Chapter 25- accounting concepts Flashcards
Accounting
- process of control on the expenditure of a business
- vehicle for the publication of figures for profit, value and cash
What are the 2 main categories of accounting?
- Financial accounting
- Management accounting
Financial accounting
- concentrates on the assets, profits and levels of cash within the business
- main purpose of this type of accounting is to satisfy the external stakeholders of a business e.g. shareholders and financial institutions
- this information will be issued in the annual report of the business
Management accounting
- concentrates on the internal financial accounts
- allows the business to monitor and evaluate its performance
- enables the business to set targets and therefore achieve its objectives
Principles of accounting
- accounts are constructed in line with 7 principles
- these principles are used to ensure that the figures are produced in a standardised manner so that accounts can be analysed knowing they have constructed in a recognised manner
- all of these principles are ‘guides’ which exist in order for stakeholders to view accounts with some degree of confidence
What are the 7 principles of accounting
- Consistency
- Going concern
- Matching (accruals)
- Materiality
- Objectivity
- Prudence (conservatism)
- Realisation
Consistency
- all accounts will be produced in the same way
- expected that a business will have a policy for the formulation of its accounts and will apply this policy consistently
- by having a principle of consistency, any person using the accounts can be confident that the information within the accounts is more likely to be accurate
Going concern
- assumes that the business is operating as normal and that there is no reason not to expect it to operate as normal in the foreseeable future
Matching accruals
- timing of information put into the accounts is another important principle
- dates used to record financial transactions are those when the transaction occurred and NOT when the actual payment is made
- it is more realistic
- in terms of producing an accurate statement of financial position (method of recording the value of a business at a given point of time) its important to record which sales have been made or which materials have been sold regardless of when there actually paid for
- more realistic approach and allows comparisons of trading to be made from year to year
Materiality
- accounting is concerned with the big picture
- calculating the value of a business requires a realistic figure to be reached
- but a business wouldn’t spend time calculating every single set if it is of little or no value and would therefore make no real (material) difference either to its balance sheet or profit and loss account
Objectivity
- based on the idea that the accounts must be realistic and therefore based on facts, not opinions or guesses
- bias must be avoided
- to ensure realistic picture is given, its important to state the real value of the assets listed
Prudence (conservatism)
- similar to that of objectivity
- not overstating the financial situation
- where there are any uncertainties as to levels of profits/ losses/ valuations then this principle suggests that its right to understate the level of profits and overstate the level of losses
- appropriate to take a pessimistic view
- being prudent is to be cautious
- business wont be affected by figures that are less than expected
- also argued that prudence involves being realistic with valuation of assets
Realisation
- similar to matching
- realisation takes place when the legal ownership changes hands and not when payment is made
- goods/services are ‘realised’ (become the property of the buyer) when any legal entitlement is exchanged
- seller has passed the legal entitlement to the buyer
Generally accepted accountancy practice (GAAP)
- framework of accounting rules or principles
- some are identical or very similar to the principles
- financial reporting council (frc) suggested there was a need to change and subsequently published three new financial reporting standards
- these are: FRS 100, FRS 101, FRS 102 which set out the rules for different businesses
What was the new reporting framework or set of rules for accounting due to?
- be mandatory from January 2015
It is assumed that the following principles are adhered to:
Economic entity assumption: separate records for each business entity
Accrual basis accounting: see matching above
Monetary unit assumption: to include only quantifiable transactions
Full disclosure assumption: disclosure of all relevant information
Time period assumption: using a set period of time (usually one year)
Revenue recognition assumption: revenue recorded when earned
Matching principle: see principle above
Cost principle: assets to be recorded at cost of acquisition
Going concern principle: see principles above
Relevance, reliability and consistency: see principles above
Conservatism: a less optimistic approach to be adopted
Materiality: see principles above
Why comply with GAAP?
- Stakeholders will often view the accounts of any given business in order to make decisions i.e. invest, check progress of a businesses performance, ensure it is credit worthy in order to trade with it
- by having GAAP it allows stakeholders to make comparisons on the basis that the business all use the same set of principles in the manner in which accounts are formulated and presented
