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Accounting Concepts and Conventions

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8 views

Accounting Concepts and Conventions

Uploaded by

Niharika
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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UCL SCHOOL OF MANAGEMENT

Accounting Concepts & Conventions

A useful guide for revision


Accounting CONCEPTS and CONVENTIONS
quick summary to add to your textbook reading!

These underpin the financial accounting


framework:
• Going concern
• Accruals (& Prepayments)
• Consistency
• Realisation
• Prudence
• Materiality
• Money measurement

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GOING CONCERN
• Assumes that the business is likely to continue its
operations and unlikely to cease its existing operations in
the foreseeable future
• Values can be affected by the state of play
• Say, Equipment is shown on the Balance Sheet at a net
book value of £30 (being, say, cost of £50 less two lots of
annual charges for depreciation of £10)
• Say the market price if sold in crisis is £10 (but the
business is not in crisis)
• Assuming Going Concern, the value shown on the
balance sheet is the net book value of £30 not the
special/unusual circumstances value of £10
• This principle applies to the majority of assets
3
ACCRUALS
• Say, in a business, Expenses in a year totalled £15
but only £10 had been paid by the end of the year
• We still charge the value of £15 to the Income
Statement and thus reduce profits by £15 – this
illustrates the inclusion of the unpaid £5 – the
inclusion of the Accrual
• We reduce Cash by the actual payment of £10
• We show the Accrual...the TIME DELAY value… of
£5 as a Current Liability on the Balance Sheet

4
PREPAYMENTS
• Imagine that in a Business the some Expenses for the
year totalled £15 but £20 had been paid by the end of
the year, with the extra £5 being paid in advance for
next year
• We would charge the value of £15 to the Income
Statement and thus reduced profits by £15
• We would reduce Cash by £20
• We would show the Prepayment...the ADVANCE
TIME DELAY value… of £5 as a Current Asset on the
Balance Sheet
5
CONSISTENCY
• If a business has a choice in its approach to
accounting for a particular transaction/event it must
continue to consistently use the chosen policy each
year.
• If it chooses straight line depreciation (there are other
approaches) in year 1 it must continue to use it in
subsequent years unless something changes in its
contextual circumstances.
• This principle applies to all assets and liabilities when
being accounted for.

6
REALISATION
• This means that recording Revenue for inclusion on the
Income Statement in the calculation of Profit, the cash
must either have been received – actually realised – OR
there must be a reasonable prospect of the cash being
collected in the future at some point
• So, if the Revenue is shown on Income Statement as,
say, £48,000, this being the value of Sales during the
year even though not all of the cash had been received,
we should assume there is a reasonable chance of it
being realised…turned into cash
• It is likely that the Account Customers have been credit-
checked and we can assume that the cash will be
collected in the future

7
PRUDENCE
• This requires the inclusion of a degree of caution in accounting
judgements under conditions of uncertainty
• For example with inventory (stock) valuation, there appears to
be a choice between valuing at the original cost price or the
sales value
• Say a desk was bought for £50 and you want to sell it at £100
– which value should it be recorded at?
• As there is no certainty of it being sold, it is valued in the
Accounts and on the Balance Sheet at Cost Price
• Similarly if the desk has been sitting there for years and has
not been sold, and it has a scrap value of £10, you should
write down (reduce) the Inventory Account by £40, and then
reduce Profits by £40
• The Prudence Principle is:
Avoid Overstatement of Assets/Understatement of liabilities
8 8
MATERIALITY
• This about setting a threshold, a limit, for considering
the inclusion of an item in financial statements
• Would a user’s decision change if the information were
omitted or mis-stated?
• For example, say there is an error of £1m in an
Expense item and Revenues are £10 billion and
Operating Profit is £1billion. The error is not material at
0.001% of profit (but would have to be corrected next
time round)
• An error of £1m in expense item with Operating Profit
£2m the error is material at 50% of profit
• Where there are non-material errors, they are still errors
and in the next financial period an adjustment must be
made
9
MONEY MEASUREMENT

• To be included in the financial statements, items must


be capable of being measured financially and
expressed in monetary terms
• Hence, despite the fact that people/staff are often
regarded as an organisation’s greatest asset (and
sometimes their greatest liability!), they are not shown
on the balance sheet as valuing their talent,
knowledge, skill, experience is very difficult if not
impossible

10
Qualitative characteristics of useful
accounting information

• The conceptual framework identifies the fundamental


qualitative characteristics to be relevance and faithful
representation.
• Relevance: relevant financial information is capable of
making a difference in the decisions made by users.
• Financial information can assist decision making if it has:
▪ Predictive value
▪ Confirmatory value

• Information’s relevance is affected by the timeliness of its


disclosure, its nature and materiality.
11
• Faithful representation: if information is to be
useful, it must represent faithfully the transactions
and other events it purports to represent.

• A faithful representation will be:


▪ Complete
▪ Neutral
▪ Free from error

12

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