URGENT!! Accounting in Australia: The framework of accounting

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SMART TOUCH LEARNING LTD Balance sheet

Assets and liabilities must be divided into current and non-current to comply with accounting standards

Assets

Current assets:

Cash

Accounts receivable

Inventory

Supplies

Prepaid rent

Total current assets

Non-current assets:

Furniture $18 000

Less: Accumulated depreciation~furniture 300

Building 48 000

Less: Accumulated depreciation— building 200

Total non-current assets

Total assets

17 700

47 800

65 500

$106 000

Liabilities

Current liabilities:

Accounts payable

Salary payable

Interest payable

Unearned service 6V6nu6

Total current liabilities

Non-current liabilities:

Loans payable

Total liabilities

Shareholders' equity

Share capital

Retained earnings

Total shareholders' equity

Total liabilities and shareholders1

equity

$ 48 700

900

100

400

50 100

20 000

70 100

30 000

5 900

35 900

$106 000

WHY DO WE NEED ACCOUNTING STANDARDS, AND WHAT MAKES A

GOOD ACCOUNTING STANDARD? Standards are needed to improve the

presentation of financial statements, but what exactly does this mean?

What part do the accounting concepts and principles discussed in earlier

chapters play in the making of accounting standards? We will discuss the

object and principles of financial reporting and the impact of the conceptual

framework on companies like Smart Touch and Greg's Tunes.

Earlier chapters have explained how accountants measure business

events and put a value on business assets, and how that information is

reported, using some basic accounting principles. Those, and later,

chapters also look at how to use this information to make business

decisions. In this chapter we look at an extensive list of principles that

have been developed into a conceptual framework of accounting. The

standard-setting process and the nature and content of the conceptual

framework in Australia are described in the first part of this chapter. The

framework relates the concepts and principles covered in earlier chapters

to broader, more general principles of reporting information. Later in the

chapter, the impact of all this is illustrated by looking at different possible

methods of recognising profits.

Learning objectives

1 Outline the process for setting accounting standards in Australia

2 Describe the conceptual framework for financial reporting

3 Explain the objective of financial reporting

4 Explain the general principles of financial reporting

5 Describe and apply four common methods of profit recognition

6 Describe typical Australian practices for the disclosure of financial information

7 Explain how market values are used in financial statements

CHAPTER 17 THE FRAMEWORK OF ACCOUNTING

L O l

Outline the

process for

setting accounting

standards in

Australia

EXHIBIT 17-1

The politics of setting accounting standards

17.1 SETTING ACCOUNTING STANDARDS IN AUSTRALIA

The political nature of the standard-setting process

The standard-setting process in Australia

CHAPTER 17 THE FRAMEWORK OF ACCOUNTING

Standard-setting bodies

Due process in standard setting

E XHIB IT 1 7 -2

Key organisations

in the standard-

setting process

C H A P TER 17 THE FRAMEWORK OF ACCOUNTING

EXHIBIT 1 7 -3

The AASB

standard-setting

process

AASB standard-setting process

International standards Australian organisations organisations AASB activities and individuals

17.2 THE CONCEPTUAL FRAMEWORK

L0 2

Describe the

conceptual

framework for

financial reporting

CHAPTER 17 THE FRAMEWORK OF ACCOUNTING

Conceptual framework

Objective of financial reporting

E XHIB IT 1 7 -4

Relationship of

conceptual

fram ew ork to

financial

statements

Financial statements

Principles and standards

CONNECT TO: Accounting standards This outline o f the conceptual fra m ewo rk was published by the AASB in 2001. It has now been

w ith d raw n by the Board from its list of official publications. However, it is still a useful explanation o f the

nature and purpose of a conceptual fram ew ork fo r accounting.

The outline describes th e building blocks o f th e conceptual fram ew ork. Figure 1 [below] is a diagram to

help in understanding th e place o f the IASB Framework statem ent and th e Australian Statements of Accounting Concepts (SACs) w ithin the overall fram ew ork structure.

The follo wing SACs have been issued:

SAC 1, Definition o f the Reporting Entity; SAC 2, Objective o f General Purpose Financial Reporting; SAC 3, Qualitative Characteristics o f Financial Information; and SAC 4, Definition and Recognition o f the Elements o f Financial Statements.

SACs 2, 3 and 4 have been superseded by the Framework for the Preparation and Presentation o f Financial Statements issued by the IASB and adopted by the AASB. SAC 1 has been retained as there is, at least fo r now, no comparable international statement on this topic.

CHAPTER 17 THE FRAMEWORK OF ACCOUNTING

Definition o f financial reporting This is concerned with setting the boundaries of financial reporting

and thus th e scope of concepts statements, accounting standards and other pronouncements. It involves

consideration o f the types of activity or inform ation to be included in th e discipline o f financial reporting,

and consideration of th e skills th a t accountants can reasonably claim.

These considerations are relevant in distinguishing general purpose financial repo rting from special

purpose financial repo rting, d eterm in in g which parts o f a periodic re p o rt by an e n tity should be

subject to rep orting requirem ents and a u dit, considering w h e th e r non-financial in fo rm a tio n (for

exam ple, a non-financial perform ance indicator) has a p art to play in financial rep orting , and

w h e th e r n e w areas o f repo rting (for exam ple, prospective financial in fo rm a tio n ) should be included

w ith in financial rep o rting .

Definition of the reporting entity This part o f the fram ew o rk is concerned w ith establishing criteria for

determ ining which entities are reporting entities and should therefore prepare general purpose financial

reports. SAC 1 addresses this aspect o f th e fram ew ork.

Objective o f general purpose financial reporting This part of the fram ew ork specifies the broad

objective which general purpose financial reporting should serve. It identifies th e users o f general

purpose financial reports, th e nature o f th e ir inform ation needs and the type o f reporting appropriate to

those needs. The IASB Framework now addresses this aspect.

Qualitative characteristics of financial information This part of the fram ew ork is concerned w ith the

identification of qualitative characteristics which financial information should possess if it is to achieve the

objective o f general purpose financial reporting. The IASB Framework addresses this aspect.

Elements of financial statements: definition and recognition Blocks 5 and 6 o f th e fra m e w o rk deal

w ith th e elem ents o f financial statem ents (assets, liabilities, equity, income and expenses). They are

concerned w ith th e ide ntifica tio n , d e fin itio n and establishment o f criteria fo r th e recognition o f th e

elem ents t h a t should be included in financial statem ents if general purpose financial reports are to

satisfy: (a) th e objective o f general purpose financial reporting; and (b) th e q ua lita tiv e characteristics

o f financial in fo rm ation .

The IASB Framework also addresses this aspect.

M easurement This part o f the fram ew ork deals w ith the bases and techniques fo r measurement of

th e elements o f financial statements. It explores alternative measurement attributes (historical cost,

current cost, current cash equivalent and other alternatives), measurement units (nominal and constant

purchasing power dollars) and concepts o f capital (financial and physical). This area of th e fram ew ork

involves exploring the relationships between the various concepts, such as th e objective of general

purpose financial reporting, th e qualitative characteristics o f financial inform ation, and th e m anner in

which inform ation is displayed in financial reports.

Display of financial inform ation This le ve l o f the fram ew ork explores in detail the nature of the

inform ation th a t should be disclosed in general purpose financial reports. As Figure 1 indicates, this will

involve identifying th e inform ation categories (financial position, performance and so on) and analysing

th e components of those categories. This should provide a logical basis fo r disclosures required by each

accounting standard and other pronouncements.

Standard-setting policy This level o f the fram ewo rk is concerned w ith th e policies th a t th e AASB should

adopt in relation to th e development, structure and application o f accounting standards and other

pronouncements, and may also influence bodies responsible for developing requirements fo r the au dit of

general purpose financial reports.

Block 13 is concerned w ith w h e th er particular accounting standards and o ther pronouncements should

apply to some or all classes o f reporting entity. The issue o f differe ntial reporting is more broadly

CHAPTER 17 THE FRAMEWORK OF ACCOUNTING

E n fo rc em e nt

Figure l Building blocks of a conceptual framework fo r general purpose financial reporting

Source: The Nature and Purpose o f Statements o f Accounting Australian

Board and Commonwealth of Australia.

CHAPTER 17 THE FRAMEWORK OF ACCOUNTING

The reporting entity

CONNECT TO: Accounting standards IASB co n ce ptua l f r a m e w o rk

IASB,s p ro je c t t o revise its con cep tu al fr a m e w o rk

Q u a litie s o f a so und co n ce p tu al f ra m e w o r k

Source: Charter,

C H A P TER 17 THE FRAMEWORK OF ACCOUNTING

17.3 THE OBJECTIVE OF FINANCIAL REPORTING

17.4 GENERAL PRINCIPLES OF REPORTING

L0 3

L0 4

CHAPTER 17 THE FRAMEWORK OF ACCOUNTING

GRI: a fra m e w o r k fo r s us ta ina bility rep o rtin g

W h a t is GRI?

A n o v e rv ie w o f GRI

G4 S usta ina bility Reportin g G uidelines

QUESTIONS TO THIN K A BO UT

W hy m ig h t business firm s be in tere sted in p u b lish in g su s ta ina bility reports? W hat be nefits m ig h t th ey

expect fro m do in g this? W hat role(s) can should accountants p la y in p re p a rin g sustaina bility reports?

H o w m ig h t governm ents encourage businesses to sta rt p re pa rin g such reports?

Relevance

Su stain

ab ility

in actio

CHAPTER 17 THE FRAMEWORK OF ACCOUNTING

M ateriality

Faithful representation

CHAPTER 17 THE FRAMEWORK OF ACCOUNTING

Comparability

Verifiability

Timeliness

CHAPTER 17 THE FRAMEWORK OF ACCOUNTING

Understandability

The cost constraint on useful financial reporting

The elements of financial statements

Balance sheet (or statement of financial position)

17 THE FRAMEWORK OF ACCOUNTING

Income statement

E X H IB IT 1 7 - 5

Summary of the

main points of the

conceptual

fram ew ork for

financial reporting

D e fin itio n o f the Reporting E ntity

Framework, Objective o f General Purpose Financial R eporting

Framework, Q ua litative Characteristics o f Financial Reports

The Elements o f Financial Statements

17 THE FRAMEWORK OF ACCOUNTING

17.5 RECOGNISING PROFIT

L0 5

Sales method

CHAPTER 17 THE FRAMEWORK OF ACCOUNTING

Collection method

Instalment method

E X H IB IT 1 7 - 6

Effective interest

calculation of

interest earned on

instalment sale

CHAPTER 17 THE FRAMEWORK OF ACCOUNTING

Percentage of completion method

Year

Cost fo r

year

Total

project

cost

Percentage of

project completion

fo r year

Total

project

revenue

Construction

revenue fo r year

Construction

p rofit fo r year

1 $ 6 $36 $ 6/$36 = 1/6 $42 $42 x 1/6 = $ 7 $ 7 - $ 6 = $1

2 18 36 18/36 = 1/2 42 4 2 x 1 / 2 = 21 2 1 - 1 8 = 3

3 12 36 12/36 = 1/3 42 4 2 x 1 / 3 = 14 1 4 - 1 2 = 2

$36 $42 $42 - $36 = $6

Year 1 Year 2 Year 3

$ o

Year

Expenses

fo r year Construction revenue fo r year

Construction profit

fo r year

1 $ 6 $0 2 18 0

12 18 ( $ 4 2 - $ 6 - $ 1 8 )

C H A P TER 17 THE FRAMEWORK OF ACCOUNTING

CONNECT TO: Ethics

The b um p y road to g lobal accounting standards

Source:

QUESTIONS TO TH IN K A BO UT

W hat d o you th in k are the benefits o f having a single set o f 'g lo b a l, accounting standards? Can you th in k

o f an y disadvantages in ha v in g such a single set o f standards? A re th e re lik e ly to be an y specific

disadvantages fo r Australian companies fro m a d o p tin g these g lo b al standards? A ustralia does have some

in p u t to the developm ent o f these standards. H o w do yo u fee l in p u t co uld be m ost effective? W hat

avenues m ig h t we, o r should we, be using to influence the standard-setting process?

C o n cep

ts in

actio n

CHAPTER 17 THE FRAMEWORK OF ACCOUNTING

17.6 DISCLOSING FINANCIAL INFORMATION

A cc o u n tin g p o licies

1 Statement of significant accounting policies

(b) Basis of preparation

(d) Summary of significant accounting policies

(v) Property, plant and equipment

(xii) Inventories

L0 6

CHAPTER 17 THE FRAMEWORK OF ACCOUNTING

(I) Inventories

(e) Revenue recognition

i. Sales revenue

ii_ Interest income

iii. Other revenue

iv. Dividend income

Changes in accounting policies or accounting estimates

C H A P TER 17 THE FRAMEWORK OF ACCOUNTING

1(d)(i) Significant accounting judgm en ts, estim ates and assumptions

S ignificant accounting jud gm en ts:

Change in presentation currency

Subsequent events

Significant events a fte r the balance date

Notes to the financial statements

17 THE FRAMEWORK OF ACCOUNTING

L0 7

CSL LIMITED

Source:

17.7 THE USE OF MARKET VALUES IN FINANCIAL J STATEMENTS ^

CHAPTER 17 THE FRAMEWORK OF ACCOUNTING

The effect of inflation on accounting

CHAPTER 17 THE FRAMEWORK OF ACCOUNTING

DECISION GUIDELINES 17.1

The framework of accounting

Assume th a t yo u have been p ro m o te d to a senior a c c o u n tin g po sitio n and are n o w responsible fo r th e

p re p a ra tio n o f yo u r firm 's annu al fin a n cia l sta te m e nts. H o w can you m a ke im p o rta n t decisions on th e

rig h t m e th o d s and principles to use? These decision g uidelines w ill help yo u in th a t task.

DECISION GUIDELINES

•

• • •

SUMMARY PROBLEM 17.1

T his c h a p te r a n d p re v io u s c h a p te rs discussed th e fo llo w in g co n ce p ts a n d p rin c ip le s :

A C C O U N T IN G CON C EPTS A N D PRINCIPLES

A c c o u n t in g e n t i t y c o n c e p t

A c c o u n tin g p e r io d c o n c e p t

C o st p r in c ip le

M a t c h in g p r in c ip le

P r o f it ( o r r e v e n u e ) r e c o g n itio n p r in c ip le

P ru d e n c e ( o r c o n s e rv a tis m ) p r in c ip le

G o in g c o n c e rn a s s u m p tio n

GE NER AL PRINCIPLES OF REPORTING

R e le va n c e

M a t e r ia lit y

F a ith fu l r e p r e s e n ta tio n

C o m p a r a b ility

V e r if i a b ilit y

T im e lin e s s

U n d e r s t a n d a b ility

CHAPTER 17 THE FRAMEWORK OF ACCOUNTING

SOLUTION

REQUIREMENT

CHAPTER 17 THE FRAMEWORK OF ACCOUNTING

Accounting vocabulary (p. 755)

(p. 756)

(p. 752) (p. 748)

(p. 749)

(p. 739)

(p. 757)

(p. 747)

(p. 744)

(p. 752)

(p. 747)

(p. 745)

(p. 753)

(p. 745)

(p. 746)

(p. 747)

(p. 744)

(p. 751)

(p. 757)

(p. 748)

(p. 749)

(p. 748)

S tu den t success tips

Quick check

CHAPTER 17 THE FRAMEWORK OF ACCOUNTING

F ra m e w o rk fo r th e P re p a ra tio n a n d P re sen ta tio n o f F in an cia l S tatem ents:

CHAPTER 17 THE FRAMEWORK OF ACCOUNTING

Starters

L0 2

S17-1 S ta n d ard s e ttin g in A u s tra lia

Requirement

S17-2 C on ceptua l fr a m e w o r k ; re p o rtin g e n tit y

F ra m e w o rk

Requirement

S17-3 O b je c tiv e o f fin a nc ia l re p o rtin g ; m a rk e t va lues

Requirement

S17-4 A c co un tin g concepts a n d principles; g e n e ra l re p o rtin g principles

Requirement

S17-5 G e n e ral re p o rtin g principles; c o m p a ra b ility

Requirement

S17-6

Requirement

S17-7

Requirements

S17-8 A c c o u n tin g concepts a n d principles; p ro fit re c o gn itio n

Requirement

S17-9

Requirements

CHAPTER 17 THE FRAMEWORK OF ACCOUNTING

Exercises

Requirement

CHAPTER 17 THE FRAMEWORK OF ACCOUNTING

E17-2 C once ptual fr a m e w o rk , ac cou nting stand a rds , acc ou ntin g concepts [1 5 - 2 0 m in ]

F ra m e w o rk

Requirement

F ra m e w o rk

E17-3 C o ncep tu al f ra m e w o r k [1 0 -1 5 m in ]

Requirement

E17-4 O b je c tiv e o f fin a n c ia l re p o rtin g [1 0 -1 5 m in]

Requirements

E17-5 A p p ly in g ac co untin g concep ts a nd principles [1 0 - 1 5 m in]

S p ortsm a d

Requirement

S portsmad

S p ortsm a d

E17-6 G oing concern as su m ptio n; g e n e ra l re p o rtin g p rinciples [15 m in ]

CHAPTER 17 THE FRAMEWORK OF ACCOUNTING

Requirements

E17-7 A c co u n ting concepts an d p rinciples; g e n e ra l re p o rtin g principles [1 5 -2 0 m in ]

Requirement

E17-8 A c co u n ting concepts an d p rinciples; g e n e ra l re p o rtin g principles [15 m in ]

Requirement

E17-9 A c co u n ting concepts an d p rinciples; g e n e ra l re p o rtin g principles [15 m in ]

Requirement

E 17-10 P ro fit re c o gn itio n [1 0 -1 5 m in]

CHAPTER 17 THE FRAMEWORK OF ACCOUNTING

Requirements

E17-11 P ro fit re c o gn itio n [1 0 -1 5 m in]

Requirement

E17-12 P ro fit re c o g n itio n ; disclosure o f reve nues [15 m in ]

Requirement

CHAPTER 17 THE FRAMEWORK OF ACCOUNTING

E17-13 P ro fit re co g n itio n ; sales m e th o d an d in s ta lm e n t m e th o d [2 0 - 3 0 m in]

$84 000 16 000 12 000 8 580

43 200

Requirements

E 17-14 P ro fit re c o gn itio n ; th e c o m p le te d c o n trac t m e th o d a n d t h e p e rc e n ta g e o f

c o m p le tio n m e th o d [1 0 - 1 5 m in]

Requirement

E17-15 D isclosure o f fina n c ia l in fo rm a tio n ; ch a n gin g th e u seful life o f a d ep re c ia b le asset

[10 m in]

Requirements

L0 6

CHAPTER 17 THE FRAMEWORK OF ACCOUNTING

E17-16 Id e n tify in g s u b s e qu e n t ev e n ts [15 m in ]

Requirements

E17-17 P ro fit re c o g n itio n ; co rrec tion o f errors [3 0 m in ]

W IL L IA M S C O M P U T E R S A LE S

In c o m e s ta t e m e n t

Revenues

$ 935 000

20 000

24 000

62 000

9 000

Total revenue $1 074 000

Cost of sales $ 526 000

183 000

64 000

18 000

59 000

26 000

17 000

61 000

85 000

80 000

6 000

$1 125 000

(51 000)

CHAPTER 17 THE FRAMEWORK OF ACCOUNTING

Requirements

E17-18 C h a n gin g prices an d in fla tio n [2 0 m in]

Requirement

Problems P17-1 O b je c tiv e o f fin a nc ia l re p o rtin g ; disclosure o f fin a n c ia l in fo rm a tio n [2 0 - 2 5 m in]

Requirements

P17-2 A c co un tin g p rinciples a nd concepts; g e n e ra l re p o rtin g princip les [2 0 - 3 0 m in] L0 4

CHAPTER 17 THE FRAMEWORK OF ACCOUNTING

Requirements

P17-3 A cco u nting concepts a n d principles; g e n e ra l princ ip les o f fina n c ia l re p o rtin g and

disclosure [2 0 - 2 5 m in ]

Requirement

2 0 1 3 2 0 1 4 20 1 5

CHAPTER 17 THE FRAMEWORK OF ACCOUNTING

P17-4 A c co u n ting concepts an d p rinciples; g e n e ra l princip les o f fina n c ia l re p o rtin g and

disclosure [2 0 - 2 5 m in ]

Requirement n o t

P17-5 P ro fit re c o g n itio n ; in s ta lm e n t m e th o d [20 m in]

CHAPTER 17 THE FRAMEWORK OF ACCOUNTING

210000

Requirements

P17-6 P ro fit re c o g n itio n ; sales and collectio n m e th o d s [10 m in ]

Previous y e a r C u rre n t y e a r

1 100000

Requirements

P17-7 P ro fit re c o g n itio n , co n structio n c o n tra c t [1 5 - 2 0 m in]

- - — —

— —

Requirements

CHAPTER 17 THE FRAMEWORK OF ACCOUNTING

P17-8 A c co u n ting concepts an d p rinciples a p p lie d t o t h e disclosure o f fin a n c ia l in fo rm a tio n

[2 0 -3 0 m in]

Requirements

Continuing exercise

E17-19 A c co u n t f o r s u b s e q u e n t e v e n ts [ 1 5 - 2 0 m in ] L0 6

C H A P T E R

Requirements

Continuing problem

P17-9 Recognising p ro fit and re v e n u e [15 m in]

Requirements

Decision cases

Case 17-1

Requirements

su b se q u e n t events lo n g -te rm c o m m itm e n ts

CHAPTER 17 THE FRAMEWORK OF ACCOUNTING

Focus on ethics

Requirements

Financial s ta te m e n t case

778

Endnotes