Lecture 3A Concepts

8/4/2019 Lecture 3A Concepts

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Lecture 3

Accounting assumptions and concepts


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Welcome


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Todays quote

Genius is one per cent inspiration andninety-nine per cent perspiration- byThomas Edison


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Specific Objectives

Students should be able to

1.Explain the definition of accounting


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Accounting Definition

The process of

accumulating,

analyzing,

quantifying,classifying,

recording,

summarizing,

Interpreting and reporting data relating to the

economic resources of an enterprise to all

interested parties


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Accounting Concepts

Accounting principles are built on the foundation of anumber of basic concepts that accountants regard as

self evident

When such concepts are followed unquestionably forgenerations they are called conventions

In order to understand accounting as it now exists,

one must understand what the underlying concepts,

assumptions and principles areThese concepts , assumptions and principles

called Generally Accepted Accounting

Principles)GAAP


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Accounting ConceptsAccrual Basis-

Also known as the Matching Concept

The effects of transactions and other events are

recognized in the accounts when they occur and not

when the cash or its equivalent is received or paid.

It means that revenue must be matched the costs,

expenses incurred against earning .


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Historical Cost Concept

The assets are normally shown at cost price and it is thebasis for valuation of the assets.

In other words, all values are based on the historical costs

incurred


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Historical Cost continued

There are exceptions such as inventories of finishedgoods, raw materials and market securities whichare shown in the balance sheet at cost or netrealizable value whichever is lower.

This implies that there are two aspects ofaccounting, one represented by the assets of thebusiness and the other by the liabilities or claimsagainst them. The concept states that these twoaspects are always equal to each other.

In other words, this is the alternate form of theaccounting equation; Assets = Capital + Liabilities


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Going concern concept-

The financial statements of an enterprise are preparedon the assumption that it will continue in operation for

the foreseeable future.


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Example- Going Concern

Let us suppose, a business is preparing itsfinancial statements at 31st December 2008.

Normally, historical using the cost concept, theassets would be shown at a total value of$100,000.

It is known that the business will be forced toclose down in February 2009, only two monthslater and the assets are expected to be sold for$60,000.

In this case, it would not make sense to keep tothe going concern concept and so we can rejectthe historical cost concept for asset valuationpurposes.

In the Balance sheet at 31st

December 2008, theassets will be shown at the fi ure of $60 000


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The business entity concept

It implies that the affairs of a business are

treated separate from the non businessactivities of its owners.

The items recorded in the books of the

business are restricted or limited to thetransactions of the business.

Example, owner starts business with $500,000,

the owner becomes a long term creditor of thebusiness, in other words the business owes the

owner $500,000.


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The money measurement conceptAccounting information has traditionally

been concerned only with those facts coveredby the following:

It can be measured in monetary units

Most people will agree to the monetary valueof the transaction

This limitation is referred to as the

monetary measurement concept and itmeans that accounting can never explain

everything about a business


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The Time Interval or Period concept

The financial statements are prepared at

regular intervals of one year.

Companies which publish financialstatements between their annual ones arecalled interim statements


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Realization concept

It states that revenues should be recorded inthe period when the goods are delivered to the

customer or when the services are rendered

Amount recognized is the amount that the

customer has a legal obligation to pay


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Prudence

This is the inclusion of a degree of caution inthe exercise of the judgment needed in makingestimates required under conditions ofuncertainty so that assets and income are notoverstated and liabilities and expenses are notunderstated.

Accountant should always exercise cautionwhen dealing with uncertainty while at the sametime ensuring that the financial statements areneutral - gains and losses are neither

overstated nor understatedRevenue are recognized only when they are

reasonably certain, whereas expenses arerecognized as soon as they can bereasonably estimated


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Qualitative Characteristics of FinancialStatements

There are four (4) qualitative characteristics

known understandability, relevance,

reliability and comparability


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1.Understandability-

Information in financialstatements should bereadily understandable by

users


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(2)Relevance-

Information in financialstatements must be relevant to thedecision making needs of users.

To be relevant, information mustinfluence the economic decisionsof users by assisting them toevaluate past, present or future orconfirming or correcting their past

evaluation


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(3) Materiality-Information is material if its omission

or misstatement could influence theeconomic decisions of users.

Material if its disclosure is likely to leadthe users of the accounting informationto act differently or to come to adifferent conclusion if it were notdisclosed

Materiality depends on the size of the

item or error judged in the particularcircumstances of its omission ormisstatement


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(4) Reliability

To be useful informationshould be on the following-

1. Faithful representation aBalance Sheet should representfaithfully the transactions and other

events that result in assets, liabilitiesand equity of the entity at thereporting date.

S b t f


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Substance over form-

Definition

Transactions and other events must beaccounted for and presented in accordance

with their substance and economic realityand not merely their legal form.


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Example- I will be using a hire purchase transaction in respect to a non

current asset, car, to illustrate this condition. What is hire purchase? Use Stewarts Motor Ltd - car

1. From a legal point of view, the car does not belong to thebusiness until all installments are made that is only when the

final payment is made2. From an economic point of view, business will have used the

car for business purposes. The car bought on hire purchasewill be shown in its ledger accounts and balance sheet, as anon current asset, as though it is legally owned by the business

as well as a liability showing separately the amount owed forthe car.

3. In this way, the substance of the transaction has takenprecedence over the legal form of the transaction


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NeutralityInformation in financialstatements must be free of bias


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Prudence (Conservatism) This is the inclusion of a degree of caution in

the exercise of the judgment needed in

making the estimates required under

conditions of uncertainty such that assets and

income are not overstated and liabilities andexpenses are not understated.

Accountant should always exercise caution

when dealing with uncertainty while at thesame time ensuring that the financial

statements are neutral that gains and losses are

neither overstated nor understated


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Jamaica scenario

Do you think with we are living in a time ofuncertainty?


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Completeness- To be reliable, information infinancial statements must be complete withinthe bounds of materiality and cost


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Comparability-

To be reliable, comparability requires

consistency. Users must be able to compare the financial

statements of an enterprise over time to

identify trends in the financial position andperformance

The measurement and display of the financial

effect of similar transactions and other eventsmust be done in a consistent way throughout

an entity and over time for the entity as well as

for other entities.


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Asset-

A resource controlled by the entity as a

result of past events and from which futureeconomic benefits are expected to flow tothe enterprise.

Examples- Building, Plant,Machineryknown as non current assets

Current assets assets that used for the

trading purposes of a business Examples- inventory, debtors, cash


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Liability- Non current liabilities andcurrent liabilities

1.An entitys present obligation arising as aresult of past transactions or events.

2.Examples- Bank Loan over one year or 12months known non current liability

Current Liabilities

1.Liabilities to be settled within 12 months2.Examples- bank overdraft, creditors


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Equity- known as CAPITAL

The residual interest in the assets afterdeducting all liabilities from TotalAssets.


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Students -Reflection on todays lesson

Summary of the days lesson


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Next week lecture


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Read Chapters 1 and 10, Frank Wood

Business Accounting Text Book, eleventhedition


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THE END

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Lecture 3A Concepts