ACCOUNTING CONCEPTS..

INTRODUCTION   Users of financial statements need relevant and reliable information.   To provide such information, the profession has developed a set of principles and guidelines.   These principles and guidelines are collectively called the Conceptual Framework.

ACCOUNTING PRINCIPLES  Accounting period concept  Matching concept  Conservatism concept  Consistency concept  Materiality concept  Realization concept

ACCOUNTING PERIOD  Business being assumed as ongoing entity, results cannot be ascertained before closure of operations  But this period is too long and users of accounting information cannot wit for this long therefore Managers adopt an artificial period of time to evaluate performance. Managers adopt an artificial period of time to evaluate performance.

Business firms prepare their income statements for a particular period. This period, known as the accounting period ACCOUNTING PERIOD Calendar Year 1 Jan – 31 Dec Financial Year 1 Apr – 31 Mar Shorter periods like month

MATCHING CONCEPTS  It is the basis for recording expenses.  Expenses are the costs of assets & the increase in liabilities incurred in the earning of revenues.  Expenses are recognized when the benefit from the expense is received.  Directs accountants to a)Identify all expenses incurred during the period & measure the expenses b)Match the expenses against revenues earned during the period

MATCHING EXPERNSES WITH REVENUES EXAMPLES  The wood was purchased from the manufacturer for RS 8,000 in March of a financial year.  Parker Floor sells a wood floor for RS15,000 on the last day of May.  The floor is installed in June.

  Revenues RS 15,000   Cost of goods sold 8,000   Net income RS 7,000 MAY

CONSERVATISM CONCEPT The concept says 'anticipate no profit and provide for all possible losses‘ ie given Alternative procedures or values, the accountant will choose the one that results in a lower profit This is because if an optimistic view of profits is given then dividends may be paid out of profits that have not been earned.

Company A has completed 50% of a project. Based on its costing and other evidence, it knows that the project is going to incur losses. Question: Should the company only take up its losses at the completion of the project. Answer: Based on conservatism concept, the company should quickly in its financial year take up this losses instead of waiting for the 100% completion of the project.

MATERIALITY CONCEPT  Materiality refers to an item’s importance to a firm’s overall financial operations. a)An item must make a difference to be material and be disclosed. b)It is a matter of the relative significance of the element.

For example  As far as an individual is concerned, the loss of a RS 500 would be important and MATERIAL.  But As far as a Bank is concerned, the loss of RS 500 could be considered unimportant in many circumstances and therefore immaterial

REALIZATION CONCEPT  Revenues realization occurs when a sale is made to a customer.  The basic rule is that revenue is created at the moment a sale is made, and not when the account is later settled by cheque or by cash.  Thus, profit can be taken to the profit and loss account on sales made, even though the money has not been collected

Here is an example from Colgate-Palmolive’s annual report : Revenues are reported at the time of product shipment. At that point, Colgate-Palmolive has fulfilled its obligation to its customer and the revenue has been earned.

Sometimes, however, cash is received prior to delivery of the product (or performance of a service). Since the revenue has not yet been earned, we must record a liability called deferred revenues to reflect our obligation to deliver the product in the future This is accomplished with the following journal entry: Cashxxx Unearned incomexxx

The above entry means on asset side we have cash and on liability side we have Unearned income. When the product is delivered in the future, the liability is reduced and earned income is reported in the income statement equal To the proportion of the product that has been delivered

CONSISTENCY CONCEPT Since the methods employed in treating certain items within the accounting records may be varied from time to time, the concept of consistency has come to be applied more and more rigidly Since the methods employed in treating certain items within the accounting records may be varied from time to time, the concept of consistency has come to be applied more and more rigidly

 For example, because there can be no single rate of depreciation chargeable on all fixed assets, every business has potentially a lot of discretion over the precise rate it chooses to use. However, if it wishes, a business may vary the rates at which it charges depreciation and alter the profits it reports at the same time. Consider the effects on profit of charging depreciation at 15% this year on Rs10,000 worth of fixed assets and then charging depreciation at 10% next