MCom - Accounts ch-2 Topic2-F

Financial Accounting &
Analysis
Elements of Conceptual framework
of financial accounting and
reporting, assumptions, principles
and constraint
(Financial Accounting & Analysis)
(Elements of Conceptual framework of financial accounting and reporting, assumptions, principles and constraint)
This chapter will teach you about the conceptual framework of financial accounting and
reporting
Learning Objectives
At the end of this topic, you will be able to:

Understand the elements under ACF
Develop an understanding of the importance of the
assumptions
principles
Understand the constraints
Basic Elements of
Financial Statements
Assets
Expenses Liabilities
Elements of
Financial
Statements
Owner’s
Revenues
Equity
Basic Elements of Financial Statements
Assets
Assets are the first one of the five elements of financial statements. They can be defined as the resources that the
company owns in which it uses for carrying out the business activities. They either have the current value (e.g.
cash) or the future value (e.g. accounts receivable).
They are probable future economic benefits obtained or controlled by a particular entity as a result of past
transactions or events. They can be said to have three essential characteristics:
1. They symbolize a future benefit that involves a capacity, singly or in combination with other assets to
contribute directly or indirectly to future net cash flows.
2. The entity can control access to the benefit
3. The transaction or event-giving rise to the entity’s right to, or control of, the benefit has already occurred
(result of past transactions).
We can classify assets into two types:

a. Current Assets
b. Non-Current Assets
Twelve months is considered as the differentiation line between current and non-current (longer than 12 months).
They may include:

• Cash and cash equivalents
• Inventory
• Accounts receivable
• Property, plant, and equipment
Liabilities
Liabilities is the second of the five elements of financial statements. They are what the company owes and has
obligations to pay in the future. Like assets, liabilities can be classified into current liabilities and non-current
liabilities.
They can also be said to be a present obligation of the entity arising from past events, the settlement of which is
expected to result in an outflow from the entity, of resources representing economic benefits.
They have three essential characteristics.
1. They represent a duty or responsibility to others that entails settlement by future transfer or use of assets,
provision of services or other yielding of economic benefits, at a specified or determinable date, on occurrence
of a specified event, or on demand.
2. The duty or responsibility is an obligation on the entity, leaving it very little or no discretion to avoid it.
3. The transaction or event which is obligating the entity has already occurred.
Liabilities can be classified into current liabilities based on operating cycle concept, maturity and held for trading.
The same concept of operating cycle regards current assets is applicable for classifying certain items of liability as
current or non-current.

Equity
Equity is the residual interest in the assets of the entity after deducting all its liabilities. It is presented in the
statement of financial position in a classified manner which helps the user-groups (particularly the investors) in
decision making. In a corporate entity, funds contributed by shareholders, retained earnings (meaning profit
retained in the business) are examples of equity.
Income
Income comprises of revenue and gain. While the former arises out of ordinary activities of entity, gain is not the
outcome of the ordinary activities.
Revenues are inflows or other enhancements of assets of an entity or settlement of its liabilities (or combination of
both) during a period from delivering or producing goods, rendering services, or other activities that constitute the
entity’s ongoing major operations.
Gains represent other items that meet the definition of income and may, or may not, arise in the course of the
ordinary activities of an entity.

Expenses
Expenses are outflows or other using up of assets or incurrence of liabilities (or combination of both) during a
period from delivering or producing goods, rendering services, carrying out other activities that constitute the
entities ongoing major operations.
The essential characteristic of an expense is that it should not have been incurred in conjunction with the
company’s revenue-generating process. Expenditures that do not qualify as expenses must be treated as assets
(future economic benefit to be derived), as losses (no economic benefit), or as distributions to owners.
Third Level: Recognition, Measurement, And Disclosure Concepts
These concepts explain how companies should recognize, measure, and report financial elements and events.

Basic Assumptions
There are the few basic assumptions of accounting.
Economic Entity – This assumption assumes that the accounting records of a business and the personal accounting
records of the business’ owner will be kept separate. Business transactions should never be mixed with the
business owner’s personal transactions in accounting practices.
Going Concern - This assumption assumes that the business in question will likely continue operating in the
foreseeable future. It assumes that the company will not go bankrupt and will be able to meet its obligations and
objectives.
Monetary Unit - The monetary unit assumption principle dictates that all financial activity be recorded in the same
currency.
Periodicity - This assumption means is that the accounting practices and methods used by a company should be
maintained and reported for specific periods of time. These periods should also be consistent each year that the
business is in operation.

Basic Assumptions
Accrual Basis of Accounting – Under this assumption, accounting transactions are recorded in the books of
accounts when they occur. This is known as the Mercantile System
Basic Principles
There are the few measuring principles of accounting.
Historical Cost is recording your assets at the original cost when purchased by the company. It’s important to
record the acquisition price of anything you spend money on and properly record depreciation for those assets.
Fair value means an amount at which asset/liability could be exchanged/settled, between knowledgeable, willing
parties in an arm’s length transaction.
IASB has given companies the option to use fair value as the basis for measurement of financial assets and
financial liabilities.
IASB has established a fair value hierarchy which helps decide the priority of valuation techniques to use to
determine fair value.
Least subjective
Level 1
Quoted
Prices in
activ e market
Level 2
Quoted pric es in ac tiv e mark ets for
identical or similar assets, or in absence
of an active mark et, in inac tive mark ets
Le ve l 3
Us e of unobse rva ble and si gni fic ant inputs for the a sse t
that reflec ts manage me nt’s own as sumptions a bout the
ass umptions that a marke t participant would use in
prici ng an ass et, inc luding as sumptions a bout risk
Most
subjective

Basic Principles
Revenue Recognition
When we are recording information about the business, the revenue recognition principle needs to be considered.
This is the period of time where revenues are recognized through the income statement of your company.
Expense Recognition
The expense recognition principle states that expenses should be recognized in the same period as the revenues to
which they relate. If this was not followed, expenses would likely be recognized as and when they are incurred,
which might precede or follow the period in which the related amount of revenue is recognized.
For example, a business pays Rs. 5,00,000 for goods, which it sells in the following month for Rs. 6,00,000. Under
the expense recognition principle, the Rs. 5,00,000 cost should not be recognized as expense until the following
month, when the related revenue is also recognized. Otherwise, expenses will be overstated by Rs. 5,00,000 in the
current month, and understated by Rs. 5,00,000 in the following month.
Provides Future Provides No Apparent

Benefits Future Benefit
Cost Incurred
Unexpired Cost Expired Cost
Benefits Decrease
Asset Expense
Expense Recognition
Let the “Expense” follow the “Revenues”


Basic Principles
Full Disclosure
The Full Disclosure Principle states that all relevant and necessary information for the understanding of a
company's financial statements must be included in public company filings. Knowing where to find this information
is a critical first step in performing financial analysis and financial modeling.
Third Level: Cost Constraint

Cost Constraint
Companies should contemplate the costs of providing the information against the benefits that can be extracted
from using it.
• Rule-making bodies and governmental agencies use cost-benefit analysis before finalizing the informational
requirements.
• In order to justify requiring a particular measurement or disclosure, it is necessary that the benefits that are
perceived to be derived from it must exceed the costs perceived to be associated with it.
In accounting, a cost constraint arises when it is excessively expensive to report certain information in the financial
statements. When it is too expensive to do so, the applicable accounting frameworks allow a reporting entity to
avoid the related reporting. The intent of allowing the cost constraint is to keep businesses from incurring
excessive costs as part of their financial reporting obligations, especially in comparison to the benefit obtained by
readers of the financial statements.
Summary
In this topic, you learnt:
Understand the elements under ACF

assumptions
principles
Understand the constraints

MCom - Accounts ch-2 Topic2-F

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Financial Accounting &

At the end of this topic, you will be able to:

Basic Elements of Financial Statements

Basic Elements of Financial Statements

We can classify assets into two types:

They may include:

Basic Elements of Financial Statements

They have three essential characteristics.

Basic Elements of Financial Statements

Basic Elements of Financial Statements

Third Level: Recognition, Measurement, And Disclosure Concepts

Third Level: Recognition, Measurement, And Disclosure Concepts

There are the few basic assumptions of accounting.

Third Level: Recognition, Measurement, And Disclosure Concepts

There are the few measuring principles of accounting.

Third Level: Recognition, Measurement, And Disclosure Concepts

Third Level: Recognition, Measurement, And Disclosure Concepts

Third Level: Recognition, Measurement, And Disclosure Concepts

Provides Future Provides No Apparent

Third Level: Recognition, Measurement, And Disclosure Concepts

Let the “Expense” follow the “Revenues”

Third Level: Recognition, Measurement, And Disclosure Concepts

Third Level: Cost Constraint

In this topic, you learnt:

Understand the elements under ACF

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