1. Lesson 2 Rules of Accounting and Financial Reports
Li, Jialong

2. The need for financial reporting
• Information for the business operations
• Financial Management
• Social and environmental responsibility
• Corporate Governance
• Ethics

3. Financial Statements What are the common ones? • Income Statements
• Balance sheets
• Statement of Changes in Equity
• Cash Flow Statement

4. How often are Financial Statements Prepared and what are the reporting periods?
• Annually
• Financial year normally 1 July to the following 30 June.
• Monthly, quarterly and six monthly are also prepared usually for internal users

5. Income Statement
• The Income Statement summarises the Revenue and expenses (running Costs) of your business operation for a given period

6. Income Statement Revenue – Expenses = Profit/ (Loss)
REVENUE Revenue or income is the earnings made from the operations of the business; it mainly comes from sales, which the business makes.
EXPENSES Expense or cost is what is incurred or spent in making the sales and in running the business.
PROFIT/LOSS: If the total sales revenue is greater than the total expenses then the business makes a profit, which is added to the Owners Equity in the Balance Sheet.
If the total sales revenue is less than the total expenses then the business has made a loss, which is reported on the Balance Sheet in the Owners Equity.

7. The Balance Sheet
Definition: The Balance Sheet is a report which shows in statement form the relationship between Assets, Liabilities and Owners Equity at a point in time.

8. Statement of Changes in Equity
This Report shows the change in the amount owed to the owners of the business and how it has changed for a period

9. Cash Flow Statement
The Cash Flow Statement summarises the flow of CASH ONLY (not credit transactions) through the business for a given period of time

10. Samples
A Sample of the four financial Statements are below taken from the Australian Accounting Standards AASB no 101 which outlines the accounting standards for the financial reports completed by businesses. There are also international accounting standards that must be complied with when reporting for a business.

11. Income Statement Example

12. Balance Sheet Example

13. Cash Flow Statement Example

14. Statement of Changes in Equity

15. Summary of Financial Statements
Items
What to tell?
Time description
Metaphor
Investment ways
Balance sheet
Lists of assets, liabilities, and owner’s equity
Specific date (end of a month or a year)
A snapshot
A pool with some water
Entrepreneur
Income statement
Summary of the revenues and expenses
Specific period (a month or a year)
A moving picture
Change of water amount in the pool
Shareholder or stockholder
Statement of cash flows
State of inflow and outflow of cash
Intake and outlet of the water
Loaner or lender
Statement of owner’s equity
Summary of changes in owner’s equity
The money get or made from the water
Opportunistic stockholder

16. Assets
These are items of value owned by the business. Examples are cars, cash, stock/inventory, accounts receivable and furniture and fittings.
An item may be an asset of the business even if the business has not paid for it. For example the business may have borrowed money from the bank to buy a motor vehicle. The accounting records show the motor vehicle as an asset.

17. Liabilities
These are the amounts of money OWED to others. Examples include accounts Payable, bank overdrafts, and mortgage loans. The money owed on the motor vehicle asset is recorded as a liability. Liability is another name for debt owed to anyone other than the owner of the business.

18. Owners Equity
This is the amount of money required by the OWNER of the business to invest in the business for it to be established and maintained. In large public companies it is the money from shareholders. It is increased when the owners contribute more funds to the business. This is called Capital.
It is reduced when the owner takes funds out of the business. This is called Drawings or dividends.

19. Revenue
A retail business normally earns revenue from selling its stock/inventory which has been specifically purchased for resale (Purchases). The total of the daily sales is the revenue for the day.
A service industry earns revenue from selling services, e.g. haircuts.
The other types of revenue that can be earned by a business include interest on cash in the bank, rental income, commissions, etc.
Revenue can be earned in cash or on the promise to pay at a later date (credit sales).
Not all money received is earned by a business. For example when a business receives money from a bank as a loan and when a debt is repaid (credit sale payment) and other loans lent by the business are repaid.

20. Expenses
A business incurs expenses as a result of supplying goods or services to a customer. For instance wages must be paid; there are bills for electricity, rates, telephone and taxes to be paid. These result in some spending of the money (cash payments) that was received from revenue (sales).
Accountants also recognise expenses that are not cash payments. Under an accrual-based accounting system, expenses are recognised when they are incurred. For example, depreciation of plant and equipment is recognised every year over the life of the asset as the asset deteriorates or erodes in value.
Some cash payments that aren’t expenses would include making loan repayments and the purchase of an asset e.g. motor car.

21. Chart of Accounts
Ledger accounts are used in the accounting system to summarise transactions. For instance, Cash at bank ledger account records all cash receipt and cash payments.
The chart of accounts is an index of ledger accounts designed to assist you to find a particular account. It is a listing that shows the arrangement of the accounts in the ledger and the number assigned to each account. Accounts of the same type are arranged together. For example all the assets are numbers 1xxx.

22. EXAMPLE OF CHART OF ACCOUNTS (Accounts List)

23. Users of accounting information
Internal Users
• Owners
• Managers
• Employees
Internal users may ask the following questions from the financial information:
• .IS CASH SUFFICIENT TO PAY YOUR DEBTS?
• What is the cost of manufacturing each unit of product?
• Can we afford to give employees pay raises this year?
• Which product line is the most profitable?

24. Users of accounting information External Users
Investors
Employees
Contributors
Members
Tax payers ( Government businesses)
Creditors (Suppliers of trading goods
Lenders
Recipients of Goods and Services
Donors
Resource Providers

25. Parties performing a review or oversight function
Parliaments state and federal
Regulatory agencies
Employer groups
Media
Special interest group
Governments
Trade unions
Analysts

26. BUSINESS STRUCTURES  Sole Trader  Partnerships  Joint Ventures
 Company
 Cooperative
 Incorporated Association
 Trust

27. Sole Proprietorship Advantages Simple to establish Owner controlled
Disadvantages
Unlimited liability
Limited cash
Ability to expand is limited

28. Partnership Advantages Simple to establish Shared control
Broader skills and resources
Disadvantages
All partners are legally bound to each other
Unlimited liability

29. Company Advantages Easier to transfer ownership
Easier to raise funds
No personal liability
Proprietary Pty Ltd Limits ownership
Disadvantages
Under company law there are substantial reporting requirements.
Lack of personal decision making

30. Trusts If you operate your business as a trust, you’re: a trustee
responsible for holding property or income for
the benefit of others (the beneficiaries).
The most common variety of trust is the discretionary
trust. If you’re the trustee of a discretionary trust,
you have the power to decide how the profit will be
distributed among the beneficiaries.

31. Trusts
Advantages
A trust has a limited liability if the trust is a company.
A trust has perpetual existence and does not cease
with the death of a beneficiary.
Increased asset protection.
Things to consider
Like a company, a trust is more expensive and
potentially complicated to establish.
It may be more expensive to complete the required
tax and administrative paperwork each year.
Profits distributed to children under 18 may be
taxed at higher rates.

32. Review Questions What are Financial Reports?
Who uses financial reports?
What information is contained in the Financial Reports?
Definitions of Assets, Liabilities, Owners Equity, Revenue and Expenses.
Types of Business Structures
Discuss the advantages and disadvantages of business structures

33. Exercises
Exercise 2.1
Put the following accounts for a Beauty Salon into a chart of accounts organising the assets, liabilities, owner’s equity, revenue and expenses into sections and numbering the accounts to provide an index.
Exercise 2.2
In groups choose a business and develop a chart of accounts for that business and explain the accounts that you have chosen to the class.
Exercise 2.3
Identify each of the following items as an asset, a liability, owner’s equity, revenue or an expense. Use the letters A, L OE R or E

34. Reading and Resources Choosing the right business structure (BUSINE_1)
Student Notes and Readings Lesson 2

35. The End of Lesson 2