Slide 1.1 UNIT ONE : INTRODUCTION TO ACCOUNTING Learning Outcome Unit 1 Describe the purpose and aims of financial and management accounting. Describe the different users of financial information. Describe the main types of business operating for profit and their accounting obligations
Slide 1.2 DEFINITION OF ACCOUNTING The process of identifying, measuring, and communicating economic information to permit informed judgements and decisions by users of the information.
Slide 1.3 DEFINITION OF ACCOUNTING What this means is that accounting involves deciding what amounts of money are, were or will be involved in transactions(often buying and selling transactions) and then organising the information obtained and presenting it in a way that is useful for decision making.
Slide 1.4 PURPOSE OF ACCOUNTING Accounts show where money came from and how it has been spent, this a)aids the efficient running of a business. b)indicates how successfully managers are performing c)provide information about the resources and activities of a business.
Slide 1.5 PURPOSE OF ACCOUNTING Accounting information aids the efficient running of a business in many ways: A business needs to pay bills for the goods and services it purchases, and collect money from its customers. It must, therefore keep a record of such bills and invoices so that the correct amounts can be paid or collected at the correct times.
Slide 1.6 PURPOSE OF ACCOUNTING Keeping records of a business s assets (e.g. motor vehicles or computers) helps keep them safe.
Slide 1.7 PURPOSE OF ACCOUNTING Accounts indicate how successfully the managers are performing. Modern business are often complicated, they seldom have a single owner (some very large enterprises, such as BP, may be owned by millions of shareholders).
Slide 1.8 PURPOSE OF ACCOUNTING Frequently the owners are not involved in the day to day running of the business but appoint managers to act on their behalf. In addition, there are too many activities and assets for the managers to keep track of simply from personal knowledge and an occasional glance at the bank statements, accounts which summarise transactions are very useful.
Slide 1.9 PURPOSE OF ACCOUNTING A business should provide information about its resources and activities because there are many groups of people who want or need that information.,
Slide 1.10 THE OBJECTIVES OF ACCOUNTING Accounting has many objectives, including letting people and organisations answer questions such as : how much profit or loss has the business made? how much money does the company owe?
Slide 1.11 THE OBJECTIVES OF ACCOUNTING will the company have sufficient funds to meet its commitments? what is the value of the business and what are its net assets? to ensure proper record keeping, and financial control
Slide 1.12 THE OBJECTIVES OF ACCOUNTING what is the growth potential for the business? to meet statutory and regulatory requirements what (if applicable) is the stock market value of our shares and do they represent good value for investors and potential investors
Slide 1.13 THE OBJECTIVES OF ACCOUNTING to aid planning and objective measuring The primary objective of accounting is to provide information for decision making. The information is usually financial, but can be given in volumes or Non Financial.
Slide 1.14 REVISED DEFINITION ACCOUNTING Accounting is concerned with recording data, classifying and summarising data, and communicating what has been learned from the data to the various users of accounts.
Slide 1.15 USERS OF ACCOUNTING INFORMATION Possible users of accounting information include: 1. Managers of the company (Board of directors). 2. Shareholders of the company 3. Trade contacts: i.e. (suppliers of goods to the company on credit and customers).
Slide 1.16 USERS OF ACCOUNTING INFORMATION 4. Providers of finance to the company: i.e. (lenders both short and long term). 5. The taxation authorities: 6. Employees of the company: 7. Financial analysts and advisers: 8. Government and their agencies
Slide 1.17 USERS OF ACCOUNTING INFORMATION 9. The public: 10.Competitors:
Slide 1.18 USERS OF ACCOUNTING INFORMATION a)managers of the company (Board of directors): appointed by the company s owners to supervise the day to-day activities of the company.
Slide 1.19 USERS OF ACCOUNTING INFORMATION They need information about the company s financial position situation as it is currently and as it is expected to be in the future. This is to enable them to manage the business efficiently and to make effective decisions.
Slide 1.20 USERS OF ACCOUNTING INFORMATION b) Shareholders of the company: i.e. the company s owners, want to assess how well the management is performing. They want to know how profitable the company s operations are and how much profit they can afford to withdraw from the business for their own use
Slide 1.21 USERS OF ACCOUNTING INFORMATION c) Trade contacts: i.e. (suppliers of goods to the company on credit and customers) include the suppliers who provide goods to the company on credit and customers who purchase the goods or services provided by the company.
Slide 1.22 USERS OF ACCOUNTING INFORMATION Suppliers want to know about the company s ability to pay its debts; customers need to know that the company is secure source of supply and is in no danger of having to close down.
Slide 1.23 USERS OF ACCOUNTING INFORMATION d) Providers of finance to the company: i.e. (lenders both short and long term) might include a bank which allows the company to operate an overdraft or provides long term finance by granting a loan. The bank wants to ensure that the company is able to keep up interest payments, and eventually to repay the amounts advanced.
Slide 1.24 USERS OF ACCOUNTING INFORMATION e) The taxation authorities: want to know about business profits in order to assess the tax payable by the company, including sales tax.
Slide 1.25 USERS OF ACCOUNTING INFORMATION f) Employees of the company: should have a right to information about the company s financial situation, because their future careers and the size of their wages and salaries depend on it.
Slide 1.26 USERS OF ACCOUNTING INFORMATION g) Financial analysts and advisers: need information for their clients or audience. For example, stockbrokers need information to advice investors; credit agencies want information to advise potential suppliers of goods to the company, and journalists need information for their reading public
Slide 1.27 USERS OF ACCOUNTING INFORMATION h) Government and their agencies: are interested in the allocation of resources and therefore in the activities of business entities. They also require information in order to provide a basis for national statistics.
Slide 1.28 USERS OF ACCOUNTING INFORMATION i) The public: entities affect members of the public in a variety of ways. For example, they may make a substantial contribution to a local economy by providing employment and using local suppliers. Another important factor is the effect of an entity on the environment, for example as regards pollution.
Slide 1.29 USERS OF ACCOUNTING INFORMATION j) Competitors: competitors will compare their own results with those of other companies. A company would not wish to disclose information which would be harmful to its own business: equally, it would not wish to hide anything which would put it above its competitors.
Slide 1.30 MANAGEMENT AND FINANCIAL ACCOUNTING COMPARED Financial accounting Financial accounting comprises two stages: book-keeping, which is the recording of day-to-day business transactions; and
Slide 1.31 MANAGEMENT AND FINANCIAL ACCOUNTING COMPARED preparation of accounts, which is the preparation of statements from the book-keeping records; these statements summarise the performance of the business usually over the period of one year.
Slide 1.32 MANAGEMENT AND FINANCIAL ACCOUNTING COMPARED Financial accounts: are produced to satisfy the information requirements of external users. Management accounting seeks to provide financial information in a form which can help decision-making in a business.
Slide 1.33 MANAGEMENT AND FINANCIAL ACCOUNTING COMPARED Management accounts are produced for internal purposes-they provide information to assist managers in the running of the business.
Slide 1.34 MANAGEMENT AND FINANCIAL ACCOUNTING COMPARED Management accounting systems produce detailed information often split between different departments within an organisation (sales, production, finance etc.). Although much of the information deals with past events and decisions management accounts produce information which is forward looking.
Slide 1.35 MANAGEMENT AND FINANCIAL ACCOUNTING COMPARED This information is used to prepare budgets and make decisions about the future activities of a business. They also compare actual performance with budget and try to take corrective action where necessary.
Slide 1.36 MANAGEMENT AND FINANCIAL ACCOUNTING COMPARED Financial accountants, however, are usually solely concerned with summarizing historical data, often from the same basic records as management accountants but in a different way.
Slide 1.37 MANAGEMENT AND FINANCIAL ACCOUNTING COMPARED This difference arises partly because external users have different interest from management and do not need very detailed information. In addition, financial statements are prepared under constraints (such as international financial standards and company law) which do not apply to managements accounts.
MANAGEMENT AND FINANCIAL ACCOUNTING COMPARED Financial Accounts Prepared for external individuals. Show performance of a defined period Management accounts Prepared for internal managers of an organisation. Aid management in recording,planning and controlling organisation s activities.
MANAGEMENT AND FINANCIAL ACCOUNTING COMPARED Financial Accounts Legal requirements for limited companies to prepare FA Format of published FA determined by: Law IASs IFRS Management accounts Help the decision making process. No legal requirements to prepare MA. Format of MA at discretion of management
MANAGEMENT AND FINANCIAL ACCOUNTING COMPARED Financial Accounts Management accounts FA covers the business as a whole. FA information monetary (mostly). MA can focus on specific areas of an organisation s activities. MA incorporate non-monetary measures.
MANAGEMENT AND FINANCIAL ACCOUNTING COMPARED Financial Accounts Historic picture of past operations Management accounts Historic record and future planning tool
Slide 1.42 THE MAIN FINANCIAL STATEMENTS OR REPORTS The principle financial statements of a business are : i. the statement of financial position (balance sheet) ii. The cash flow statement iii. and the income statement (trading,profit and loss account)
Slide 1.43 THE STATEMENT OF FINANCIAL POSITION This is simply a list of all the assets owned and all the liabilities owed by a business as at a particular date. It is a snapshot of the financial position of the business at a particular moment. Monetary amounts are attributed to each of the assets and liabilities.
Slide 1.44 ASSETS Definition of an asset: An asset is a resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity.
Slide 1.45 ASSETS An asset is something valuable which a business owns or has the use of. Examples of assets are factories, office buildings, warehouses, delivery vans, lorries, plant and machinery, computer equipment, office furniture, cash and goods held in store awaiting sale to customers
Slide 1.46 ASSETS Some assets are held and used in operations for a long time. Such as office buildings, factories or plant and machinery, such assets are often referred to as fixed assets or non-current assets.
Slide 1.47 ASSETS Other assets are held for only a short time. Such as cash and goods held in the stores awaiting sale to customers, these assets are referred to as current assets.
Slide 1.48 LIABILITIES Definition of a liability. A liability is a present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow of economic benefits.
Slide 1.49 LIABILITIES A liability is something which is owed to somebody else. A liability is the accounting term for the debts of a business. Examples of liabilities are amounts owed to a supplier for goods bought on credit, amounts owed to a bank (or other lender), a bank overdraft and amounts owed to tax authorities (e.g. in respect of sales tax).
Slide 1.50 LIABILITIES Some liabilities are due to be repaid fairly quickly e.g. suppliers or bank overdrafts; these are referred to as current liabilities. Other liabilities may take some years to repay (e.g. bank loan) these are referred to as the long term liabilities or non current liabilities.
Slide 1.51 CAPITAL AND EQUITY The amounts invested in a business by the owner are amounts that the business owes to the owner. This is a special kind of liability, called capital. In a limited liability company, capital usually takes the form of shares. Share capital is also known as equity.
Slide 1.52 EXAMPLE OF STATEMENT OF FINANCIAL POSITION A statement of financial position used to be called a balance sheet. The former name in apt because assets will always be equal to liabilities plus capital (or equity). A very simple statement of financial position for a sole trader can be shown as follows:
Slide 1.53 EXAMPLE OF STATEMENT OF FINANCIAL POSITION A TRADER STATEMENT OF FINANCIAL POSITION AS AT 30 JUNE 2015 ASSETS K K Non current assets Plant and machinery 55,000 Current assets Inventory 5,000 Receivables(from customers) 1,500 Bank 500 Total current assets 7,000 Total assets 62,000
Slide 1.54 EXAMPLE OF STATEMENT OF FINANCIAL POSITION Capital K Balance brought forward 25,000 Profit for the year 10,400 Balance carried forward 35,400 Liabilities Bank loan 25,000 Payables to suppliers 1,600 Total capital and liabilities 62,000
Slide 1.55 INCOME STATEMENT An income statement is a record of revenue generated and expenditure incurred over a given period. The statement shows whether the business has had more revenue than expenditure (a profit) or vice versa (loss). The period chosen will depend on the purpose for which the statement is produced
Slide 1.56 INCOME STATEMENT The income statement which forms part of the published annual financial statements of a limited liability company will usually be for a period of a year, commencing from the date of the previous year s statements.
Slide 1.57 INCOME STATEMENT INCOME Income is the increase in economic benefits during accounting period. It can arise from inflows of assets, enhancement of assets or decreases in liabilities. Income results in an increase in equity. (However, contributions from shareholders are not income.)
Slide 1.58 INCOME STATEMENT EXPENSES Expenses are decreases in economic benefits during an accounting period. It can arise from outflows of assets,depletion of assets or increases in liabilities. Expenses result in a decrease in equity. (However, distributions to shareholders are not expenses)
Slide 1.59 INCOME STATEMENT A simple income statement for a sole trader is shown as follows:
Slide 1.60 INCOME STATEMENT A TRADER INCOME STATEMENT FOR THE YEAR ENDED 30 JUNE 2013 $ Revenue 150,000 Less: cost of sales -75,000 Gross profit 75,000 Other expenses -64,600 Net profit 10,400
Slide 1.61 PURPOSE OF FINANCIAL STATEMENTS Both the statement of financial position and the income statement are summaries of accumulated data. For example, the income statement shows a figure for revenue earned from selling goods to all customers. This is the total amount of revenue earned from all the individual sales made during the period
Slide 1.62 PURPOSE OF FINANCIAL STATEMENTS One of the jobs of an accountant is to devise methods of recording such individual transactions, so as to produce summarised financial statements from them. The statement of financial position and the income statement form the basis of the financial statements of most businesses
Slide 1.63 DEFINITION OF A BUSINESS There are a number of different ways of looking at a business. Some ideas are listed as follows: A business is a commercial or industrial concern which exists to deal in the manufacturer, re-sale or supply of goods and services. A business is an organisation which uses economic resources to create goods or services which customers will buy. A business is an organisation providing jobs for people.
Slide 1.64 DEFINITION OF A BUSINESS A business invests money in resources (for example: buildings, machinery, employees) in order to make even more money for its owners. Profit is the excess of revenue (income) over expenditure. When expenditure exceeds revenue, the business is running at a loss.
Slide 1.65 TYPES OF BUSINESS ENTITY There are three main types of business entity and these are: a)sole traders b)partnerships c)limited liability companies
Slide 1.66 SOLETRADERS The term really reflects the ownership of the entity; the main requirement is that only one individual should own it. The owner would normally also be the main source of finance and he would be expected to play a reasonably active part in its management The term sole trader refers to the ownership of the business, sole traders can have employees.
Slide 1.67 SOLETRADERS Sole trader entities usually operate on a 67 very informal basis and some private matters relating to the owner are often indistinguishable from those of the business. Sole trader accounts are fairly straightforward and there is no specific legislation that covers the accounting arrangements. Examples include the local shopkeeper, a 8/12/2015
Slide 1.68 PARTNERSHIPS A partnership entity is very similar to a sole 68 trader entity except that there must be at least two owners of the business. Partnerships often grow out of a sole trader entity, perhaps because more money needs to be put into the business or because the sole trader needs some help. But it is also quite common for a new business to begin as a partnership, e.g. when some friends get together to start a business. 8/12/2015
Slide 1.69 PARTNERSHIPS 69 The partners should agree among themselves how much money they will each put into the business, what jobs they will do, how many hours they will work, and how the profits and losses will be shared. In the absence of any agreement (whether formal or informal), the courts will deduce from the way the partners having been conducting business what the agreement was. Examples include an accountancy practice, a medical practice and legal practice 8/12/2015
Slide 1.70 LIMITED LAIBILITY COMPANIES A company is an entity that has a separate 70 existence from that of its owners. In this course we are going to be primarily concerned with limited liability companies. The term limited liability means that the owners of such companies are required to finance the business only up to an agreed amount. Once they have contributed that amount they cannot be called on to contribute any more, even if the company gets into financial difficulties. 8/12/2015
Slide 1.71 LIMITED LAIBILITY COMPANIES Companies are incorporated to take advantage of limited liability for their owners (shareholders). This means that, while sole traders and partnerships are personally responsible for the amounts owed by their business, the shareholders of a limited liability company are only responsible for the amount to be paid for their shares.
Slide 1.72 LIMITED LAIBILITY COMPANIES In law sole traders and partnerships are not separate entities from their owners. However, a limited liability company is legally a separate entity from its owners and it can issue contracts in the company s name. For accounting purposes, all three entities are treated as separate from their owners. This is called the separate business entity concept.
Slide 1.73 ADVANTAGES OF TRADING AS A LIMITED LIABILITY COMPANIES a) Limited liability makes investment less risky than investing in a sole trader or partnership. However, lenders to small company may ask for a shareholder s personal guarantee to secure any loans. b) It is easier to raise finance because of limited liability and there is no limit on the number of shareholders.
Slide 1.74 ADVANTAGES OF TRADING AS A LIMITED LIABILITY COMPANIES c) A limited liability company has a separate legal identity from its shareholders. So a company continues to exist regardless of the entity of its owners. In contrast, a partnership ceases, and a new one starts, whenever a partner joins or leaves the partnership.
Slide 1.75 ADVANTAGES OF TRADING AS A LIMITED LIABILITY COMPANIES d. There are tax advantages to being a limited liability company. The company is taxed as a separate entity from its owners and the tax rate on companies may be lower than the rate for individuals. e) It is relatively easy to transfer shares from one owner to another. In contrast, it may be difficult to find someone to buy a sole trader s business or to buy a share in a partnership.
Slide 1.76 DISADVANTAGES LIMITED LIABILITY COMPANIES a)limited liability companies have to publish annual financial statements. This means that anyone (including competitors) can see how well (or badly) they are doing. In contrast, sole traders and partnerships do not have to publish their financial statements.
Slide 1.77 DISADVANTAGES LIMITED LIABILITY COMPANIES b) Limited liability company financial statements have to comply with legal and accounting requirements. In particular financial statements have to comply with accounting standards. Sole traders and partnerships may comply with accounting standards, but are not compelled to do so.
Slide 1.78 DISADVANTAGES LIMITED LIABILITY COMPANIES c) The financial statements of larger limited liability companies have to be audited. This means that the statements are subject to an independent review to ensure that they comply with legal requirements and accounting standards. This can be inconvenient, time consuming and expensive.
Slide 1.79 DISADVANTAGES OF LIMITED LIABILITY COMPANIES d) Share issues are regulated by law. For example it is difficult to reduce share capital. Sole traders and partnerships can increase or decrease capital as and when the owners wish.
Slide 1.80 END OF UNIT ONE
Slide 1.81 UNIT ONE TWO Describe the role and function of accounting concepts, standards and principles, including: International Financial Reporting Standards (IFRSs), and International Accounting Standards (IASs). Identify and explain the four main characteristics of useful information to users namely relevance, reliability, understandability and comparability. Identify and explain the sub-characteristics of the four main characteristics
Slide 1.82 (ACCOUNTING STANDARDS) As different businesses use different methods of recording transactions, the result might be that financial accounts for different businesses would be very different in form and context. To get around this problem, various standards for the preparation of accounts have been developed over the years which companies are required to follow, and which underpin the whole world of accounting.
Slide 1.83 (ACCOUNTING STANDARDS) We shall be looking at the layout of financial accounts in later chapters, but here we are concerned with general underlying rules. The main accounting principles and rules are those laid down by the accounting profession itself through both national and international standards bodies. With regard to companies, there are also various rules incorporated into legislation (Companies Acts)and companies whose shares are listed on the Stock Exchange are subject to Stock Exchange rules
Slide 1.84 (ACCOUNTING STANDARDS) Note that the accounts of sole traders and partnerships are not required to follow these accounting rules, but since these lay down the widely accepted principles of accounting, it makes sense for them to do so. (Most sole traders and many partnerships also do not have the range of different types of transactions which companies have to deal with).
Slide 1.85 SETTING ACCOUNTING STANDARDS The International Accounting Standards (IASs) are issued by the International Accounting Standards Committee (IASC) which was established in 1973. The need for the IASC arose because of international investment, the growth of multinational firms and the desire to have common standards worldwide. The IASC became known as the International Accounting Standards Board(IASB) under a restructuring in 2000.
Slide 1.86 SETTING ACCOUNTING STANDARDS It is governed by a group of 19 individual trustees, known as the IASC Foundation, with diverse geographical and functional backgrounds. The IASB's sole responsibility is to set International Financial Reporting Standards(IFRSs). As such, it is at the forefront of harmonisation of accounting standards across the world. With the issuing by the IASB of new accounting standards (IFRSs), there are currently both a number of IFRSs and IASs in force.
Slide 1.87 INTERNATIONAL ACCOUNTING STANDARDS IAS 1:Presentation of Financial Statements IAS 2:Inventories IAS 7:CashFlowStatements IAS8:Accounting Policies, Changes in Accounting Estimates and Errors IAS 10:Events After the Reporting Period IAS 16:Property, Plant and Equipment IAS 18:Revenue IAS 21: The Effects of Changes in Foreign Exchange Rates IAS 33:EarningsperShare
Slide 1.88 INTERNATIONAL ACCOUNTING STANDARDS IAS 36:Impairment of Assets IAS 37: Provisions, Contingent Liabilities and Contingent Assets IAS 38:IntangibleAssets
Slide 1.89 International Financial Reporting Standards None of the IFRSs impact on accounting items that you will encounter at this level, but the following list is presented here to give you an indication of the elements covered. IFRS1 First-time Adoption of International Financial Reporting Standards IFRS2 Share-based Payment IFRS 3 Business Combinations IFRS 4 Insurance Contracts IFRS 5 Non-current Assets Held for Sale and Discontinued IFRS 6 Exploration for and evaluation of Mineral IFRS 7 Financial Instruments: Disclosures IFRS 8 Operating Segments.
Slide 1.90 QUALITATIVE CHARACTERISTICS OF ACCOUNTING INFORMATION These characteristics are the attributes that make the information provided useful to users. The IASB states that they are four principal characteristics understandability, relevance, reliability and comparability. These are defined below as follows:
Slide 1.91 QUALITATIVE CHARACTERISTICS OF ACCOUNTING INFORMATION a)understand ability: Information provided to users must not be so complex that a user with a reasonable knowledge of business and economic activities and accounting, and a willingness to study the information with reasonable diligence, would not be able to understand it.
Slide 1.92 UNDERSTAND ABILITY: Complex matters should not be left out of financial statements simply due to its difficulty if it is relevant information. The information in financial statements should be presented in such a way that it can be understood by users. For this to happen users are assumed to have some business, economic and accounting knowledge and to be able to apply themselves to study the information properly.
about it. Slide 1.93 QUALITATIVE CHARACTERISTICS OF ACCOUNTING INFORMATION b) Relevance: To be useful, information must be relevant to the decision-making needs of users Relevance is closely related to its predictive role that is the extent to which the information helps users to predict the organisation's future and so make decisions
Slide 1.94 RELEVANCE: A sub characteristic to relevance is materiality information is material and therefore relevant if its omission or misstatement could influence the economic decisions of users. Materiality depends on the size of the item or error judged in the particular circumstances.
Slide 1.95 QUALITATIVE CHARACTERISTICS OF ACCOUNTING INFORMATION c) RELIABILITY Information has the quality of reliability when it is free from material error and bias and can be depended upon by users to represent faithfully that which it either purports to represent or could reasonably be expected to represent. Reliable information also requires several subcharacteristics to be present as follows:
Slide 1.96 RELIABILITY a) Faithful representation information provided must represent faithfully those transactions and other events it purports to represent. b) Substance over form transactions need to be accounted for in accordance with their substance not merely their legal form. Substance is not always consistent with legal form.
Slide 1.97 RELIABILITY c) Neutrality information must be neutral, that is free from bias and provided in an objective manner. d) Prudence as accountants have to contend with the uncertainties that inevitably surround many events and transactions, then a degree of caution must be brought to bear when making judgements on such events and transactions. This degree of caution is required such that assets or income are not overstated and liabilities or expenses are not understated.
Slide 1.98 RELIABILITY e) Completeness for information to be reliable it must be complete within the bounds of materiality and cost. An omission can cause information to be false or misleading and thus unreliable and deficient in terms of its relevance.
Slide 1.99 QUALITATIVE CHARACTERISTICS OF ACCOUNTING INFORMATION d) COMPARABILITY: Users need to be able to compare financial statements of a business through time in order to identify trends in its financial position and performance. Users also need to be able to compare one business with another and, therefore, the measurement and display of the financial effect of transactions and other events must be carried out in a consistent way for different entities. Thus, we have the need for accounting standards from this characteristic.
Slide 1.100 OTHER FACTORS TO CONSIDER In addition to the above qualitative factors other factors to consider when preparing accounts include the following: a) Objectivity: This is often referred to as comprising verifiability or faithful representation and neutrality. Financial statements must represent faithfully the effect of transactions and other events if either does so or could be expected to do so it should be based on verifiable evidence.
Slide 1.101 OBJECTIVITY: Financial statements are not judged to be neutral if by the selection or presentation of information they influence the making of a decision or judgement in order to achieve a predetermined result or outcome. Example: Internally generated goodwill should not be included in the balance sheet as a fixed asset because its value cannot be determined objectively
the omission or misstatement. Slide 1.102 OTHER FACTORS TO CONSIDER b) Materiality: Information is material if its omission or misstatement could influence the economic decisions of users taken on the basis of its financial statements. Materiality depends on the size of an item or error judged in the particular circumstances of
Slide 1.103 MATERIALITY Thus materiality provides a threshold or cut off point rather than being a primary qualitative characteristic that information must have if it is to be useful. Materiality is applied to numerous items in financial reports. Example: the amount of a trade debt written off as irrecoverable would be disclosed by note only if material.
Slide 1.104 OTHER FACTORS TO CONSIDER c) Prudence. This is the inclusion of a degree of caution in the exercise of the judgments needed in making the estimates required under conditions of uncertainty so that assets or income are not overstated and liabilities or expenses are not understated.
Slide 1.105 PRUDENCE. However prudence should not be carried so far as to result in misleading financial statements by taking the most pessimistic view possible of all matters in doubt. Example: Stock at the balance sheet date should be included at net realisable value if it is likely to be saleable only at a figure below cost.
Slide 1.106 ACCOUNTING CONCEPTS These are defined as basic assumptions which underlie the preparation of financial accounts of business enterprises. They include the following: a)going concern concept b)consistency concept c)concept of prudence
Slide 1.107 ACCOUNTING CONCEPTS d)accruals concept e) materiality f) dual action g)historical cost concept
Slide 1.108 GOING CONCERN CONCEPT The assumption is made that the business entity will continue in existence for the foreseeable future. This is an important concept, as the value placed on the assets of a continuing business is different from the value placed on the assets of a closing business.
Slide 1.109 GOING CONCERN CONCEPT Stock is normally valued at cost price but if the business were about to cease trading, then the resale value of the stock would be more relevant, as the owner will try to sell off the remaining stock. One obvious problem with this concept is that we can never be entirely sure that the business will continue. The concept also applies to the significant curtailment of any part of the business operation
Slide 1.110 CONSISTENCY CONCEPT Once a business has decided which accounting methods it is going to apply and how it is going to interpret the various rules of accounting, it should be consistent in these matters from year to year. Consistency is necessary so that the results of the business, as shown by the accounts, may be compared from year to year.
Slide 1.111 CONSISTENCY CONCEPT Changes should be adopted only if the old methods, for a good reason, can no longer apply, e.g. using the same depreciation method.
Slide 1.112 CONCEPT OF PRUDENCE The accountant should adopt procedures which do not overstate or anticipate profits and do not understate losses but which do provide for all potential losses. Profit should be included only when it is reasonably certain that cash will be received.
Slide 1.113 CONCEPT OF PRUDENCE Adopting the concept of prudence is a measure against drawing money from the business out of profits which may not materialise, or when a loss arises which had not been anticipated, e.g. providing for bad debts.
Slide 1.114 ACCRUALS CONCEPT Revenues and costs are recognised as they are earned or incurred, and not when the money is received or paid.
Slide 1.115 ACCRUALS CONCEPT For example, if in year 1 a trader has only paid three of four telephone bills, and in year 2 pays the outstanding bill in addition to the four bills received in year 2, then the outstanding bill should be adjusted for ( accrued ) in the accounts of year 1, so that each year is charged with the appropriate telephone costs incurred, rather than with the amount actually paid.
Slide 1.116 HISTORICAL COST Items are stated in accounts at historical cost i.e. at the amount which the business paid to acquire them. An important advantage of this procedure is that the objectivity of accounts is maximised. There is usually documentary evidence to prove the amount paid to purchase an asset or pay an expense.
Slide 1.117 MATERIALITY CONCEPT If it would serve no useful purpose, i.e. it is not worthwhile to record an item in a particular way, or to show an item separately in the accounts, then it should not be done. If an item is immaterial, it may be that the costs of recording it in a particular way outweigh any benefit of doing so.
Slide 1.118 MATERIALITY CONCEPT Each business must quantify materiality individually as, for example, an item costing K50 might be material to a business with a turnover of K1,000 and a profit of K100, but not to a business with a turnover of K5m and a profit of K350,000. Also, other conventions may be ignored if the cost of adopting them outweighs the benefits.
Slide 1.119 DUAL ACTION CONCEPT Every transaction involves an act of giving and an act of receiving. It is from this aspect of transactions that the double entry system of bookkeeping was developed. For example if the business buys a new asset for K10,000 then the business receives the asset and gives K10,000
Slide 1.120 OTHER ACCOUNTING CONVENTIONS a) Accounting bases These are different accounting methods that have been developed for expressing or applying the fundamental accounting concepts, such as the calculation of depreciation and the valuation of stocks. b) Accounting policies These are the specific accounting bases judged by business enterprises to be the most appropriate to their circumstances and adopted by them for the purpose of preparing their financial accounts.
Slide 1.121 OTHER ACCOUNTING CONVENTIONS c) Matching concept: Income should be included in the accounts in the same accounting period as the expenses relating to that income. d) Realisation concept Transactions are recorded when the customer incurs liability for the goods and services (normally liability is incurred when the goods or services are actually received). Any profit on the transaction is not realised until that time.
Slide 1.122 OTHER ACCOUNTING CONVENTIONS e) Separate Determination the amount of each individual asset or liability should be determined separately from all other assets and liabilities e.g. 3 Machines concept prohibits the netting off of potential liabilities and potential gains f) The money measurement concept: Accounting information is concerned with transactions which can be measured in monetary units
Slide 1.123 AFIN 102 ASSIGNMENT 1 QUESTION ONE Explain, and illustrate with an example, the use of each of the following accounting concepts: (i) Going concern (ii) Consistency (iii) Prudence (iv) Accrual (v) Historical cost (vi) Materiality (vii) Dual aspect (21 marks)
Slide 1.124 AFIN 102 ASSIGNMENT 1 QUESTION TWO Qualitative characteristics are the attributes that make the information provided in financial statements of enterprises useful to users. There are four principal qualitative characteristics described in the IASB s framework, namely: understandability, relevance, reliability and comparability. Required :Describe and analyse each of these four characteristics. (Total 25 marks)
Slide 1.125 AFIN 102 ASSIGNMENT 1 QUESTION THREE The International Accounting Standards Board (IASB) issues International Accounting Standards (IASs) and is also responsible for the Framework for the Preparation and Presentation of Financial Statements. Required: Describe seven users of financial statements as identified by the IASB in the Framework for the Preparation and Presentation of Financial Statements. Within your description, comment on the needs of each user. (14 marks)
Slide 1.126 END OF UNIT TWO