CHAPTER

Introduction to
1
Accounting
LEARNING OUTCOMES:
On completion of this chapter, you should be able to:
G define accounting
G distinguish between book-keeping and accounting
G explain the activities involved in the process of the accounting cycle
G explain the principal accounting assumptions used in the preparation of financial reports
G explain qualitative characteristics of financial statements.

1.1 DEFINITION

Various authors and professional bodies have defined accounting in various ways. The following
are commonly used definitions.
Accounting is that discipline which measures, records, reports and interprets
financial information about an entity to users of financial information to enable them
to make appropriate decisions.
Accounting is a process of recording, classifying, summarising and interpreting
the financial transactions and communicating the results thereof to the persons
interested in such information for decision making purpose.

According to the above definitions, accounting is a process and not a single activity which
involves several sequential steps.
1. Identification of transactions
2. Measurement of transactions
3. Classification, summarization and recording
4. Communication of accounting information
Identification of transactions involves identification and recognition of business transactions
that are relevant to the business entity, e.g., sales, payment of wages. The source documents are
used to extract data regarding business transactions.
2 Introductory Accounting for PNG

Measurement of transactions in money terms is important in accounting because there is no

other way of expressing the value of transactions and measuring the business results. The different
monetary units are being used in different countries. In PNG, it is Kina and toea.
Classification of transactions permits the reduction of the effects of many transactions into
useful and meaningful categories, e.g., classification of purchases into purchase of goods for resale,
office supplies and non-current assets.
Summarising involves summarisation of accounting data. It enhances the use of accounting
information by various users. In every step in the accounting process, summrisation of data is
carried out.
1. Totaling of special journals and posting totals to the ledger accounts at regular intervals.
2. Balancing ledger accounts at regular intervals and extract balances.
3. Extracting a trial balance.
4. Preparing of financial statements- The financial reports include annual summaries of accounting
data.
Recording involves recording of transactions in the books of accounts. Once business transactions
are identified and measured in terms of Kina value, all these transactions are recorded in journals
before entering in the ledger.
Communicating involves the preparation and distribution of financial statements with interpretative
disclosures to make accounting information understandable. Now, it is a common feature to include
diagrams, charts, graphs and accounting ratios as part of interpretations.

Id en tific atio n
o f tran sac tion s

M easu rem en t
o f tran sac tion s
in m o n ey te rm s

C lassifica tio n ,
s um m aris atio n
an d reco rd in g

C o m m u n ic atin g
acco un tin g
in form atio n
in th e fo rm o f
fin an c ial s tatem en t

Fig.1.1: The Accounting Process

Chapter 1. Introduction to Accounting 3

1.2 PURPOSE OF ACCOUNTING

The purpose of accounting is to provide accounting information about an entity to the users to
enable them to make appropriate decisions.

Users of Accounting Information

User Purpose
1. Owner To assess performance of the business. The owner wishes
to evaluate how efficiently and profitably management
has used the resources entrusted to it.
..............................................................................................................................................................................................
2. Prospective investors To assess business for investment potentials.
..............................................................................................................................................................................................
3. Tax authorities To assess tax liability of the business.
..............................................................................................................................................................................................
4. Creditors To assess creditworthiness.
..............................................................................................................................................................................................
5. Banks and financial institutions To assess repayment ability of loans with interest.

1.3 BOOK-KEEPING AND ACCOUNTING

Book-keeping involves record keeping in relation to business transactions. Extraction of accounting

data from source documents, analysis of accounting data and recording are the main functions of
book-keeping. This activity is undertaken by book-keepers. Accounting involves all activities relating
to book-keeping and interpretation and presentation of accounting information to the users. Presentation
involves preparation of financial reports, such as Income Statement and the Balance Sheet of a
business entity. Interpretation involves detailed analysis of performance using accounting ratios,
cash flow statements, graphics, etc. Accountants usually undertake the presentation and interpretation
part of accounting because it needs higher level of knowledge in accounting. Apart from this, it is
also necessary to follow Generally Accepted Accounting Principles (GAAPs), Accounting Standards
and other relevant statutes, e.g., Companies Act, when preparing financial statements.
According to the above explanation, recording of transactions, as they occur in the books of
business is usually referred to as book- keeping. Accounting is a broader concept compared to book-
keeping. Book-keeping is carried out by book-keepers. They to work under the guidance and
supervision of accountants. The accountant is the person in-charge of the overall accounting
function of any entity.

1.4 ACCOUNTING RECORDS

Accounting records include all the records that are maintained by a business in respect of
business transactions. These records could be divided into four categories.
1. Source Documents
2. Journals
3. Ledger Accounts
4. Financial Statements
4 Introductory Accounting for PNG

1.5 FUNCTIONS OF ACCOUNTING

The functions of accounting can be summarised as
1. To provide information useful to users for making decisions
2. To provide a measure of an entity’s performance and financial position
3. To assist in discharging accountability of the management
4. To provide information for future planning

1.6 SOURCE DOCUMENTS

Source documents provide documentary evidence of transactions. In accounting, all the
transactions should be supported by documentary evidence. No transaction will take place verbally.
Source documents are used to extract information relating to transactions, e.g.

Source Document Related Transaction

Cheque Butt Cash Payments
..............................................................................................................................................................................................
Receipts Cash Receipts
..............................................................................................................................................................................................
Sales Invoice Credit Sales

1.7 JOURNALS
Journals are books of prime entry or first entry. The data gathered from source documents are first
entered in journals. This means that all the transactions are recorded first in journals before making an
entry in the ledger. The journals provide summarised information gathered from source documents, e.g.

Transaction Related Journal

Credit Sales Sales Journal
..............................................................................................................................................................................................
Credit Purchases Purchases Journal
..............................................................................................................................................................................................
Cash Payments Cash Payments Journal
..............................................................................................................................................................................................
Cash Receipts Cash Receipts Journal

1.8 LEDGER

A ledger is a collection of accounts. It takes various forms, such as books, set of loose cards,
files or diskettes. A ledger consists of individual accounts, e.g. wages, rent, furniture. Information
for ledger accounts is transferred from journals and they are further summarised at this stage.

1.9 FINANCIAL STATEMENTS

Financial statements1 consist of Profit & Loss Statement2 and the Balance Sheet. These reports

1
Financial statements1 are also referred to as financial reports or final reports.
2
Profit & Loss Statement is also referred to as Income Statement or Statement of Financial Performance.
Chapter 1. Introduction to Accounting 5

are used to ascertain profits or losses and to assess profitability and evaluate liquidity and solvency.
In small organizations, financial reports are prepared annually whereas in large organisaions prepare
financial reports for less than a year (quarterly, half-yearly) for management and control purposes.
The period covered is called the Accounting Year or Reporting Period. If the accounting year
begins on 1st January 2008 and ends on 31st December 2008, the reporting period is 1st January
to 31st December 2008. The last day of the accounting period is called Balance Day. On balance
day, all the ledger accounts are closed and a Trial Balance is extracted. The Trial Balance is used
to prepare final reports.

1.10 ACCOUNTING CYCLE

Accounting is a process. It passes through a sequence of steps to process transactions and

prepare reports. Each step of the process depends on the previous step. Therefore, these steps are
interdependent.

E xtra cting
A cco un ting D ata
fro m S ou rce
D o cu m e nts

Tra nsfe rrin g

a ccou nting d ata
fro m so urce
d ocum en ts to
jo urn als

P o sting a cco un tin g

d ata from jou rna ls
to le dg er accou nts

B a la ncin g led ge r
a ccou nts an d
p repa rin g a
Trial B alan ce

Fig.1.2: The Accounting Cycle

1.11 ASSUMPTIONS MADE IN THE PREPARATION OF FINANCIAL STATEMENTS

As accounting evolved, the accountants have developed certain principles, methods and guidelines
to be followed in accounting profession in recognising, measuring, identifying, recording and
communicating accounting information. These principles, methods and guidelines form generally
accepted accounting principles or practices. They are referred to as accounting principles, assumptions,
concepts, conventions and doctrines in accounting literature. Some authors have gone to the extent
of classifying them as assumptions, conventions, concepts and doctrines. Different authors have
6 Introductory Accounting for PNG

different opinions regarding the classification. Therefore, to avoid confusions in the minds of
beginners and for easy understanding of these principles, methods and guidelines are explained in this
chapter as assumptions made in the preparation of financial statements.
Some of the assumptions identified separately in the past are now incorporated into the
accounting standards and others are used by the accounting profession. The use of accounting
assumptions enhances the comparability of information.
The major accounting conventions, assumptions, concepts and doctrines mentioned in the
accounting literature are listed below.
1. Business Entity Assumption 7. Monetary Assumption
2. Cost Assumption 8. Consistency Principle
3. Going Concern Assumption 9. Prudent Concept
4. Accounting Period Assumption 10. Accrual Basis Accounting Assumption
5. Reliability Assumption 11. Substance Over Form
6. Materiality Assumption
1.11.1 Business Entity Assumption
The Business Entity Assumption assumes that the business is distinct from its owner for
accounting purpose. In other words, affairs of a business are treated as being quite separate from
the private affairs of the owner. This assumption is extremely helpful in keeping business accounts.
Therefore, the business unit should be treated as owning the assets and responsible for liabilities
including the owner’s equity.
Failure to follow this assumption makes it extremely difficult to ascertain the business results
(Profit/Loss) and value of business assets and liabilities accurately, e.g. during June 2008 Jerry made
following payments.
1. Rent for business premises K 200
2. Rent for house K 150
3. Purchase of furniture for his house K 1 500
4. Purchase of furniture for business K 2 000
5. School fees for Jerry’s children K 300
Out of the above list, transactions mentioned only at 1 and 4 relate to business. Therefore, only
these two transactions should be recorded in the business books. Other transactions are private
transactions and they should be used when preparing owner's private accounts for tax or some other
purpose.

1.11.2 Historical Cost Assumption

The historical cost assumption assumes that all transactions of a business entity are recorded
at original cost to the business. Therefore, according to this convention:
(a) an asset is recorded at the acquisition cost, and
(b) this cost is the basis for all subsequent accounting for the asset.
Chapter 1. Introduction to Accounting 7

This means that when an asset is recorded at cost price, the change in value of an asset is not
ordinarily recorded in the books. For example, land and building has been purchased for K 80 000
in January 2008. At the end of the accounting period, when preparing final reports, the market value
rose to K 100 000. But, market value is disregarded and historical cost is included in financial
statements.
1.11.3 Period Assumption
The period assumption (sometimes referred to as accounting period assumption) assumes that
the life of the business can be divided into meaningful accounting periods. The business units have
an indefinite period of existence. In the absence of such accounting periods, owners have to wait
until business ceases to operate to determine profit or loss. Therefore, a division of indefinite period
of business life into shorter periods is useful for reporting purpose.
Accounting period is usually one year. This is referred to as accounting year or accounting
period. In Papua New Guinea, accounting year and calendar year are the same. Therefore, both the
accounting year and the reporting period span for a period of twelve-months, i.e., from 1st January
to 31st December. The balancing date is also 31st December in this case.
When applying this assumption, a business entity must take every possible step to match
revenue with expenses for the period under consideration. Accounting period assumption allows the
division of the life of a business into predetermined accounting periods, usually one year. It helps
in matching revenue earned with expenses incurred in determining profits or loss. Use of period
assumption requires the application of accounting entity principle.
The accrual basis accounting principle is applied by accounting profession to match revenue
with expense. Under this principle, accountants recognise effects of all transactions and other events
when they occur rather than when cash is received or paid. Further, balance day adjustments are
required to include expenses incurred and revenue earned during the period. In other words, accrual
basis accounting principle is applied because of period assumption. Following adjustments are
arising from period assumption.
1. Adjustments for accrued expenses and pre-payments
2. Adjustments for unearned and unrecorded revenue
3. Depreciation of non-current assets
1.11.4 Monetary Assumption
The monetary assumption assumes that money could be used as the common denominator by
which economic activity is measured and reported. It further assumes that the financial information
expressed in terms of the money unit (Kina) represents realistic value that can be used to measure
business performance and financial position. It ignores the changes in the value of money to measure
and record business transactions. As a result of our adopting the monetary assumption, all
transactions are recorded and replaced at historical cost.
Application of monetary assumption requires the accountants to identify economic events and
then measure in terms of monetary units before they can be entered into the accounting records. The
events that cannot be expressed in terms of money are excluded from accounting records and reports.
8 Introductory Accounting for PNG

In the absence of monetary assumption, it is extremely difficult to measure business performance

or value of a business. Consider the following situations.
Kanage and his wife had the following assets.

Kanage Kanage’s Wife

10 hectares of land 10 hectares of land
20 pigs 30 pigs
10 goats 20 coffee bags
40 Total 60 Total

By looking at the two lists one cannot compare and understand the richest person because;
i. they are expressed in different measuring units, and
ii. they are different assets and therefore total of these assets does not provide any meaning
If these assets are expressed in terms of Kina value, it is easy to compare and understand. Now,
consider the following list. The value of assets of Kanage’s wife is greater than the Kanage’s assets.

Kanage Kanage’s Wife

10 hectares of land × K 1 000 10 000 10 hectares of land × K1 000 10 000
20 pigs × K 200 4 000 30 pigs × K 200 6 000
10 goats × K 100 1 000 20 coffee bags ×K 100 2 000
15 000 18 000

Monetary unit is considered as common denominator for measurement of transactions in

accounting. The values shown in accounting records are expressed in terms of monetary units.
1.11.5 Materiality Assumption
Materiality assumption assumes that information can be omitted, mis-stated or grouped with
other information if they do not mislead the users. At the same time, it requires to disclose all material
information if they influence users decisions.
Materiality relates to the relative size and nature of an item. Complete and reliable accounting
information include all material items that are needed for decision making purposes.
Consider following situations:
Situation 1
Cost of a pocket calculator purchased for office use is K 150. The company’s office supplies
expense for the year is K 125 000. Inclusion of cost of pocket calculator as part of office expense
is acceptable as there is no significant impact on profit or value of assets.
Situation 2
Purchase of photocopy papers costing K 45 000 is included in purchases rather than office
supplies expenses. This is a significant amount that has an impact on profit and value of assets.
Therefore, this amount is considered as material.
Chapter 1. Introduction to Accounting 9

1.11.6 Going Concern Assumption

Going concern assumption assumes that the entity will continue to operate for an indefinite
period of time and there is no intention to liquidate or resale the business. This enables the
accountants to apply period assumption and cost assumption and also to follow accrual basis
accounting principle.
The going concern assumption must not be followed when conclusive evidence is available to
prove that the entity will wind up in the near future. In such a situation, asset values are determined
on the basis of estimated sales or liquidation values for financial reporting.
1.11.7 Consistency Principle
Use of the same accounting method every year, as far as possible, is referred to as consistency
principle. Use of consistency principle enables the users of financial statements to compare financial
performance and position from one period to another. When alternative accounting methods exist,
entities should select most appropriate method and apply the same method consistently.
For example, if stock is valued at FIFO method, this method should be followed in the following
years. Changing from FIFO to LIFO in the following year or abruptly, is a violation of the
consistency principle. Another example is changing straight line method to reducing balance method
for depreciation of non-current assets.
1.11.8 Prudent Concept
The prudent concept3 refers to exercising care and caution when dealing with uncertainties
particularly when recording uncertain anticipated gains and losses. According to this concept, no
anticipated profits should be taken into accounts but provisions should be made for all possible
losses. In practice, inventory is valued at lower of cost or net realizable value to apply this concept.
Another example is provision for bad debts when determining profits.
1.11.9 Accrual Basis Accounting Assumption
Accrual basis accounting assumption refers to the recognition of effects of transactions and
other events when they occur. This means that, in practice, accountants recognise revenue and
expense when they occur and do not wait either to receive or be paid cash. As a result of adoption
of this assumption, accounting reports contain accrued expenses and unearned revenues.
Application of accrual basis accounting is possible because of the use of going concern and
accounting period assumptions.
1.11.10 Substance Over Form (Economic Reality)
Substance Over Form recognises economic reality as opposed to legal form, when recording
transactions and events of an entity. For example, in financial leases, ownership passes to the lessee
on completion of all instalments payable as per lease agreement. But lessee bears the risk of the asset
and uses for his benefit. Therefore, leased assets are recorded in lessee’s books as an asset.
Reliability Principle is explained in Section 1.14
3 Alternative term is Convention of Conservatism
10 Introductory Accounting for PNG

1.12 GENERALLY ACCEPTED ACCOUNTING PRINCIPLES

The Generally Accepted Accounting Principles (GAAPs) are the procedures, principles and
rules followed in accounting profession. They are derived from assumptions, concepts and accounting
methods evolved over many years in response to changes in business environment.
The practising accountants are required to apply GAAPs when preparing financial statements.
Some of these principles have been gradually incorporated into accounting standards while
others have gained acceptance through widespread use.

1.13 ACCOUNTING STANDARDS

The Accounting Standards are the written rules, principles and guidelines to be followed in
accounting. The members of accounting professional bodies are required to follow standards formulated
or adopted by that professional body. In practice, today most of the countries adopt International
Accounting Standards(IASs) formulated by the International Accounting Standards Board. The
Certified Practising Accountants, PNG, is the professional body which adopts international standards
for practice in Papua New Guinea. The latest development in International Standards is the
introduction of International Financial Reporting Standards (IFRSs). The following list shows the
IASs and IFRSs in force at the time of writing of this book.
International Accounting Standards
IAS 1 Presentation of Financial Statements
IAS 2 Inventories
IAS 7 Cash Flow Statements
IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors
IAS 10 Events after the Balance Sheet Date
IAS 11 Construction Contracts
IAS 12 Income Taxes
IAS 14 Segment Reporting
IAS 16 Property, Plant and Equipment
IAS 17 Leases
IAS 18 Revenue
IAS 19 Employee Benefits
IAS 20 Accounting for Government Grants and Disclosure of Government Assistance
IAS 21 The Effects of Changes in Foreign Exchange Rates
IAS 23 Borrowing Costs
IAS 24 Related Party Disclosures
IAS 26 Accounting and Reporting by Retirement Benefit Plans
IAS 27 Consolidated and Separate Financial Statements
Chapter 1. Introduction to Accounting 11

IAS 28 Investments in Associates

IAS 29 Financial Reporting in Hyperinflationary Economies
IAS 30 Disclosures in the Financial Statements of Banks and Similar Financial Institutions
IAS 31 Interests in Joint Ventures
IAS 32 Financial Instruments: Disclosure and Presentation
IAS 33 Earning Per Share
IAS 34 Interim Financial Reporting
IAS 36 Impairment of Assets
IAS 37 Provisions, Contingent Liabilities and Contingent Assets
IAS 38 Intangible Assets
IAS 39 Financial Instruments: Recognition and Measurement
IAS 40 Investment Property
IAS 41 Agriculture
International Financial Reporting Standards
IFRS 1 First-time Adoption of International Reporting Standards
IFRS 2 Shared- Payment
IFRS 3 Business Combinations
IFRS 4 Insurance Contracts
IFRS 5 Non-current Assets Held for Sale and Discontinued Operations
IFRS 6 Exploration for and Evaluation of Mineral Recourses

1.14 QUALITATIVE CHARACTERISTICS OF FINANCIAL STATEMENTS

The qualitative characteristics of financial statements are the attributes that make the accounting
information useful for a wide variety of users. The conceptual framework of the IAS identifies the
following four principles of characteristics.
1. Understandability
2. Relevance
3. Reliability
4. Comparability
1.14.1 Understandability
Financial information should be presented in a form that assists users in its understanding. This
means preparers of financial statements must take every possible effort to provide ‘user friendly’
format and disclosures when presenting financial information. It is a common feature of general
purpose financial statements presented with graphs, diagram, etc. to enhance the quality of
presentation.
12 Introductory Accounting for PNG

1.14.2 Relevance
Information is relevant when it influences the users for decision making. The two components
that enhances the relevance of accounting information are materiality and timeliness. Information is
material if its omission or misstatement could influence the economic decision by users. To be
useful, information must be provided to users within the time frame.
1.14.3 Reliability
The users of financial information want to compare an entity’s performance from one period
to another and with competitors to enable them to identify financial performance, financial position
and trends.
To achieve this quality, accountants often follow the consistency principle and disclose all
material information either on the surface of the financial statements or as notes.

1.15 ACCOUNTING PRACTICE IN PNG

The accounting practice in Papua New Guinea is largely controlled and monitored by following
institutions and legislations.
1. Certified Practising Accountants, PNG
2. Companies Act
3. Accountants Act
4. Port Moresby Stock Exchange
5. Internal Revenue Commission
6. International Accounting Standards and International Financial Reporting Standards

ACTIVITY 1.1
1. Define accounting ________________________________________________________
_______________________________________________________________________
_______________________________________________________________________
2. State three functions of accounting
(i) ___________________________________________________________________
(ii) ___________________________________________________________________
(iii) ___________________________________________________________________
3. Name four users of accounting information
(i) ___________________________________________________________________
Chapter 1. Introduction to Accounting 13

(ii) ___________________________________________________________________
(iii) ___________________________________________________________________
(iv) ___________________________________________________________________
4. Name four commonly accepted accounting assumptions
(i) ___________________________________________________________________
(ii) ___________________________________________________________________
(iii) ___________________________________________________________________
(iv) ___________________________________________________________________
5.* Restate the following steps of the accounting process in the correct sequence.
(i.) Journals (i) ___________________________
(ii) Source documents (ii) ___________________________
(iii) Final reports (iii) ___________________________
(iv) Ledger (iv) ___________________________
6.* Martin is an owner of a trading business. Identify the items to be recorded in his business
accounts. Write the item number in the space provided.
i. Revenue from sale of pigs owned by his wife
ii. Revenue received from sale of coffee grown in his garden
iii. Wages paid to coffee garden workers
iv. Transport expenses incurred for transportation of goods for re-sale
v. Rent for warehouse building
vi. Purchase of goods for re-sale
vii. Sale of goods to credit customers
viii. Purchase of goods on credit
ix. Purchase of a truck for business use
x. Purchase of a car for personal use
………………………………………………………………………………………………
7.* Prepare a list of five activities included in the accounting cycle.
i. ___________________________________________________________________
ii. ___________________________________________________________________
14 Introductory Accounting for PNG

iii. ___________________________________________________________________
iv. ___________________________________________________________________
v. ___________________________________________________________________
8.* The following table shows the uses of accounting information by different users. Complete
the blank column.

Uses/purpose User
1. To assess the performance of business
..................................................................................................................................................................................
2. To assess business for investment potential
..................................................................................................................................................................................
3. To evaluate the repayment ability of loans

9.* Which of the following are book-keeping activities? Write the item number in the space
provided.
(i) Extracting accounting data from source documents
(ii) Analysing accounting data
(iii) Recording accounting data
(iv) Presenting accounting information
(v) Interpreting accounting information
(vi) Communicating accounting information
…………………………………………………………………………………..
10.* State whether each of the following statements is true or false.
(i) The source documents provide documentary evidence of business transactions __
(ii) A journal is a collection of ledger accounts _______________________________
(iii) A ledger consists of individual accounts _________________________________
(iv) Presentation of final reports is the final stage of accounting _________________
11.* Complete the following table using relevant terms

Source Document Related Transaction Relevant Journal

(a) Cheque butt
..................................................................................................................................................................................
(b) Credit sales
..................................................................................................................................................................................
(c) Cash receipts journal
..................................................................................................................................................................................
(d) Suppliers’ invoice

12.* State whether each of the following statements is true or false.

Chapter 1. Introduction to Accounting 15

(i) The accounting assumptions are generally accepted accounting principals followed by
accounting profession._______
(ii) The accounting standards are written rules and procedures followed by accountants.
_________
(iii) In terms of business entity assumption, it is necessary to prepare accounts for the
owner.__________
(iv) The historical cost assumption assumes that all transactions of business be reported at
acquisition cost irrespective of market value. _________
(v) Revenue earned is matched with expenses incurred during the accounting year when
using the accounting period convention.___________
13.* State the relevant accounting assumption relating to following situations
(i) The business life is divided into meaningful periods for reporting purpose. ____
(ii) Owner's private affairs are not taken into account when preparing business accounts.
__________
(iii) The purchase price of a building at the time of acquiring was K 60 000 and current
market value is K 80 000. The market value is ignored for reporting purpose._____
(iv) For reporting purpose, changes in real value of money is not taken into account.
_________
14.* Evidence of accepting accounting assumptions and qualitative characteristics are given in
column (1.) of the following table. Indicate the appropriate accounting assumption or
qualitative characteristics in column (2.) Select your answer from the following list.
Materiality Assumption Accounting Period Assumption Going Concern Assumption
Consistency Assumption Historical Cost Assumption Monetary Assumption
Prudence Principle Business Entity Assumption

Evidence Accounting Assumption / Qualitative Characteristic

1. Use of same depreciation method over the

period.
..............................................................................................................................................................................................
2. Owner’s private vehicle is not included in
business books.
..............................................................................................................................................................................................
3. All amounts are presented in millions of Kina
in large business entities rather than disclosing
values to the nearest toea.
..............................................................................................................................................................................................
4. Profit and Loss Statement is prepared for
the year ended 31 December 2007
..............................................................................................................................................................................................
5. Adoption of historical cost method for
depreciation of assets.

contd...
 16 Introductory Accounting for PNG

6. The cost of 3 pocket calculators (costing

K 30 each) was charged to office supplies
expenses when purchased, though they had
a useful life of several years.
..............................................................................................................................................................................................
7. Inclusion of purchase price of land and
building in financial statements and ignore
current market value.
..............................................................................................................................................................................................
8. Exclusion of value of efficient staff from the
financial statements.
..............................................................................................................................................................................................
9. The recognistion of gain is deferred until the
earning process is complete but losses are
recognised as soon as they become known.
..............................................................................................................................................................................................
10. Use of same inventory valuation method over
a period.

15.* Indicate the accounting assumptions or principles that had been violated under each of the
following situations given below.

Situation Accounting Assumption/principle violated

1. The owner of the business included his
personal medical expenses on entity’s income
statement.
..............................................................................................................................................................................................
2. Assets were reported at cost although business
is under liquidation.
..............................................................................................................................................................................................
3. The cost of three Arch Liver files (costing
K 5.20 each) was included as an asset in the
balance sheet because they had a useful life
of more than one year.
..............................................................................................................................................................................................
4. The LIFO inventory method was used in
2006 and FIFO in 2007 and weighted average
in 2008.
..............................................................................................................................................................................................
5. Land was reported at current market value
which is substantially higher than the cost.

16.* Identify the correct term that matches the description given in column (1.) and include it
in column (2.) Choose terms from the following list.
Substance over form Monetary
Prudence Business Entity Assumption

Column I Column II

1. Business transactions are separated from the

owner’s personal transactions for accounting
purpose.
Chapter 1. Introduction to Accounting 17

2. The use of money as a common denominator

to record and report business transactions
and events.
..............................................................................................................................................................................................
3. Use of same accounting methods from one
year to another year.
..............................................................................................................................................................................................
4. Exclusion of estimated gains and inclusion of
estimated losses in financial statements.
..............................................................................................................................................................................................
5. Recognition of economic impact of a
transaction rather than its legal form.

ANSWERS TO SELECTED ACTIVITIES

Activity 1.1

5. i. Source documents
ii. Journals
iii. Ledger
iv. Final reports
6. iv, v, vi, vii, viii, ix
7. i. Extracting accounting data from source documents
ii. Transferring accounting data from source documents to journals
iii. Posting accounting data from journals to ledger accounts
iv. Balancing ledger accounts and preparing Trial Balance
v. Preparing final reports
8. i. Owners
ii. Prospective investors
iii. Banks and financial institutions
9 i, ii, iii
10. i True ii False iii. True iv. True
11. a. Cash payments Cash Payments Journal
b. Sales invoice Sales Journal
c. Cash receipts Cash Receipts Journal
d. Credit purchases Purchases Journal
12. i. True ii. True iii. False iv. True v. True
18 Introductory Accounting for PNG

13. i. Period Assumption

ii. Business Entity Assumption
iii. Historical Cost Assumption
iv. Monetary Assumption
14. 1. Consistency 2. Business Entity 3. Materiality 4. Period
5. Going Concern 6. Materiality 7. Historical cost 8. Monetary
9. Prudent 10. Consistency
15. 1. Business Entity 2. Going Concern 3. Materiality 4. Consistency
5. Historical Cost
16. 1. Business Entity 2. Monetary 3. Consistency 4. Prudence
5. Substance Over Form