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Accounting always existed in some form throughout time. E.g. The Parable of the Talents.

Really took off in the Renaissance Period in Venice when Venice was the trading capital of the western world.

The Italians developed the first banking system that the Roman Catholic Church allowed.

A mathematician and monk Luca Pacioli published the first book on double entry accounting in 1494.

His methods spread as the influence of Venice spread.

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Overtime double entry accounting became the standard.

There are, of course, many ways to record the same transaction but as time passed time, generally accepted ways of recording were developed.

 They are known as Accounting Principles.

In the 20th Century, as business became more advanced, Accounting Standards were developed to govern the recording of entries in each country.

This also led to the International Accounting Standards. Contained in the standards are the Qualitative Characteristics.

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The purpose of accounting is to provide business owners with financial information that will assist them in making decisions about the activities of their firm

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The accounting process involves collecting source documents, recording financial data and then reporting financial information, and subsequently advising the owner on an appropriate course of action

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• Entity – the business is assumed to be separate from the owner and other businesses, and its records should be kept on that basis

• Going Concern – the life of the business is assumed to be continuous, and its records are kept on that basis

BHP Billiton – the biggest mining company in the world, is Australian and has been doing business since 1860.

Lloyd’s of London – an insurance began in business in 1688.

The oldest continuous business in the world is Kongo Gumi – a Japanese construction company which began business in 578.

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• Reporting Period – the life of the business must be divided into periods of time to allow reports to be prepared

• Historical Cost – the recording of a transaction at its original cost or value, as this value is verifiable by reference to the source document

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• Conservatism – losses should be recorded when probable but gains should only be recorded when certain, so that liabilities and expenses are not understated and assets and revenues are not overstated

• Consistency – accounting methods should be applied in a consistent manner to ensure that reports are comparable between periods

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Monetary Unit – all items must be recorded and reported in a common unit of measurement; that is, Australian dollars

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• Relevance – is the information in the report useful for decision-making?

• Reliability – is it accurate, and free from bias or error?

• Comparability – can the reports be compared over time?

• Understandability – is the information presented in an easy-to-understand manner?

Qualitative Characteristics

Com› Comparability

Rel› Relevance› Reliability

U› Understandability

Accounting Principles Cricket Consistency

@ H Historical Cost E Entity R Reporting

Period

M Monetary Unit C Conservatism G Going Concern

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The following three-step approach may help you to earn the maximum marks for theory questions.

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Identify› Identify the important term, concept, accounting

principle or qualitative characteristic

Define› Define the term using a glossary definition

Link› Link the definition back t the intent of the

question, that is, answer the question

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IDENTIFY Entity Principle

DEFINE The entity principle states that the personal affairs of the owner should be kept separate from the affairs of the business.

LINK In this case, Jessica’s use of business finances should be treated as drawings, as the family holiday in not an expense of the business.

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1 mark for the correct accounting principle

1 mark for a correct definition 1 mark for linking back to the

questions accurately

Remember to always link the explanation back to the question or scenario.

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1.1Mornington General Store has just revalued their non-current assets upwards by 4% to reflect the rate of inflation. Referring to an accounting principle, explain why the non-current assets should not be revalued.

IDENTIFY

DEFINE

LINK

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The purchase price is verifiable by the cheque whereas it is difficult to verify an inflation increase of 4%.

Non current assets are valued at Historical Cost or at the price for which they were purchased.

Historical Cost

1.2 Frankston Petrol Station has decided that it is going to record the stock of petrol on hand in litres rather than dollars in the Balance Sheet. Referring to one accounting principle, explain why the stock of petrol should be recorded in dollars rather than in litres. Hint: It two or more accounting principles are relevant, use the principle that is MOST appropriate to the scenario.

IDENTIFY

DEFINE

LINK

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Monetary

All transactions are to be valued in the monetary terms of the country in which they are located.

Valuing the petrol in litres means that profit or loss cannot be calculated and this also means that the reports could not be compared one reporting period to the next.

1.3 Roger Moore plans to start up a business to organise a music festival on the Mornington Peninsula over the summer. He plans to wind up the business the day after the music festival is finished. Referring to an accounting principle, explain why, as accountants, we must assume the business will continue indefinitely.

IDENTIFY

DEFINE

LINK

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Going Concern

The life of a business is considered to go on forever.

The time and effort that Roger puts into the festival is wasted if he winds the business up at the end of the festival. Presumable he will run it next year and he would have to start the business up again. And what does he do with the money left over from the first festival.

1.4 Hasting Hardware currently depreciates all its non-current assets using the straight-line method of depreciation. Next year they are planning to change the way they calculate depreciation on their assets. Referring to an accounting principle, explain why the business should use the same method of calculating depreciation each year.

IDENTIFY

DEFINE

LINK

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Consistency

The same accounting methods must be used from one reporting period to the next.

This makes it easier to see if the changes in finance are due to business performance rather than changes to methods.

1.5 Portsea Bait Shop recently discovered that half its stock of bait had become rotten, so they threw it all away. The value of the rotten stock lost was $20,000 and has to be written off as a loss. Referring to an accounting principle, explain why Portsea Bait Shop should write off the lost bait as an expense.

IDENTIFY

DEFINE

LINK

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Conservatism

Losses must be recognised as soon as the business becomes aware of them so that assets and expenses are not overstated.

If the bait was not written off then Stock would $20,000 too high or $20,000 overstated.

1.6 Rachael owns and operates a small shop in Red Hill selling clothing and jewellery. Most weeks Rachael takes home clothing to keep for her personal use. She claims this clothing is an expense of the business. Referring to an accounting principle, explain why the clothing should not be treated as a business expense.

IDENTIFY

DEFINE

LINK

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Entity

The private transactions of the owner must be kept separately from those of the business.

If Rachael write the clothing and jewellery off as expenses it will increase expenses, reduce profit and reduce the tax bill. She should record these as drawings which will reduce capital.

1.7 Bill operates Sorrento Computer Repairs. At the end of each month he prepares a Profit and Loss Statement and a Balance Sheet. He believes this helps him better understand and analyse the performance of his business. Referring to an accounting principle, explain why it is important that Bill has broken down the life of the business into amounts of time.

STATE

DEFINE

LINK

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Reporting Period

The continuous life of a business is divided up into arbitrary periods of time for profit calculation.

Bill can compare a report over a number of reporting periods and see the favourable or unfavourable trends. He can then make decisions about improving his business.

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2.1Cassandra recently opened a restaurant in 2.1Cassandra recently opened a restaurant in Arthurs Seat. She handles all the cash receipts Arthurs Seat. She handles all the cash receipts and payments for the business. Recently she and payments for the business. Recently she decided not to give customers receipts ... “as decided not to give customers receipts ... “as they don’t want them”. Using a qualitative they don’t want them”. Using a qualitative characteristic, explain why it is important that all characteristic, explain why it is important that all transactions need to have a source document to transactions need to have a source document to prove that the transaction occurred.prove that the transaction occurred.

IDENTIFY

DEFINE

LINK

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Reliability

All transaction should be free from bias and be able to be verified by source documents.

How can Cassandra prove that a transaction took place if she has not recorded it on a source document? And how easy would it be for her to forget the amount or details of any transaction?

2.2 David owns and operates a boat hire business at 2.2 David owns and operates a boat hire business at Mornington pier. Until recently he has been using Mornington pier. Until recently he has been using straight-line method of calculating depreciation for non-straight-line method of calculating depreciation for non-current assets, but he has now decided to use a current assets, but he has now decided to use a different method which means depreciation expense different method which means depreciation expense will be less and therefore his net profit will be much will be less and therefore his net profit will be much higher, and this will mean his business is performing higher, and this will mean his business is performing much better. Referring to a qualitative characteristic, much better. Referring to a qualitative characteristic, explain why it may not be the case that David’s explain why it may not be the case that David’s business has performed better.business has performed better.

IDENTIFY

DEFINE

LINK

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Comparability

Reports should be prepared using the same accounting method so that they can be compared over time.

Changing the depreciation rate gives an unrealistically high profit one year compared to a lower one the year before.

2.3 When preparing the financial reports for profit 2.3 When preparing the financial reports for profit and cash position for her business, Aisha decided and cash position for her business, Aisha decided to simplify the accounting reports and convert to simplify the accounting reports and convert some financial information into charts. Referring some financial information into charts. Referring to a qualitative characteristic, explain why to a qualitative characteristic, explain why simplifying the accounting reports and using simplifying the accounting reports and using charts can be an advantage in accounting.charts can be an advantage in accounting.

IDENTIFY

DEFINE

LINK

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Understandability

Reports should be prepared in a way that people outside the business can easily understand them.

Charts and graphs are easy to read and understand.

2.4 When preparing the Profit & Loss Statement for 2.4 When preparing the Profit & Loss Statement for Rye Fish and Chip Shop, Jason made an error. Rye Fish and Chip Shop, Jason made an error. He forgot to include $5,000 paid in wages He forgot to include $5,000 paid in wages throughout the year to one of his workers. This throughout the year to one of his workers. This resulted in the net profit being overstated by resulted in the net profit being overstated by $5,000. Referring to a qualitative characteristic, $5,000. Referring to a qualitative characteristic, explain why it is important that all information explain why it is important that all information that is useful be included in the Profit & Loss that is useful be included in the Profit & Loss Statement.Statement.

IDENTIFY

DEFINE

LINK

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Relevance

All information that is useful for decision making should be included in the reports.

Jason needs accurate information so that he can make accurate decisions.

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The three general-purpose financial reports are the:• Cash Flow Statement• Income Statement • Balance Sheet

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• Asset – a resource controlled by an entity, as a result of past events, from which future economic benefits are expected to flow to the entity

• Liability – a present obligation of the entity as a result of past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits

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• Owner’s equity – the residual interest in the assets of the entity after the deduction of its liabilities• Revenue – an increase in assets (or decrease in liabilities) that increases owner’s equity, except for

capital contributions by the owner• Expense – the decrease in owner’s equity that occurs through business activities

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