PREPARED BY:

SYAZLIANA HJ. KASIM

KAMARUZZAMAN MUHAMMAD
FACULTY OF ACCOUNTANCY
UiTM SHAH ALAM
 FINANCIAL ACCOUNTING

After studying this chapter, you should be able to:

1. Explain the meaning of generally accepted accounting
principles and identify the key items of the conceptual
framework.
2. Describe the basic objectives of financial reporting.
3. Discuss the qualitative characteristics of accounting
information and elements of financial statements.
 FINANCIAL ACCOUNTING

After studying this chapter, you should be able to:

4. Identify the basic assumptions used by accountants.
5. Identify the basic principles of accounting.
6. Identify the two constraints in accounting.
7. Identify business cycles
8. Identify relevant financial statements
9. Differentiate between trading company and manufacturing
company.
 PREVIEW

The Conceptual International

Constraints in
Framework of Assumptions Principles Accounting
Accounting Standards
Accounting
 Objectives of  Monetary unit  Revenue  Differences
Materiality
reporting  Economic
recognition
entity Conservatism  Uniformity
 Qualitative  Time
 Matching
period  Summary of
characteristics  Full
 disclosure conceptual
Going concern 

Elements of  framework

financial
statements

Operating
guidelines
 STUDY OBJECTIVE 1

................................

1. Explain the meaning of generally accepted

accounting principles and identify the key
items of the conceptual framework.
 PREVIEW

The Conceptual International

Constraints in
Framework of Assumptions Principles Accounting
Accounting Standards
Accounting
 Objectives of  Monetary unit  Revenue  Differences
Materiality
reporting  Economic
recognition
entity Conservatism  Uniformity
 Qualitative  Time
 Matching
period  Summary of
characteristics  Full
 disclosure conceptual
Going concern 

Elements of  framework

financial
statements

Operating
guidelines
CONCEPTUAL FRAMEWORK OF ACCOUNTING
 Generally accepted accounting principles are a set of standards
and rules that are recognized as a general guide for financial
reporting.
 Generally accepted means that these principles must have
substantial authoritative support.
 This support usually comes from the International Accounting
Standards Board (IASB), Financial Accounting Standards Board
(FASB) and Securities and Exchange Commission (SEC).
 The FASB has the responsibility for developing accounting
principles in the United States.
 FASB’S CONCEPTUAL FRAMEWORK
The conceptual framework serves as the basis for resolving
accounting and reporting problems.
Under the conceptual framework consists of:
Objectives of financial reporting;
Qualitative characteristics of accounting information;
Elements of financial statements; and
Operating guidelines (assumptions principles, and constraints).
 STUDY OBJECTIVE 2

................................

2 Describe the basic objectives of financial reporting.

 PREVIEW

The Conceptual International

Constraints in
Framework of Assumptions Principles Accounting
Accounting Standards
Accounting
 Objectives of  Monetary unit  Revenue  Differences
Materiality
reporting  Economic
recognition
entity Conservatism  Uniformity
 Qualitative  Time
 Matching
period  Summary of
characteristics  Full
 disclosure conceptual
Going concern 

Elements of  framework

financial
statements

Operating
guidelines
 OBJECTIVES OF FINANCIAL
REPORTING
The objectives of financial reporting are to provide
information that:

1 Is useful to those making investment and credit

decisions.
2 Is helpful in assessing future cash flows.
3 Identifies the economic resources (assets), the
claims to those resources (liabilities), and the changes in
those resources and claims.
 STUDY OBJECTIVE 3

................................

3 Discuss the qualitative characteristics of

accounting information and elements of
financial statements
 PREVIEW

The Conceptual International

Constraints in
Framework of Assumptions Principles Accounting
Accounting Standards
Accounting
 Objectives of  Monetary unit  Revenue  Differences
Materiality
reporting  Economic
recognition
entity Conservatism  Uniformity
 Qualitative  Time
 Matching
period  Summary of
characteristics  Full
 disclosure conceptual
Going concern 

Elements of  framework

financial
statements

Operating
guidelines
QUALITATIVE CHARACTERISTICS OF
ACCOUNTING INFORMATION
 To be useful, information should possess the following qualitative
characteristics:

1. relevance
2. reliability
3. comparability
4. consistency
 RELEVANCE
 Accounting information has relevance if it makes a
difference in a decision.

 Relevant information helps users forecast future

events (predictive value), or it confirms or corrects
prior expectations (feedback value).

 Information must be available to decision makers

before it loses its capacity to influence their decisions
(timeliness). i.e. the information no longer timely for
decision.
 RELIABILITY
 Reliability of information means that the information
is free of error and bias. In short, it can be depended
on.

 To be reliable, accounting information must be

verifiable – we must be able to prove that it is free of
error and bias.

 The information must be a faithful representation of

what it purports to be – it must be factual.
COMPARABILITY AND CONSISTENCY
 Comparability means that the information should be
comparable with accounting information about other
enterprises.

 Consistency means that the same accounting principles and

methods should be used from year to year within a
company.

2008 2009 2010

 QUALITATIVE CHARACTERISTICS OF ACCOUNTING
INFORMATION

Useful
Financial
Information has:

Relevance Reliability
1 Predictive value 1 Verifiable
2 Feedback value 2 Faithful representation
3 Timely 3 Neutral

Comparability Consistency
 THE OPERATING GUIDELINES OF
ACCOUNTING
 Operating guidelines are classified as assumptions, principles, and
constraints.
 Assumptions provide a foundation for the accounting process.
 Principles indicate how transactions and other economic events should be
recorded.
 Constraints on the accounting process allow for a relaxation of the principles
under certain circumstances.

Assumptions Principals Constraints

Monetary unit Revenue recognition Materiality
Economic entity Matching Conservatism
Time period Full disclosure Cost
Going concern
 STUDY OBJECTIVE 4

................................

4 Identify the basic assumptions used by accountants.

 PREVIEW

The Conceptual International

Constraints in
Framework of Assumptions Principles Accounting
Accounting Standards
Accounting
 Objectives of  Monetary unit  Revenue  Differences
Materiality
reporting  Economic
recognition
entity Conservatism  Uniformity
 Qualitative  Time
 Matching
period  Summary of
characteristics  Full
 disclosure conceptual
Going concern 

Elements of  framework

financial
statements

Operating
guidelines
 ASSUMPTIONS
1 The monetary unit assumption states that only
transaction data that can be expressed in terms of
money be included in the accounting records.

Example: employee satisfaction and percent of

international employees are not transactions that
should be included in the financial records.
Customer Satisfaction

Percentage of
International Employees
Should be included
in accounting records
Salaries paid
 ASSUMPTIONS
2 The economic entity assumption states that the activities
of the entity be kept separate and distinct from the
activities of the owner of all other economic entities.
 ASSUMPTIONS
3 The time period assumption states that the economic life
of a business can be divided into artificial time periods.
Example: months, quarters, and years

2008 2009 2010

QTR 1 JAN FEB MAR
QTR 2 APR MAY JUN
QTR 3 JUL AUG SEPT
QTR 4 OCT NOV DEC
 GOING CONCERN
ASSUMPTION
4 The going concern assumption assumes that the
enterprise will continue in operation long enough to
carry out its existing objectives.

Implications: depreciation and amortization are used,

plant assets recorded at cost instead of liquidation
value, items are labeled as fixed or long-term.
 STUDY OBJECTIVE 5

................................

5 Identify the basic principles of accounting.

 PREVIEW

The Conceptual International

Constraints in
Framework of Assumptions Principles Accounting
Accounting Standards
Accounting
 Objectives of  Monetary unit  Revenue  Differences
Materiality
reporting  Economic
recognition
entity Conservatism  Uniformity
 Qualitative  Time
 Matching
period  Summary of
characteristics  Full
 disclosure conceptual
Going concern 

Elements of  framework

financial
statements

Operating
guidelines
 PRINCIPLES
REVENUE RECOGNITION
 The revenue recognition principle dictates that
revenue should be recognized in the accounting
period in which it is earned.

 When a sale is involved, revenue is recognized at the

point of sale.
PERCENTAGE-OF-COMPLETION METHOD OF REVENUE
RECOGNITION

 In long-term construction contracts, revenue

recognition is usually required before the contract is
completed.
 The percentage-of-completion method recognizes
revenue on the basis of reasonable estimates of progress
toward completion.
 A project’s progress toward completion is measured by
comparing the costs incurred in a year to total estimated
costs of the entire project.
FORMULA TO RECOGNIZE REVENUE IN THE PERCENTAGE-OF-
COMPLETION METHOD

Costs Incurred Total Percent

(Current ÷ Estimated = Complete
Period) Cost (Current
Period)

Percent Revenue
Complete X Total Revenue = Recognized
(Current (Current
Period) Period)
 PRINCIPLES
MATCHING (EXPENSE RECOGNITION)
 Expense recognition is traditionally tied to revenue recognition.
 This practice – referred to as the matching principle –
dictates that expenses be matched with revenues in the period in
which efforts are made to generate revenues.
 To understand the various approaches for matching expenses
and revenues on the income statement, it is necessary to examine
the nature of expenses.
1 Expired costs are costs that will generate revenues only in the
current period and are therefore reported as operating expenses
on the income statement. E.g. Salary expenses
2 Unexpired costs are costs that will generate revenues in future
accounting periods and are recognized as assets. E.g. Insurance
prepaid.
 PRINCIPLES
MATCHING (EXPENSE RECOGNITION)
Unexpired costs become expenses in 2 ways:
1) Cost of goods sold – Costs carried as
merchandise inventory become expensed when the inventory is
sold. They are expensed as cost of goods sold in the period in
which the sale occurs – so there is a direct matching of expenses
with revenues.
2) Operating expenses – Other unexpired costs become operating
expenses through use or consumption or through the passage of
time.
 PRINCIPLES
FULL DISCLOSURE
 The full disclosure principle requires that circumstances
and events that make a difference to financial statement
users be disclosed.
 Compliance with the full disclosure principle is
accomplished through
1 the data in the financial statements and
2 the notes that accompany the statements.
 A summary of significant accounting policies is usually the
first note to the financial statements.
 BASIC PRINCIPLES USED IN
ACCOUNTING
Revenue Recognition Matching
Costs Matching Sales Revenue

At end At
point of CEM
ENT
Materials
of production sale

During At time Labor

production cash received

Operating Expenses
Revenue should be recognized in the Delivery
accounting period in which it is earned Expenses should be
(generally at point of sale). matched with revenues
Advertising Utilities

Full Disclosure

* Financial Statements
* Balance Sheet
* Income Statement
* Retained Earnings
Statement
* Cash Flow Statement

Circumstances and events that make a

difference to financial statement users
should be disclosed.
 STUDY OBJECTIVE 6

................................

6 Identify the two constraints in accounting.

 PREVIEW

The Conceptual International

Constraints in
Framework of Assumptions Principles Accounting
Accounting Standards
Accounting
 Objectives of  Monetary unit  Revenue  Differences
Materiality
reporting  Economic
recognition
entity Conservatism  Uniformity
 Qualitative  Time
 Matching
period  Summary of
characteristics  Full
 disclosure conceptual
Going concern 

Elements of  framework

financial
statements

Operating
guidelines
 CONSTRAINTS IN ACCOUNTING
 Constraints permit a company to modify generally accepted
accounting principles without reducing the usefulness of the
reported information.

 The constraints are materiality and conservatism.

1 Materiality relates to an item’s impact on a firm’s overall
financial condition and operations.
2 The conservatism constraint dictates that when in doubt, choose
the method that will be the least likely to overstate assets and
income.
 CONSTRAINTS IN ACCOUNTING

Materiality Conservatism
$
$
$
$ $ $
$ $ $

If dollar amounts of costs are small, When in doubt, choose the solution
GAAP does not have to be followed. that will be least likely to overstate
assets and income.
 CONCEPTUAL FRAMEWORK

Objectives of Financial Reporting

Qualitative Elements of
Characteristics of Financial Statements
Accounting Information

Operating Guidelines

Assumptions Principles
 STUDY OBJECTIVE 7

................................

7 Identify business cycles.

 BUSINESS TRANSACTIONS
Business cycle starts with the occurrence of business
transactions e.g. buying (purchase cycle) and selling
of goods and services (revenue cycle) whether in cash
and/or credit term.

Examples of related source documents from this cycle

are invoices and receipts.

INTEGRATED ACCOUNTING STUDY (FAR 360)

FINANCIAL ACCOUNTING MODULE 41
 REVENUE AND RECEIPT CYCLES

Revenue cycle starts with sales of goods (cash and credit).

Sales will be recognized as the transactions occurred due to
revenue recognition concept.
For cash transactions, cash collection is made immediately.
For credit transactions, cash will be received in the future
depending on the credit terms.
Management requires debtors ageing reports for controlling
purpose.
Debtors ageing report will be used to assess the repayment
capability of the debtors as well as extend of bad debts that
can occur.

INTEGRATED ACCOUNTING STUDY (FAR 360)

FINANCIAL ACCOUNTING MODULE 42
EXPENDITURE AND PAYMENT CYCLES
Purchase cycle starts based on sales and production
budget (cash or credit).
Purchase will be recognized on accrual basis.
For cash transaction, cash payment is made
immediately.
For credit transaction, cash will be paid in the
future depending on the credit terms.
Management requires creditor ageing reports for
payment decision.
 Creditors ageing report will be used to assess the cash
requirement by the company

INTEGRATED ACCOUNTING STUDY (FAR 360)

FINANCIAL ACCOUNTING MODULE 43
Journalising Source
of Closing Documents
Journalising
Entries
Recording
Adjusting
Journal Entries JOURNALS
Extraction of
Balances of
Accounts
Preparation of LEDGERS
Pre-Adjusted Preparation of
Trial Balance Post-Adjusted
Trial Balance
Extraction of
the Balances
of Accounts

Preparation of
Financial
Statements

INTEGRATED ACCOUNTING STUDY (FAR 360)

FINANCIAL ACCOUNTING MODULE 44
 STEPS IN ACCOUNTING CYCLE
Identifying and recording the transactions in the journal –
a process called journalising.
Making entries in the ledger from the journal – a process
called posting.
Extracting the balances of the accounts in the ledger.
Preparing a pre-adjusted trial balance.
Recording adjusting entries in the journal.
Posting the adjusting entries to the ledger.
Preparing a post-adjusted trial balance.
Journalising the closing entries.
Posting closing entries to the ledger.
Balancing off the accounts in the ledger.
INTEGRATED ACCOUNTING STUDY (FAR 360)
FINANCIAL ACCOUNTING MODULE 45
 STUDY OBJECTIVE 8

................................

8 Identify relevant financial statements

 FINANCIAL STATEMENTS
After transactions are identified, recorded, and summarized, 4
financial statements are prepared from the summarized
accounting data:
1 An income statement presents the revenues and expenses and
resulting net income or net loss for a specific period of time.
2 An owner’s equity statement summarizes the changes in
owner’s equity for a specific period of time.
3 A balance sheet reports the assets, liabilities, and owner’s
equity at a specific date.
4 A statement of cash flows summarizes information
about the cash inflows (receipts) and outflows
(payments) for a specific period of time.
 FINANCIAL STATEMENTS AND THEIR INTERRELATIONSHIPS

SOFTBYTE
Income Statement
For the Month Ended September 30, 2002
Revenues
Service revenue $ 4,700
Expenses
Salaries expense $ 900
Rent expense 600
Advertising expense 250
Utilities expense 200
Total expenses 1,950
Net income 2,750

Net income of $2,750 shown on the income statement is added to the

beginning balance of owner’s capital in the owner’s equity statement.
 FINANCIAL STATEMENTS AND THEIR INTERRELATIONSHIPS

SOFTBYTE
Owner’s Equity Statement
For the Month Ended September 30, 2002
Capital, September 1 $ –0–
Add: Investments $ 15,000
Net income 2,750 17,750
17,750
Less: Drawings 1,300
Capital, September 30 $ 16,450

Net income of $2,750 is determined from the information in the owner’s

equity column of the Summary of Transactions.
 FINANCIAL STATEMENTS AND THEIR INTERRELATIONSHIPS

SOFTBYTE
Owner’s Equity Statement
For the Month Ended September 30, 2002
Capital, September 1 $ –0–
Add: Investments $ 15,000
Net income 2,750 17,750
17,750
Less: Drawings 1,300
Capital, September 30 $16,450

Net income of $2,750 carried forward from the income statement to the owner’s
equity statement. The owner’s capital of $16,450 at the end of the reporting
period is shown as the final total of the owner’s equity column of the Summary
of Transactions.
FINANCIAL STATEMENTS AND THEIR INTERRELATIONSHIPS

SOFTBYTE
Balance Sheet
September 30, 2002
Assets
Cash $ 8,050
Accounts receivable 1,400
Supplies 1,600
Equipment 7,000
Total assets $ 18,050
Liabilities and Owner’s Equity
Liabilities
Accounts payable $ 1,600
Owner’s equity
16,450
R. Neal, capital
Total liabilities and owner’s equity $ 18,050

Owner’s capital of $16,450 at the end of the reporting period shown

in the owner’s equity statement is shown on the balance sheet.
 FINANCIAL STATEMENTS AND THEIR INTERRELATIONSHIPS

SOFTBYTE
Balance Sheet
September 30, 2002
Assets
Cash $ 8,050
Accounts receivable 1,400
Supplies 1,600
Equipment 7,000
Total assets $ 18,050
Liabilities and Owner’s Equity
Liabilities
Accounts payable $ 1,600
Owner’s equity
16,450
R. Neal, capital
Total liabilities and owner’s equity $ 18,050

Cash of $8,050 on the balance sheet is reported on the statement of cash flows.
 FINANCIAL STATEMENTS AND THEIR INTERRELATIONSHIPS

SOFTBYTE
Statement of Cash Flows
For the Month Ended September 30, 2002
Cash flows from operating activities
Cash receipts from revenues $ 3,300
Cash payments for expenses (1,950)
Net cash provided by operating activities 1,350
Cash flows from investing activities
Purchase of equipment (7,000)
Cash flows from financing activities
Investment by owners $ 15,000
Withdraws by owners (1,300)
Net cash provided by financing activities 13,700
Net increase in cash 8,050
Cash at the beginning of the period –0–
Cash at the end of the period $ 8,050

Cash of $8,050 on the balance sheet and statement of cash flows is shown as the
final total of the cash column of the Summary of Transactions.
 STUDY OBJECTIVE 9

................................

9. Differentiate between trading company and

manufacturing company.
TRADING COMPANY
 A trading company is an enterprise that buys
and sells goods to earn a profit.
1) Wholesalers sell to retailers
2) Retailers sell to consumers
 A trader’s primary source of revenue is sales.
 MEASURING NET INCOME
 Expenses for a trading company are divided into two categories:
1) cost of goods sold and
2) operating expenses
 Cost of goods sold is the total cost of goods sold during the period.
 Operating expenses are expenses incurred in the process of earning
sales revenue. Examples are sales salaries and insurance expense.
 Gross profit is equal to Sales Revenue less Cost of Goods Sold.
 INCOME
INCOME MEASUREMENT
MEASUREMENT PROCESS
PROCESS FOR
FOR A
A
TRADING
TRADING COMPANY
COMPANY

Sales Less
Revenue

Equals

Cost of Gross Less

Goods Sold Profit
Equals

Operating Net
Expenses Income
(Loss)
TRADING VS MANUFACTURING
 Trading activities involve buying and selling finished products
from another enterprise and resell them at a profit.
 Example: shoes, books.

 Manufacturing activities involve buying raw materials and

converting them into finished products. Subsequently, the
finished products are sold to customers.
 Examples:
 Purchase raw tomatoes, chilli and other related raw materials
and process them into tomato sauce
 Purchase wood planks and other related materials to produce
furniture

Syazliana Hj. Kasim

58
Faculty of Accountancy UiTM Shah Alam
 TRADING INVENTORY
CHARACTERISTICS
Trading inventory has two common characteristics:
1 it is owned by the company and
2 it is in a form ready for sale in the ordinary course of
business
 CLASSIFYING INVENTORY IN A
MANUFACTURING ENVIRONMENT
 Unlike trading inventory, manufacturing inventory may not
yet be ready for sale.
 As a result, inventory is usually classified into three categories:
1 Finished goods - inventory which is completed and ready for
sale.
2 Work in process - inventory in various stages of production
but not yet completed.
3 Raw materials - components on hand
waiting to be used in production.

A manufacturing company need to prepare Manufacturing Account

INTEGRATED ACCOUNTING STUDY (FAR 360)
FINANCIAL ACCOUNTING MODULE 61