Dpa1013 Note Chapter 1b.docx

7/23/2019 Dpa1013 Note Chapter 1b.docx

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Introduction


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Introduction

Meaning of Accounting

Accounting, as an information system is the process of identifying,

measuring and communicating the economic information of anorganization to its users who need the information for decision making.

It identifies transactions and events of a specific entity. A transaction is an exchange in which each participant receives or

sacrifices value (e.g. purchase of raw material). An event (whether internal or external) is a happening of conseuence to

an entity (e.g. use of raw material for production). An entity means aneconomic unit that performs economic activities


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Introduction

Important of Financial Accounting

To keeping systematic record: It is very difficult to remem"er all the "usiness transactions

that take place. Accounting serves this purpose of recordkeeping "y promptly recording all the "usiness transactions in

the "ooks of account.

To ascertain the results of the operation: Accounting helps in ascertaining result i.e., profit earned or

loss suffered in "usiness during a particular period. #or thispurpose, a "usiness entity prepares either a $rading and %rofit

and &oss account or an Income and 'xpenditure accountwhich shows the profit or loss of the "usiness "y matching theitems of revenue and expenditure of the some period.

.


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Introduction

Important of Financial Accounting

To ascertain the financial position of the business: In addition to profit, a "usinessman must know his financial position

i.e., availa"ility of cash, position of assets and lia"ilities etc. $his helps the "usinessman to know his financial strength.

#inancial statements are "arometers of health of a "usiness entity.

To portray the liquidity position: #inancial reporting should provide information a"out how an

enterprise o"tains and spends cash, a"out its "orrowing and repaymentof "orrowing, a"out its capital transactions, cash dividends and other

distri"utions of resources "y the enterprise to owners and a"out otherfactors that may affect an enterprises liuidity and solvency.


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Introduction

Define of Accounting Conceptual Framework

Actually there are a num"er of accountingconcepts and principles "ased on which weprepare our accounts

$hese generally accepted accountingprinciples lay down accepted assumptions

and guidelines and are commonly referred toas accounting concepts


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sers of #inancial -tatements

Investors eed information a"out the profita"ility, dividend yield

and price earnings ratio in order to assess the uality andthe price of shares of a company

&enders eed information a"out the profita"ility and solvency of

the "usiness in order to determine the risk and interest rateof loans

/anagement eed information for planning, policy making and

evaluation

-uppliers and trade creditors eed information a"out the liuidity of "usiness in order to

access the a"ility to repay the amounts owed to them


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1overnment eed information a"out various "usinesses for statisticsand formulation of economic plan

ustomers Interested in long3tem sta"ility of the "usiness and

continuance of the supply of particular products 'mployees

Interested in the sta"ility of the "usiness to provideemployment, fringe "enefits and promotion opportunities

%u"lic

eed information a"out the trends and recent development

0

sers of #inancial -tatements


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&imitations of conventional financial statements

ompanies may use different methodsof valuation, cost calculation and

recognizing profit $he "alance sheet does not reflect thetrue worth of the company

#inancial statements can only showpartial information a"out the financialposition of an enterprise, instead of thewhole picture


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Accounting oncepts

6usiness entity

/oney /easurement7sta"le monetary

unit 1oing oncern

8istorical ost

%rudence7conservatism

/ateriality


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;"isclosure

=elevance

Accounting oncepts


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6usiness 'ntity

/eaning $he "usiness and its owner(s) are two

separate existence entity Any private and personal incomes and

expenses of the owner(s) should not "etreated as the incomes and expenses of

the "usiness


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6usiness 'ntity'xamples

Insurance premiums for the ownershouse should "e excluded from theexpense of the "usiness

$he owners property should not "eincluded in the premises account of the"usiness

Any payments for the owners personalexpenses "y the "usiness will "e treatedas drawings and reduced the ownerscapital contri"ution in the "usiness


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/oney /easurement

/eaning All transactions of the "usiness are

recorded in terms of money

It provides a common unit ofmeasurement

'xamples

/arket conditions, technological changesand the efficiency of management wouldnot "e disclosed in the accounts


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1oing oncern

/eaning $he "usiness will continue in operational

existence for the foreseea"le future

#inancial statements should "e preparedon a going concern "asis unlessmanagement either intends to liuidatethe enterprise or to cease trading, or hasno realistic alternative "ut to do so


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'xample %ossi"le losses form the closure of

"usiness will not "e anticipated in theaccounts

%repayments, depreciation provisionsmay "e carried forward in the expectationof proper matching against the revenuesof future periods

#ixed assets are recorded at historicalcost

1oing oncern


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8istorical ost

/eaning Assets should "e shown on the "alance

sheet at the cost of purchase instead of

current value'xample

$he cost of fixed assets is recorded at thedate of acuisition cost. $he acuisition

cost includes all expenditure made toprepare the asset for its intended use. Itincluded the invoice price of the assets,freight charges, insurance or installation

costs


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%rudence7onservatism

/eaning =evenues and profits are not anticipated.

;nly realized profits with reasona"lecertainty are recognized in the profit andloss account

8owever, provision is made for all knownexpenses and losses whether the amountis known for certain or


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/ateriality

/eaning Immaterial amounts may "e aggregated

with the amounts of a similar nature orfunction and need not "e presentedseparately

/ateriality depends on the size and

nature of the item


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'xample -mall payments such as postage,

stationery and cleaning expenses shouldnot "e disclosed separately. $hey should

"e grouped together as sundry expenses $he cost of small3valued assets such as

pencil sharpeners and paper clips should"e written off to the profit and loss

account as revenue expenditures,although they can last for more than oneaccounting period

/ateriality


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onsistency

/eaning ompanies should choose the most

suita"le accounting methods and

treatments, and consistently apply themin every period

hanges are permitted only when the newmethod is considered "etter and can

reflect the true and fair view of thefinancial position of the company

$he change and its effect on profitsshould "e disclosed in the financial

statements


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onsistency

'xamples If a company adopts straight line method

and should not "e changed to adoptreducing "alance method in other period

If a company adopts weight3averagemethod as stock valuation and should not

"e changed to other method e.g. first3in3first3out method


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Accruals7/atching

/eaning =evenues are recognized when they are

earned, "ut not when cash is received 'xpenses are recognized as they are

incurred, "ut not when cash is paid

$he net income for the period is

determined "y su"tracting expensesincurred from revenues earned


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Accruals7/atching

'xample 'xpenses incurred "ut not yet paid in

current period should "e treated as

accrual7accrued expenses under currentlia"ilities

'xpenses incurred in the following period"ut paid for in advance should "e treated asprepayment expenses under current asset

>epreciation should "e charged as part ofthe cost of a fixed asset consumed duringthe period of use


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%ro"lems in the recognition of expenses

ormally, expenses representsresources consumed during the current

period. -ome costs may "enefit several

accounting periods, for example,

development of expenditures,depreciation on fixed assets.


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Association "etween cause and effect 'xpenses are recognized on the "asis of a direct

association "etween the expenses incurred on the

"asis of a direct association "etween the expensesincurred and revenues earned

#or example, the sales commissions should "eaccounted for in the period when the products are

sold, not when they are paid


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-ystematic allocation of costs ?hen the cost "enefit several accounting periods,

they should "e recognized on the "asis of asystematic and rational allocation method

#or example, a provision for depreciation should

"e made over the estimated useful life of a fixedasset

Immediate recognition If the expenses are expected to have no certain

future "enefit or are even without future "enefit,

they should "e written off in the currentaccounting period, for example, stock losses,advertising expenses and research costs



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=ealization

/eaning

=evenues should "e recognized when

the ma


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=ecognition of revenue

$he realization concept develops rules forthe recognition of revenue

$he concept provides that revenues are

recognized when it is earned, and not whenmoney is received A receipt in advance for the supply of goods

should "e treated as prepaid income undercurrent lia"ilities

-ince revenue is a principal component inthe measurement of profit, the timing of itsrecognition has a direct effect on the profit


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$he uncertain profits should not "e estimated,whereas reported profits must "e verifia"le

=evenue is recognized when

9. $he ma


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'xample 1oods sent to our customers on sale or

return "asis

$his means the customer do not pay for thegoods until they confirm to "uy. If they donot "uy, those goods will return to us

1oods on the sale or return"asis will not"e treated as normal sales and should "e

included in the closing stock unless thesales have "een confirmed "y customers



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%ro"lems in the recognition of revenue

ormally, revenue is recognized when thereis a sale

$he point of sales in the earning process is

selected as the most appropriated time torecord revenues 8owever, if revenue is earned in a long and

continuous process, it is difficult todetermine the portion of revenue which isearned at each stage

$herefore, revenue is permitted to "erecorded other than at the point of sales


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'xceptions to rule of salesrecognition&ong3term contracts

;wning to the long duration of long3termcontracts, part of the total profit estimated tohave "een arisen from the accounting period

should "e included in the profit and loss account

8ire %urchase -ale 8ire purchase sales have long collection period.

=evenue should "e recognized when cash

received rather than when the sale (transfer ofownership) is made

$he interest charged on a hire purchase saleconstitutes the profit of transaction


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!. =eceipts from su"scriptions A pu"lisher receives su"scriptions "efore itsends newspapers or magazines to its customers

It is proper to defer revenue recognition until theservice is rendered.

8owever, part of su"scription income can "erecognized as it is received in order to matchagainst the advertising expenses incurred

'xceptions to rule of sales recognition


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>isclosure

/eaning #inancial statements should "e prepared

to reflect a true and fair view of thefinancial position and performance of theenterprise

All material and relevant informationmust "e disclosed in the financialstatements


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niformity

/eaning >ifferent companies within the same

industry should adopt the sameaccounting methods and treatments forlike transactions

$he practice ena"les inter3company

comparisons of their financial positions


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=elevance

/eaning #inancial statements should "e prepared

to meet the o"


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Dpa1013 Note Chapter 1b.docx