The basic accounting concepts are
It is important to understand these basic concepts because it is by applying these concepts that accounting standards are created and specific transactions are considered.
Showing posts with label Principles Of Accounting. Show all posts
Showing posts with label Principles Of Accounting. Show all posts
Friday, November 23, 2007
Monday, November 19, 2007
Accruals / Matching
The accruals concept is to match revenues and expenses to the period to which they relate.
Application of this concept is the justification for the following examples.
Depreciation/Amortisation - matching the benefits coming from the use of an asset to the periods to which that benefit relates.
Calculating Cost Of Goods Sold - matching sales to the relevant stock movements.
Adjusting Deferred and Accrued Revenues -
1. Deferred revenue arises when cash is received from a customer in advance of the delivery of service or stock to which the cash receipt relates. An example might be if you are an insurer who has been paid by a customer upfront to provide insurance. In order to match revenues to the correct period it should not be included within the income statement. If it has been, then the following adjustment is required.
Dr Revenue (to decrease recorded income)
Cr Deferred Revenue (this is an increase in the deferred revenue account which is a liability account on the balance sheet)
2. Accrued revenues arises when work is done but remains unpaid and uninvoiced at the balance sheet date. An example might be a painter who has painted half a house. In order to match the revenue the following adjustment is required
Dr Accrued Revenue (this is an increase in the accrued revenue account which is an asset on the balance sheet)
Cr Revenue (increasing recorded income)
Note
In the examples above, the insurance customer who has prepaid possesses a prepaid asset and the painter's customer has an accrued asset.
Application of this concept is the justification for the following examples.
Depreciation/Amortisation - matching the benefits coming from the use of an asset to the periods to which that benefit relates.
Calculating Cost Of Goods Sold - matching sales to the relevant stock movements.
Adjusting Deferred and Accrued Revenues -
1. Deferred revenue arises when cash is received from a customer in advance of the delivery of service or stock to which the cash receipt relates. An example might be if you are an insurer who has been paid by a customer upfront to provide insurance. In order to match revenues to the correct period it should not be included within the income statement. If it has been, then the following adjustment is required.
Dr Revenue (to decrease recorded income)
Cr Deferred Revenue (this is an increase in the deferred revenue account which is a liability account on the balance sheet)
2. Accrued revenues arises when work is done but remains unpaid and uninvoiced at the balance sheet date. An example might be a painter who has painted half a house. In order to match the revenue the following adjustment is required
Dr Accrued Revenue (this is an increase in the accrued revenue account which is an asset on the balance sheet)
Cr Revenue (increasing recorded income)
Note
In the examples above, the insurance customer who has prepaid possesses a prepaid asset and the painter's customer has an accrued asset.
Prudence / Conservatism
This is the concept of tending to take the less optimistic view when preparing financial statements.
For example, a revenue should not be recognised until it is reasonably certain, but costs should usually be included once they become probable.
The valuing of stock at the lower of cost and market price is another application of this concept.
For example, a revenue should not be recognised until it is reasonably certain, but costs should usually be included once they become probable.
The valuing of stock at the lower of cost and market price is another application of this concept.
Consistency
Having a consistent set of accounting rules and treatments helps make financial statements more easily understandable and more comparable. If a company adopts different rules or policies this risks making it more difficult to make valid comparisons over time or between companies.
Going Concern
In making up a set of accounts, it is usual to assume that the business is going to continue to operate as a going concern. If the business does go into liquidation or is expected to when the accounts are being prepared, the financial statements ought to be prepared on the break up basis.
Areas Of Difference
1. Asset Valuation
Under the going concern assumption, business assets are recorded using usual methods. When the break up basis assumption applies, assets are valued at their net realisable value. For example, when a business buys a piece of machinery, it records the cost as a fixed asset and depreciates that asset over its useful economic life.
2. Closure Costs
Upon closure of a business, certain liabilities associated with the closure should be included in the balance sheet. For example, there may be costs associated such as redundancy, decontamination and administrator's fees.
Areas Of Difference
1. Asset Valuation
Under the going concern assumption, business assets are recorded using usual methods. When the break up basis assumption applies, assets are valued at their net realisable value. For example, when a business buys a piece of machinery, it records the cost as a fixed asset and depreciates that asset over its useful economic life.
2. Closure Costs
Upon closure of a business, certain liabilities associated with the closure should be included in the balance sheet. For example, there may be costs associated such as redundancy, decontamination and administrator's fees.
Thursday, October 18, 2007
Other Accounting Principles
Objectivity principle accounting guideline that requires financial statement information to be supported by independent, unbiased evidence rather than someone's opinion; objectivity adds to the reliability, verifiability, and usefulness of information.
Full disclosure principle the accounting principle that requires financial statements (including the notes) to report all relevant information about the operations and financial position of the entity.
Revenue recognition principle provides guidance on when revenue should be reflected on the income statement; the rule includes three guidelines: (1) revenue must be recognized at the time it is earned; (2) the inflow of assets associated with revenue may be in a form other than cash; and (3) the amount of revenue is measured as the cash plus the cash equivalent value of any noncash assets received from customers in exchange for goods or services.
Full disclosure principle the accounting principle that requires financial statements (including the notes) to report all relevant information about the operations and financial position of the entity.
Revenue recognition principle provides guidance on when revenue should be reflected on the income statement; the rule includes three guidelines: (1) revenue must be recognized at the time it is earned; (2) the inflow of assets associated with revenue may be in a form other than cash; and (3) the amount of revenue is measured as the cash plus the cash equivalent value of any noncash assets received from customers in exchange for goods or services.
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