Accounting Principles and Concepts PDF

Accounting Principles and Concepts  GAAP Generally Accepted Accounting Principles  Generally Accepted Accounting Principles GAAP- these principles are not laws, but are guidelines determined primarily by the Financial Accounting Standard Board (FASB) a...

Accounting Principles and Concepts  GAAP Generally Accepted Accounting Principles  Generally Accepted Accounting Principles GAAP- these principles are not laws, but are guidelines determined primarily by the Financial Accounting Standard Board (FASB) and its predecessor, the Accounting Principles Board (APB). Provide the general framework for determining what information is included in financial statements and how this information is to be prepared and presented. Accounting Entity Principle  Accounting Entity Principle An accounting entity consists of people, assets, liabilities and activities devoted to a specific economic purposes. Accounting information is developed for clearly identified accounting entities such as sole proprietorships, partnerships, and corporations. In any of these arrangements, nonrelated business interests are accounted for separately. In corporations, accounting entity coincides with the legal entity. In proprietorships, it is the accounting entity but the proprietor is the legal entity liable for both personal and business obligations. Going Concern Principle  Going-Concern Principle Assumes that an accounting entity will continue to operate indefinitely, thus allowing a business to defer certain costs that are to be charged against the revenues of future periods. Examples of such costs are undepreciated assets, ending inventories, prepaid expenses. For firms about to liquidate, the going concern principle is ignored , with assets being reported at the current liquidating value and liabilities at the amount required to settle debts immediately. Time Period Principle  Time Period Principle Financial statements are prepared for specific relatively brief accounting periods, ordinarily one year, in order to assists in decision making and for tax purposes. The year chosen for financial measurement is referred to as the fiscal year which does not necessarily correspond to the calendar year but corresponds to the natural cycle of business activity. In addition to one year, shorter time periods e.g. one month, months and year-to- date also may be used for presenting financial reports. Monetary Principle  Monetary Principle States that money is the basic unit of measurement for financial reporting. The principle gives accountants a common denominator for adding and subtracting heterogeneous transactions occurring at various times during the life of an accounting entity The principle also allows for the comparison of financial statements between and within firms. The monetary principle assumes that money is a stable unit of value over time. However this assumption is unrealistic because money loses its value over time. Another difficulty with this principle is that not all things of value to the organization can be measured in monetary terms. Historical Cost Principle  Historical Cost Principle Involves valuing assets at the original cost of acquiring them But should consider adjustments for price level changes. These involves the use of price level indices, e.g prescription price indices. An Rx drug $5.00 in 20X1 (the base year) 5.25 in 20X2 5.50 in 20X3 The price index in 20X3 is 5.50/5.00 x 100=110% Objectivity Principle  Objectivity Principle Requires unbiased verifiable measurements. The accountant seeks the most objective evidence available in order to support financial statements. This may include invoices, cancelled checks, bank statements, inventory counts, deeds and contracts and use of historical costs. Despite this goal, however, it is not possible to prevent accounting data from being subject to some bias primarily because of the existence of alternative accounting method and future uncertainties. Consistency Principle  Consistency Principle Related to the objectivity principle. It requires that a particular accounting technique not be changed from period to period, thus facilitating comparison of financial statements over time On occasion, however, the management will change to a different accounting method when the change will serve the needs of the user’s of the statement e.g change in depreciation method from linear to sum of years digit method. Conservatism Principle  Conservatism Principle Related to the objectivity principle Requires the selection of accounting method that neither overstate nor understate the facts. However, accounting takes place in an environment of uncertainty. Thus where doubt exists, the accountant selects the option that produces the lower net income and less favorable financial position, Use of historical cost is an example of conservatism. Materiality Principle  Materiality Principle Refers to the relative importance of an item. An item is considered to be material if it significantly affects the financial statements, thus influencing the decisions of prudent users of the statements. Accounting transactions too small or insignificant to affect user actions are recorded as is most expedient, thus saving the expense of initiating a more expensive accounting procedure. Materiality of an item depends not only on the amount but also on the nature of the item. Purchase of a spatula is an expense not a asset for depreciation. Full Disclosure Principle  Full Disclosure Principle Requires that all relevant facts concerning the financial position of a business be presented in the financial statements. Even significant events occurring after the end of the fiscal period, but before release of the financial statements should be included in the reports Full disclosure can be accomplished either in the body of a financial statement or in its footnotes. Realization Principle  Realization Principle Fundamental in the accrual basis of accounting States that revenue is recognized when it is realized ,i.e.when the earning process is complete and when objective evidence exists as to the amount of revenue earned Thus revenue is recognized at the time goods are sold or services rendered. Matching Principle  Matching Principle The measurement of an expense occurs in two phases. The first stage involves measuring the cost of goods and services consumed or expired in the process of generating revenue. The second phase considers matching cost and revenue and involves determining when the goods and services acquired have contributed to revenue, at which time their cost becomes an expense. Independent CPA Opinion  Independent CPA Opinion An audit opinion is issued by independent certified public accountants after they have audited the financial statements and accounting records of a business. The opinion is published as part of the company’s annual report. Standard wording that consists of two paragraphs has been developed. The first paragraph describes the scope of the examination and the second paragraph presents the actual opinion.  Independent CPA Opinion We have examined the Balance Sheet of _______Pharmacy as of December 31, 200X and the related statements of income, retained earnings and changes in financial position for the year then ended. Our examination was made in accordance with generally accepted auditing standards, and accordingly included such tests of the accounting records and such other auditing procedures as we considered necessary under the circumstances. – In our opinion, the above financial statement present fairly the financial statement position of _____Pharmacy as of December 31, 200X and the results of its operations and the changes of its financial position for the year then ended, in conformity with generally accepted accounting principles applied on a consistent basis.  Independent CPA Opinion The statement may also include comments on any unusual factors in the financial position. The primary responsibility for the accuracy of the financial statements belong to the management. The CPA’s task, is to render an opinion as to fairness of the presentation. Thus, his independent status is as important as his technical competence in accomplishing the auditing task.