reported at the amount when it was purchased. Liabilities are reported at the amount When it occurred. Historical Cost is a measurement method that measures assets and liabilities.

HISTORICAL COST Question Yummy Noodles purchased a machine 10 years ago at $10,000. After 10 years, same sort of machine is now worth $30,000. Under Historical Cost Concept, which machine value you will choose to report on Balance Sheet?

HISTORICAL COST Question Yummy Noodles purchased a machine 10 years ago at $10,000. After 10 years, same sort of machine is now worth $30, years ago?Current price? What does Historical Cost say?

HISTORICAL COST ANSWER According to Historical Cost Concept, Yummy Noodles will report the amount of machinery at $10,000 (that was purchased 10 years ago) because the concept states that assets should be reported at the dollar amount when it was purchased (i.e. 10 years ago)

HISTORICAL COST Another example Doctor Surgery Balance Sheet as at 31 March 2006 PROPERTY, PLANT AND EQUIPMENT Medical Equipment (cost)$10,000 This represents the HISTORICAL COST

GOING CONCERN When accountants prepare financial statements, like Balance Sheet, they always assume the entity (such as business or club) is GOING CONCERN. Going Concern is: An entity will continue its operation in the FORSEEABLE future.

Why Going Concern is important? If the entity is NOT in GOING CONCERN. Q:What do we mean by ‘NOT in GOING CONCERN’? A: The entity (such as club/business) will NOT continue its operation in the foreseeable future

If an entity is not going concern, its accountant will use other ways to measure the amount of assets and liabilities. NOT GOING CONCERN?

Going Concern Question If a business which uses historical cost measurement, is going to shut down next month. Will the accountant keep using historical cost method?

Going Concern Answer As the business is going to shut down next month, that means the business is NOT going concern. The accountant needs to use OTHER measurement method to measure the assets and liabilities.

PERIOD REPORTING Thinking Time!!!!! DO YOU CHECK YOUR SCHOOL PERFORMANCE YEARLY OR AT THE END OF YOUR UNIVERSITY SCHOOL LIFE?

PERIOD REPORTING Period Reporting Concept states: The [foreseeable] life of an entity is divided into nominated EQUAL period of time [usually a year] Going Concern/Life of the entity

PERIOD REPORTING Why do accountants prepare their financial statements using PERIOD REPORTING concept? [Hint: Why does school want to have tests every term?]

PERIOD REPORTING The reason that accountants prepare the financial statements using period reporting concept is: Users of accounting can measure and compare financial performance and financial position from period to period so users can make better economic decisions.

PERIOD REPORTING Q:Following shows the heading of Income Statement for Small Business Small Business Income Statement for the year ended 31 March 2006 Explain how does Period Reporting applies

Answer This is where when Period Reporting concept applies : Small Business Income Statement for the year ended 31 March 2006 The concept applies because the statement is prepared based on equivalent period of time (i.e. yearly).

Another Question Auckland Sailing Club prepares its financial statements at the end of every June and December. Q:Does it mean Period Reporting concept not apply? Explain.

Answer The Period Reporting concept applies because: The concept states that the life of the entity is divided into nominated equal period of time. As Auckland Sailing Club prepares financial statements every 6 months (June and December), the concept applies.

ACCRUAL BASIS Thinking Time: Write YES or NO for the following questions. If you are the owner of a dairy shop. Assume the year ended on 31 December Will you include the following in 2005 financial statements. 1. The sale of milk to Mr Moo on credit on 1 January The purchase of fridge on 31 December The staff wages (from 7 December – 28 December 2005) but not yet paid.

ACCRUAL BASIS - DEFINITION Transactions (like purchasing stock, sale of good etc) are recognised when they occur (and not as cash is received or paid) Recorded in the accounting records Reported in the financial statements of the periods which they relate. AND

Why Accrual Basis is important? It is important so the financial statements reflect all transactions belong to a particular period only. Not a combination of different periods (such as including 2005 and 2007 financial transactions)

ACCRUAL BASIS Paid wages by cash on 15 Dec 2006 Purchased stock on credit on 4 April 2006 Sold goods on credit to customer on 2 Dec 2006 but received on 4 Jan 2007 Cash Sales on 8 November 2006 Paid electricity by cash on 10 February 2007 Repay loan on 15 May 2007 Received cash from accounts receivable on 4 April 2007 Credit Sales on 3 June 2007

Transaction (a cash or credit transaction) is only recognised when it occurred, and recorded in the accounting records and reported in the financial statements of a period which the transaction belongs to. ACCRUAL BASIS REMINDER For example, when there is a credit sale transaction in 2005, even though there is no cash receipt, the transaction still be recognised as part of 2005 transactions, and should be recorded in 2005 accounting records and reported in 2005 Income Statement as Income.

Accrual Basis – Solution The sale of milk to Mr Moo on credit on 1 January 2006 will NOT include in the 2005 financial statement because the ACCRUAL BASIS concept states that: Transaction hasn’t occurred in 2005 (sale of milk happened on 1 January 2006) so it CANNOT be recognised as a 2005 transaction AND CANNOT be recorded in 2005 accounting records AND CANNOT be reported in 2005 financial statements.

ACCRUAL BASIS Q & A The purchase of fridge on 31 December 2005 should be included in 2005 Balance Sheet because ACCRUAL BASIS concept states that: should be recorded in the accounting records (the fridge would be recorded in 2005 accounting records) Transaction should be recognised when it occurred (The fridge was purchased on 31/12/2005) and and should be reported in the financial statements of the period to which it relates (the fridge would be reported in 2005 Balance Sheet)

ACCRUAL BASIS Q & A The staff wages (from 7 December – 28 December 2005) but not yet paid should be included in 2005 Income Statement because Transaction should be recognised when it occurred (the transaction has occurred in 2005 as workers worked from 7 Dec – 28 Dec) and should be recorded in the accounting records (the wages would be recorded in 2005 accounting records) and should be reported in the financial statements of the period to which it relates (the wages should be reported in 2005 Income Statement)

TASK Try to complete the task on page 18 of your Achievement Standard 1.1 booklet.