Introduction to Accounting
June 17, 1994 (as amended)

Accounting is "the process of identifying, measuring and communicating economic information to permit informed judgement and decisions by users of the information." (AAA, 1966). A more detailed description comes from AICPA:

Accounting has a number of facets:

The information is usually quantiative, financial in nature, and is usually presented in the form of reports, which need to be tailored for the intended audience.

Accounting is used by both individuals and enterprises for planning, controlling and decision making. Enterprises also use accounting to present information about themselves to external users (financial accounting). Financial accounting is for everyone (including external users), whilst managerial accounting is specificially for internal users only, usually management. External users can be grouped into:


annual reportbalance sheet, income statement (profit and loss statement), cashflow statement, misc. extras
enterpriseany organisation involved in commercial dealings
entityany individual or body, company or business, group, etc.
external usersusers outside an entity eg, tax, shareholders, creditors, special-interest groups
financial accountinginformation for external users (eg. annual report)
internal usersusers inside an entity (eg. management, owner, partners)
management accountinginformation for internal users
qualitativean opinion or value judgement, eg. "this is a good idea"
quantitivereal-world, factual information, eg. 1+1
scarce resourcesany resources where supply is limited, or obtained at a price
usersany entity that uses accounting information
assetan item that has likely and measurable service potential or future economic benefit (SPFEB), controlled by the entity as a result of past transactions or events (AARF, 1995)
liabilitylikely and measurable future sacrifices of SPFEB than an entity is obliged to make as a result of past transactions or events (AARF, 1995)
expenselikely and measurable consumption or loss of SPFEB in terms of decreased assets/increased liability, not including owner's withdrawals (AARF, 1995)
revenuelikely and measurable increase in inflow/reduction of outflows of SPFEB in terms of increased assets/decreased liability, not including owner's contributions (AARF, 1995)
equitywhat's left after assets minus liabilities (the definition is dependent on the definition of assets/liabilities)
operating cyclego-to-woe; from raw materials to finished product
realisation periodlength between production of financial reports - usually 12 months
wealthwhat a business controls vs. what it owes; A vs. L+E
profitdifference in wealth at the start and end of a period (performance)
liquiditythe ease with which an asset can be converted to cash
current assetan asset that in the normal course of business would be consumed or converted to cash within 12 months after the end of the period
non-current assetan asset that isn't current
current liabilitya liability which in the normal course of business would fall due within 12 months of the end of the period
non-current liabilitya liability which isn't current
original costthe cost of the item to the entity at the time of the transaction
historic costoriginal cost; not useful if time has passed
replacement costthe cost of the item should it be purchased at today's prices; not useful if the item is not to be replaced
net realisable valueestimated proceeds of sale minus all further costs of sale
residual valueestimated value of an asset at the end of its useful life
written-down valuenet book value: the value of an asset after depreciation
capital expenditureadds value to an asset
revenue expenditureaffects only the current period (eg. repair of storm damage)
debtorsaccounts receivable: entities who owe through provision of goods and services on credit
creditorsaccounts payable: entities who are owed through provision of goods and services on credit
bad debtsunpaid accounts. PFDD (contra). % of credit sales (PL) or age of accounts (BS).
prepaymentspayments in advance; where there is unused SPFEB in an expense paid upfront.
accrualspayments owed, where the amount is not known, eg, phone, energy bill.
depreciationthe allocation of a portion of the cost of an asset, as an expense, against the value of an asset, over the life of the asset as it is used. That is, as the SPFEB of an asset is consumed, the value of the SPFEB is deducted from the value of the asset. This permits reflection of a loss in value of an asset due to time, wear and tear, technological advances etc. Depreciation must be systematic, consistent and rational. Depreciation requires estimates of the useful life of the asset, the residual value of the asset, and the historical cost of the asset. Depreciation can be straight-line or reducing balance. straight-line = (cost-residual)/useful life; reducing balance = 1-(useful life root (residual/cost)). Straight-line assumes that the asset will be equally useful throughout its life; reducing assumes that the asset will be most useful when it is new. Straight-line is best for time-based things such as buildings, while reducing is best for output-based things like car engines.
fixed costscosts that remain constant irrespective of output. eg rent
variable costscosts that vary according to output, eg raw materials
total costfixed costs + variable costs
cost-volume-profit analysisuse of the CVP equation to assess financial position.

CVP equation: Sx=VCx+FC+P where S=sales, VC=variable costs, FC=fixed costs, P=profit and x=units of output.
break-even pointwhere sales revenue cancels costs. Where P=0.
contribution margincontribution per unit: (sale price/unit)-(variable cost/unit) or (S-VC)x

Since Cx=FC+P (because the contribution margin eliminates cost and creates profit), the margin can be used to calculate breakeven from FC and C data. P is 0 (since we are at breakeven) thus Cx=FC, thus x=FC/C.
auditinga process by which entities have their financial statements analysed by an external third party. The analysis is accompanied by an opinion from the auditor, and both serve to add credibility to the financial statements and the entity as a whole; users expect the audit to give them a 'true and fair' picture of the financial position of the entity. Corporations Law requires all companies, barring exempt proprietary companies, to undertake an audit, however, many entities outside the corporate sphere, such as clubs and societies, also undertake an audit, either through alternate legislation or voluntarily. Auditors use industry standards, such as those issued by the PSASB, ratio analysis (eg debt:equity), statistical methods, comparisons with previous audits and the 'rule of thumb' to arrive at their conclusions. An expectation gap arises where the users of financial reports, hence the users of audits, expect additional information or reliability from the audit. The gap is damaging because it undermines confidence in the audit process and consequently reduces its effectiveness.
financial riskthe difference between debt finance, such as loans, and equity finance, such as owner contributions. The difference between interest repayments and interest earnings is leverage, and can be used as a method of expansion. Financial risk can be generally thought of as the degree of likelihood of a safe return of investment.
business riskthe degree of likelihood of an entity being able to survive in its marketplace. It takes into account the size and nature of the business, the diversity of the product line, the susceptibility of the product line to technological change, and the vulnerability to competition. Business risk also considers the social, political and economic environment within which the business operates.