UNIT 2

ACCOUNTING CONCEPTS AND

PRINCIPLES
 LEARNING OBJECTIVES

At the end of the session, you should be able to:

1. Define GAAP and give the status and purpose of
conceptual framework of financial reporting
2. Enumerate and discuss briefly the qualitative
characteristics
3. Enumerate and discuss briefly the basic assumptions
4. Enumerate and discuss briefly the basic principles and
other related concepts
GENERALLY ACCEPTED ACCOUNTING PRINCIPLES
(GAAP)
 Accounting principles refer, to certain rules, procedures,
practices, standards and conventions which represent a
consensus view by those indulging in good accounting
practices and procedures.
 GAAP are like laws that must be followed in financial
reporting
 The principles have developed on the basis of experience,
reason, custom, usage and practical necessity.
CONCEPTUAL FRAMEWORK FOR
FINANCIAL REPORTING
 STATUS
 describes the objectives of, and the concepts for, general purpose financial reporting
 PURPOSE
 assist the International Accounting Standards Board (IASB) to develop International Financial Reporting
Standards (IFRS) that are based on consistent concepts
 to assist preparers develop consistent accounting policies when no Standards applies to a particular
transaction or other event, or when a Standard allows a choice of accounting policy; and
 assist all parties to understand and interpret the Standard
 CONCEPTUAL FRAMEWORK IS NOT A STANDARD
What is the Conceptual Framework?
A practical tool that assists

Board Preparers All

• to develop Standards • to develop consistent • to understand and
accounting policies interpret Standards

Addresses fundamental issues

What are assets, liabilities, equity,

income and expenses, when should
What is the objective of What makes financial
they be recognised and how should
financial reporting? information useful?
they be measured, presented and
disclosed?
OBJECTIVE OF GENERAL PURPOSE
FINANCIAL REPORTING

To provide financial

information about the reporting
entity that is useful to existing
and potential investors, lenders
and other creditors in making
decisions relating to providing
resources to the entity.
 Objective of financial reporting
Provide financial information useful to users in making decisions

Users’ decisions involve decisions about

voting and influencing
buying, holding or selling providing or settling loans
management

To make these decisions, users assess

prospects for future net cash inflows to the management’s stewardship of the entity’s
entity economic resources

To make both these assessments, users need information about both

economic resources, claims and changes in how efficiently and effectively management has
those resources and claims discharged its responsibilities
 Qualitative characteristics
Fundamental qualitative characteristics

Relevance Faithful representation

• Information is relevant if it is capable of • Information must faithfully represent the
making a difference to the decisions made substance of what it purports to
by users represent

Enhancing characteristics

Comparability Verifiability Timeliness Understandability

Cost constraint
INGREDIENTS OF RELEVANCE

1. Predictive value
 Financial information has predictive value when it can help users
increase the likelihood of correctly or accurately predicting or
forecasting outcome of events
 If it can be used as an input to processes employed by users to
predict future outcome.
2. Confirmatory value
 Financial information has confirmatory value if it provides
feedback about previous evaluations
 When it enables users confirm or correct earlier expectations
 MATERIALITY
 When is an item material?
 An item is material if knowledge of it would
affect or influence the decision of the informed
users of the financial statements.
 Information is material if its omission or
misstatement could influence the economic
decision of the users taken on the basis of the
financial statements
ENHANCING QUALITATIVE
CHARACTERISTICS
 Comparability
 Ability to bring together for the purpose of noting points of
likeness and difference
 Consistency is an adjunct to comparability
 Verifiability
 Financial information is verifiable in the sense that it is supported
by evidence
 Helps assures users that information represents the economic
phenomenon or transaction that it purports to represent.
ENHANCING QUALITATIVE
CHARACTERISTICS-continued
 Timeliness
 Financial information must be available or communicated early
enough when a decision is to be made
 Relevant and faithfully represented financial information furnished
after a decision is made is useless or no value
 Understandability
 Financial information must be comprehensible or intelligible if it is
to be most useful
 Information should be presented in a form and expressed in
terminology that a user understands
 ACCOUNTING CONSTRAINT

COST CONSTRAINT
 COST CONSTRAINT

 Reporting financial information imposes

cost and it is important that such cost is
justified by the benefit derived from the
financial information
 Thebenefit derived from the information
should exceed the cost incurred in
obtaining the information
 BASIC ASSUMPTIONS

1.Economic entity
2.Going Concern
3.Time Period/Periodicity
4.Monetary
 ACCOUNTING ENTITY

 In accounting the entity is the specific business

enterprise, which may be a proprietorship,
partnership or corporation.
It is assumed that the business is separate
from the owners, managers and employees
who constitute the firm. Accordingly, the
transactions of the enterprise should not be
merged with the transactions of the owners.
 GOING CONCERN

 Itis assumed that in the absence of

evidence to the contrary, the business will
continue to operate indefinitely to carry
out its existing contracts and commitments.
 Going concern is the very foundation of the
cost principle.
Time Period/Accounting Period

 Requires that the indefinite life of an

enterprise is subdivided into time periods
or accounting periods which are usually of
equal length to ensure reports at regular
intervals.
 MONETARY

Moneyis used as the unit of

measure
• 2 Aspects:
▫ Quantifiability
▫ Stability
 BASIC PRINCIPLES

1.Revenue recognition
2.Matching
3.Fulldisclosure
4.Cost principle
Revenue Recognition Principle

 Revenue is recognized when earned regardless of

when cash is received.
- Point of sale is the point of revenue recognition
Serviceconcern- point of sale is the point
when service is rendered
Merchandising concern – point of sale is the
point when goods sold are delivered
 Matching Principle

All costs and expenses incurred

in earning a revenue should be
reported in the same period.
 Adequate Disclosure

 Means that all significant and relevant

information leading to the preparation
of financial statements should be
clearly reported so as not to make the
financial statements misleading.
 COST PRINCIPLE

This principle requires that assets

should be recorded initially at
original acquisition cost.
OTHER RELATED CONCEPTS

1.Accrual
2.Conservatism or prudence
 Accrual Concept
 The effects of transactions and other
events are recognized when they occur
and not as cash is received or paid
 Means that income is recognized when
earned regardless of when received
and expense is recognized when
incurred regardless of when paid.
CONSERVATISM OR PRUDENCE

 Resolves uncertainties in accounting. When alternatives

exist, the alternative which has the least favorable effect
on owner’s equity should be chosen. It is synonymous
with prudence.
 Prudence is the desire to exercise care and caution in
dealing with the uncertainties in the measurement
process such that assets or income are not overstated and
liabilities and expenses are not understated.
Elements of financial statements relate
to financial position
A present economic resource controlled by the entity as a result
of past events
Asset • An economic resource is a right that has the potential to
produce economic benefits

A present obligation of the entity to transfer an economic

resource as a result of past events
Liability • An obligation is a duty or responsibility that the entity has no
practical ability to avoid

The residual interest in the assets of the entity after deducting

all its liabilities
Equity
Elements of financial statements relate
to financial performance
Increases in assets, or decreases in liabilities, that result in
Income increases in equity, other than those relating to contributions
from holders of equity claims

Decreases in assets, or increases in liabilities, that result in

Expenses decreases in equity, other than those relating to distributions
to holders of equity claims

Information about income and expenses is just as important as information about

assets and liabilities
 END OF UNIT 2

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