Fundamentals of Accounting - unit 2

What is the purpose of the framework work

The purpose of the framework work is to assist:

a)      the Board to develop IFRS Standards (Standards) based on consistent concepts, resulting in financial information that is useful to investors, lenders and other creditors

b)      preparers of financial reports to develop consistent accounting policies for transactions or other events when no Standard applies or a Standard allows a choice of accounting policies

c)      all parties to understand and interpret Standards

What is the framework?

This framework is not an International Accounting Standard (IAS) and therefore does not determine standards for any particular measurement or disclosure issue it does not override any specific International Accounting Standards.

It does provide concepts and guidance that underpin the decisions the Board makes when developing Standards.

Define the International Financial Reporting Standards (IFRS)

It is a single set of accounting standards, developed and maintained by the IASB with the intention of those standards being capable of being applied on a globally consistent basis

What is the goal of International Financial Reporting Standards (IFRS) ?

The goal of IFRS is to provide a global framework for how public companies prepare and disclose their financial statements. IFRS provides general guidance for the preparation of financial statements, rather than setting rules for industry-specific reporting.

What are the purpose of financial statements?

Financial statements provide information in a particular form that tells about an entity's:

• assets

• liabilities

• equity

• income and expenses, including, gains and losses

• contributions by and distributions to owners (in their capacity as owners)

• cash flows.

It also assists users of financial statements in predicting the entity's future cash flows and, in particular, their timing and certainty.

What are the Qualitative Characteristics of useful financial information?

1. Relevant

2. Faithfully representation

3. Timeliness

4. Comparability

5. Understandability

6. Verifiability

Qualitative Characteristics - Relevant

- Information is relevant if it is capable of making a difference in the decisions made by users. making a difference in decisions  where it influences the economic decisions of users by helping them evaluate past, present or future events or confirming, or correcting

Qualitative Characteristics - Faithfully representation

To be reliable, information must represent faithfully the transactions and other events (substance) of what occurred during the period.

Qualitative Characteristics - Timeliness

This means that information is available to decision-makers in time to be capable of influencing their decisions; information should be provided when needed.

To provide information on a timely basis it may often be necessary to report before all aspects of a transaction or other event are known, thus impairing reliability.

Qualitative Characteristics - Comparability

Comparability enables users to identify and understand similarities in, and differences among, items in order to identify trends in the financial position and performance of entities.

Transaction and other events must be carried out in a consistent way throughout the enterprise and in a consistent way for different enterprises.

Qualitative Characteristics - Understandability

The financial statements should be uncomplicated, structured, and clearly presented. Classifying, characterizing, and presenting information clearly and concisely make it understandable.

Qualitative Characteristics - Verifiability

The financial statements should be able to be reproduced by different knowledgeable and independent observers.

Verifiability helps to assure users that information represents faithfully the economic phenomena it purports to represent.

What are the accounting principles?

1. Historical Cost Principle

2. Revenue Recognition Principle

3. Accruals Principle

4. Matching Principle

5. Full disclosure Principle

6. Prudence/ Conservatism Principle

7. Consistency Principle

Accounting principle - Historical Cost

Requires that entities record the purchase of goods, services or assets at the amount of cash or cash equivalents paid or the fair value of the consideration given to acquire them at the time of their acquisition.

Assets are then to remain on the statement of financial position without being adjusted for fluctuations in market value. Liabilities are recorded at the amount of proceeds received in exchange for the obligation

Accounting principle - Revenue Recognition

This principle states that a transaction should record revenue when the event from which the transaction stems has taken place and the receipt of cash from the transaction is reasonably certain

Accounting principle - Accruals

The accrual principle is an accounting concept that requires accounting transactions to be recorded in the time period in which they occur, regardless of the time period when the actual cash flows for the transaction are received.

Not only of past transactions involving the payment and receipt of cash but also obligations to pay cash in the future and of resources that represent cash to be received in the future.

Accounting principle - Matching

States that all expenses must be matched and recorded with their respective revenues in the period they were incurred instead of when they are paid and they are recorded in the accounting records and reported in the financial statements of the period to which they relate.

Accounting principle - Full Disclosure

Disclosure of all the relevant information that would materially affect a financial statement user’s decision is needed on the face of the financial statements or by way of notes, so that users can make rational decisions.

Accounting principle - Prudence/ Conservatism

The preparers of financial statements have to contend with the uncertainties that inevitably surround many events and circumstances.

Prudence is the exercise of caution when making judgments needed in making estimates required under conditions of uncertainty, it does not allow for the overstatement or understatement of assets, liabilities, income or expenses.

Accounting principle - Consistency

This principle states that the presentation, classification of items, accounting principles and assumptions in the financial statements should be retained from period to the next unless:

a)      a significant change in the nature of the operations of the business or a review of its financial statement presentation demonstrates that the change will result in a more appropriate presentation of events or transactions

b)      a change in presentation is required by an IAS/IFRS

This ensures that the financial statements are comparable between periods and throughout the entities history.

What are the accounting concepts?

1. Business entity concept

2. Going Concern concept

3. Materiality Concept

Accounting Concepts - Business Entity

This concept implies that the affairs of a business are to be treated separately from the private affairs of the owner(s) and should be accounted for separately.

Accounting Concepts - Going Concern

This concept states that financial statements are normally prepared on the assumption that an enterprise is going to continue in operation for the foreseeable future.

It is assumed that the enterprise has neither the intention nor the need to be dissolved nor declare bankruptcy unless we have evidence to the contrary.

Accounting Concepts - Materiality

The relevance of information is affected by its nature and materiality. In some cases, the nature of information alone is sufficient to determine its relevance.

Information is material if omitting

Thus materiality provides a threshold or cut-off point rather than being a qualitative characteristic that information must have if it is to be useful.

What are the assumptions in accounting?

1. Money measurement/Monetary Unit Assumption

2. Time period assumption

3. True and fair view

4. Substance over Form

5. Aggregation

6. Offsetting

7. Duality

Accounting Assumptions - Money measurement/Monetary Unit

Events, transactions or items can only be reported in the financial statements if they can be expressed in monetary terms.

Accounting Assumptions - Time period

This concept states that the life of a business can be divided into artificial time periods and that useful report covering those periods can be prepared for the business.

Accounting Assumptions - True and fair view

Financial statements are frequently described as showing a true and fair view of, or as presenting fairly, the financial position, performance, and changes in the financial position of an enterprise.

As a whole, it should be free from bias and independent. There should be no attempt to persuade users to take certain actions.

Accounting Assumptions - Substance over Form

If information is to represent faithfully the transactions and other events that it purports to represent, it is necessary that they are accounted for and presented in accordance with their substance and economic reality and not merely their legal form

Accounting Assumptions - Aggregation

Each material item should be presented separately in the financial statements. Immaterial amounts should be aggregated with amounts of a similar nature" or function and need not be presented separately.

Accounting Assumptions - Offsetting

Items of income and expenses should be offset when and only when:

a)      an International Accounting Standard requires or permits it; or

b)      gains, losses and related expenses arising from the same or, similar transactions and events are not material. Such amounts should be aggregated.

Assets and liabilities should not be offset except when offsetting is required or permitted by another International Accounting Standard

Accounting Assumptions - Duality

There are two aspects to the recording of a transaction, one is represented by the assets of the business and the other the claims against them. The concept states that these two aspects are always equal to each other.

Define an asset

It is a present economic resource controlled by an entity as a resulting of past events. An economic resource is a right that has the potential to produce economic benefits.

What is an equity?

It is the residual interest in the assets of the entity after deducting all its liabilities.

Define an expense

The decrease in assets or increases in liabilities that results in a decrease in equity, other than that relating to distributions from equity investors.

What are the two types of expenditure?

Capital and Revenue expenditure

What are current assets?

It is expected to be realized in, consumed, or sold in the normal course of the enterprise’s operating cycle; or

It is held primarily for trading purposes

It is either cash or a cash equivalent asset that is not restricted in its use.

example: inventory/stock, trade receivables/debtors/trade receivables, cash in hand and at bank, prepaid expenses

What are non current assets?

Non-current assets are bought for continuing use in the business for the long term.

example: Motor vehicles, Equipment, Land, Patents, Copyrights, and buildings

What are Revenue expenditures?

These are expenses for the regular day-to-day running of the business such as wages, utilities, an stationery.

These are accounted for in the statement of profit or loss. They cannot be capitalized as a part of the non-current asset.

What are capital expenditures?

These are transactions for the acquisition in improvement to the book value of fixed asset item, e.g. purchase of an asset, delivery, installation, inspection, testing,  legal fees, contractors costs, and cost involve in the removal of an older asset item.

Capital expenditure items are accounted for in the statement of financial position. They can be capitalised as a part of the non-current asset.