Uses, Users, Advantages and limitations of Accounting Accounting Concepts DR CR Chapter-2

What are the objectives of accounting? Is the business making a profit or a loss? What is the business worth? What is a transaction worth? How much cash is in the business? How wealthy is the business? How much is the business owed? How much does the business owe? Keeping a financial check on activities.

Users of accounting information Managers Owner(s) of the business A prospective buyer The bank Tax inspectors A prospective partner Investors Creditors

WHY Accounting? USERS & OBJECTS USERS OBJECTS Managers To monitor and control business throughout by comparing actual with targets/budgets for sales, purchase, expenses To take necessary business decisions- make or buy/ stop or continue/ expand or reduce a business activity. To identify problems, inefficiencies and take necessary steps to provide solutions

WHY Accounting? USERS & Uses OWNERS: Proprietor Partners Share holders To find performance of business in terms of profits/ loss. To measure financial strength Financial Position.

USERS & OBJECTS USERS OBJECTS Financers and Creditors: Banks Financial institutions Debenture holders Investors prospective buyers Creditors for goods and expenses To measure risk and reward attached thereto To measure creditworthiness of business to continue business relations To decide about present and future investments in the business.

USERS & OBJECTS Tax authorities Employees USERS OBJECTS To assess tax liabilities To measure growth and development of business and consequential job security, promotions, rewards, incentives, bonuses on the basis of financial report. Employees

USERS & OBJECTS Government bodies and regulatory authorities. To obtained necessary information about activities of the business. To regulate compliances of law and procedures

Functions of Accounting Record keeping Function Managerial Function Legal requirement Function Business Language function

Advantages of Accounting Complete record of all business Transactions Information about Profit/ Loss and Financial Positions Information for important economic decisions Comparative study. Helps to judge managements abilities. Provides factual and interpretive information. Helps in legal compliance.

Limitations of Accounting It gives historical facts not current worth. It reports monetary and financial information not the non monetary and qualitative information. It depends upon personal judgment and conventions. The accounting principles are not fixed and therefore accept different alternatives. So they are not comparable.

Limitations of Accounting Its cost based and changes in prices are not accepted. It does not reflect true money value. It does not show the effect of inflation. The increase in value of assets is not considered unless realised.

Chapter 10 Accounting concepts and assumptions

Learning objectives After you have studied this chapter, you should be able to: Describe the assumptions which are made when recording accounting data Explain why one set of financial statements has to serve many purposes Explain the implications of objectivity and subjectivity in the context of accounting

Learning objectives (Continued) Explain what accounting standards are and why they exist Explain the underlying concepts of accounting Explain how the concepts and assumptions of materiality, going concern, comparability through consistency, prudence, accruals, separate determination, substance over form and other concepts and assumptions affect the recording and adjustment of accounting data and the reporting of accounting information

Objective of financial statements Financial statements should provide information about the financial position, performance and changes in the finances of an entity. Financial statements should be useful to a wide range of users in making economic decisions. Financial statements are prepared on the basis of established concepts and must adhere to the rules and procedures set down in regulations, called accounting standards.

Objectivity Financial accounting seeks objectivity and consistency in the preparation and presentation of information. To achieve objectivity, a set of fundamental rules have been devised, laying down the way transactions are recorded. These rules are known as accounting concepts and are enforced by their incorporation in accounting standards issued.

Concepts – Historical cost The historical cost concept requires that assets are normally shown at cost price. Cost price is the basis for valuation of the assets.

Concepts – Money measurement The money measurement concept requires that accounting information is traditionally only concerned with facts that: (a) Can be measured in monetary units. (b) Most people will agree to the monetary value of the transaction.

Concepts – Business entity The business entity concept implied that the affairs of a business are to be treated as being quite separate from the non-business activities of its owner(s). Therefore, items recorded in the books of the business are restricted to the transactions of the business.

Concepts – Dual aspect The dual aspect concept states that there are two aspects of accounting – one represented by the assets of the business and the other by the claims against them. This concept can be summarised by a form of the accounting equation:

Concepts – Time interval The time interval concept requires that an entity will prepare financial statements at regular intervals during the year.

Concepts – Accruals The accruals concept states that the effects of transaction and other events are recognised when they occur and they are recorded in the books and reported in the financial statements of the period to which they relate. This allows income and charges relating to the period to be taken into account by matching the income with the expenditure.

Concepts – Going concern The going concern concept assumes that the business will continue to operate for at least 12 months after the end of the reporting period. This concept should only be ignored if the business is going to close down in the near future, or if a shortage of cash makes it likely that the business will cease trading.

Qualitative characteristics of financial statements There are four principal qualitative characteristics: Understandability Relevance Reliability Comparability

The quality of understandability Information in financial statements should be readily understandable by users.

The quality of relevance Information in financial statements must be relevant to users and influence their economic decisions That which is material is relevant and should be included. Information is material if its omission or misstatement could influence the economic decisions of users

The quality of reliability The information in the financial statements must be reliable – free from error and bias, and able to be depended upon: It must be a faithful representation of transactions. Transactions must be accounted for and presented in accordance with their substance, not their legal form. Information must be free from bias. A degree of caution should be exercised when making estimates. The information must be complete.

The quality of comparability The measurement and display of the financial effect of similar transactions and other events must be done in a consistent way throughout an entity and over time for that entity, and in a consistent way for different entities. Users must be informed of accounting policies used and any changes. Financial statements must include corresponding information for preceding periods.

Constraints on relevant and reliable information Information must be reported in a timely manner. The benefits of information should exceed the costs of obtaining it. The aim should be to achieve a balance among the characteristics that best meets the objective of financial statements.

Learning outcomes You should have now learnt: Why one set of financial statements has to serve many purposes Why the need for general agreement has given rise to the concepts and conventions that govern accounting The implications of objectivity and subjectivity in the context of accounting

Learning outcomes (Continued) What accounting standards are and why they exist The assumptions which are made when recording accounting data The underlying concepts of accounting

Learning outcomes (Continued) How the concepts and assumptions of materiality, going concern, comparability through consistency, prudence, accruals, separate determination, substance over form, and other concepts and assumptions affect the recording and adjustment of accounting data and the reporting of accounting information That an assumption is made that monetary measures remain stable, that is that accounts are not normally adjusted for inflation or deflation