What is Accounting?

Accounting has been defined as the process of

 identifying,
 measuring,
 recording and
 communicating

economic information to permit informed judgement and decisions by users of the information

Why is Accounting important?

 Accounting is often called the “language of business”.
 Accounting communicates financial information that is useful for decision-making by:
o Owners
o Managers
o Investors
o Creditors
o Others

What is Profit?
Profit = Income (what we earn from operating a business) – Expenses (what we incur in costs
from running that business)

Foundations of Accounting
Historically, the importance of accounting was about:

 Stewardship
o Recording of transactions
o Monitoring of use of assets
 Accountability
o Measures of efficiency and effectiveness
o Evaluation of management

Conceptual Framework
To provide:

 a structure and a coherent and interrelated body of knowledge and reasoning for
accounting to achieve certain outcomes which provide:
o Guidance for preparers of financial statements
o Guidance for standard setters to derive standards
o A system that allows for a more consistent articulation of standards
o A more logical, thoughtful, and justifiable framework for the process of
accounting
Statement of Concepts for General Purpose Financial Reporting (SOC - ICANZ 1993)
1. Assessing the reporting entity’s financial and service performance, financial position, and
cash flows
2. Assessing the reporting entity’s compliance with legislation, regulations, common law,
and contractual arrangements, as these relate to the assessment of the reporting entity’s
financial and service performance, financial position, and cash flows; and
3. Making decisions about providing resources to, or doing business with the reporting
entity

Importance of the SOC objectives

 Objectives (1) and (2) were essentially accountability functions
o Focused on the past
 Objective (3) related to decision-usefulness and would incorporate using past information
to help with making decisions for the future.

Important Note:

 From 2007, preparers of financial statements will need to start applying IFRSs.
 This means a new New Zealand Financial Reporting Framework and the parameters for
NZ financial reporting will be made up of:
 Statement of Concepts for General Purpose Financial Reporting
 To be superseded by New Zealand Framework for the Preparation and Presentation of
Financial Statements (NZ Framework)
 Framework for Differential Reporting
 To be superseded by Framework for Differential Reporting for Entities Applying the NZ
Equivalents to IFRSs Reporting Regime
 Explanatory Foreword to General Purpose Financial Reporting
 To be superseded by New Zealand Preface
 FRS-1: Disclosure of Accounting Policies
 To be superseded by NZ IAS 8 : Accounting Policies, Changes in Accounting Estimates and
Errors
 FRS-2: Presentation of Financial Reports
 To be superseded by NZ IAS 1 : Presentation of Financial Statements
 XRB website: https://www.xrb.govt.nz/

NZ Framework
 Sets out the concepts that underlie the preparation and presentation of financial
statements by entities required to prepare general purpose financial statements for
external users.
 New Zealand Equivalent to the IASB Conceptual Framework for Financial Reporting (2018
NZ Conceptual Framework)
(https://www.xrb.govt.nz/standards/accounting-standards/for-profit-standards/
conceptual-frameworks/)

Scope of NZ Framework
1. The objective of financial statements
 2. The qualitative characteristics that determine the usefulness of the information in
financial statements
3. The definition, recognition and measurement of the elements from which financial
statements are constructed
4. concepts of capital and capital maintenance
a. (para 5)
b. Note: You can compare this with the 2018 NZ Conceptual Framework (for profit).

NZ Framework
 objectives of financial statements:
 significant emphasis:
 on the issues of decision usefulness of information and
 the accountability of reporting entities.

For instance, paragraphs 12 and 14 in NZ Framework

12) The objective of financial statements is to provide information about the financial position,
performance, and changes in financial position of an entity that is useful to a wide range of users
in making economic decisions.

14) Financial statements also show the results of the stewardship of management, or the
accountability of management for the resources entrusted to it. Those users who wish to assess
the stewardship or accountability of management do so in order that they may make economic
decisions; these decisions may include, for example, whether to hold or sell their investment in
the entity or whether to reappoint or replace the management.

Note: You can compare this with the 2018 NZ Conceptual Framework (for profit).

2018 NZ Conceptual Framework

 The objective of general purpose financial reporting is to provide financial information
about the reporting entity that is useful to existing and potential investors, lenders and
other creditors in making decisions relating to providing resources to the entity. (para 1.2)
 The decisions described in paragraph 1.2 depend on the returns that existing and
potential investors, lenders and other creditors expect, for example, dividends, principal
and interest payments or market price increases. Investors’, lenders’ and other creditors’
expectations about returns depend on their assessment of the amount, timing and
uncertainty of (the prospects for) future net cash inflows to the entity and on their
assessment of management’s stewardship of the entity’s economic resources. Existing
and potential investors, lenders and other creditors need information to help them make
those assessments. (para 1.3)
 The objective of financial statements is to provide financial information about the
reporting entity’s assets, liabilities, equity, income and expenses that is useful to users of
financial statements in assessing the prospects for future net cash inflows to the
reporting entity and in assessing management’s stewardship of the entity’s economic
resources (see paragraph 1.3). (para 3.2)

Generally Accepted Accounting Practices

 Entity Convention
 o Provides the scope or boundary within which the user of the reports can know
that the information has been properly prepared

o We will discuss a number of GAAPs

 that are important conventions for
 the preparation of financial statements.
 Going Concern
o The entity will continue to exist indefinitely
o Because of the assumption, records are produced in such a manner to account for
the continued existence of the entity
 Accrual Basis
o Recording and recognising all those transactions relating to a particular
accounting period.
 Cash Basis
o Recording and recognising all cash based transactions.
 Matching Principle
o Costs of operating the entity should be associated with the income that is
generated in a particular accounting period
o Brings in concepts of:
 Depreciation
 Inventory valuation
 Accruals
 Deferrals
 Monetary Convention
o All events need to be expressed in money terms before they can be recorded
 Historical Cost Convention
o Transactions are recorded in the dollars of the day when the transaction
happened
 i.e. at the cost of acquisition
 Advantage:
o information is reliable & verifiable
 Disadvantage:
o Information may not be relevant
 Income Recognition
o When should income be recognised?
 Cash
 Credit
 Completion of project
 Orders

NZ Framework
 Qualitative characteristics of useful financial information:
 If financial information is to be useful, it must be relevant and faithfully represent what it
purports to represent. The usefulness of financial information is enhanced if it is
comparable, verifiable, timely and understandable. (2018 NZ Conceptual Framework para
2.4)
 o
Fundamental qualitative characteristics
 Relevance* (predictive value, confirmatory value or both)
 Materiality
 Faithful representation (complete, neutral and free from error)
 Enhancing qualitative characteristics
o Comparability
o Verifiability
o Timeliness
o Understandability
 “Financial reports are prepared for users who have a reasonable
knowledge of business and economic activities and who review and
analyse the information diligently. At times, even well-informed and
diligent users may need to seek the aid of an adviser to understand
information about complex economic phenomena.” (2018 NZ Conceptual
Framework para 2.36)

Goods and Services Tax

 GST is a tax on the consumption of goods and services. It is a tax on the final
consumption by the end consumer.
 The income statement and balance sheet will be produced … exclusive of GST except for
financial instruments, debtors and creditors
 Simple Example: A business purchased goods for resale on credit for $720 (GST exclusive)
o GST rate = 15%
o GST on goods purchased = ($720 *15%) = $108
o Owed to Creditor = $720 + $108 = $828
o GST to be claimed back from the IRD = $108
o Purchases Expense to be recorded = $720

Example 1:
 Jane who runs a tyre and mag wheel outlet purchases a set of four high-performance
tyres for $1,000 (including GST)
 and then sells them to a client for $1,200 (including GST).
 You may say that she has made $200 on this transaction
 but this is not the case!
Example 2:

Stakeholders
 equity providers
 bankers & lenders
 government
 customers
 employees and employee representatives
 management
 auditors
 analysts
 environmental groups
 local government
 suppliers
 competitors

General Purpose Financial Statements

 Income Statement
 o To record profit/loss made by the entity
o Statement of Changes in Equity
o To show how the equity figure changed during the year
 Balance Sheet
o To show the assets, liabilities, and equity situation
 Cash Flow Statement
o To show how cash was provided and used

Types of Business Organisation

 Sole Trader
o No statutory regulations for the establishment of a sole trading concern
o Easy to establish, easy to close down
o Minimal administration except for GST maybe
o Sole trader are taxed on profits as they become reported as personal income
o No separate legal liability status
 Partnership
o Partnership Act 1908
o Easy to form but partners need to be aware of joint liabilities
o Partnership agreement important to set out business relationships clearly
o No separate legal liability status
 Company
o Companies Act 1993
o Separate legal liability status
o Directors’ liability dependent upon whether they gave personal guarantees
and/or
o Whether the Directors did not conduct business according to regulations
 Special Entity
o Clubs
o Not-for-profit organisations
 Examples: Red Cross, Salvation Army

What is Ethics?
 Ethics is:
o about behaviour
o a principle of right or good conduct
o may deal with moral obligations
o or may deal with obligations of individuals to act appropriately in all aspects of life

Different types of ethical actions

 Ethical actions can become questionable
o Some actions are both unethical and unlawful
o Some actions are recognised as being ethically wrong but within the law
o Some actions are ethically questionable but are not clearly right or wrong
Examples:
Importance of Ethics
 Herrera noted:
o professionals were the moral reserve of nations and that all professionals had to
distinguish themselves because they served society

Ethics and the Accounting Profession

 CAANZ Code of Ethics:
o Integrity
 Also implies fair dealing and truthfulness
o Objectivity
o Professional competence and due care
o Confidentiality
o Professional behaviour

Ethical Decision Making

A decision making model for evaluating ethical dilemmas

 Step 1: Identify the facts

 Step 2: Identify the ethics issues and the stakeholders involved
 Step 3: Define the norms, principles, and values related to the situation
 Step 4: Identify the alternative courses of action
 Step 5: decide the best course of action consistent with the norms, principles and values
 Step 6: Evaluate the consequences of each possible course of action
 Step 7: If appropriate, discuss the alternatives with a trusted person to help gain greater
perspective regarding the alternatives
 Step 8: Reach a decision to the appropriate course of action