4.1 A Basic Concepts And Underlying Principles Of Fin Acc Flashcards
Purpose of GAAP
GAAP - generally accepted accounting principles
Reports prepared using these principles allow investors and other stakeholders to compare one company to another.
Who is FASB?
Financial Accounting Standards Board
They are the authoritative body having the primary responsibility for developing accounting principles
FASB publishes Statements of Financial Accounting Standards and Interpretations to those Standards.
Business Entity Concept
The business entity must be identified so that the accountant can determine which economic data should be analysed, recorded and summarised in reports.
It is important because it limits the economic data in the accounting system to data related directly to the activities of the business.
Business is viewed as an entity separate from its owners, creditors or other stakeholders.
Business Entity Concept can be related to which other concepts?
Economic entity assumption
Going-concern assumption
Monetary unit assumption
Economic entity assumption
Economic activity can be identified with a particular unit of accountability
Going-concern assumption
Accountant assumes that, unless there is evidence to the contrary, the reporting entity will have a life long enough to fulfill its objectives and commitments
Monetary unit assumption
All transactions and events can be measured in terms of a common denominator - the dollar
Cost Concept
Basis for entering the exchange price or cost of an asset into the accounting records.
Involves two other important concepts: objectivity and unit of measure.
Objectivity - requires that accounting records and reports be based on objective evidence.
Unit of measure - requires that economic data be recorded in dollars.
Matching Concept
- Is based on accrual accounting
- Refers to the matching of expenses and revenues for an accounting period.
Accrual Basis
Revenues are recognised when sales are made or services are performed, and expenses are recognised as incurred.
Revenues and expenses are recognised in the period in which they occur rather than when cash is received or paid out.
Cash Basis
Revenues and expenses are reported in the income statement in the period in which cash is received or paid.
Advantages:
- increased reliability: transactions are not recorded until complete
- simplicity: fewer estimates and judgments are required
Not in accordance with GAAP
Materiality Concept
Implies that errors, which could occur during journalising and posting transactions, should be significant enough to affect decision making process.
Accounting information should contain 2 qualitative characteristics…
Primary and secondary qualities
Primary Qualities that distinguish useful accounting information
Relevance
Reliability
Primary Qualities - Relevance
Information must have a bearing on a particular decision situation.
Relevant accounting information possesses at least 2 characteristics: Timeliness and Predictive value or feedback value.
Timeliness - accounting info must be provided in time to influence a particular decision
Predictive value - accounting info can be used to predict the future and timing of cash flows.
Feedback value - accounting function must provide decision makers with information that allows them to assess the progress or economic worth of an investment.
Primary Qualities - Reliability
- Reliable accounting information must possess 3 qualities: verifiability, representational faithfulness and neutrality.
- Verifiability - several individuals, working independently, would arrive at similar conclusions using the same data.
- Representational faithfulness - Accounting information must report what actually happened
- Neutrality - accounting information must be free of bias or distortion.
Secondary Qualities of accounting information
Does not mean of lesser importance than primary qualities.
If a secondary characteristic is missing, the accounting info is not necessarily useless.
Secondary qualities are comparability and consistency.
Secondary quality: comparability
Accounting reports generated for one firm may be easily and usefully compared with accounting reports generated for other firms.
Secondary quality: consistency
A firm systematically uses the same accounting methods and procedures from one accounting period to the next accounting period.
Additionally to primary and secondary qualities accounting info must be…
Understandable to economic decision makers. The earnings mgt strategy can destroy the primary and secondary qualities of acc information
Two factors allow the recording of a transaction:
Evidence: an exchange is an observable event and therefore provides evidence of business activity.
Measurement: The exchange takes place at a set price and thus provides an objective measure of the economic activity.
The accounting cycle is one of 4 cycles; name the other 3
Sales
Finance
Production
Double entry bookkeeping
Assets = Liabilities + Owners Equity
Total amount of debits must equal total amount of credits
Debits: Assets Liabilities Owners equity Owners drawings Revenues Expenses
Increase assets Decrease liabilities Decrease Owners Equity Increase Owners drawings Decrease Revenues Increase Expenses
Steps in accounting cycle
1) analysis of transactions
2) journalising of transactions
3) posting to ledger
4) trial balance and working papers
5) adjusting journal entries
6) closing journal entries
7) preparing financial statements
8) reversing journal entries
Step 1: analysis of transactions
- each transaction must be analysed to determine effect on assets, liabilities and owners equity accounts.
Step 2: Journalising of transactions
- transactions are recorded in the accounting journal
Step 3: Posting to the ledger
Ledger is the complete collection of all the accounts of an organisation.
Ledger maintain current balance of all the accounts.
Step 4: Trial balance and working papers
First step in preparation of working papers is preparation of trial balance.
Trial balance lists all accounts with balances as of the end of accounting period.
Debits will equal credits.
Trial balance does not provide a means of determining whether transactions have been posted to correct accounts or journalised and/or posted to general journal.
Working papers - prepared at end of an accounting period and are for internal use only.
Step 5: Adjusting Journal Entries
1) Allocate the cost of assets used in several accounting periods and revenues earned in several accounting periods
2) Accrue revenues and expenses attributable to current period that have not been recorded
3) Make appropriate end-of-period adjustments in the carrying value of certain assets
4) cost of long-term assets must be apportioned to the periods that benefit from their use - apportioned to periods through depreciation, depletion and amortisation (productive assets (building, machinery), wasting assets(minerals), and intangible assets (patents, copyrights)
5) Record portion of unearned revenues earned during the year and portion of prepaid expense that expired during year -1 determine current balance in account, -2 determine appropriate balance for account, -3 make appropriate entry to achieve desired ending balance
6) May be necessary to reduce asset to market value (A/R, inventory, marketable security) - debit expense or loss account and credit contra asset account
Step 6: Closing journal entries
Step 7: Preparing Financial Statements
Step 8: Reversing Journal Entries
Real Accounts
Asset, liability and equity accounts
Not closed at end of accounting period
Represent the financial position of an organisation at any point in time
Nominal accounts
Revenue and expense accounts
Are closed at end of accounting period
Balances are reduced to zero
Represent the results of operations over a given period of time
Subsidiary ledger
Most organisations maintain subsidiary ledgers for AR and AP.
Sum of all subsidiary ledgers should be equal to the master account in general ledger.
