[FDNACCT] Unit 2: Accounting Concepts and Principles

Materiality

To ignore the amount because it is small in relation to the financial statements taken as a whole

Generally Accepted Accounting Principles

fundamental truths or axioms that can be derived from laws of nature

Going Concern

companies continue to sell goods on account because it believes its customers will make good their promise to pay their account

Entity

limits the economic data in the accounting system to data related directly to the activities of the business

Entity

an individual economic unit for which data are recorded, analyzed, and reported

Fundamental qualitative characteristics

qualities that make accounting information useful for decision making by interested users; if financial information is to be useful, it must be relevant and faithfully represent what it purports to represent.

Relevance
Faithful representation

(2) Fundamental qualitative characteristics

Relevance

Financial information that is capable of making a difference in the decisions made by users.

Predictive Value
Confirmatory value
Materiality

(3) Relevance

Predictive value

Financial information that can be used as an input to predict future outcomes.

Confirmatory value

Financial information that provides feedback about previous evaluations.

interrelated

relationship of the predictive value and confirmatory value of financial information; revenue information for the current year, which can be used as the basis for predicting revenues in future years, can also be compared with revenue predictions for the current year that were made in past years.

Materiality

Financial information that could reasonably be expected to influence decisions made by users.

Faithful representation

Financial reports represent economic phenomena in words and numbers. To be useful, financial information must also faithfully represent the substance of the phenomena that it purports to represent

Faithful representation

freedom from material error

Completeness
Neutrality
Free from error

(3) Faithful representation

Completeness

Financial reports that include all necessary information for users to understand the phenomenon being depicted, including all necessary descriptions and explanations.

Neutrality

without bias in the selection or presentation of financial information

Prudence

the exercise of caution when making judgements under conditions of uncertainty

Free from error

no errors or omissions in the description of the phenomenon, and the process used to produce the reported information has been selected and applied with no errors in the process; estimates should be described clearly and accurately as being an estimate, the nature and limitations of the estimating process are explained, and no errors have been made in selecting and applying an appropriate process for developing the estimate

Enhancing qualitative characteristics

attributes that enhance the fundamental qualitative characteristics of financial information

Comparability
Verifiability
Timeliness
Understandability

(4) Enhancing qualitative characteristics

Comparability

enables users to identify and understand similarities in items and differences among items

Consistency
Uniformity

(2) Comparability

Consistency

use of the same methods for the same items, either from period to period within a reporting entity or in a single period across entities.

Uniformity

comparability of financial information is not enhanced by making unlike things look alike any more than it is enhanced by making like things look different.

Verifiability

helps assure users that different knowledgeable and independent observers could reach consensus, although not necessarily complete agreement, that a particular depiction is a faithful representation

Timeliness

Having information available to decision-makers in time to influence their decisions; “the older the information is, the less useful it is”

Understandability

classifying, characterising, and presenting information clearly and concisely

Underlying assumptions

assumptions made when preparing financial statements to avoid misunderstanding

Entity
Going concern
Monetary
Time period
Accrual

(5) Underlying assumptions

Entity

assumes that a business unit is separate and distinct from its owner/s; requires that business’s accounting records should always be kept separate from the owner’s personal accounting records

Going concern

assumes that a business entity has an indefinite life, that it will continue to operate in the foreseeable future in the absence of any evidence to the contrary

Monetary

1. assumes that only transactions that can be expressed in monetary terms are recorded

2. assumes that the peso is used to record transactions and that it is relatively free from value fluctuations

Time period

assumes that the indefinite life of a business entity is subdivided into short periods of equal length within which financial statements are prepared to provide users of financial statements with timely information

Accrual

1. revenue should be recognized when earned, regardless of when cash is received

2. expenses should be recognized when incurred, regardless of when cash is paid

General principles

guidelines in preparing financial statements

Historical Cost
Revenue Recognition
Matching
Full disclosure

(4) General principles

Historical cost

transactions should be recorded at the cost paid by the business and that assets should be shown at their original cost

Revenue recognition

1. revenue is recorded when it is earned regardless of when cash is received when a sale in made or a service is provided (Exception: ‘sale or return’)

2. revenue is recorded only if it has been earned and realized (cash/accounts receivable)

Matching

revenues earned during an accounting period should be matched (offset) with the expenses incurred in generating this revenue in the same accounting period (cause and effect)

Full disclosure

the business entity should provide financial information and other facts that are necessary for the users to properly interpret the financial statements

Modifying constraints

limitations that restrict and practical considerations that modify the accounting choices that an accountant makes in preparing financial statements

Materiality

if omitting, misstating, or obscuring an information could reasonably be expected to influence decisions that the primary users of general-purpose financial reports make on the basis of those reports

Cost-Benefit Test

• the cost of gathering information to fully comply with an accounting principle or rule may be much higher than the benefit received

• information is cost effective only if the benefit of increased decision usefulness exceeds the costs of providing that information

Conservatism

if there are two or more equally acceptable treatments to record a transaction, then the accountant should choose the conservative approach (lower assets/revenue, higher liabilities/expenses)

Industry Practice

Some industries have unusual tax laws or regulatory requirements and so have developed special accounting principles and procedures for their industry. These practices may not conform completely with GAAP or IFRS Standards and so are not suitable for other industries.

Objectivity

the business entity should use documents as basis for recording business transactions and so avoids subjectivity when preparing financial statements

Substance over form

business transactions should be treated according to the real substance, not the legal position (legal form)

Entity

personal financial information and business financial information should not be combined

Historical cost

an asset is recorded and remains in the account at its original cost

Going Concern

on the premise that the business will continue to operate normally unless conditions contrary to such premise exists such as filing for bankruptcy or termination of the business.

earned

Revenue is reported when it’s ______, regardless of when collection is actually received

incurred

while expense is reported when it’s ________, regardless of when payment is actually made

Accrual

assumes that revenue is reported when it’s earned, regardless of when collection is actually received while expense is reported when it’s incurred, regardless of when payment is actually made

Relevance

capability of information to make a difference in the decisions made by the user

Full disclosure

requires important facts that would have an effect on an investor's decisions be included in the financial statements

Neutrality

information in financial statements cannot be selected or presented in a way to favor one set of interested parties over another

Cost-benefit Test

in certain circumstances, it is permissible to avoid full compliance with an accounting principle when the cost of doing so exceeds the benefits

Materiality

concerns the monetary or financial significance of an item in relation to the particular monetary or financial situation of which it is a part

Monetary

in times of currency appreciation or depreciation, any fluctuations in currency value will not be reflected in the books of the company

Prudence

being conservative in your accounting assumption

Time Period

the life of a company can be divided into time periods such as months and years