003 Caaccst Ch01 Amndd Hs RP Sec

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chapter 1

Introduction to accounting

Contents
Contents

Introduction
Examination context
Topic List
1 The purpose of accounting information
2 The main financial statements
3 The regulation of accounting
4 Qualitative characteristics of accounting information
5 Capital and revenue items
Summary and Self-test
Technical reference
Answers to Self-test
Answers to Interactive questions

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Accounting

Introduction

Learning objectives Tick off


 Specify why an entity maintains financial records and prepares financial statements
 Record and account for transactions in accordance with the laws, regulations and accounting
standards applicable to the financial statements

Specific syllabus learning outcomes are: 1a, c

Practical significance
Since your role as a Chartered Accountant will be concerned with the maintenance of financial records and
preparation of financial statements, the contents of this chapter are fundamental to what you do.

Stop and think


Why do you think an entity needs to record financial transactions? For whom do you think they need to
record them, and what are these users going to do with the information?
To answer these questions you need to think in terms of what accounting is for.

Working context
In the work you are doing at this stage in your career it is very helpful to know what you are helping to
produce (financial information in the form of financial statements) and what is going to be done with it.

Syllabus links
The material in this chapter will be developed further in this paper, and then in the Financial Accounting
paper later in the Professional Stage and Financial Reporting paper in the Advanced Stage.

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INTRODUCTION TO ACCOUNTING 1

Examination context

Exam requirements
In the exam you may be required to:
 Identify capital as opposed to revenue expenditure
 Distinguish between the different qualitative characteristics
 Identify the principles that relate to each qualitative characteristic
 Identify the different interests of stakeholders

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Accounting

1 The purpose of accounting information

Section overview
 Accounting is a way of recording, analysing and summarising the transactions of an entity.
 The three main types of business entity are sole traders, partnerships and companies.
 Users who need financial information include: managers, owners, customers, suppliers, lenders,
employees, National Board of Revenue (NBR) and Customs, financial analysts and advisers, the
government and the public at large.
 Managers and (present and potential) owners are the prime users of published financial statements.
 People need financial information on a company to make economic decisions, to assess managers'
stewardship of the company's resources, and to assess the level, timing and certainty of its future cash
flows.

1.1 What is accounting?


Accounting is a way of recording, analysing and summarising transactions of an entity (a term we shall use
to describe any business organisation).
 The transactions are recorded in 'books of original entry' (see Chapter 3).
 The transactions are then analysed and posted to the ledgers (see Chapter 4).
 Finally the transactions are summarised in the financial statements (see Chapter 5).
One of the roles of an accountant is to measure the revenue and expenditure of an entity and, if it is a
business, its profit. This is not as straightforward as it may seem and in later chapters we will look at some
theoretical and practical difficulties.

1.2 Types of business entity


There are three main types of profit-making business entity.
 Sole traders
 Partnerships
 Limited liability companies
Sole traders are people who work for themselves. Examples include a local shopkeeper, plumber or
hairdresser. The term sole trader refers to the ownership of the business; sole traders can have
employees.
Partnerships occur when two or more people decide to share the risks and rewards of a business
together. Examples include an accountancy, medical or legal practice.
Limited liability companies are registered to take advantage of 'limited liability' for their members
(shareholders). This means that, while sole traders (always) and partners (usually) are personally
responsible for the amounts owed by their businesses, the shareholders of a limited liability company are
only responsible for the amount to be paid for their shares or the specified amount guaranteed
by the members to be contributed to the company.

1.3 The objective of financial statements


The International Accounting Standards Board (IASB) adopted the Framework for the Preparation and
Presentation of Financial Statements in 2001. It is concerned with general purpose financial statements that are
prepared at least annually and that are directed toward the common information needs of a wide range of
users, many of whom have to rely on financial statements as their major source of financial information on
an entity.

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INTRODUCTION TO ACCOUNTING 1

Why do businesses need to produce accounting information in the form of financial statements? If a
business is being run efficiently, why should it have to go through all the bother of accounting procedures in
order to produce financial information? The Framework states that:
'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.'
In other words, a business should produce information about its activities because there are user groups
who want or need to know that information in order to make economic decisions.
When making economic decisions, users need to assess:
 The ability of the business to generate cash, and
 The timing and certainty of cash flows.
Whether the business can generate cash of the right amount determines whether it can:
 Pay its employees and suppliers
 Meet interest payments
 Repay loans
 Pay something to its owners
Bangladesh Accounting Standard 1 (BAS 1) Presentation of Financial Statements adds two other functions to
BAS Framework's statements:
 To show the results of management's stewardship of the resources entrusted to it, and
 To help users of financial statements in predicting the entity's future cash flows and, in particular,
their timing and certainty.
Large businesses are of interest to a greater variety of people and so we will consider the case of a large
public company, whose shares can be purchased and sold on a stock exchange.

1.4 Who needs financial information?


The following people are likely to be interested in financial information about a large company with listed
shares.
 Managers/directors appointed by the company's owners to supervise the day-to-day activities of the
company. They need information about the company's present and future financial situation. This
enables them to manage the business efficiently (exercising the stewardship function) and to make
effective decisions.
 Shareholders, i.e. the company's owners, want to assess management performance. They want to
know how profitable the company's operations are and how much profit they can afford to withdraw
from the business for their own use.
 Trade contacts include suppliers who provide goods on credit and customers who purchase goods
or services. Suppliers want to know about the company's ability to pay its debts; customers need to
know that the company is a secure source of supply.
 Finance providers include banks which allow the company to operate an overdraft, or provide
longer-term loan finance secured on the company's assets. A bank wants to ensure that the company
is able to keep up loan payments.
 National Board of Revenue (NBR) wants to know about business profits in order to assess the
company's tax liabilities.
 Employees have an interest in the company's financial situation, because their careers and
remuneration depend on it.
 Financial analysts and advisers need information for their clients or audience. For example,
stockbrokers need information to advise investors; credit agencies want information to advise
potential suppliers of goods to the company; and journalists need information for their reading public.

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Accounting

 Government agencies are interested in the efficient allocation of resources and therefore in the
activities of enterprises. They also require information in order to provide a basis for national
statistics.
 The public. Business entities affect members of the public in a variety of ways. For example, they may
make a substantial contribution to a local economy by providing employment and using local suppliers.
Another important factor is the effect of an entity on the natural environment, for example as regards
pollution.
Accounting information is summarised in financial statements to satisfy the information needs of these
different groups. Not all will be equally satisfied.
Managers of a business need the most information, to help them make planning and control decisions.
They have greater access to business information, because they are able to review internally produced
statements. Managers can obtain extra information through the cost and management accounting
system.

Interactive question 1: Accounting information [Difficulty level: Intermediate]


It is easy to see how 'internal' people get hold of accounting information. A manager, for example, can just
go along to the accounts department and ask the staff there to prepare whatever accounting statements she
needs. But external users of accounts cannot do this. How, in practice, can a business contact or a financial
analyst access accounting information about a company?
See Answer at the end of this chapter.

In addition to management information, additional financial statements are prepared for the benefit of other
user groups, who may demand particular information.

 NBR will receive information to make tax assessments.


 A bank might demand a cash flow forecast as a pre-condition of granting an overdraft.
 The Institute of Chartered Accountants of Bangladesh is responsible for issuing Bangladesh
Accounting Standards and Bangladesh Financial Reporting Standards (BASs and BFRSs)
and these require companies to publish certain additional information. Accountants, as members of
professional bodies, are placed under an obligation to ensure that company financial statements
conform to the requirements of BAS/BFRS, where relevant.
 Over time, some commonly used accounting practice has developed in Bangladesh. Many companies,
as well as sole traders and partnerships, prepare their accounting information following those common
practices rather than IFRS.
Note that, in this study manual, we will refer to the collective body of standards issued by the ICAB as
BASs.

1.4.1 Not Government Organisations (NGOs)


It is not only businesses that need to prepare financial statements. NGOs and clubs, for example, prepare
financial statements every year. Accounts also need to be prepared for government (public sector)
organisations.

1.5 BFRS Framework: users and their information needs


As well as identifying the objectives of financial statements the BFRS Framework sets out who uses financial
statements and their specific information needs.
 Investors (current and potential shareholders) are the providers of risk capital for the company, so
they are interested in the risk to their capital presented by the investment, and the return they will
get for taking that risk. They need information to help them determine whether they should buy, hold

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INTRODUCTION TO ACCOUNTING 1

or sell shares. Shareholders are also interested in information which enables them to assess the ability
of the entity to pay dividends.
 Employees and their representative groups need information about the stability and profitability of
their employers, so they can assess the entity's ability to provide remuneration, retirement benefits
and employment opportunities.
 Lenders need information that enables them to determine whether their loans, and the interest
attached to them, will be paid when due.
 Suppliers and other creditors need information that enables them to determine whether amounts
owing to them will be paid. Trade creditors are likely to be interested in an entity over a shorter
period than lenders, unless they are dependent upon the continuation of the entity as a major
customer.
 Customers need information about the entity's continuance, especially when they have a long-term
involvement with, or are dependent on, the entity.
 Governments and their agencies have the needs listed in section 1.4. They also require
information in order to regulate the activities of entities, and determine taxation policies.
 Public. Members of the public have the needs listed in section 1.4, that is they wish to see how the
company will be able to continue employing local people and using local suppliers. Financial statements
may assist the public by providing information about the trends and recent developments in the
prosperity of the entity and the range of its activities.
The Framework does not identify managers primarily as users of financial statements but instead as being
primarily responsible for their preparation and presentation.

2 The main financial statements

Section overview
 The main financial statements include a balance sheet, an income statement, a cash flow statement
and notes.
 BAS 1 Presentation of Financial Statements sets out the form and content of the income statement and
balance sheet.

BAS 1 Presentation of Financial Statements (and the Framework) identifies a complete set of financial
statements as comprising a balance sheet, an income statement, a statement of changes in equity,
a cash flow statement, and notes.

2.1 Balance sheet

Definitions
Balance sheet: A list of all the assets controlled and all the liabilities owed by a business as at a particular
date: it is a snapshot of the financial position of the business at a particular moment. Monetary amounts
are attributed to assets and liabilities. It also quantifies the amount of the shareholders' interest in the
company: equity.
Equity: The amount invested in a business by the owners.

Assets and liabilities are explained in more detail in Chapter 2. However, the sum of the assets will always
be equal to the sum of the liabilities plus equity/capital.

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The Framework gives a useful analysis of what factors affect a company's financial position at any one time:
(a) The economic resources it controls (cash, labour, materials, machinery, skills)
(b) Its financial structure (whether it is funded by owners, lenders, suppliers, or by all three)
(c) Its liquidity (short-term availability of cash) and solvency (long-term access to funds)
(d) Its adaptability to changes in its operating environment
The Framework also sets out how information about three of these features can be used by users.

Factor Information on this helps users

Economic resources  To predict the entity's ability to generate cash in the future
Financial structure  To predict future borrowing needs
 To predict how future profits and cash flows will be distributed among
owners and lenders
 To predict how successfully it will be able to raise future finance
Liquidity/solvency  To predict its ability to meet financial commitments as they fall due

2.2 Income statement


In Bangladesh (sole proprietor and partnership businesses), the income statement is called the profit and
loss account.

Definition
Income statement: A record of income recognised and expenditure incurred over a given period.
It is a record of the entity's financial performance over a period of time. The statement shows whether
the business has had more revenue than expenditure (a profit) or vice versa (a loss).

The accounting period chosen will depend on the purpose for which the statement is produced. The
income statement which forms part of the published annual financial statements of a limited liability
company will usually be for the period of a year, commencing from the date of the previous year's
financial statements. On the other hand, management might want to keep a closer eye on a company's
profitability by making up quarterly or monthly statements.
The Framework sets out how information about the business's financial performance, i.e. its profits, is
needed by users.
 To assess potential changes in the economic resources it uses in the future (information about
variability of performance is potentially important here)
 To predict the business's capacity to generate cash flows from its existing resource base
 To judge how effectively the business might employ additional resources.
The link between the balance sheet and the income statement is provided by the cash flow statement
and the statement of changes in equity. These are covered later in your professional studies.
The only note that is covered in this exam syllabus is the summary of accounting policies, which we
will see later.

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INTRODUCTION TO ACCOUNTING 1

2.3 Presentation of financial statements


Both the balance sheet and the income statement are summaries of accumulated data. For example,
the income statement shows a figure for revenue earned from selling goods and services to customers. This
is the total revenue earned from all sales made during the period. An accountant devises methods of
recording such transactions, so as to produce summarised financial statements from them.
The balance sheet and the income statement form the basis of financial statements for most businesses. For
limited liability companies, other information by way of statements and notes is required by statute and
accounting standards, for example a cash flow statement and a statement of changes in equity.
These are covered later in your professional studies.

3 The regulation of accounting

Section overview
 Financial statements are regulated by legislation, the application of judgement using established
accounting concepts, accounting and financial reporting standards, commonly used accounting
practices and the need for fair presentation (or a true and fair view).

A number of factors have shaped the development of accounting.


You may be aware from media comments that there have recently been fairly considerable upheavals in
accounting, mainly in response to criticism. The regulatory framework of accounting, and the technical
aspects of the changes made, will be covered later in this study manual and in your professional studies. The
purpose of this section is to give a general picture of some of the factors which have shaped accounting.
We will concentrate on the financial statements of limited liability companies, as these are the ones most
closely regulated by statute or otherwise.
The following factors can be identified.
 Legislation
 Accounting concepts and individual judgement
 Accounting standards
 Commonly used accounting practice
 True and fair view/fair presentation

3.1 Legislation
Limited liability companies are required by the Companies Acts to prepare and publish financial statements
annually. Their form and content are regulated by legislation but must comply with accepted accounting
standards. For limited liability companies this means compliance with BAS and BFRS.

3.2 Accounting concepts and individual judgement


Many figures in financial statements are derived from the application of judgement in applying
fundamental accounting concepts.
Different people exercising their judgement on the same facts could arrive at very different conclusions.

Interactive question 2: Value of reputation [Difficulty level: Intermediate]


An accountancy training firm has an excellent reputation amongst students and employers. How would
you value this?
See Answer at the end of this chapter.

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Accounting

Other examples of areas where the judgement of different people may vary are as follows.
 Valuation of buildings in times of changing property prices.
 Research and development (R&D): is it right to treat this only as an expense? In a sense it is an
investment to generate future revenue.
 Brands such as 'Snickers' or 'iPod'. Are they assets in the same way that a fork lift truck is an asset?
Working from the same data, different groups of people may produce very different financial statements,
but if judgement is completely unregulated, there will be no comparability between the financial statements
of different organisations. This will be all the more significant in cases where deliberate manipulation occurs,
in order to present financial statements in the most favourable light.
We shall come back to accounting concepts and conventions in Chapter 7.

3.3 Accounting standards


To deal with some of this subjectivity, and to achieve comparability between different organisations,
accounting standards were developed at both a national level by the ICAB and at an International level,
by the IASB. In this study manual we are concerned with two BASs: BAS 1 Presentation of Financial
Statements and BAS 8 Accounting Policies, Changes in Accounting Estimates and Errors.

3.4 Generally Accepted Accounting Practice (GAAP)


Generally GAAP includes the local applicable Accounting Framework, related accounting law, rules and
Accounting Practices. For example, UK GAAP rules derive from:
� UK Companies Acts
� UK and international accounting standards
� Statutory requirements in other countries
� Stock exchange listing requirements
In the USA generally accepted accounting principles, commonly abbreviated as US GAAP or simply
GAAP, are US Accounting Standards used to prepare, present, and report financial statements.
In Bangladesh, other than BAS/ BFRS, GAAP as a term is not applicable.

3.5 True and fair view/faithful representation


Financial statements are required to give a true and fair view or present fairly in all material
respects the financial results of the entity. These terms are not defined and tend to be decided in courts of
law on the facts.
 The BFRS Framework states that, to be reliable, financial information must represent faithfully the
business's transactions

 The Companies Acts require that the financial statements should give a true and fair view of the
state of the affairs of the company and to explain its transactions.
 In terms of BAS 1, financial statements should present fairly the financial position and performance,
and the cash flows, of the entity. This requires faithful representation of the effects of transactions.

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4 Qualitative characteristics of accounting


information

Section overview
 Ideally financial information will be relevant, understandable, reliable and comparable.

What type of information then should financial statements contain? What should its main qualities be from
the user's point of view? The following is a summary of the qualitative characteristics of useful
accounting information according to the Framework.
 Relevance. Accounting information is relevant where it helps users evaluate past and present events,
and predict future events. Information's relevance is affected by its nature and materiality. (We
shall come back to materiality; for now you can think of it as 'important'). It may become less relevant
if there is undue delay in its reporting.
 Understandability. Information may be difficult to understand because it is incomplete, but too
much detail can also cause difficulties. Users are assumed to have a reasonable knowledge of business
and economic activities, and to be diligent.
 Reliability. Information is reliable if it is free from error and can be depended upon by users to
represent faithfully what it is reasonably expected to represent. As well as faithful representation and
accuracy, reliable information is:
– Accounted for on the basis of a transaction's economic substance rather than its legal
form
– Prudent – a degree of caution is exercised in making estimates where conditions of uncertainty
exist
– Neutral (unbiased)
– Complete within the bounds of materiality and cost.
 Comparability. Information should be produced on a consistent basis, so that valid comparisons can
be made with information from previous periods and with information produced by other entities (for
example, the financial statements of similar companies operating in the same line of business).
We shall look in more detail at these qualities, and how they might be undermined, in Chapter 7.

5 Capital and revenue items

Section overview
 Capital and revenue income and expenditure must be distinguished from each other.

5.1 Capital and revenue expenditure

Definition
Capital expenditure: Expenditure which results in the acquisition of long-term assets, or an
improvement or enhancement of their earning capacity.

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Accounting

Long-term assets are those which will be kept in the entity for more than one year.
 Capital expenditure is not charged as an expense in the income statement (although a 'depreciation'
charge will usually be made to write off the capital expenditure gradually over time; depreciation
expense is shown in the income statement).
 Capital expenditure on long-term assets appears in the balance sheet.

Definition
Revenue expenditure: Expenditure which is incurred either
 For trade purposes. This includes purchases of raw materials or items for resale, expenditure on
wages and salaries, selling and distribution expenses, administrative expenses and finance costs, or
 To maintain the existing earning capacity of long-term assets.

Revenue expenditure is charged to the income statement of a period, provided that it relates to the trading
activity and sales of that particular period.

Example: Revenue expenditure


If a business buys ten steel bars for CU200 (CU20 each) and sells eight of them during an accounting
period, it will have two steel bars left at the end of the period. The full CU200 is revenue expenditure but
only CU160 is the cost of the goods sold during the period. The remaining CU40 (cost of two units) will be
included in the balance sheet as 'inventory' valued at CU40.

Example: Capital expenditure


A business purchases a building for CU300,000. It then adds an extension to the building at a cost of
CU100,000. After a few months the building needs to have a few broken windows mended, its floors
polished and some missing roof tiles replaced. These cleaning and maintenance jobs cost CU900.
In this example, the original purchase (CU300,000) and the cost of the extension (CU100,000) are capital
expenditure, because they are incurred to acquire and then improve a long-term asset. The other costs of
CU900 are revenue expenditure, because these merely maintain the building and thus its 'earning
capacity'.

Capital expenditure can include costs incurred in bringing a long-term asset to its final condition and
location, such as legal fees, duties and carriage costs borne by the asset's purchaser, plus installation costs.
Repair, maintenance and staff costs in relation to long-term assets are revenue expenditure.

5.2 Capital income and revenue income

Definition
Capital income: Proceeds from the sale of non-current assets.

The profits (or losses) from the sale of long-term assets are included in the income statement for the
accounting period in which the sale takes place. For instance, the business may sell machinery or property
which it no longer needs.

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INTRODUCTION TO ACCOUNTING 1

Definition
Revenue income: Income derived from
 The sale of trading assets, such as goods held in inventory
 The provision of services
 Interest and dividends received from business investments

5.3 Capital transactions


The categorisation of capital and revenue items given above does not mention raising additional funds
from the owner(s) of the business, or raising and repaying loans.
 These transactions add to the cash assets of the business and create corresponding capital or liabilities
(loans).
 When a loan is repaid, it reduces the liabilities (loan) and the assets (cash).
None of these transactions would be reported through the income statement.

5.4 Why is the distinction between capital and revenue items


important?
Calculating profit for any accounting period depends on the correct and consistent classification of
revenue or capital items. You must get used to the terminology here as these words appear in the
accounting standards themselves.

Interactive question 3: Capital or revenue? [Difficulty level: Intermediate]


State whether each of the following items should be classified as 'capital' or 'revenue' expenditure or
income.
(a) The purchase of a property (e.g. an office building)
(b) Property depreciation
(c) Solicitors' fees in connection with the purchase of property
(d) The costs of adding extra memory to a computer
(e) Computer repairs and maintenance costs
(f) Profit on the sale of an office building
(g) Revenue from sales by credit card
(h) The cost of new machinery
(i) Customs duty charged on machinery when imported into the country
(j) The 'carriage' costs of transporting the new machinery from the supplier's factory to the premises of
the business purchasing it
(k) The cost of installing the new machinery in the premises of the business
(l) The wages of the machine operators
See Answer at the end of this chapter.

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Accounting

Summary and Self-test

Summary

Accounting

Business entity
Sole trader Partnership Company

Capital Transactions Revenue

Record (Chapter 3)

Analyse (Chapter 4)

Summarise (Chapter 5)

Accounting Information:
financial statements

Regulation Content Objective

Financial performance: Financial position:


Use Users
income statement balance sheet

Managers
Accounting Accounting Make Shareholders
Assess
concepts Standards economic Customers
stwewardship
(Chapter 7) (Chapters 7 & 12) decisions Suppliers
Lenders
Employees
Framework:
Legislation GAAP Estimate Government
qualitative characteristics
cash flows Analysts
Public

Relevance Understandability Reliability Comparability

Substance Faithful
Materiality Neutrality
Form representation

Prudence Completeness

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INTRODUCTION TO ACCOUNTING 1

Self-test
Answer the following questions.
1 An entity’s transactions are recorded first in
A Books of original entry
B Ledger accounts
C The income statement
D The balance sheet
2 Liability for the debts of the business does not fall on
A A sole trader
B Partners in a general partnership
C A limited liability company
D Shareholders
3 According to the BFRS Framework and BAS 1 which of the following does not represent an objective
of financial statements?
A To provide information to investors in making economic decisions
B To provide information to managers in making business decisions
C To show the results of management’s stewardship of the resources entrusted to it
D To help users predict the entity’s future cash flows
4 Which TWO of the following issues in an entity’s financial statements are identified by the Framework
as being of interest to the public?
A Whether the entity has paid a dividend
B Whether the entity will repay a loan when it falls due
C Whether the entity will continue to be able to employ people
D Whether the entity will continue
E Whether the entity patronises local suppliers
5 A balance sheet is best described as:
A A snapshot of the entity’s financial position at a particular point in time
B A record of an entity’s financial performance over a period of time
C A list of all the income and expenses of the entity at a particular point in time
D A list of all the assets and liabilities of the entity over a period of time
6 In applying fundamental accounting concepts the preparers of financial information are also using
A Legislation
B Accounting standards
C Judgement
D Financial reporting standards
7 Which of the following is not a source of the accounting rules embodied in in GAAP?
A The Companies Acts
B Commonly used accounting practices
C Listing requirements of Dhaka Stock Exchange
D Accounting requirements of an entity’s US parent company
8 Which of the following factors have not influenced financial reporting?
A National legislation
B Economic factors
C International Accounting standards
D GAAP

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9 Accounting for a transaction’s economic substance rather than its strict legal form is a feature of:
A Relevance
B Understandability
C Reliability
D Comparability
10 Which of the following is an item of capital expenditure?
A Cost of goods sold
B Purchase of a machine
C Repairs to a machine
D Wages cost
Now, go back to the Learning Objectives in the Introduction. If you are satisfied that you have achieved
these objectives, please tick them off.

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INTRODUCTION TO ACCOUNTING 1

Technical reference

1 The purpose of accounting information


 To provide information about the financial position, performance and changes in BAS Framework
financial position of an entity that is useful to a wide range of users in making para 12
economic decisions
 To show the results of management’s stewardship of the resources entrusted to it BAS 1 para 7

 To help users of the financial statements in predicting the entity’s future cash flows BAS Framework
and, in particular, their timing and certainty paras 16/17

2 The main financial statements


 Needs of investors, employees, lenders, suppliers and other trade creditors, BAS Framework
customers, governments and their agencies and the public, for whom annual paras 6/ 9
financial statements are the major source of information
BAS Framework
 Responsibility of directors for preparation of financial statements
para 11

3 The regulation of accounting


BAS 1 para 8
 A balance sheet, an income statement, a statement of changes in equity, a cash
BAS Framework
flow statement and notes
para 7

BAS 1 para 13;


 Fair presentation/faithful representation BAS Framework
para 33

4 The desirable qualities of accounting information


BAS Framework
 Relevance, understandability, reliability and comparability
paras 24-42

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Accounting

Answers to Self-test

1 A Books of original entry form the primary record of transactions. These are analysed and posted
to the ledger accounts and summarised in the income statement and balance sheet
2 D Sole traders and partners bear full liability for the debts of the business entity, as does a limited
liability company itself. The liability of the shareholders for the debts of a company is, however,
limited
3 B BAS Framework identifies A as the objective, and BAS 1 identifies C and D. The use of accounting
information by managers is not identified as an objective in either document; instead managers
are identified in the BAS Framework is being primarily responsible for the preparation and
presentation of financial statements
4 C, E According to the Framework, A is of interest to investors; B is of interest to lenders, D is of
interest to customers
5 A A balance sheet is a list of assets and liabilities which represent the entity’s financial position at a
particular point in time. D is wrong because it refers to ‘a period of time’; C refers to income and
expenditure, not assets and liabilities; B defines the income statement
6 C Many figures in financial statements are derived from the application of judgement in putting
fundamental accounting concepts into practice
7 D GAAP relates to generally accepted accounting practice; the rules applied as a result of internal
requirements can therefore not be part of GAAP
8 B Economic factors do not influence the development of financial reporting; all the others do (see
section 3)
9 C
10 B This results in the acquisition of a long-term asset. All the others are revenue expenditure

18 © The Institute of Chartered Accountants in England and Wales, March 2009


INTRODUCTION TO ACCOUNTING 1

Answers to Interactive questions

Answer to Interactive question 1


Limited liability companies (though not other forms of business such as general partnerships) are required
to make certain accounting information public. This is done by filing information centrally, as a government
requirement.

Answer to Interactive question 2


The firm may have relatively little in the form of things you can touch, perhaps a building, desks and chairs.
If you simply drew up a balance sheet showing the cost of the things owned, then the business would not
seem to be worth much, yet its income earning potential might be high. This is true of many service
organisations where the people are among the most valuable assets, but justifying their exact value is
extremely problematic.

Answer to Interactive question 3


(a) Capital expenditure
(b) Depreciation is revenue expenditure
(c) Legal fees associated with purchasing a property may be added to the purchase price and classified as
capital expenditure
(d) Capital expenditure (enhancing an existing long-term asset)
(e) Revenue expenditure (restoring an existing long-term asset)
(f) Capital income (net of the costs of sale)
(g) Revenue income
(h) Capital expenditure
(i) If customs duties are borne by the purchaser of the long-term asset, they should be added to the
purchase cost of the machinery and classified as capital expenditure
(j) If carriage costs are paid for by the purchaser of the long-term asset, they should be included in the
cost of the long-term asset and classified as capital expenditure
(k) Installation fees of a long-term asset are also added to cost and classified as capital expenditure
(l) Revenue expenditure

© The Institute of Chartered Accountants in England and Wales, March 2009 19


Accounting

20 © The Institute of Chartered Accountants in England and Wales, March 2009

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