TOPIC 1

CONCEPTUAL FRAMEWORK
In Your Textbook...

Roshayani Arshad, et al. (2009), Financial

Accounting An Introduction, 3rd Edition,
Malaysia, McGraw Hill.
 Chapter 1: Introduction to Accounting

 Chapter 2: Basic Framework of

Accounting
Learning Objectives
1. Explain the definition of accounting.
2. Explain the various users group of accounting
information and their needs.
3. Explain the various form of business categories.
4. Explain Basic accounting concepts used in
preparing the financial statements.
 What is Accounting?
4
 Accounting can be defined as
 the process of recording, reporting, and interpreting
financial information
 to permit informed judgments and decisions by users of the
information.
 Vs. Book-keeping – involves only the recording of
data.
 Accounting is concerned with the uses which accountants
might make of the bookkeeping information given to
them.

UTAR/FBAF1023/Topic1
What is Accounting?
Flows of Accounting process

The accounting process includes

the all the functions of bookkeeping.

LO 1 Explain what accounting is.

 What does Accounting record?
 Transactions:
 Refer to any economic event or activity
 that affects the financial condition of a business
 must be entered into the accounting records.
 Two types of transactions:
1. Cash transaction – for which immediate payment is
made.
2. Credit transaction – for which payment is postponed
to a future date.
Purpose of Accounting

 To provide financial information about business

organisations to various interested parties for decision
making.
 Accounting information is used by:
1. External users
e.g. investors, government, creditors, taxing authorities,
general public
2. Internal users
e.g. managers, business owners, shareholders

Looking at the examples above, how do you think we

differentiate external users from internal users?
Who Use Accounting Data?

Business Stakeholders
A business stakeholder is a person or
entity with an interest in the economic
performance of the business.
Internal Users
1.Government
& taxing
1.Owner authorities
2. Manager 2.Investors

3.Shareholder

3.Labor
Unions
4.Employees

4.Creditors
/ Bankers
External
Users
Owner

 To decide whether to expand, continue or close

down the business.

Example question asked by Owner:

Should I close down the business if it has
been suffering losses for the past 3 years?
Manager
 To make decision on the operation of a firm

Example question asked by Manager:

Is it possible to change the operation

from labour intensive to machinery
intensive?
 Shareholder
To buy, remain or sell out the shares.

Example question asked by shareholder:

How much dividend can I get by the

end of this year?
 Employees

 To determine ability to pay salaries

and other employment benefits, job security and
career prospects.

Example question asked by employees:

How much bonus can I get by the

end of the year?
 External Users

1.Government
& taxing 2.Investors
authorities

3.Labor 4.Creditors/
Unions Bankers
 Government & Taxing authorities

To administer and enforce laws on companies.

Example question asked by Government:

Does the business follow the
business act?
Example question asked by Taxing authorities:
How much tax to charge a business?
 Investor

 To evaluate what income they can expect from their

investment.

Example question asked by Investor:

Is a company earning satisfactory

income?
 Labor unions
 Definition
 anorganization of workers formed for the purpose of
advancing its members' interests in respect to wages,
benefits, and working conditions
 Bargains with the employer on behalf of union
members (employee) and negotiates labor contracts
with employers.

Example question asked by labour unions:

Are the laborers' wages too low?
 Creditor / Bankers
 To determine borrower’s ability to meet scheduled
payments by evaluating borrower’s financial
position and prediction of future operations.

Example question asked by Creditors/ Bankers:

Can the companies afford to repay

the loan?
 The Process of Providing
Information

STAKEHOLDERS
Identify Internal: External:
1 stake-
holders.
Owners,
managers,
Customers,
creditors,
employees government

Assess
stakeholders’
2 informational
needs.
 The Process of Providing
Information

Record Design the

economic Accounting accounting
information
4 data about
business
Information
System
3 system to meet
activities stakeholders’
and events. needs.
 The Process of Providing
Information
STAKEHOLDERS
Internal: External:
Owners, Customers,
managers, creditors,
employees government

Prepare
accounting
5 reports for
stakeholders. Accounting
Information
System
 Who Uses Accounting Data?
Common Questions Asked User
1. Can we afford to give our
employees a pay rise?

2. Did the company earn a

satisfactory income?

3. Do we need to borrow in the

near future?
4. Is cash sufficient to pay
dividends to the stockholders?

5. What price for our product will

maximize net income?

6. Will the company be able to

pay its short-term debts?
 Nature of a Business
 A business is an organisation in which basic resources
(inputs) are assembled and processed to provide
goods or services (outputs) to customers.
 Objective of most businesses – to maximise profits
(difference between revenue and cost/expenses).
 Some businesses operate with an objective other than
to maximise profits.
Types of Businesses
1. Manufacturing Business

Product
Proton Cars, automotive parts
Intel Computer chips
Boeing Jet aircraft
Nike Athletic shoes and apparel
Coca-Cola Beverages
Sony Stereos and television
Types of Businesses
2. Merchandising Business

Product
Jusco General merchandise
Toys “R” Us Toys
Tower Records Music & video records
Guardian Beauty & health products
Amazon.com Internet books, music, video
retailer
Types of Businesses
3. Service Business

Product
Disney Entertainment
Malaysia Airline Transportation
Hilton Hotels Hospitality and lodging
A Cut Above Hairdressing services
Maxis Telecommunication
There are three forms of
business organizations

 Proprietorship
 Partnership
 Corporation
A proprietorship Advantages
is owned by one • Ease in organizing
individual. • Low cost of organizing

Disadvantage
Joe’s • Limited source of
financial resources
• Unlimited liability
A partnership is
Advantages
owned by two or
more individuals. • More financial resources.
• Additional management
skills.

Joe and Marty’s Disadvantage

• Unlimited liability.
Unlimited Liability ?
 The responsibility of owner(s) of a business
 TOTAL amount of debt and other liabilities that the
business accrues/owes
 regardless of how much the owner(s) have
personally invested
Example :
 Two persons form a general partnership and each
invests RM10,000. Total capital invested RM20,000.
 If the business later accrues RM100,000 in liabilities,
 Both partners are equally responsible for the
$80,000.
 If the business fail to pay, the PERSONAL ASSETS of
the partners may be seized to REPAY debts.
 A corporation is
organized under Advantage
Company Law as a • The ability to obtain
separate legal entity. large amounts of
resources by issuing
shares.
J & M, Bhd. Disadvantage
• Double taxation.
Forms of Business Ownership
Proprietorship Partnership Corporation
Generally owned Owned by two Ownership
by one person. or more divided into
Often small persons. shares of stock
service-type Often retail and Separate legal
businesses service-type entity organized
Owner receives businesses under state
any profits, corporation law
Generally
suffers any unlimited Limited liability
losses, and is personal liability
personally liable
Partnership
for all debts.
agreement
Take A Break!
“HOW” TO RECORD?
General Accepted Accounting Principles

 Financial statements have to be prepared in accordance to

General Accepted Accounting Principles (GAAPs).
 GAAPs are the standards and principles (i.e. rules, practices
and procedures) used in the preparation of financial
statements.
 International Accounting Standards Board (IASB) issues the
International Financial Reporting Standards (IFRS).
 In Malaysia, the Malaysian Accounting Standards Board
requires companies to adopt the IFRS with effective 1
January 2006.
Basic Accounting Concepts
 The accountant uses a number of accounting
concepts and conventions as guides to accounting
practice.
 These concepts have been derived over the years
from customs and general accounting practices.
 Accounting Concepts

1.Accounting/Business 7.Consistency
Entity
8.Conservatism/Prudence
2.Going Concern
9.Accrual
3.Money Measurement
10.Matching Principle
4.Historical Cost
11.Materiality
5.Accounting Period
12.Full disclosure
6.Objectivity
 Basic Accounting Concepts
1. Accounting/Business Entity
 For accounting purposes,
 the business is regarded as an accounting entity or business
entity
 which is different from its owners, creditors, employers,
customers and other persons.
 All of the dealings or transactions of the business are
recorded from the point of view of the business, as a
separate entity.
 E.g.: drawings account opened to record withdrawal by
owner.
Example :
 On 30 April, Sean paid deposit for his son’s new car
using company cheque.
 According to the business entity concept, all transactions
recorded must be transactions for the business ONLY.
 The car is belong to his son (personal transaction) and cannot
be treated as business transaction.
 Therefore, the company will record the amount paid as
withdrawal by owner, separately in drawings account.
Basic Accounting Concepts
2. Going Concern
 The business enterprise is assumed to have an
indefinite life.
 The accountant will
 ignore the current liquidation values of the resources in
the business
 because he assumes that these resources will not be sold
but will be utilized by the business in its normal
operations.
 E.g.: Assets will be recorded at original cost
regardless the current market price
Example:

 P&C Sdn. Bhd. business cycle ends every 31 December

and it will assume to be still continuously operating in the
future. On 31 Dec 2014, Co. recorded its land at
RM100,000 which is the same amount as it bought 5 years
ago although the current value of that land has increased
to RM350,000.
 According to the going concern concept, the business is assumed to
have an indefinite life.
 Due to this, the co will ignore the land’s current value (RM350,000)
but will record it at the original price (RM100,00).
 With the assumption that the asset (land) will be utilized by the
business in its normal operations as the co. will still continuously be
operating and not to be sold/liquidated/shut down/closed.
Basic Accounting Concepts
3. Money Measurement
 Money is used as the basic measuring unit for

financial reporting.
 If the event cannot be measured in monetary terms,

it is not considered as part of the accounting data.

 E.g. of non accounting data

 motivational level of the staff, inefficient management,

poor working conditions.
 Example :

 On Dec 15, co. is hiring a new account assistant and

agreed to pay her a salary of RM2,500 a month.
 Accounting data?/ non accounting data?

Record Don’t need to record

-because it can be measured in -because it cant be measured
monetary terms (RM) in monetary terms (RM)
 Continued,
 On Dec 31, co. paid salary RM2,500 to a new
account assistant.
 Accounting data?/ non accounting data?

Record Don’t need to record

-because it can be measured in -because it cant be measured
monetary terms (RM) in monetary terms (RM)
 Basic Accounting Concepts
4. Historical Cost
 All transactions of a business entity are recorded at

the original cost to the enterprise.

 Current market value irrelevant.

 This practice is based on the assumption that the

business is a going concern and is not likely to be
liquidated/closed/shut down.
Example :
 P&C Sdn. Bhd.’s year ends every 31 December. On
31 Dec 2014, Co. recorded its land at RM100,000
which is the same amount as it bought 5 years ago
although the current value of that land has increased
to RM350,000.
 According to the historical cost concept, the current value of
the asset (land) is not relevant because it is deemed to be a
going concern .
 Due to this, the co will record the land value at the original
price (RM100,00) regardless the current value of the land
(RM350,000).
Basic Accounting Concepts
5. Accounting Period
 The life of a business is divided into units of equal length
for the purpose of preparing financial reports.
 The period may be;
 a month ( 1 Jan – 31 Jan, 1 Feb – 28 Feb)
 a half-year ( 1 July- 31 Dec, 1 Jan – 30 June,
1 Nov- 30 Apr, 1 May- 31 Oct)
 a full year (1 Jan-31 Dec, 1 July-30 June, 1 Mar-28 Feb)
 or any other length of time
 depending on the volume and nature of the business.

 Purpose: to enable comparisons and analysis of the

business’s financial position over a period of time.
Example :

 Tab Corporation’s year ends every 31 December (1

Jan – 31 Dec)
 E.g.; 1 Jan 2014- 31 Dec 2014
 Transactions occurred within this period will be recorded and
reported in 2014’s accounting reports.
 If there is a transaction that do not fall within this
period(before 2014 or after 2014) but has been recorded,
that transaction must be adjusted.
 Basic Accounting Concepts

6. Objectivity
 Any accounting information reported must always
have objective verifiable evidence.
 Objective verifiable evidence?

 The evidence that a business transaction has taken place

and the details pertaining to that transaction are
contained in source documents.
 e.g. receipts, invoices, cheques, and vouchers.
Example :

 The accountant recorded the furniture purchased by

company based on the information(amount, date,
supplier name, etc) written on the invoice.
 According to the objectivity concept, there must always be
objective verifiable evidence.
 The transaction recorded by the accountant can be
considered as objective verifiable evidence.
 This is due to the report is based on the information obtained
from the invoice which is the proof for the transaction.
Basic Accounting Concepts
7. Consistency
 The same accounting method should be applied in
each accounting period when preparing financial
reports.
 Purpose:
1. to ensure that the accounting reports of a business
are comparable from period to period.
2. to prevent misleading profits arising from differing
accounting methods, from being reported.
Example:
 Zippi Sdn. Bhd. commences business on 1 January and
ends on 31 December every year. It will continuously
apply since Zippi Sdn. Bhd. has been applying this
accounting period in the future.
 According to the consistency concepts, the same accounting method
should be applied in each accounting period when preparing
financial reports.
 Therefore, Zippi Sdn. Bhd. Has been applying this concept and
will consistently maintain that accounting period for its life.
Basic Accounting Concepts
8. Conservatism/Prudence
 Due to uncertainty of future events, cautious
accounting practices are observed so that;
 income statement & assets are not overstated
 expenses & liabilities are not understated.

 The accountant will try;

 not to anticipate income
 but to provide for all possible losses.
Example :
 Daisy Sdn. Bhd. has allocated 2% of trade debtors’
balance for the provision for doubtful debt due to
uncertainty about some of its debtors’ ability to
settle their debts.
 According to the prudence/conservatism concepts, a company cannot
report overstated income and assets and understated expenses and
liability.
 Therefore, Daisy Sdn. Bhd. might be facing some debtors who cannot
settled their debts and has allocated 2% for the provision for doubtful
debt.
 As a result, it has reported this doubtful debt as an expense which will
reduce its income so that they do not overstate income and understate
the expenses.
Basic Accounting Concepts
9. Accrual Concept
 Revenue reported when earned
 (goods sold or services performed)
 Expense reported when incurred
 (used)

 Cash receipts/payment irrelevant

Example :
• TH Manufacturing Sdn. Bhd. received RM120,000 as annual
rental fees from the tenant of its building on 1 May 2014.
• Therefore, it is for 1 May 2014 – 30 April 2015 rental fees. The
company’s year ends on December every year.
• In 2014’s annual reports, the co. will report RM80,000 as rental
revenue for 2014(May-Dec @ 8 months)
• the remaining balance RM40,000 which is for 2015(Jan-Apr @ 4
months) will be reported as advanced rental revenue ( Unearned
rental revenue).
- According to the accrual concepts, revenue will be reported when it is
earned. Cash is not relevant.
- Therefore, the co. cannot record RM120,000 as its rental revenue for 2014
because some from the revenue belongs to 2015 even though cash is
received in 2014.
- Only rental revenue for May-Dec 2014 has been earned and allowed to
be reported in 2014’s annual reports. The remaining rental revenue is not
earned and will reported as unearned rental revenue.
 Basic Accounting Concepts

10. Matching Principle

 Revenue earned during an accounting period has to

be matched with the expenses associated with

earning that revenue.

Sales made “Matched”

(earned)
during 1/1/14
– 31/12/14 Bills incurred during
1/1/14 – 31/12/14
 Example :
 At the end of the year, sales earned by Johnny Sdn.
Bhd. is RM25,000. During the year, the co. has incurred
RM15,000 for several expenses in order to generate
revenue for the business. Therefore, the reported profit
by the company is RM10,000.
 According to the matching concepts, revenue earned must be
matched with the expenses incurred to generate that revenue.
 The profit reported by the company shown that the company
has adopted matching concepts when it matched(deduct)
expenses incurred (RM15,000) with the revenue
earned(RM25,000).
Basic Accounting Concepts
11. Materiality
 Materiality is a concept relating to the
importance/significance of an amount, transaction, or
discrepancy.
 The principle that trivial matters are to be disregarded
in accounting, and all important matters are to be
disclosed.
 The assessment of what is material is a matter of
professional judgment.
Example :
 A box of paper clips which consist of 100 pieces clips
was bought at RM3 and it will be used up over a
period of time. The box of the paper clips is an asset
as long as nobody uses it. The cost should be incurred
when someone uses a paper clip.
 It is possible to record this as an asset and expense
every time someone used it.
 But, the price of paper clip is so small that is not worth
recording it in this manner.
 Since the box of paper clips is not a material item, it can be
disregarded as an asset.
 the box can be charged as an expense in a period it was bought.
Basic Accounting Concepts
12. Full disclosure principle
The full disclosure principle requires that
financial statements include disclosure of
information on conditions that may have
imminent and significant effects on the
company's financial status.
For example,
-information on contingent liabilities
-pending lawsuits
-incomplete transactions
-the policies the company uses to record and report
business transactions
Example:
 A $100,000 lawsuit filed against your company is a contingent
liability (or loss contingency). Your company will have a liability
and a loss only if your company is found guilty. If your
company proves that it is not guilty, the contingent liability will
not become an actual liability and loss.
 Another example of a contingent liability is a product warranty.
If a company promised to replace a defective unit at no cost to
the customer within one year of purchase, the company will
have an actual liability only if units are defective. If the
company is certain that no units will be returned as defective,
the company will have no liability and no warranty expense.
These are not transactions but must be disclosed in the notes to
the accounts.
Accounting reports, called
financial statements,
provide summarized
information to the owner.
 Financial Statements
 Statement of Comprehensive Income — A summary of the
revenue and expenses for a specific period of time.
 Statement of Financial Position — A list of the assets,
liabilities, and owner’s equity as of a specific date.
 Statement of cash flows — A summary of the cash receipts
and disbursements for a specific period of time.
 Cycle of
Accounting Record Process

Source Journal
Documents

Transactions
take place
Ledger
Balance Sheet

Income Trial Balance

Statement
Exercises
Self- Exercise 1
1. Valuing closing stock at cost is an application of which concept?

a. Prudence
b. Consistency
c. Historical cost
d. Money measurement

2. Which of the following statements is not true?

‘The going concern concept can be ignored if ______’.

a. business closure is in the near future

b. the business is likely to fail in the forthcoming accounting period
c. parts of the business are likely to face closure
d. similar firms also have chosen to ignore the concept
3. Including private costs incurred in running a car as business costs would violate the concept of:

a. Historical cost
b. Going concern
c. Consistency
d. Business entity

4. Combining the activities of Mei Ling (the owner) and Mills Sdn Bhd would violate
the

a. Cost principle.
b. Business entity.
C. monetary unit assumption.
d. Consistency principle.

5. A business organized as a separate legal entity under state law having ownership
divided into shares of stock is a

a. proprietorship.
b. partnership.
c. corporation.
d. sole proprietorship.
 Self-Exercise 2
 In each of the following events or transactions, identify
the relevant accounting concepts.
(a) At the end of the financial year, Company A recognized
stationery consumed but not yet invoiced as expenses.
(b) During the accounting period, Company B acquired a new
machine. The machine will be used by the manufacturing
department for 8 years. Depreciation will be provided on a
straight line basis so as to be similar to the other machines
owned by the company.
(c) As at the year end, Company C discovered that debtors
figures includes several debts which have been outstanding
for some time. The amount for doubtful debts will be
provided in the financial statements.
Continued… self- exercise 2
(d) The owner of Company D takes goods from stock for his own
personal use. This event is not recorded in the financial
statements of Company D.
(e) Company E accounting period ends on 31 March every year.
(f) Company F recognized the building acquired two years ago
at RM1.2 million, which is the value at the acquisition date. The
current market price of the building is now at RM1.5
million.
(g) As at the year end, Company G discovered that 10% of its stock
are obsolete. The amount of the obsolete stock will be
recognized in the financial statements.
Self-exercise 3
 Identify the appropriate concepts in each of the
following situations. The accounting year ends on 31
December.
(a) Blue Enterprise acquired stock worth RM1,000 on 1
November 20X2. As at the Statement of Financial
Position date, the stock still unsold and reported in
the Statement of Financial Position at RM1,000.
(b) Red Enterprise stock as at 1 October 20X2 was
valued at RM10,000. As at 31 December 20X2,
company expects to sell this stock at RM15,000.
However, the expected profit of RM5,000 is not
recorded in the Statement of Comprehensive
Income.
Continued… Self-exercise 3

(c) As at 31 December 20X2, the stock of Green

Enterprise is worth RM50,000. Due to stock obsolescence,
50% of the stock will be sold at a discount of 70%. The
expected loss on the stock is recorded in the Statement of
Comprehensive Income for the year ended 31
December 20X2.
(d) It is a company policy for Purple Enterprise to provide
depreciation on a reducing balance method for all motor
vehicles owned by the business.
Self-exercise 4
 Enterprise GI has the following events and
transactions.
(a) On 5 January 20x3, Enterprise GI has received an
invoice of RM3,000 from VW Consultant for management
services provided during the months of October,
November and December 20x2.
(b) On 1 October 20x2, Enterprise GI received a new
photocopier machine. The machine will be used by the
retailing department for 5 years.
(c) On 22 December 20x2, Enterprise GI paid a deposit
of RM5,000 for television advertising time in February
20x3.
Continued… Self-exercise 4

(d) Enterprise GI incurred RM50,000 for advertising

campaign in newspaper during the period starting 1
November to 10 December 20x2. This amount will be
paid in January 20x3.

Required:
Explain the application of matching or accruals concepts in
each of the above events or transactions.
The End