PRINCIPLES OF FINANCIAL ACCOUNTING - II

Introduction:

Meaning and Definition of Accounting

Accounting has been termed as the language of the business. It records, classifies, analyses
and communicates all the business transactions that have taken place during a particular
period. It is a system of recording and reporting business transactions in financial terms, to
interested parties.

According to American Institute of Certified Public Accounts, “Accounting is the art of

recording, classifying and summarizing in a significant manner in terms of money,
transactions and events which are , in part at least, of a financial character and interpreting the
results there of”

Thus, accounting is the art of recording, classifying, summarizing, analyzing and interpreting
the financial transactions and communicating the results thereof to the interested parties

Features or characteristics or nature of Accounting

Following are the features of accounting:-

1. Accounting is an art.

2. Accounting is a science.

3. Recording of business transactions.

4. Classifying business transactions.

5. Summarizing the classified data

6. Analysis and interpret the summarized data

7. Communicating information to the interested parties

8. Records transaction and events which are financial character.

Objectives of Accounting or functions of accounting

The following are the main objectives:

1. To keep systematic records.

2. To ascertain the operational profit or loss.

3. To ascertain the financial position of the business.

 4. To make information available to various users.

5. To protect business properties.

6. To facilitate rational decision making.

7. To ascertain the cost of production and selling price.

8. To control expenditure of business.

9. To satisfy the requirements of law.

10. To calculate/ determine the amount due to and due from others.

Importance of accounting (Uses or advantages)

Accounting brings the following advantages:

1. It serves as a historical record.

2. It facilitates the preparation of financial statements

3. It supplies information to interested persons

4. It helps the management in taking important business decisions.

5. It facilitates comparative study of the performance of business over different periods.

6. It provides evidence in case of disputes.

7. It helps to forecast the future.

8. It provides information for judging the efficiency of business

9. It is useful in getting loans.

10. It helps in valuation of good will.

11. It helps in controlling expenses.

12. It helps in controlling employees.

13. It helps in prevention and detection of errors and frauds.

Scope of Financial accounting

Following activities are included within the framework of financial accounting:

1. Book-keeping

2. Financial Statements
 3. Analysis and interpretation of financial statements.

4. Financial reporting

5. Accounting principles

6. Accounting standards.

Limitations of Accounting

Accounting suffers from the following limitations:

1. It is historical in nature.

2. Transactions of non-monetary nature will not be recorded in accounting.

3. Information recorded in accounts is influenced by the personal judgment of the

accountant.

4. In accounting valueless assets are also shown.

5. In accounting price changes are not considered.

6. It is not an exact science.

7. Use of different accounting methods reduces the reliability of accounts.

8. Account records show only actual cost figures.

Accounting Concepts or principles

Accounting concepts are those assumptions, principles or conditions on which the

accounting system is based. Principles are set of rules to be followed in accounting. The
following are important accounting concepts or principles

1. Business Entity Concept

According to this concept, a business is treated as separate Entity distinct from its owner.
This means that in accounting the business and owner must be treated separately. Therefore,
when a person invests an amount in to the business, it will be deemed to be the liability of the
business. The concept of separate entity is applicable to all forms of business.

2. Going concern concept:

According to this, it is assumed that a business will exist for a long time. There is no intention
to liquidate the business in the foreseeable future.

3. Money measurement concepts:

Accounting records only those transactions which are and can be expressed in monetary
terms. Transactions which cannot be expressed in monetary terms cannot be included in
financial statements,

4. Cost Concepts:

According to this concept, all transactions are recorded in the books of accounts at actual
price/cost involved.

5. Dual aspect Concepts:

The dual aspect concept states that every transaction has two aspects. These two aspects are
receiving aspect and giving aspect (Debit and credit). These two aspects have to be recorded.
The basis of this principle is that for every debit, there is an equal and corresponding credit.

6. Realization Concept:

According to this principle revenue is said to be realized when goods or services are sold to a
customer and not necessarily when cash is received. It emphasizes the fact that the mere
receipt of an order for goods or services cannot be taken for the realization of revenue, and
advance payment received from a customer cannot be considered as revenue earned.

7. Matching Concept:

According to this concept, costs incurred by a business in particular period is compared with
the revenue of that period in order to ascertain net profit or net loss.

8. Accounting period Concept:

According to this assumption, the life of a business is divided in to different periods for the
purpose of preparing financial statements. Generally business concern adopt twelve months
period for measuring the income of the concern. This time interval is known as accounting
period.

Accounting conventions

Accounting conventions are the customs, traditions, methods and/or procedures which have a
universal acceptance and they guide the accountant while preparing accounting statements.
Some of the accounting conventions are:

1. Convention of consistency
This convention follows that the basis followed in several accounting periods should be
consistent. This means the methods adopted in one accounting year should not be changed in
another year. This makes comparison of results possible.

2. Convention of conservatism

This is a convention of playing safe, which is followed while preparing the financial
statements. The idea of this convention is to take into account all possible losses and to
ignore all probable profits.

3. Convention of Materiality

Materiality means relevance, importance or significance. It is generally accepted in the

accounting circle that the accounting statements and records must reveal all material facts.

4. Convention of full disclosure

The accounting convention of full disclosure implies that accounts must be honestly prepared
and all material information must be disclosed therein.

Accounting standards

Accounting standards are guidelines for maintaining and preparing accounts. They are the
rules that ensure uniformity of preparation, presentation and reporting of accounting
information. Accounting standards may be defined as the accounting principles and rules
which are to be followed for various accounting treatments while preparing financial
statements on uniform basis and which will reveal the same meaning to all the interested
groups.

Need for accounting standards (Objects of Accounting standards):

The need for accounting standards arises from limitations of financial statements. The need
for accounting standards arises due to the following reasons.

1. To communicate uniform results to external users as well as internal users for

decision making.

2. To serve as a tool for information systems catering for the needs of management,
owners, creditors, Government etc.

3. To facilitate inter firm, intra firm comparison.

4. To make the financial statement more reliable comparable and understandable.

International Financial Reporting Standards (IFRS)

IFRS is the abbreviation for International Financial Reporting Standards. It is a set of rules
and guidelines that every firm has to adhere to ensure their financial statements are consistent
with other firms worldwide. These rules determine how a company should record a
transaction in the accounting books, among other things. The use of IFRS helps to ensure the
transparency and credibility of the accounting statements. And this, in turn, allows third
parties to make decisions by going through these financial records.

IFRS mandates that all companies follow it uses the same rules and standards to prepare their
financial statements. It means there is uniformity in the financial statements across firms,
segments, and nations. And, in turn, it gets easier to evaluate the numbers of two or more
companies. The benefit to the companies is that investors are more likely to trust and invest
in companies that are transparent and follow standard accounting and disclosure norms.

IFRS History

Initially, the IFRS was known as IAS (International Accounting Standards), and it issued
standards from 1973 to 2000. In 2001, when IASB (International Accounting Standards
Board) took up the responsibility for developing new accounting standards, the name was
changed to IFRS.

More than 100 countries currently follow these standards, including the EU, South America,
and many Asian countries. However, few countries like the US and the UK follow their
accounting standards known as GAAP (Generally Accepted Accounting Principles).

Objectives

The following are the objectives of IFRS:

 To establish a universal language for the companies to prepare the accounting

statements.

 To establish accounting rules to make it easier for the stakeholders to interpret the
financial statements, irrespective of the business location.

 Make the accounting statements credible and transparent.

 To assist companies in appropriately categorizing and reporting financial data.

 It makes international comparisons and analysis an easy task.

Importance of IFRS

It is treated as an international accounting standard and holds great importance for many
countries and the world economy. Here is its significance:

#1 – Transparency

It encourages transparency and accountability of financial statements prepared by companies,

small firms, and government agencies. As a result, it minimizes the margin of error and
manipulation of any holdings and irregularities of funds, transactions, and balances. Besides,
it also motivates consistency and clarity of work.

#2 – Uniformity and Comprehensive

The International Financial Reporting Standards are developed to set uniformity in the
presentation and understandability of statements. When everyone follows and recognizes the
standards, it becomes easy for companies and agencies to follow a common law that helps
world economies compare their growth comprehensively. Also, it is easy to read for
everyone.

#3 – Security and Flow

It helps track the flow of transactions, records funds information, and works towards attaining
a security level for direct and indirect foreign investments across nations. This accounting
standard is essential when we are dealing with significant assets or getting into heavy
transactions.

#4 – Accountability

It strengthens accountability by bridging the gap of incompetent financial reporting. If not

complied with it, the companies may face penalties.

Topics Covered

IFRS has set rules and guidelines for a range of areas. These topics are
IFRS 1 First-time Adoption of IFRS
IFRS 2 Share-based Payment
IFRS 3 Business Combinations
IFRS 4 Insurance Contracts
IFRS 5 Non-current Assets Held for Sale and Discontinued Operations
IFRS 6 Exploration For and Evaluation of Mineral Resources
IFRS 7 Financial Instruments: Disclosures
IFRS 8 Operating Segments
IFRS 9 Financial Instruments
IFRS 10 Consolidated Financial Statements
IFRS 11 Joint Arrangements
IFRS 12 Disclosure of Interests in Other Entities
IFRS 13 Fair Value Measurement
IFRS 14 Regulatory Deferral Accounts
IFRS 15 Revenue from Contracts with Customers
IFRS 16 Leases
IFRS 17 Insurance Contracts
IFRS for SMEs
IAS standards
International Accounting Standards (IASs) are international accounting standards issued by
the International Accounting Standards Committee (IASC). The IASC was replaced by the
IASB in 2001.
IAS 1 Presentation of Financial Statements
IAS 2 Inventories
IAS 7 Statement of Cash Flows (previously Cash Flow Statements)
IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors
IAS 10 Events after the Reporting Period
IAS 12 Income Taxes
IAS 16 Property, Plant and Equipment
IAS 19 Employee Benefits
IAS 20 Government Grants and Disclosure of Government Assistance
IAS 21 The Effects of Changes in Foreign Exchange Rates
IAS 23 Borrowing Costs
IAS 24 Related Party Disclosures
IAS 26 Accounting and Reporting by Retirement Benefit Plans
IAS 27 Separate Financial Statements
IAS 28 Investments in Associates and Joint Ventures
IAS 29 Financial Reporting in Hyperinflationary Economies
IAS 32 Financial Instruments: Presentation
IAS 33 Earnings Per Share
IAS 34 Interim Financial Reporting
IAS 36 Impairment of Assets
IAS 37 Provisions, Contingent Liabilities and Contingent Assets
IAS 38 Intangible Assets
IAS 39 Financial Instruments: Recognition and Measurement
IAS 40 Investment Property
IAS 41 Agriculture

IFRS has also set mandatory rules for what should be part of financial statements. And these
are:

1. Statement of Financial Position

IFRS mandates the components of how to report and prepare the balance sheet.

2. Statement of Comprehensive Income

The statement of comprehensive income means preparing a statement of income. It could be

one single statement for all income sources. Or, one can prepare it in several parts, such as a
profit and loss statement, other income statements, and more.

3. Statement of Changes in Equity

Another name for this is the statement of retained earnings. Based on the inputs, It concludes
any increase or decrease in the retained earnings during the period.

4. Statement of Cash Flow

It categorizes all the cash transactions into Operations, Investing, and Financing.

Apart from these statements, entities following IFRS also need to provide an overview of
their accounting policies. Also, a parent firm needs to prepare individual reports for every
subsidiary.
IFRS Assumptions

All the rules, regulations, and guidance provided under IFRS are based upon four key
accounting assumptions. And these assumptions are:

1. Going Concern

The first and foremost assumption is that the sole concept will guide all number crunching,
evaluation, estimation, and recording that the business or the company will continue its
activity. In other words, the business continues for the foreseeable future, and there is nothing
like business is coming to an end.

2. Accrual Basis

This assumption implies that a business will recognize the impact of transactions as they
occur and not when it results in cash inflow and outflow. In other words, a transaction
happening or an event is essential rather than the exchange of money, which can occur in
advance or later on.

3. Stable Measuring Unit

This assumption implies that all financial transactions and recordings will consistently
happen in the common standard currency across accounting periods. It further directs that a
company will record the assets and liabilities at their acquisition value or original cost.

4. Units of Constant Purchasing Power

This assumption implies a few exceptions to the stable measuring unit concept in certain
situations, such as inflation or deflation.
Scientific methodology must include:

 Objective observation and measurement

 Evidence
 Experimenting and testing of hypotheses
 Reasoning to establish conclusions drawn from facts
 Repetition
 Analysis of the resulting data
 Verification and testing

Nowadays, no one can deny the scientific nature of

accounting, although there are still many authors that keep
denying these facts.

So, if you dissect the science and art in the following basic
components:

 Analysis and interpretation of operations: the

series of personal judgments related to the content of
the financial statements, based on analysis and
comparison. It’s obtained from the information
contained in the financial statements.
 Evaluation: the evaluation of the financial and
economic situation of the company as an effect of the
diagnosis that results from the analysis and
interpretation of the operations have determined both
the behaviour and the result of the operations.
 Decision making: the administrative action adopted
based on various criteria and therefore not determined
solely by accounting.