Accounting Principles, Concepts and Policies

October 11th,2009

Introduction

• An appreciation of conceptual and theoretical foundations of financial accounting is fundamental to the preparation, understanding and interpretation of financial statements.

• This can be described as a set of rules, principles, postulates, conventions and methods. Accounting concepts are referred ( in IASC,1989) framework for the preparation and presentation of financial statements.

Cont’d

• The framework is supported by IAS1- presentation of financial statements and IAS8 focuses on selection, change in disclosure of accounting policies, accounting estimates and errors.

The nature of Accounting Principles

The most useful way of describing the nature of accounting principles is probably in terms of the contents of the frame work

The objectives of financial statements Underlying assumptions of accounting The qualitative characteristics of financial statements The elements of financial statements such as

Assets,liabilities,ownership interests(equity), income Recognition of elements in financial statements Measurement of the elements in financial statements Concepts of capital maintenance- the accounting equation

Accounting Concepts

DefinitionAccounting concepts are defined by UK SSAP-2

as ‘broad basic assumptions that underlie the periodic financial statements of business enterprises’. There several though the framework makes mention of going concern concept and accruals concept as crucial importance in ensuring that financial statements meet there objective.

Concepts Cont’D

Going Concern• This is the assumption that an entity will continue

in operational existence for the foreseeable future. users should be able to predict from the financial statements that prior activity as an indication of future activity e.g. assets kept at historical/fair value.

• IAS1 requires entities to disclose on the going concern position of the entity when preparing financial statements

Concepts cont’d

Accruals concept• According to the framework and IAS1, to meet

their objectives financial statements should be prepared on the accrual basis of Accounting

• Under this basis the effects of transactions are recognised when they occur( and not when cash or its equivalent is received)and are recorded in the accounting records and reported in the financial statements in the periods to which they relate.

Concept Cont’d

• Accrual concept cont’d• e.g in Revenue recognition concept relates to the assumption

that a sale is deemed to have taken place at the time the good are delivered( i.e. when revenue is earned ) and not when the proceeds of the sale are received. IAS 18

• Accrual concept also assumes that costs should be recognised when they occur not when the money is paid. at the end of the period cost consumed during the year for which no invoice has been received should be treated as accrued expenses(liabilities)

• In contrast services paid for in advance, that have not been received at the end of the period are treated as prepaid expenses or prepayments

Concepts Cont’d

Realization concept. can also be used to explain the accrual concept. that profits shall be treated as realised ,only when realised in the form of cash or other assets, the ultimate cash realization of which can be assessed with reasonable certainty.

Concepts Cont’d

Matching Concept• Refers to the assumption that in the

measurement of profit, costs should be set against the revenue that they generated

• Where good are bought in one accounting period and sold in the next period, their cost is carried forward as inventory at the end of the year and set against the proceeds of sale in the accounting year in which they occur. IAS 2

Concepts cont’d

Entity concept other wise known as accounting entity, or business entity concept

This concept allows the user to look at the financial statements of reporting entity and to know that the statements represent the performance and position of the business unit not that related to any other business

Concepts cont’d

Materiality ConceptThe materiality concept affects every transaction and every set of financial statement, specifically in two areas presentation and application of accounting standards

• It assumes that only material items should be disclosed in the financial statements.

• The concepts also becomes relevant in deciding whether to comply with guidance given in accounting standards

Concepts cont’d

Time period conceptRefers to the practice of dividing the life of an entity into discrete periods for the purpose of preparing financial statements. The norm as required by most company law is one year

Concepts cont’d

Historical cost concept/Fair value• The historical cost concept allows the user to assume

that all the transactions in the entity financial statements reflect the actual cost price billed or revenue charged.

• This concept is becoming less relevant as it is widely believed that historical cost information does not useful for decision making than fair value information.

• Fair Value is defined by IASB as the amount for which an asset could be exchanged or liability settled between knowledgeable willing parties

Concept Cont’d

Money measurement conceptThis concept allows the user to assume that the

performance and the financial position of a reporting entity will be expressed in monetary amounts ( usually the currency of the country where the business is registered).

Concepts Cont’d

Duality ConceptThe duality concept, also known as the dual

aspect or double entry, assumes that every transaction has two aspects. every transaction affects tow accounts in a set of financial statements in such a manner as to keep the accounting equation in balance

Concepts

Prudence concept• Assumes that the financial statements have

been prepared on prudent basis. This allows the user to have confidence that no profit has been included that are not earned and if not yet received are reasonably certain to be received

• There no over statement of assets, and liabilities are complete and not understated.

Concepts cont’d

Substance over form conceptThis concept assumes that when accounting for transactions the preparer should look at the economic substance of the transaction not its legal form

Concepts Cont’d

Consistency ConceptThe consistency concept allows the user to look at a set of financial statements over a period of a number of years for an entity and to assume that the same methods , policies and estimation techniques have been applied from year to year

Concepts Cont’d

The separate determination concept• This concept protects the user.IAS1 states that an entity

shall not offset assets and liabilities or incomes and expenses unless required or permitted by the IFRS.

• Under this concept netting transactions is only allowed when offsetting reflects the substance of the transactions or other event.e.g trade discounts against sales revenue

• This concept allows the user to look at assets, liabilites,income and expenditure and to know that ,that is the total value for each transaction.

Question

Accounting concepts are fundamental underlying assumptions that accountants are required to use in recording of transactions and preparation and presentation of Financial statements.Using in details the various accounting concepts and there application in the financial reporting process clearly stating any relationships, contradictions and limitations in each.