Lecture 17

Accounting
standards, policies
and qualitative
characteristics
Identify

Measure

Record

Report
Lecture outline

▪ Who sets the accounting rules and regulations?

▪ Accounting concepts (principles)

▪ The qualitative characteristics of accounting

information
 Accounting standards and policies
Accounting standards Accounting policies
▪Accounting rules which show ▪are the specific accounting
how transactions should be methods selected by companies
disclosed, measured and from those methods allowed in
recognised. the accounting standards
▪Accounting standards must be ▪Accounting policies are disclosed
followed to ensure financial by entities in the notes to the
statements give a true and fair financial statements in the annual
view of the entity’s activities report
▪E.g. how to prepare and present ▪e.g. depreciation method,
revenue, expense, assets and inventory cost flow method, etc.
liabilities (IAS 39)
The development of accounting rules

• Most games have an agreed set of rules (e.g. football)

– Rules define the game and provide a structure for players to
follow
• In accounting, over a long period of time, companies gradually
adopted similar procedures for recording transactions
• The procedures then became generally accepted and became
the rules
• Accountants don’t like to call them “rules”, they’d rather say
‘this is the way we usually do it’
• If you don’t adopt the rules but you would create confusion
The development of accounting rules

Worldwide Accounting
2020(?)
Standards
ASB
1999 Framework

IASB Framework
1989

International Accounting
1973
Standards
UK Accounting
1971 Standards
18th UK Company
century Law
12th
century Conventions
Advantages of international accounting
standards
• Allows a multi-national company to account for all of its operations in the
same way. This helps the company:
– Less work and cost in preparing accounts
– Easier for managers to compare and understand their operations
– Less training of staff
• Easier international comparison of companies:
– Helps shareholders & lenders
– Helps suppliers & customers
– Better benchmarking by managers
• Easier for companies to raise capital (shares & loans) in other countries,
giving wider and cheaper sources of capital
• Countries that allow use of IFRS may be more attractive for inward
investment by foreign companies
Environmental Forces Shaping
Globalization

15-15
Political and Legal Systems

• Threat of government control or seizure of assets.

• Differing taxes, tariffs and licensing fees.
• Restrictions on foreign ownership percentage.
• Restrictions on currency flows.
• Trade agreements specifying raw material sources
and labor content.
• Duty-free foreign trade zones.
• Tax incentives encouraging or discouraging stock
ownership.
• Policies affecting individual savings.
• Policies impacting educational level of citizens.

15-16
Accounting Concepts
Accounting concepts or principles are broad, basic assumptions
that underlie the periodic financial statements of companies.
1. Going concern
2. Historical cost
3. Accruals concept
4. Matching
5. Materiality
6. Entity
7. Periodicity
8. Money measurement
9. Realization
1. Going concern concept
▪ This concept is the assumption that the business will
continue operating into the foreseeable future.
▪ If so, assets, liabilities, income and expenses will be
valued using historical cost
▪ If the business is not likely to continue, assets etc are
valued for their net realisable value – what the
business could get for them if they were sold today.
▪ Information in the accounts informs users whether the
accounts are prepared on a going concern basis or
not.
2. Historical cost

• Amounts in the accounts will be recorded at the original cost

when the transaction took place. Increasingly, under IASB rules,
there are some transactions which do not use historic cost but
instead use e.g. fair value
3. The accruals concept
▪ Income, expenses, assets and liabilities are recognised
(shown in the accounts) when they occur even if the
cash relating to them is paid or received at a different
time.
▪ Closely associated with 4. the matching concept: all
expenses incurred in an accounting period must be
matched with the revenue earned in that period
▪ Accounts are not prepared on the basis of cash
received and cash paid during the accounting period
because there are delays between receipt and
payment of cash.
4. the matching concept
▪ All expenses incurred in an accounting period must be
matched with the revenue earned in that period

▪ Accounts are not prepared on the basis of cash

received and cash paid during the accounting period
because there are delays between receipt and
payment of cash.
5. Materiality

• Material information is information which if omitted

or misstated could affect a user’s decision. The level of
materiality is entity-specific, i.e. it depends on the size
and business of the entity

• Only material items should be disclosed in financial

statements.
Other accounting concepts

6. Entity concept: to keep strictly separate the affairs of

the company from the private affairs of its owners.

7. Periodicity: the main accounting period is considered

to be 12 months.
Other accounting concepts

8. Money measurement concept –only items which can

be measured in monetary terms are included in the
accounts
9. Realisation is the concept that profits should only be
treated as realised when there is reasonable certainty
that cash or other assets will be received for the
transaction
Qualitative characteristics of accounting
information
Attributes that make the information provided in
financial statements useful to users.
Purpose:
– Assist preparation and audit of financial statements
– Assist User’s interpretation of financial statements
– Help managers understand financial reporting, and
communicate with accountants
 Qualitative characteristics
of useful financial information

Fundamental Relevance: Reliability: Faithful

qualitative Materiality representation
characteristics
Complete

Neutral

Free from error

Enhancing Comparability Verifiability

qualitative
characteristics Understand-
Timeliness ability
Fundamental: relevance
▪ Relevant financial information is capable of making a
difference in the decisions made by users.
▪ E.g. out of date information is irrelevant for decision
making
▪ Material = information that is relevant
Either because of:
– Large £ amount, or
– Nature indicates something that is important to external
users’ decisions
e.g. something that jeopardises company’s strategy
Fundamental: reliability
▪ To be useful, financial information must represent faithfully the
event it purports to represent (i.e. does not mislead users)
▪ To do so, it should be:
• Complete:
Has sufficient information for users to understand the
phenomena that the financial statements report
So nothing material omitted
• Neutral:
Free from bias
Not manipulated to influence users’ decisions
• Free from error:
No material errors
Enhancing: verifiability and understandability

▪ Verifiability: different users would agree that the

economic event is faithfully represented. Auditors will
verify information for investors.
▪ Understandability: information should be clearly and
concisely presented. Complex transactions should be
explained clearly.
▪ For all qualitative characteristics, users are assumed to
have some knowledge of the business and its activities
Enhancing: timeliness and
comparability
▪ Timeliness: information is available to users in time to
be of use to them for decisions

▪ Comparability: information enables users to identify

and understand similarities and differences between
items. Consistency of reporting (using the same
method for the same items over time and between
entities) assists with this.
 Constraints on the qualitative characteristics

▪ Cost is a “pervasive constraint” – the benefits of reporting

information should not be less than the costs of reporting it
▪ Qualitative characteristics can conflict with each other
– e.g. relevance and understandability – some information may be
too complex for most users to understand – in this case, it should
be reported anyway because relevance is more important than
understandability
– comparability may conflict with relevance, e.g. a new accounting
treatment may provide more relevant information.