Accounting principles and concepts

ACCOUNTING CONCEPTS,

CONVENTIONS AND

PRINCIPLES By Habibu Ayuba, BSc; PGDE, MSc; ACA inview.

08030527135

4/8/2014By Habibu Ayuba, BSc; PGDE, MSc; ACA inview. 08030527135 1

Aim and objectives the

presentation

At the end of the sessions, the participants should be able to:

To understand accounting and reporting policies.

To define accounting concepts and convention.

To explain factors to be considered in selecting an appropriate accounting policies.

To examine changes in accounting policies.

To state the disclosure requirement of accounting policies.

To discuss the impact of accounting policies on the recognition of asset and liability..


Understanding of Accounting

and Reporting policies

Imagine that you are a business owner and you take

copies of your financial records (books) to six different

accountants, you ask each one to calculate your profit

for the year. A fortnight later they each provide you

with their answers. There are six different profit

figures, with very wide variations between them.

What would you do?

Why do accountants give you six (6) different profits

figure?


Then what will be your impression

about the accounting profession.

To avoid this kind of situations. We

need to know why things are like that

in accounting.

Various rules or accepted ways of

going about things have evolved in

accounting profession. These things

are like rules of the game and are

known as “Concepts and Conventions”4/8/2014By Habibu Ayuba, BSc; PGDE, MSc; ACA inview. 08030527135 4

Therefore to make the accounting language capable of

conveying similar and the same meaning to all its stake

holders, concepts, methods and policies of preparing

financial accounting statements are coined.

To make it more meaningful, accountants have agreed

on a number of concepts which are usually followed for

preparing the financial statements and are now

internationally recognized as international reporting

standard (IFRS).

These concepts provide a foundation for accounting

process. No enterprise can prepare its financial

statements without considering these concepts.


Accounting and reporting

policies

Reporting policies consists of the interplay of the

following:

Accounting policies

Accounting concepts

Accounting methods

Accounting bases

Accounting assumptions

Accounting conventions

• These terms are what are referred to as accounting

concepts and convention.


Accounting policies

Accounting policy of a giving company is simply means all those specificaccounting concepts, accounting methods and accounting bases whichare adopted by the entity in the presentation of its financialstatements.

A complete set of financial statements comprises according to IFRS isthe following:

■ Statement of Financial Position (formerly Balance Sheet);

■ Statement of Comprehensive Income (formerly Income Statement);

■ Statement of changes in equity;

■ Statement of cash flows;

■ Notes to the financial statements that contain accounting policies andother explanatory -information; and

■ Statement of financial position for the beginning of the earliestcomparative period when an entity applies an accounting policyretrospectively, makes a retrospective restatement of items in itsfinancial statements, or reclassifies items in its financial statements


Financial Statements

According to CAMA, 1990


Accounting concepts

Accounting concepts are defined as a those fundamentalassumptions or postulates that underlie the preparation andpresentation of financial statements.

They are as follows:

Going concern concept

Legal entity concept

Periodicity concept

Realization concept

Matching/Accrual concept

Historical cost concept

Consistency concept

Dual concept

Monetary measurement concept (quantitative)


Going concern concepts

It states that a company would operate

(never die or stop) for a foreseeable long

future.

In this concept, it is assumed that the

business will continue to be in operation

for an indefinite period of time. If the

business were going to be sold, then it

would be necessary to know how much

the assets will fetch.

4/8/201

4By Habibu Ayuba, BSc; PGDE, MSc; ACA inview. 08030527135 10

Legal/Business entity

concept

It states that a modern business is always

separate, distinct and independent of its

owners/shareholders/ managers/directors.

This concept state that a business is an entity

(perceived to have its own existence) separate

from its owner. Therefore business record should

be separated and kept distinct from the personal

record of the business owner . At time law makes

the same distinction, as in the case of limited

company which is a separate legal entity from the

shareholders or its Directors.


Periodicity concept

It states that in every financial accounting

records kept and prepared, there must

have a time for its reporting. The time

accepted for the report is the period of

12 months.

The results of the business must be

prepared in a shorter interval not to be

allowed until its final liquidation. That is

why business is divided into accounting

period.4/8/2014By Habibu Ayuba, BSc; PGDE, MSc; ACA inview. 08030527135 12

Realization concept It states that rule for recognizing the revenue of the business.

Periodic recognition of revenue is made as soon as: it is capable ofobjective measurement and the value of assets received or receivable inthe exchange is reasonably certain.

In accounting; profit is normally regarded as being earned at the timewhen the goods or services are passed to the customers and he incursliabilities for them.

Revenue is recognized at a variety of time but four (4) instances areprominent which are:

1. At the time of sale of asset

2. During production of asset

3. At the completion of the production of asset

4. At a point of cash collection.

The choice of the time usually is more of industrial norms.


MONEY MEASUREMENT It states that every item in accounts should be

measureable in monetary terms such as Naira,Dollar etc.

In this concept, accounting is only concernedwith items that can be quantified in monetaryterms. That is a business may have valuableresource like workforce skill, morale, marketleadership, brand recognition, qualifymanagement but these do not get recorded inthe financial statement because they can notbe quantified in monetary terms.


THE HISTORICAL COST CONCEPT

It states that the purchasing price as a cost of an

asset/liability is the appropriate basis for the

initial accounting recognition of an asset acquired;

services rendered; expenses incurred; creditors

and owners interest. It should be retained through

out accounting process.

This requires that assets of a business be recorded

in the ledger account at the actual price paid to

acquire them. This means asset be recorded at

their original price of acquiring them. This cost

serves the basis for further accounting treatment

of the asset.


THE DUAL ASPECT CONCEPT

It states that every Debit (receive) Entry musthave a correspondent Credit (give) Entry, viceversa.

This principle states that there are two aspect ofaccounting. One represented by the assets ofthe business and the other by the claims againstthem . This is based on the accounting equation:-Asset = Liabilities + Owners Equity. alltransactions recorded in the account must keepthis equation in balance. To do this financialtransaction are allocated to both a debit sideand credit side of equal amounts.


THE ACCRUAL/MATCHING CONCEPT

It states that the profit of the business shouldbe recorded at a point of sale irrespective ofwhether cash is due or in arrears as theexpenses related to it is simultaneouslyrecognized when incurred not necessarilywhen cash is paid.

The principle states that the income and costaccruing to the owner of a business is notnecessarily the amount of cash actuallyreceived in a period of account. That isrevenue and costs are recorded when theyoccur rather than when the cash is receivedor paid.


Accounting Methods

They are ways or media through which a the

accounting concepts are applied in the

preparation and presentation of financial

statement.

Examples are:

1. Straight line/reducing methods of depreciating

assets.

2. Closing rate/ temporal method for translating.

3. Completed contract methods or percentage of

completion method and so on.


Accounting Bases

These are totality of accounting methods that are

employed in the preparation and presentation of

financial statement.

Generally, accounting methods are grouped into:

Cash Basis: states that all business transactions

are recognized only when the actual cash is paid

or received by the entity.

Accrual Basis: states that all business transactions

are recognized whether the cash has been

received or not.


Contents of accounting

policy

Items to be included in the accounting policies of a givencompany are:

1. General accounting policies

2. Policies on measuring fixed assets

3. Policies on stock or work in progress valuation

4. Policies of depreciating assets and depreciation methods

5. Policies on investment

6. Policies on lease

7. Policies on research and development

8. Policies on franchises

9. Policies on employee retirement methods

10. Policies on consolidation etc.


Accounting Assumptions

These are the beliefs of which preparation and

presentation of financial statement is built upon.

In accounting, there are two assumptions:

Stability: a belief that the monetary units which is

the basis of valuation and measurement of all

transaction remain the same over a foreseeable

future period of time.

continuity: A going concern which share the belief

that the business entity will survive and continue

operation in a foreseeable future.


THE ACCOUNTING CONVENTIONS

The accounting conventions can beinterpreted in many ways. What weretherefore grown up in accounting aregenerally accepted approaches to theapplication of the concepts. Theseapproaches are known as the conventions ofaccounting ( Regulation). The mainconventions are:-

- Materiality

- Conservatism/prudence

- Consistency

- objectivity


MATERIALITY CONVENTION

It states that a financial statement should present and

report all items of transaction which are capable of

influencing the decision of stakeholders and if such

items omission completely or wrongly stated would

significantly alter the stakeholders’ decision.

This is a convention that records any thing that are

significant enough to justify the usefulness of the

information. Only items that are deemed significant for

a given size of operation should be recorded.

Accountants are guided to ignore insignificant details

otherwise the account will be burdened down with

minute details. Therefore materiality is an issuer of

judgment.


CONSERVATISM/PRUDENCE

CONVENTION

It states that a financial statements report and

recognize instantly and adequately known loses and

gains/profit is ignored until its full realization is

certain.

Very often an accountant has to make a choice as to

which figure he will take for a given item.

Conservatism means that the accountant will take the

figure, which will understate rather than overstate the

profit. All anticipated losses should be recorded but all

anticipated gains should be ignored.

Therefore provisions is made for all losses even though

the amount can not be determined with certainty.


CONSISTENCY CONVENTION

It states that the financial statements shouldbe prepared in a way that a similar items oftransactions are treated equally and similarlyso as to maintain uniform presentation formatadoptable over a time.

The concept and convention already listedare so broad that in fact there are manydifferent ways in which items may berecorded in the accounts.

By this assumption, accountants are expectedto record and report accounting activities inthe same way year by year if any sensible andmeaningful comparison would be made tofinancial report of a firm for differentperiods. Having a particular method wouldgive the firm the most equitable picture ofthe activities of the business.


OBJECTIVITY CONVENTION

It states that preparation andpresentation of financialstatements should be made freefrom the accountants/ preparersbias, undue influence andconflict of interest.

All items of transactions reportedare supported by thedocumentary evidence andfacts..


Factors to Consider when

Choosing Accounting policies

Some concepts, methods and bases conflict with one

another. Thus, judgment is required to select the good

relevant policies for your financial statement so as to

ensure true and fair view of the reporting. These factors

are as follows:

Fairness

Materiality

Substance over form

Objectivity

prudence


Disclosure Requirement of Accounting

policies

IFRS-IAS/SAS 1 states that allaccounting policies of areported entity should bedisclosed together under onecaption rather than as notesto the individual items in thefinancial statement.


Changes in the Accounting

Policies

Consistency is required to be applied in financial

reporting, yet, instances may warrant changes of

accounting policies.

The circumstances giving rise to changes are:

Where the existing policies no longer ensure true and

fair view of the event.

Where there is a new accounting standard that

renders the existing policies invalid.

Where there in new legislation/ regulation that would

ensure a better presentation of true and fair view of

the account.


ACCOUNTING PRINCIPLES

Accounting is guided by the following principles:

Substance over form

Objectivity

Fairness

Materiality

Prudence

Substance over form: states that substance/uses/economicreality of an item of transaction is always reported at theexpense of legal form.

Fairness: states that all stakeholders of accounting aretreated with equally without favoring a group at theexpense of another.


Impact of Accounting Policies on

the recognition/measurements of

Assets and Liability

The value of assets and liabilities to be disclosed in the

financial statements are greatly affected by the policies

adopted.

Assets and Liabilities are subject to or exposed to these

methods of valuation as proposed by accounting

policies.

The methods include:

Historical cost methods

Realization value methods

Current value methods

Replacement cost methods


Impact of policies Cont….

Historical cost value assets and liability based on theactual cost of the assets acquired or the liabilityincurred.

Realization value method value assets and liabilitybased on what the assets/liabilities could fetch at thepoint of disposal after removing disposal expenses.

Current value method value assets/liability based onwhat a new brand one is being sold in the market at anarm length transaction. It is called fair value.

Replacement cost method value assets/liability basedon what, new but similar one would cost in the openmarket if acquired to replace the existingasset/liability.


ACCOUNTING BOOKS

There are various forms of accounting books depending on what the book is used for. The main books of accounting and financial statement known are:

a) Cash register

b) Cash book

c) Petty cash book

d) General ledger

e) Trading, profit and loss account


f) Trial balance

g) Balance sheet

h) Bank reconciliation statement

The following are the subsidiary books of

account:

a) Purchases day book

b) Sales day book

c) Purchases return day book

d) Sales return day book4/8/2014By Habibu Ayuba, BSc; PGDE, MSc; ACA inview. 08030527135 34

THANK YOU FOR YOUR PRESENCE


Economy & Finance

Accounting principles and concepts