AA015 TOPIC 2

FINANCIAL ACCOUNTING
AA015

KOLEJ MATRIKULASI
NEGERI SEMBILAN
SESSION 2020/2021

TOPIC 2

THE CONCEPTUAL FRAMEWORK
OF ACCOUNTING

Learning Objectives

GAAP
The Accounting Principles
The Accounting Equation
Double entry system

Generally Accepted Accounting Principles

Objective :
- This is an ongoing process, accounting principles change to reflect

changes in the business environment.
- The different opinions between the Accountants can be solved by

referring this Recognized set of Standards is called Generally Accepted
Accounting Principles (GAAP)
- It covers convention, concept, regulations, procedure and the
guidelines standards.
- The report must be recorded in the Financial Statements and it must be
completed and easy to understand in order to make a comparison.

4

ACCOUNTING CONCEPT

1. HISTORICAL COST
2. THE MONETARY UNIT CONCEPT
3. THE ECONOMIC ENTITY CONCEPT
4. GOING CONCERN CONCEPT
5. CONSISTENCY CONCEPT
6. ACCOUNTING PERIOD CONCEPT
7. MATERIALITY CONCEPT
8. REVENUE RECOGNITION
9. EXPENSE RECOGNITION
10. FULL DISCLOSURE
11. OBJECTIVITY
12. FAIR VALUE MEASUREMENT

The Cost Principles (Historical Cost)

- The acquired assets and services should be recorded at their actual cost.
- The cost is a reliable measure and can be approved and should continue

reporting the historical cost of an asset over its useful life
Example:
The company purchases a car from supplier with a cost price RM20,000 at 21
August 2014. The market value increases up to RM25,000 on the next day.
What is the cost should be recorded by the company? Why?
Conclusion :
The value should be recorded as RM20,000 because cost is a reliable
measure.

The Monetary Unit Concept

Money is the common denominator in business. Expressing transactions and
events in monetary units is crucial to the use of financial statements for
business communications.
Accounting generally assumes a stable monetary unit. Example of monetary
units are the ringgit in the Malaysia.
Example:
A transaction occurred in The organization but the value cannot be determined.
Conclusion :
The transaction must be recorded in the monetary unit concept and the value
must not change with the inflation situation.

7

The Economic Entity Concept

 The activities of the entity be kept separated and distinct from the activities of
the owner and of all other economic entities such as the owner of the entity,
supplier, customer .
The entity needs to be evaluated separately and the transaction of different
entities should not be accounted for together.

Example:
The company purchases a car for his wife by using money from the business’
operations. He had recorded the purchases as a business’ assets. Besides
that, all the expenses such as fuel oil was recorded as business expenses.
Conclusion:
The company does not follow the Economic Entity Concept . The purchase
should be recorded as drawing because the transaction was the personal
transaction.

Going Concern Concept

The enterprise will continue in operation long enough to carry
out its existing objectives. It means that the entity will remain
in operation for the foreseeable future.
Most firm resources such as supplies, land, buildings and
equipment are acquired to use rather than to sell.

Example:
The company purchases a car with a cost of RM20,000 with
the estimated useful life for 10 years . The market value for
that car is RM25,000. It is suggested that the car should be
depreciated for 5 years because the business is expected to
make a clearance in a short period.

Conclusion :
The suggestion is rejected because it is contra with the Going
Concern Concept. The vehicle should be recorded as the
value of RM20,000 and must be depreciated for 10 years
because the trade must be assumed to operate for the period
that cannot be expected.

Consistency Concept

Consistency means that a company uses the same accounting principles and
methods from year to year.
When financial information has been reported on a consistent basis, the
financial statements permit meaningful analysis of trends within a company.

Example:
The company uses straight line method in depreciating the fixed asset of the
company. The company decides to change to declining balances method.
Conclusion:
It does not follow the rules of the consistency because the method should be
used from year to year. Any changes should be disclosed in the notes to the
financial statements.

Accounting Period Concept

Time period covered by financial statements is known as accounting period.

Time period assumption means business activities can be divided into specific
period such as a month, a quarter and a year in order to enables comparison of
business performance over time.

Example:

The company has established at 1 January 2013. The trade closes the business
account every 12 months at 31 December every year. Explain the concept
involved.

Conclusion:

That is normal condition when the trade follow the Accounting period where the
financial statements will be held every 12 months.

Materiality Concept

Materiality relates to an item’s impact on a firm’s overall financial condition and
operations.
An item is material when it is likely to influence the decision of a reasonably
prudent investor or creditor.
To determine the materiality of an amount, the accountant usually compares it
with such items as total assets, total liabilities and net income.

Example:
A company purchases a calculator at cost RM20 and it will depreciate for 5
years over its useful life.
Give your opinion.
Conclusion:
Although the proper accounting would depreciate the calculator over its useful
life, but this cost are considered immaterial. It will not make a material
difference on total assets and net income.

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Revenue Recognition

Revenue is recognized in the period they are earned.

When the merchandise has arrived to the buyer or when services are rendered
even cash receivable

Criteria: -

there is a change of ownership/title.

buyers are willing to pay.

the stability of the currency.

Buyers are able to pay.

Example:

Azmal is an entrepreneur pottery. He has received 100 reservations porcelain
vase on January 1, 2013 and has received a payment of RM1,000. The booking
was sent on January 15, 2013. When the sales above should be recognized?
Give your opinion.

Solution:

En. Azmal need to recognize sales revenue of RM1,000 on 15 January 2013
because of a change of ownership at that date.

Expense Recognition

Expenses are recorded in the accounting period in which it has been involved
for a business revenue.
Expenses are recognized when they are incurred even if payment has not been
made.
The goal - to find out the actual amount of revenue and expenditure for a
financial period.
Example:
Pn. Tina has recorded expenses of RM2,000 for the utility in December 2012,
although payment will only be made in January 2013.
Explanation:
Pn. Tina comply the concept of expense recognition as an expense of the
current period should be recorded in the current accounting period.

Full Disclosure

The company should report the sufficient information (ie: relevant, reliable,
comparable) so that external parties can make a reasonable decision.

Example:
Farida businesses have made changes in stock valuation method used. The
company did not disclose the information in the financial statements for the
accounting period.
Explanation:
The situation does not comply with the concept of full disclosure where a
change is made it should be reported in the notes to the accounts. The aim is
to inform the user of changes in the financial statements.

Objectivity

All accounting data must be evidence of valid and reliable to support
transactions occur.

The goal - to prevent accountants in giving subjective and inaccurate opinion.

Example:

KZB basic business is only issued a receipt for cash transactions, but for the
return of goods sales transactions no source document is issued. Give your
opinion.

Solution:

The Company does not comply with the concept of objectivity for the return of
goods sales transaction for all transactions that occurred needs to be
confirmed with the release of the source document. In addition to the evidence
it can also facilitate the recording.

ACCOUNTING EQUATION

ASSETS = LIABILITIES + OWNER’S
EQUITY

Assets

 Wealth / resources owned by the business.
 Assets are divided into two: -

1. Non-current Assets
 Assets that have a life of more than one year.
 Divided into three: -
i. Tangible/fixed assets - can be seen physically.

Example: buildings, vehicles, equipment
ii. Intangible assets – can not be physically.

Example: - Trademarks, patents, copyrights
iii. Long-term investments - fixed deposits for

more than a year, the purchase of bonds

2. Current assets
 Exist in one accounting period and can be

converted into cash within a year.
 Constantly of changing form and value.
 Example: - Inventory, Accounts Receivable, Cash,

Bank and so on.

LIABILITY

 Debt / businesses obligation to be paid by business
entity to another party.

 Liabilities divided into 2 types: -
1. Non-current liabilities (> 1 year)
 Debt to be settled within a period exceeding
one year.
 Example: - Long-term loans, mortgage

2. Current liabilities (<1 year)
 Debt due in less than a year.
 Example: - Accounts payable, expense
payables, unearned revenue.

OWNER’S EQUITY

Owner’s claims on the business. They include:
 Capital invested by the owner into the business.
 The net profit result of the business activities.

The elements involved in owners'

equity:

 Capital
 Consists of assets in the business by the
owners.
 It will add the owner's equity.

 Drawing
 Owner issuing asset (cash or merchandise) for
its own use.
 The effect will be to reduce the value of owners'
equity.

 Profit
 Expenditure
 The effect will reduce the owner's equity.
 Income
 The effect will add value to the owner's equity.

Revenues

All income from the sale of goods or
the provision of services based on the concept of
revenue recognition.

2 types of revenue: -
 Revenue of Business

Example: - Sales, service revenue

 Revenue of Non Business
Example: - Interest income, rental income, gains on
sales of fixed assets

Expenses

Expenses use up assets or create liabilities in the
course of operating a business. Expenses
decrease equity.

2 type of expenses:
Operating expenses
Example:- Utilities , sales commissions, delivery
expense
Non operating expenses
Example:- property taxes on the administrative
office building

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ANALYSIS OF TRANSACTIONS

The accounting equation shows how
assets,liabilities, and owner’s equity are
related. Assets appear on the left side
of the equation, and the liabilities and
owner’s equty appear on the right side.

ANALYSIS OF TRANSACTIONS

EXAMPLE 1
Start the new business with cash RM 1,000.

ASSET = LIABILITY + EQUITY

Cash EFFECT Capital
+RM 1,000 +RM 1,000

Increases of Increases of
assets equity

ANALYSIS OF TRANSACTIONS

EXAMPLE 2
Owner withdraws RM 100 cash from the business
for its own used.

ASSET = LIABILITY + EQUITY

Cash EFFECT Drawings
- RM 100 -RM 100

Decrease of Decrease of
asset equity

ANALYSIS OF TRANSACTIONS

EXAMPLE 3
Received RM 3,000 cash from Maybank for
business loan.

ASSET = LIABILITY + EQUITY

Cash Bank Loan EFFECT
+ RM 3,000 + RM 3,000

Increase of Increase of
assets liability

ANALYSIS OF TRANSACTIONS

EXAMPLE 4
The business pays loan RM 100 with cash.

ASSET = LIABILITY + EQUITY

Cash Loan
- RM 100 - RM 100

Decrease of Decrease of EFFECT
asset liability

ANALYSIS OF TRANSACTIONS

EXAMPLE 5
Business performs a service for YY Agency in
credit RM 2,000.

ASSET = LIABILITY + EQUITY

Accounts EFFECT Earns the
Receiveble revenue
+ RM 2,000 + RM2,000

Increase of Increase of
asset Equity

ANALYSIS OF TRANSACTIONS

Example 6
Business pays RM 290 for utilities expenses.

ASSET = LIABILITY + EQUITY

Cash Utilities
- RM 290 expenses
- RM290

Decrease of EFFECT Decrease of Equity
asset
(Increase of Expenses )

Double- Entry Accounting

Accounting uses the double-entry system,
which means that we record the dual effects
of each transaction. As a result, every
transaction affects at least two accounts.It
would be incomplete to record only the giving
side, or only the receiving side, of a
transaction.

Double- Entry Accounting

DEBIT = The left side of the account
CREDIT = The right side of the account

The following T-accounts :

Title of account

DEBIT CREDIT

Rules of Debit and Credit

Account Record DR/CR Baki Normal
 DEBIT DEBIT
ASSET  CREDIT
EXPENSES  CREDIT CREDIT
DRAWINGS  DEBIT

LIABILITY
EQUITY
REVENUE