Assignment 1 - Step 5: Chapter 2 & 3 KCQs

What is Accrual Accounting?

When producing financial reports, firms following GAAP do not necessarily measure sales when the initial cash changes hands, but when the economic substance occurs.  For my firm, BrainChip, the flow is as follows. Customer signs a contract agreeing that BrainChip will provide them with a licence to produce Akida Chips and pays upfront, even though the product isn’t ready.  Those funds are recorded as deferred revenue, (a liability) because BrainChip hasn’t delivered yet.  After a few months the Akida Chip development is complete and BrainChip delivers the licence to the customer. These funds then move from Deferred Revenue to Revenue.  This shows a accrual accounting an action because revenue is recognised when brain chip fulfilled its obligation not when the cash was received.

Who Has to Follow the Generally accepted accounting principles (GAAP) in Australia?

I’ve been thinking about this question because it really highlights how financial reporting ties into fairness for investors. In Australia, principles GAAP isn’t a separate set of rules like in the U.S, it’s basically our Australian Accounting Standards, which are built on International Financial Reporting Standards (IFRS). These standards apply when a company prepares general purpose financial statements, meaning reports intended for people outside the business who rely on them to make decisions. The rule of thumb is fairly simple, if outsiders, like investors, lenders, or regulators are using your financial statements, you need to follow GAAP. This helps to create a level playing field, for investors. As a retail investor, I can’t just call up Ken Scarince, the CFO of BrainChip, for a chat, like a big fund manager from BlackRock might. My funds are far too inconsequential to them and Ken is too busy trying to find a way to make the company profitable. GAAP compliance helps bridge that gap by giving everyone access to consistent, reliable information. Public companies on the ASX, must comply with GAAP, as do large proprietary companies that meet certain thresholds under the Corporations Act 2001. On the flip side, small private companies with no external investors often prepare special purpose financial statements, which don’t require full GAAP compliance. This seems sensible. Why burden a small family business with complex reporting if no one outside the business needs it? For me, the takeaway is that GAAP isn’t just a box ticking exercise, it’s about trust and transparency. It ensures that whether you’re a global investment firm or like me, you're investing the money from Grandmas Christmas card, you can make decisions based on credible, comparable information.

How do the financial statements presented in an annual report appear relatively short, despite companies being involved in numerous transactions and often holding interests in other entities?

Annual reports keep financial statements short for the same reason a restaurant menu doesn’t list every ingredient in the meal, it would be chaotic and overwhelm you. Instead, the menu gives you the highlights, and if you want the details, you ask the chef. In financial reporting, those “chef’s notes” are called footnotes. The balance sheet, statement of changes in equity, and income statement show the big picture: total revenue, total expenses, consolidated assets. The footnotes explain the recipe: accounting policies, breakdowns of major items, details of subsidiaries, and obligations. So, when you notice something like an “other equity reserve” disappearing from one year to the next, you simply check the footnotes and see that the reserve has been transferred to accumulated losses. Thanks, chef.