Week 2 - Accounting concepts, rules and the accounting equation Flashcards
What are accounting concepts/ conventions
the basic assumptions that underlie the accounts
What are accounting standards?
technical rules which give guidance on how specific transactions should be accounted for
What are accounting policies
detailed methods of measurement and valuation adopted by specific entities
What are the two basic fundamental accounting concepts?
- going concern concept
- accruals concept
(apply to all financial statements)
What is the going concern concept
this concept is the assumption that the business will continue operating into the foreseeable future
What will be valued with the going concern concept if it continues to operate into the foreseeable future?
assets, liabilities, income and expenses will be valued using the normal rules of accounting (usually historical cost)
What will be valued with the going concern concept if it doesn’t continues to operate into the foreseeable future?
if the business is not likely to continue, assets, liabilities, income and expenses are valued for their net realisable value (what the business could get for them if they were sold today)
What informs users about the going concern concept?
information in the accounts informs users whether the accounts are prepared on a going concern basis or not
What is the accruals concept
this concept is the assumption that income, expenses, assets and liabilities are recognised (shown in the accounts) when the transaction takes place. It doesn’t matter if they are paid for/ cash is received at that date
How is revenue recorded in the accruals concept
assumed that revenue is recorded in the accounts when earned, and expenses is recorded when incurred and matched with revenue regardless of when cash is received or paid out
What is closely associated to the accruals concept?
the matching concept
What is the matching concept?
all expenses incurred in an accounting period must be matched with the revenue earned in that period
(seen as part of the accruals concept)
Example of accruals (matching)
eg business has following transactions
15th Jan: Purchase £100 of goods on credit
15th Feb: Paid for the purchased goods
15th Mar: Sold on credit for £150 goods purchased on 15th Jan
15th Apr: Received payment for goods sold on 15th March
Cost of the goods was incurred in Janurary.
The sales revenue was earned in March.
The profit of £50 occurred in March when the cost of the goods is matched against the sale of the goods.
There is no profit or loss in Jan, Feb or April. The cost of the goods is carried forward as inventory/ stock at the end of Jan and Feb.
Cost of the goods sold become “cost of goods sold” in March when sales happens. “cost of goods sold” become an expense
What do you use in accounting to make the number negative
brackets
Eg for profit or loss on the accrual basis
Eg Even though interest is charged in the third month, 30,000 spread it over the three months
Loan interest 10,000 in Jan, Feb, March
What sort of profit is accrual based?
Accounting profit
What two financial statements use accrual based profits?
Income Statement and Balance Sheet
Why are income statements and balance sheets use accrual-based profits?
they give a more realistic view of the company’s performance and financial position than cash-based profits
What is a historical cost?
record items in accounts at the original cost when the transaction took place
usually to measure assets
What is a money measurement concept?
only items which can be measured in monetary terms are included in the accounts
eg human capital, unable to put a specific number on it
What is the entity concept?
business can be separated from the owner
What is the time period concept?
life of business can be split into different time periods so information can be recorded
What are the 4 other accounting concepts
Historical cost, money measurement concept, the entity concept, the time period concept
What are accounting standards
are accounting are rules which show how transactions should be disclosed, measured and recognised
(must be followed to ensure financial statements give a true and fair view of the entity’s activities)
What are accounting policies?
are the specific accounting methods selected by companies from those methods allowed in the accounting standards
(accounting policies are disclosed by entities in the notes to the financial statements in the annual report)
Who sets the accounting rules?
1. The accounting profession
International Accounting Standards Board (IASB)
Financial Reporting Council (FRC)(UK)
Financial Accounting Standards Board (FASB)(US)
Who sets the accounting rules?
2. Legislation
EU law
Home law, eg UK corporate law
Who sets the accounting rules?
3. Stock exchanges
London Stock Exchange
New York Stock Exchange (NYSE)
What does the IASB conceptual framework (2018) aim to provide?
to provide some broad guiding principles to assist with the development of new accounting standards and treatments to reduce variation in accounting rules across counties
What is the purpose of the IASB conceptual framework (2018)?
to help national standards setters develop new standards
to help preparers of financial statements with areas where there arent any standards
to help auditors to assess whether a set of financial statements meet accounting rules
What characteristics does the IASB conceptual framework (2018) have?
Qualitative characteristics of accounting information
Fundament characteristics
Enhancing characteristics
What fundamental characteristics must financial information have?
relevance and faithful representation
What enhancing characteristics should financial information have?
comparability, verifiability, timeliness, understandability
What is relevance (a fundamental characteristic)
Relevant financial information is capable of making a difference in the decisions made by users
What should financial information have to be relevant?
predictive value (can be used to make predictions or forecasts of future outcomes) and/ or
confirmatory value (can provide feedback about previous decisions)
What is faithful representation (a fundamental characteristic)
to be useful, financial information must represent faithfully the event it purports to represent
What should financial information have to have faithful representation
completeness (all the information a user needs to understand the event)
neutrality (no bias in the selection or presentation of the information)
freedom from error (no errors or omissions in describing the event)
What is timeliness (enhancing characteristic)
information is available to users in time to be use of them for decisions
What is comparability (enhancing characteristic)
information enables users to identify and understand similarities and differences between items. Consistency of reporting (using the same method for the same items over time and between entities) assists with this
What is verifiability (enhancing characteristic)
different users would agree that the economic event is faithfully represented. auditors will verify information for investors
What is understandability (enhancing characteristic)
information should be clearly and concisely presented. complex transactions should be explained clearly
What are the 3 main characteristics in the Statement of financial position (SOFP)/ Balance sheet?
Assets, liabilities and capital
How are assets grouped?
by how long a company intends to keep them
What are non-current assets?
assets which will be used for more than one year from the date of the financial statements. these are used to run the business over the long term
What are current assets?
assets which are expected to turn into cash by sale or use within a year
What are liabilities split into
current liabilities or non-current liabilities
What is a non-current liability?
where the entity is not required to pay the liability within a year
What are liabilities?
amounts owed by the company including:
1. payments to suppliers (trade payables)
2. accruals (which are expenses owed at the date of the SOFP)
3. repayments of bank loans (often classified as financial liabilities)
4. provisions (amounts provided for liabilities likely to occur in the future
How to calculate net assets
total assets - total liabilities
What does equity represent?
the owners share in the business
eg cash or property that the owner brought into the business
How is equity similar to liability
because it represents what the business owes to the owners
What 3 things does equity consist of?
- share capital (own contribution to the business, ordinary and preference)
- retained profit (earnings, profits brought forward from previous years)
- other reserves (eg from revaluing assets)
What does capital consist of?
for sole traders (instead of equity) it is usually called capital and consists of the owners share +profits less any withdrawals made by the owner (called drawings)
Total assets equation
Total assets = total liabilities + total equity
What is the difference in the SOFP for a sole trader and companies
For sole trader its called capital and drawings
For companies it is equity/ share capital and dividends
What is the duality/ dual aspect concept
every transaction has two aspects (this is the basis for the accounting equation and double-entry bookkeeping)
What does the duality aspect concept affect?
every transaction affects two items in the financial statements
What is the Assets extended accounting equation
Assets = Liabilities + Opening Equity + Revenues - Expenses
Why do entities need accounting systems? (5 reasons)
- To record and control business transactions
- To maintain accuracy in recording
- To meet the requirements of the law
- To present final financial statements to the owners of the business
- To facilitate the efficient allocation of resources
What is the flow of data through the accounting system? (Financial statements from scratch)
- Basic documentation
- Books of prime entry
- Ledger accounts
- Trial balance
- Adjustments
- Financial statements
What is basic documentation?
- Invoices from suppliers for credit purchases
- Sales invoices - issued by you for credit sales
- Invoices and other documentation for non-current assets
- Cheque books and paying-in slips
- Receipts for petty cash
- Credit notes received or issued for returned goods
What are books of prime/ original entry
- Source documents are used to enter transactions into the accounting system to ensure the business can keep track of payments due and owned
- Transactions are often recorded in books of prime entry before being entered in the ledger accounts. Books of prime entry are used to summarise transactions
- Postings to the ledger can then be made with these summarised amounts periodically instead of requiring each transaction to be posted one at a time
What are the main books of prime entry?
Sales day book
Purchase day book
Cash book
Petty cash book
Payroll
