Financial Accounting: Recognition, Measurement and Reporting
Core concepts
Financial accounting produces general-purpose reports for external users under accrual accounting and the concepts in the Conceptual Framework. Candidates must know the elements (assets, liabilities, equity, income, expenses), the recognition criteria, and the qualitative characteristics: relevance, faithful representation, comparability, verifiability, timeliness and understandability. Be fluent with the accounting equation, double-entry, adjusting entries (accruals, prepayments, depreciation, doubtful debts), closing entries, and the construction of the income statement, balance sheet and cash flow statement. Know the difference between capital and revenue expenditure, and between cash and accrual profit.
Traps
Questions often test whether a transaction affects profit or only the balance sheet: collecting receivables, borrowing cash, owner contributions and asset revaluations do not create income. Watch for GST being excluded from revenue and from asset cost when the entity is registered. Depreciation is an allocation of cost, not a valuation. A prepayment is an asset; an accrued expense is a liability. Contra entries (accumulated depreciation, allowance for doubtful debts) reduce assets without being liabilities. Cash flow classification trips candidates: interest and dividends paid are financing under the typical presentation, while interest and dividends received are investing, and non-cash transactions are disclosed separately.
Worked example
A business pays $2,400 on 1 March for 12 months of insurance. At 30 June, four months have expired: expense = 2,400 x 4/12 = $800; remaining prepaid asset = $1,600. The adjusting entry debits Insurance Expense 800 and credits Prepaid Insurance 800. Rule of thumb: at each reporting date, ask what portion of the cash flow has been consumed and what future benefit remains; the consumed portion is expense, the remainder is an asset or liability.