Financial Accounting: Recording, Reporting and Interpreting
Core concepts
Financial accounting records transactions, applies accrual and matching principles, and reports position and performance through the income statement, balance sheet, cash flow statement and statement of changes in equity. Candidates must handle double-entry logic, the accounting equation (Assets = Liabilities + Equity), period-end adjustments (accruals, prepayments, depreciation, doubtful debts, inventory write-downs), and the distinction between capital and revenue expenditure. Know the qualitative characteristics: relevance, faithful representation, comparability, verifiability, timeliness, understandability.
Common traps
- Accrual vs cash confusion: revenue is recognised when earned, not when cash arrives. A question describing cash received in advance is a liability (unearned revenue), not income.
- Depreciation method errors: straight-line uses (cost − residual)/useful life; reducing balance applies the rate to carrying amount, not original cost. Watch for mid-year purchases requiring pro-rata.
- GST treatment: GST collected is not revenue and GST paid is not an expense; both sit in a clearing account.
- Direction of adjustments: a prepaid expense already recorded as an expense must be reduced and an asset created.
- Closing vs reversing entries and the effect of each on the trial balance.
Worked example
A business pays $2,400 on 1 October for 12 months' insurance. At 30 June, nine months have expired. Monthly expense = $200; expired = $1,800 (expense); prepaid asset = $600. Entry: Dr Insurance expense 1,800; Cr Prepaid insurance 1,800.
Rule of thumb
Before answering, ask: has the economic benefit been consumed or earned by balance date? If yes, it belongs in the income statement; if no, it belongs on the balance sheet.