dpa1013 note chapter 1b.docx
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Introduction
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Introduction
Meaning of Accounting
Accounting, as an information system is the process of identifying,
measuring and communicating the economic information of anorganization to its users who need the information for decision making.
It identifies transactions and events of a specific entity. A transaction is an exchange in which each participant receives or
sacrifices value (e.g. purchase of raw material). An event (whether internal or external) is a happening of conseuence to
an entity (e.g. use of raw material for production). An entity means aneconomic unit that performs economic activities
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Introduction
Important of Financial Accounting
To keeping systematic record: It is very difficult to remem"er all the "usiness transactions
that take place. Accounting serves this purpose of recordkeeping "y promptly recording all the "usiness transactions in
the "ooks of account.
To ascertain the results of the operation: Accounting helps in ascertaining result i.e., profit earned or
loss suffered in "usiness during a particular period. #or thispurpose, a "usiness entity prepares either a $rading and %rofit
and &oss account or an Income and 'xpenditure accountwhich shows the profit or loss of the "usiness "y matching theitems of revenue and expenditure of the some period.
.
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Introduction
Important of Financial Accounting
To ascertain the financial position of the business: In addition to profit, a "usinessman must know his financial position
i.e., availa"ility of cash, position of assets and lia"ilities etc. $his helps the "usinessman to know his financial strength.
#inancial statements are "arometers of health of a "usiness entity.
To portray the liquidity position: #inancial reporting should provide information a"out how an
enterprise o"tains and spends cash, a"out its "orrowing and repaymentof "orrowing, a"out its capital transactions, cash dividends and other
distri"utions of resources "y the enterprise to owners and a"out otherfactors that may affect an enterprises liuidity and solvency.
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Introduction
Define of Accounting Conceptual Framework
Actually there are a num"er of accountingconcepts and principles "ased on which weprepare our accounts
$hese generally accepted accountingprinciples lay down accepted assumptions
and guidelines and are commonly referred toas accounting concepts
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sers of #inancial -tatements
Investors eed information a"out the profita"ility, dividend yield
and price earnings ratio in order to assess the uality andthe price of shares of a company
&enders eed information a"out the profita"ility and solvency of
the "usiness in order to determine the risk and interest rateof loans
/anagement eed information for planning, policy making and
evaluation
-uppliers and trade creditors eed information a"out the liuidity of "usiness in order to
access the a"ility to repay the amounts owed to them
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1overnment eed information a"out various "usinesses for statisticsand formulation of economic plan
ustomers Interested in long3tem sta"ility of the "usiness and
continuance of the supply of particular products 'mployees
Interested in the sta"ility of the "usiness to provideemployment, fringe "enefits and promotion opportunities
%u"lic
eed information a"out the trends and recent development
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sers of #inancial -tatements
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&imitations of conventional financial statements
ompanies may use different methodsof valuation, cost calculation and
recognizing profit $he "alance sheet does not reflect thetrue worth of the company
#inancial statements can only showpartial information a"out the financialposition of an enterprise, instead of thewhole picture
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Accounting oncepts
6usiness entity
/oney /easurement7sta"le monetary
unit 1oing oncern
8istorical ost
%rudence7conservatism
/ateriality
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;"isclosure
=elevance
Accounting oncepts
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6usiness 'ntity
/eaning $he "usiness and its owner(s) are two
separate existence entity Any private and personal incomes and
expenses of the owner(s) should not "etreated as the incomes and expenses of
the "usiness
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6usiness 'ntity'xamples
Insurance premiums for the ownershouse should "e excluded from theexpense of the "usiness
$he owners property should not "eincluded in the premises account of the"usiness
Any payments for the owners personalexpenses "y the "usiness will "e treatedas drawings and reduced the ownerscapital contri"ution in the "usiness
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/oney /easurement
/eaning All transactions of the "usiness are
recorded in terms of money
It provides a common unit ofmeasurement
'xamples
/arket conditions, technological changesand the efficiency of management wouldnot "e disclosed in the accounts
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1oing oncern
/eaning $he "usiness will continue in operational
existence for the foreseea"le future
#inancial statements should "e preparedon a going concern "asis unlessmanagement either intends to liuidatethe enterprise or to cease trading, or hasno realistic alternative "ut to do so
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'xample %ossi"le losses form the closure of
"usiness will not "e anticipated in theaccounts
%repayments, depreciation provisionsmay "e carried forward in the expectationof proper matching against the revenuesof future periods
#ixed assets are recorded at historicalcost
1oing oncern
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8istorical ost
/eaning Assets should "e shown on the "alance
sheet at the cost of purchase instead of
current value'xample
$he cost of fixed assets is recorded at thedate of acuisition cost. $he acuisition
cost includes all expenditure made toprepare the asset for its intended use. Itincluded the invoice price of the assets,freight charges, insurance or installation
costs
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%rudence7onservatism
/eaning =evenues and profits are not anticipated.
;nly realized profits with reasona"lecertainty are recognized in the profit andloss account
8owever, provision is made for all knownexpenses and losses whether the amountis known for certain or
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/ateriality
/eaning Immaterial amounts may "e aggregated
with the amounts of a similar nature orfunction and need not "e presentedseparately
/ateriality depends on the size and
nature of the item
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'xample -mall payments such as postage,
stationery and cleaning expenses shouldnot "e disclosed separately. $hey should
"e grouped together as sundry expenses $he cost of small3valued assets such as
pencil sharpeners and paper clips should"e written off to the profit and loss
account as revenue expenditures,although they can last for more than oneaccounting period
/ateriality
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onsistency
/eaning ompanies should choose the most
suita"le accounting methods and
treatments, and consistently apply themin every period
hanges are permitted only when the newmethod is considered "etter and can
reflect the true and fair view of thefinancial position of the company
$he change and its effect on profitsshould "e disclosed in the financial
statements
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onsistency
'xamples If a company adopts straight line method
and should not "e changed to adoptreducing "alance method in other period
If a company adopts weight3averagemethod as stock valuation and should not
"e changed to other method e.g. first3in3first3out method
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Accruals7/atching
/eaning =evenues are recognized when they are
earned, "ut not when cash is received 'xpenses are recognized as they are
incurred, "ut not when cash is paid
$he net income for the period is
determined "y su"tracting expensesincurred from revenues earned
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Accruals7/atching
'xample 'xpenses incurred "ut not yet paid in
current period should "e treated as
accrual7accrued expenses under currentlia"ilities
'xpenses incurred in the following period"ut paid for in advance should "e treated asprepayment expenses under current asset
>epreciation should "e charged as part ofthe cost of a fixed asset consumed duringthe period of use
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%ro"lems in the recognition of expenses
ormally, expenses representsresources consumed during the current
period. -ome costs may "enefit several
accounting periods, for example,
development of expenditures,depreciation on fixed assets.
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%ro"lems in the recognition of expenses
Association "etween cause and effect 'xpenses are recognized on the "asis of a direct
association "etween the expenses incurred on the
"asis of a direct association "etween the expensesincurred and revenues earned
#or example, the sales commissions should "eaccounted for in the period when the products are
sold, not when they are paid
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-ystematic allocation of costs ?hen the cost "enefit several accounting periods,
they should "e recognized on the "asis of asystematic and rational allocation method
#or example, a provision for depreciation should
"e made over the estimated useful life of a fixedasset
Immediate recognition If the expenses are expected to have no certain
future "enefit or are even without future "enefit,
they should "e written off in the currentaccounting period, for example, stock losses,advertising expenses and research costs
%ro"lems in the recognition of expenses
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=ealization
/eaning
=evenues should "e recognized when
the ma
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=ecognition of revenue
$he realization concept develops rules forthe recognition of revenue
$he concept provides that revenues are
recognized when it is earned, and not whenmoney is received A receipt in advance for the supply of goods
should "e treated as prepaid income undercurrent lia"ilities
-ince revenue is a principal component inthe measurement of profit, the timing of itsrecognition has a direct effect on the profit
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=ecognition of revenue
$he uncertain profits should not "e estimated,whereas reported profits must "e verifia"le
=evenue is recognized when
9. $he ma
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'xample 1oods sent to our customers on sale or
return "asis
$his means the customer do not pay for thegoods until they confirm to "uy. If they donot "uy, those goods will return to us
1oods on the sale or return"asis will not"e treated as normal sales and should "e
included in the closing stock unless thesales have "een confirmed "y customers
=ecognition of revenue
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%ro"lems in the recognition of revenue
ormally, revenue is recognized when thereis a sale
$he point of sales in the earning process is
selected as the most appropriated time torecord revenues 8owever, if revenue is earned in a long and
continuous process, it is difficult todetermine the portion of revenue which isearned at each stage
$herefore, revenue is permitted to "erecorded other than at the point of sales
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'xceptions to rule of salesrecognition&ong3term contracts
;wning to the long duration of long3termcontracts, part of the total profit estimated tohave "een arisen from the accounting period
should "e included in the profit and loss account
8ire %urchase -ale 8ire purchase sales have long collection period.
=evenue should "e recognized when cash
received rather than when the sale (transfer ofownership) is made
$he interest charged on a hire purchase saleconstitutes the profit of transaction
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!. =eceipts from su"scriptions A pu"lisher receives su"scriptions "efore itsends newspapers or magazines to its customers
It is proper to defer revenue recognition until theservice is rendered.
8owever, part of su"scription income can "erecognized as it is received in order to matchagainst the advertising expenses incurred
'xceptions to rule of sales recognition
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>isclosure
/eaning #inancial statements should "e prepared
to reflect a true and fair view of thefinancial position and performance of theenterprise
All material and relevant informationmust "e disclosed in the financialstatements
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niformity
/eaning >ifferent companies within the same
industry should adopt the sameaccounting methods and treatments forlike transactions
$he practice ena"les inter3company
comparisons of their financial positions
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=elevance
/eaning #inancial statements should "e prepared
to meet the o"
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