Chapter 7 Accounting Concepts and Assumptions PDF

Slide 7.1 Chapter 7 Accounting concepts and assumptions Copyright © 2019, 2016, 2012 Pearson Education, Inc. All Rights Reserved Slide 7.2 Learning objectives After you have studied this chapter, you...

Slide 7.1 Chapter 7 Accounting concepts and assumptions Copyright © 2019, 2016, 2012 Pearson Education, Inc. All Rights Reserved Slide 7.2 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  explain what accounting standards are and why they exist Copyright © 2019, 2016, 2012 Pearson Education, Inc. All Rights Reserved Slide 7.3 Learning objectives (Continued)  describe the history of accounting standards in the UK and the current accounting standard options for UK entities  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 Copyright © 2019, 2016, 2012 Pearson Education, Inc. All Rights Reserved Slide 7.4 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. Copyright © 2019, 2016, 2012 Pearson Education, Inc. All Rights Reserved Slide 7.5 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. Copyright © 2019, 2016, 2012 Pearson Education, Inc. All Rights Reserved Slide 7.6 Accounting standards and financial reporting standards in the UK  Financial Reporting Council (FRC) is the main UK and Ireland standard setter.  International Accounting Standards Board (IASB) has 14 members from Europe , the Americas, Asia/Oceania and Africa.  Most UK companies quoted on London Stock Exchange follow these standards.  Anticipated that smaller entities will also follow. Copyright © 2019, 2016, 2012 Pearson Education, Inc. All Rights Reserved Slide 7.7 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. Copyright © 2019, 2016, 2012 Pearson Education, Inc. All Rights Reserved Slide 7.8 Concepts – money measurement The money measurement concept requires that accounting information is traditionally only concerned with facts that: (a) it can be measured in monetary units; and (b) most people will agree to the monetary value of the transaction. Copyright © 2019, 2016, 2012 Pearson Education, Inc. All Rights Reserved Slide 7.9 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. Copyright © 2019, 2016, 2012 Pearson Education, Inc. All Rights Reserved Slide 7.10 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: Copyright © 2019, 2016, 2012 Pearson Education, Inc. All Rights Reserved Slide 7.11 Concepts – time interval  The time interval concept requires that an entity will prepare financial statements at regular intervals during the year. Copyright © 2019, 2016, 2012 Pearson Education, Inc. All Rights Reserved Slide 7.12 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. Copyright © 2019, 2016, 2012 Pearson Education, Inc. All Rights Reserved Slide 7.13 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. Copyright © 2019, 2016, 2012 Pearson Education, Inc. All Rights Reserved Slide 7.14 Qualitative characteristics of financial statements There are four principal qualitative characteristics:  Understandability  Relevance  Materiality  Reliability  Comparability Copyright © 2019, 2016, 2012 Pearson Education, Inc. All Rights Reserved Slide 7.15 The quality of understandability Information in financial statements should be readily understandable by users. Copyright © 2019, 2016, 2012 Pearson Education, Inc. All Rights Reserved Slide 7.16 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. Copyright © 2019, 2016, 2012 Pearson Education, Inc. All Rights Reserved Slide 7.17 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. Copyright © 2019, 2016, 2012 Pearson Education, Inc. All Rights Reserved Slide 7.18 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. Copyright © 2019, 2016, 2012 Pearson Education, Inc. All Rights Reserved Slide 7.19 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. Copyright © 2019, 2016, 2012 Pearson Education, Inc. All Rights Reserved Slide 7.20 Other assumptions  Separate determination – The amount of each individual asset or liability should be determined separately from all other assets and liabilities.  Stability of currency – The historical cost concept normally shows assets at their original cost, which can distort the financial statements in times of inflation. Copyright © 2019, 2016, 2012 Pearson Education, Inc. All Rights Reserved Slide 7.21 Learning outcomes You should have now learnt: 1. Why one set of financial statements has to serve many purposes. 2. Why the need for general agreement has given rise to the concepts and conventions that govern accounting. 3. The implications of objectivity and subjectivity in the context of accounting. Copyright © 2019, 2016, 2012 Pearson Education, Inc. All Rights Reserved Slide 7.22 Learning outcomes (Continued) 4. What accounting standards are and why they exist. 5. That while most UK entities have adopted IFRS, those that have not apply the accounting standards issued by the Financial Reporting Council (FRC). 6. The assumptions which are made when recording accounting data. 7. The underlying concepts of accounting. Copyright © 2019, 2016, 2012 Pearson Education, Inc. All Rights Reserved Slide 7.23 Learning outcomes (Continued) 8. 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. 9. That an assumption is made that monetary measures remain stable, i.e. that accounts are not normally adjusted for inflation or deflation. Copyright © 2019, 2016, 2012 Pearson Education, Inc. All Rights Reserved