Lecture#2

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Financial Accounting– Conceptual

Framework

Prepared & Delivered by: Babar Akhtar

Lecture Outline – Types of Business Activity – Accounting Systems – Methods and Approaches – GAAP/GAAS – Key terms .

however there is no maximum limit of owners. They contribute their capital and start a business on a large scale.  Joint Stock Company– A business which has an unlimited number of owners. having limited liability equal to their respective investment. .Types of Business 1) On the basis of ownership:  Sole Proprietorship– A business in which there is only one owner who has an unlimited liability and carries on business on his own risk. The minimum number of owners is seven. who carry on business together.  Partnership– A business in which there are 2 to 19 owners having unlimited liability.

 Servicing Business– A business which does not sell any tangible goods. but provide services and earns income.  Trading/Merchandizing Business– A business which purchases ready-made goods and sells them to its customers. .  Manufacturing Business– A business which produces goods and sells them to its customers.Types of Business 2) On the basis of activities.

it does not matter when cash is received or paid. Simply put.Accounting Systems • The cash basis of accounting recognizes sales revenue inflows when cash is received and operating expense outflows to generate sales revenue when cash is paid. • The accrual basis of accounting recognizes inflows of sales revenue when earned and operating expense outflows to produce sales revenues when incurred. . the cash basis recognizes sales revenue and operating expenses only when cash changes hands.

Accounting– Methods and Approaches • Conservative accounting methods: These accounting methods delay the recording of revenue and accelerate the recording of expenses. Profit is reported slowly. and liberal methods are optimistic. and owners’ equities in the balance sheet. • Summing up. • Liberal accounting methods: These accounting methods accelerate the recording of revenue and delay the recording of expenses. liabilities. conservative accounting methods are pessimistic. . The choice of accounting methods also affects the values reported for assets. Profit is reported quickly.

• Constraints permit a company to modify generally accepted accounting principles without reducing the usefulness of the reported information.GAAP– Assumptions. . Principles and Constraints • Assumptions provide accounting process. a foundation for the • On the basis of the fundamental assumptions of accounting. the accounting profession has developed principles that dictate how economic events should be recorded and reported.

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not-for-profit organization whose primary purpose is to develop generally accepted accounting principles (GAAP) within the United States.Who Develops GAAP/GAAS??? • The Financial Accounting Standards Board (FASB) is a private. • The Securities and Exchange Commission (SEC) is a federal agency which holds primary responsibility for enforcing the federal securities laws and regulating the securities industry. and to facilitate FASB in development of GAAP. the nation's stock and options exchanges. .

standards and procedures that are adhered by companies while preparing financial statements. and are verifiable. These guidelines ensure that auditors do not miss on any material information. are consistent.GAAP Vs GAAS • GAAP (Generally Accepted Accounting Principles) is a set of rules meant for companies to help and assist in preparing financial statements that are followed in all parts of the world. These are accounting principles. . • GAAS (Generally Accepted Auditing Standards) is a set of guidelines for auditors that are meant to help them in the audit of companies in such a way that these audits are accurate.

the value of a company president is not reported in a company’s financial records because it cannot be expressed easily in dollars.GAAP– Assumptions/Convention s • The monetary unit assumption states that only transaction data that can be expressed in terms of money be included in the accounting records. For example. Gourmet. For example. etc . it is assumed that the activities of Coke can be distinguished from those of other companies such as PEPSI. • The economic entity assumption states that the activities of the entity be kept separate and distinct from the activities of the owners and of all other economic entities. An important corollary to the monetary unit assumption is the assumption that the unit of measure remains relatively constant over time.

. Lever Brothers. or any enterprise can be subdivided into months. Thus. quarters. • The going concern assumption assumes that the enterprise will continue in operation long enough to carry out its existing objectives. In spite of numerous business failures.Cont’d • The time period assumption states that the economic life of a business can be divided into artificial time periods. Carlson Hospitality. companies have a fairly high continuance rate. it is assumed that the activities of business enterprises such as PSO. It has proved useful to adopt a going concern assumption for accounting purposes. or a year for meaningful financial reporting purposes.

• The Matching principle dictates that expenses be matched with revenues in the period in which efforts are made to generate revenues. Expenses are not recognized when cash is paid.Cont’d • The Revenue Recognition/Realization principle dictates that revenue should be recognized in the accounting period in which it is earned. Compliance with the .” • The full disclosure principle requires that circumstances and events that make a difference to financial statement users be disclosed. they are recognized when the labor (service) or the product actually makes its contribution to revenue. Rather. Expense recognition is traditionally tied to revenue recognition: “Let the expense follow the revenue. or when the work is performed. or when the product is produced.

An item is material when it is likely to influence the decision of a reasonably prudent investor or creditor. the assets sacrificed.Cont’d • The cost principle dictates that assets be recorded at their cost. It is immaterial if its inclusion or omission has no impact on a decision maker. . • The Materiality relates to an item’s impact on a firm’s overall financial condition and operations. Cost is used because it is both relevant and reliable. Cost is relevant because it represents the price paid. or the commitment made at date of acquisition.

Key Terms Merchandize/Goods– The items or objects which are traded in a business to earn revenue. Sales– The sale of merchandize/goods only. Cost/Prepaid– The payments for which respective benefit is yet to be derived in full. .Accounting-. Purchases– The purchase of merchandize/goods only. Expense– The payments for which respective benefit has been derived in full.

Accounting-. from which all expenses have been deducted. Income/Profit– That part of earnings. Accounts Payable– Parties. from which expenses have not been deducted yet.Key Terms Revenue– That part of business earnings. to whom payments have not been paid yet. (Profit/Income = Revenue – Expenses) Accounts Receivable– Parties. by whom payments have not been received yet. Drawings– That part of capital which is withdrawn by the owner for his personal use .

In case of trade discount. Cash Discount– Reduction in price.Accounting-. Trade Discount– Reduction in list price of goods. which is paid by the seller. cash is not involved. .  Discount Received– Discount. offered by the seller to the purchaser/customer.Key Terms Discount– The reduction or price cut.  Discount Allowed– Discount. paid by the seller to the purchaser in terms of cash. which is received by the customer.