11 ACCOUNTING

Strand 1: Communication Financial and Non- Sub-strand 1.1 Conceptual Basis

Financial Information of Accounting
LESSON ACTIVITY 3: The Accounting Principles/Assumptions

The Specific Learning Outcomes (SLO) targeted in this lesson is provided in the table below.

SLO # Students are able to: Skill SLO Code

Level
1 List the accounting principles/assumptions and 1 11ACC1.1.1.6
qualitative characteristics of accounting information
2 Describe the principles and the qualitative characteristics 2 11ACC1.1.2.3
of accounting information
3 Explain the accounting entity concept 3 11ACC1.1.3.1

The Conceptual Framework

A conceptual framework is a formal way of thinking about a process or system under study. There is no
general agreement as to the contents of a conceptual for financial reporting but any model should at least
be based on a:

1. statement of objectives;

2. set of definitions;

3. specification of what to measure; and

4. set of rules concerning how to measure.It is a collection of concepts, principles, assumptions

that guide the manner in which accounting information is reported.

It sets out the concepts that underlie the preparation and presentation of financial statements for external
users. It is commonly known as accounting framework.

The main objective of a conceptual framework is to improve financial report by providing a more
complete, clear and updated set of concepts.

Generally Accepted Accounting Principles/Practice

Compilation: J Baltor 2023

GAAP are the basic assumptions, concepts, conventions and guidelines for preparing
financial statements that are based on long-used accounting practices. Accounting principles are a
common set of assumptions, concepts, rules, conventions and guidelines that help accountants prepare
financial statements. Let’s briefly look at a few of these important assumptions or concepts.

Application:

Malcolm goes to Unelco to pay electricity bills. 6,550vt is incurred to his business, 3,450vt is Malcolm’s
electricity bill at home. Malcolm is only going to record the business electricity bill which is the 6,550vt.
He will not include his household electricity bills in the financial reports because that must be kept
separate. Whatever belongs to the owner must be kept separate from the activities of the business. We
only record from the business point of view.

Logic: No mixim nani

wetem sip sip, business
transactions must be
separated from the
owners’ personal
transactions.

Compilation: J Baltor 2023

Applications:

 Jacob opens the financial statement of a business, he finds assets like vehicle 4,000,000vt,
buildings 350,000,000vt etc… Every item recorded has a value attached to it and it is in Vanuatu
currency vatu. It cannot be just 4,000,000.

 Mary imports furnitures for her office in Vanuatu, from Fiji. The furnitures value are converted
into vatu and recorded in the financial reports.

Application:

Tom purchased 2ha of land 10 years ago for 800,000vt. The land was re-valued by a valuer and it is now
worth 2,000,000vt. The historical cost is 800,000vt and the fair market value or current market value is
2,000,000vt. The business will record the land in terms of its original cost which is 800,000vt and not 2
million vt.

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The going concern assumption can also be termed as continuity concept. The concept assumes that the
business will continue to operate endlessly until there is an event that may bring about its liquidation.

Applications:

 Moderna Ltd manufactures a special vaccine for COVID19 that it then markets and sells
overseas. Suddenly, the Vanuatu government imposes a ban on the manufacture, export, import
and sale of this COVID19 vaccine in the country. Now if this vaccine is the only product that
XYZ Ltd creates, then the company can longer be a going concern.
 Air Vanuatu in 2022 has been in a tough financial sistuation and wass struggling to pay its debt.
The Vanuatu government gives Air Vanuatu a bailout and guarantees a company bailout and
guarantees all payments to Air Vanuatu’s creditors. Air Vanuatu is a going concern despite its

poor financial position.

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Why do we have accounting periods?

To allow for consistent financial reporting and analyzing purposes.

Application: Every year, a business records its transactions from January 1 st to December 31st and then
prepares a financial report.

The accounting period can also be a week, a month or a quarter (3 months period).

Compilation: J Baltor 2023

This concept is also known as the revenue realization concept. This rule determines
what our revenue is or when the business makes its money. So this concept states that we make money or
a business realizes revenue during the selling and earning process.

What is the earning process?

The process from when the product is delivered to the buyer or when the seller has performed its services
requested by the buyer. Basically when the exchange of transaction is complete, then the earning process
is completed.

So this rule states that we recognize revenue when the earning process is completed.

Application customer sells a pair of shoes online or on facebook and agrees to deliver them to the
customers house. The customer pays when the item/product reaches their hands. So the business can only
record the transaction as a revenue when the customer receives the shoes because by then the earning
process is complete.

Compilation: J Baltor 2023

Applications of the Accrual Principle:

 Record revenue when you invoice the customer, you don’t have to wait until the customer pays
you.

Application: You own a baking business. A customer places a wedding cake order amounting to
40,000vt for next week. In your records, this 40,000vt is recorded as a

revenue. Even though the customer has not given you cash/you have not received cash, for the cake
order yet.

 Record an expense when you incur it, you don’t have to wait till you pay for the expense.

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 Application: As a baker, you need to pay the rental space for your business in town.
Rent per month is 15,000vt. So in your records, you record rent as an expense every beginning of the
month even though you do not pay it until it is due at the end of the month.

Applications:

 The revenue earned in the year 2004 less the expenses incurred in the same year, 2004 would
determine the profit in 2004.
 Sales revenue made on the month of April is matched against the expenses of April to determine
monthly profit.
 You are working as a sales representative at Computer World. Sales commission is 10% of
monthly sales. If Computer World earned 250,000vt worth of laptop sales in November, CW pays
you (sales rep) 25,000vt in commissions in December. Even though they paid you a month later,
when it comes to recording and calculation of profit, the matching principle states that the
25,000vt worth of commissions is part of the November expenses along with the November
laptop sales revenue. Therefore the commission expense is minus from the laptop sales in
November not in December.

Compilation: J Baltor 2023

Application:

 It’s the start of the business year and James is already anticipating a 2 million vatu profit for the
business.
 Angela owns Jungle Café, while recording the business assets, the accountant did not provide
(make provisions) for wear and tear (accumulated depreciation) of the furniture and did not
provide for any doubtful debts for her debtors.

Compilation: J Baltor 2023

Application:

 The business uses the FIFO method of inventory valuation for the past 5 years.

Application:

 Recording small items as an expense e.g. a 2000vt stapler recorded has a stationery expense. The
price of the stapler is not large enough to influence decisions of users.
 Recording a 4 million vatu purchase of land as an asset procurement/purchase because the price
of the land is large enough to warrant questioning and decisions from users.

Application:

 A transaction happens and it affects two or more accounts of the business.

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 E.g. The business takes a 500,000vt loan from NBV. The cash (asset) account is
debited (increased) to $500,000 and the outstanding debt which is the loan (liability) account is
credited (increased) to 500,000vt.

Application:

 Au Bon Marche Supermarket uses the FIFO method for valuing its inventory. Due to the
increasing cost of its materials, the managers decided that LIFO will better indicate the company's
true profit. In the year of the change from FIFO to LIFO (and in years when comparisons are
presented), the company must disclose the break in consistency in its financial report.

Activity

1. Accounting is built on a number of principles (concepts). One of these principles is

“Conservatism”. In your own words, define Conservatism Concept.

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2. Which is true about Historical Cost?

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 A. Recording assets at their historical cost
B. Selling asset in Vanuatu vatu
C. Valuing assets at its current value
D. Selling assets at its current value

3. Mary purchases a new desk from Fiji for her business. In the statement of Financial
Position of Mary’s Law Firm, Mary must record the char in Vanuatu Vatu and not in Fiji
dollars that she had paid the chair for. Which concept allows Mary to do that?

A. Accrual Basis
B. Monetary measurement
C. Period Reporting
D. Conservatism

4. Adam is an owner of a Café shop in Vila known as Jungle Café. The balance sheet
statement is prepared every 12 months on the same date ending 31st July for Jungle Café.

a) Describe the accounting concept that is being applied in Adam’s business? (2)

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b) Adam’s personal insurance policy is NOT recorded as a business expense.

Explain using an accounting concept why Adam’s personal insurance policy is
not treated as an expense of the business. (3)

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_________________________________ ________________________________
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5. A number of independent situations are given below. For each situation, you are to:
A. State whether you agree or disagree with the treatment being suggested.
B. Justify your answer above by describing which accounting principles/assumptions
is applied or not applied in each situation.

Situation 1:

The business pays the owner’s personal insurance policy of 80,000vt. The amount of 80,000vt is
not regarded as a business item, thus is not recorded as part of the business’ expenses.

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Situation 2:

Holiday Inn recognises room-rental revenue on the date that the reservation is received. For the
summer season, many guests make reservations as much as a few weeks in advance.

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Situation 3:

The business purchased a piece of land for 2,800,000vt ten years ago. The value of the land if it
were to be sold now is 10,000,000vt. The value of the land as shown in the accounting records is
10,000,000vt.

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Situation 4:

Your firm has decided to change the inventory valuation because of the change in accounting
standards. The change is all disclosed by way of a notes in the financial statement, to various
users.

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Situation 5:

The bursar of Kwataparen records stapler of 2000vt as a stationery expense and not a separate
asset because the price is not large enough to influence decision making.

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Situation 6:

XYZ Ltd procured a new Ford vehicle (asset). There was no provisions made for depreciation
(wear & tear/losses) of the vehicle. There was no insurance of the vehicle thereby causing
company profits to be overstated.

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Situation 7:

Mary runs a furniture business in Santo. She bought a furniture from Fiji and recorded the
furniture in Fiji dollars.

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Situation 8:

The accountant calculated the business profit for July by offsetting expenses in May 2022, from
revenue earned in July 2022.

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Situation 9:

The law firm continued to use the same method of asset valuation for the past five years.

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