Slide 1.

UNIT ONE : INTRODUCTION TO ACCOUNTING

 Learning Outcome Unit 1
 Describe the purpose and aims of financial
and management accounting.
 Describe the different users of financial
information.
 Describe the main types of business
operating ‘for profit’ and their accounting
obligations
Slide 1.2

DEFINITION OF ACCOUNTING

• The process of identifying, measuring, and

communicating economic information to permit
informed judgements and decisions by users of
the information.
Slide 1.3

DEFINITION OF ACCOUNTING
• What this means is that accounting
involves deciding what amounts of
money are, were or will be involved in
transactions(often buying and selling
transactions) and then organising the
information obtained and presenting it
in a way that is useful for decision
making.
Slide 1.4

PURPOSE OF ACCOUNTING

 Accounts show where money came

from and how it has been spent, this
a)Aids the efficient running of a
business.
b)Indicates how successfully managers
are performing
c)Provide information about the
resources and activities of a business.
Slide 1.5

PURPOSE OF ACCOUNTING

 Accounting information aids the efficient

running of a business in many ways:
A business needs to pay bills for the
goods and services it purchases, and
 collect money from its customers.
It must, therefore keep a record of such
bills and invoices so that the correct
amounts can be paid or collected at the
correct times.
Slide 1.6

PURPOSE OF ACCOUNTING
• Keeping records of a business‘s
assets (e.g. motor vehicles or
computers) helps keep them safe.
Slide 1.7

PURPOSE OF ACCOUNTING
 Accounts indicate how successfully
the managers are performing.
Modern business are often
complicated, they seldom have a
single owner (some very large
enterprises, such as BP, may be
owned by millions of shareholders).
Slide 1.8

PURPOSE OF ACCOUNTING
Frequently the owners are not involved
in the day to day running of the business
but appoint managers to act on their
behalf.
In addition, there are too many activities
and assets for the managers to keep
track of simply from personal knowledge
and an occasional glance at the bank
statements, accounts which summarise
transactions are very useful.
Slide 1.9

PURPOSE OF ACCOUNTING
 A business should provide
information about its resources and
activities because there are many
groups of people who want or need
that information.,
Slide 1.10

THE OBJECTIVES OF ACCOUNTING

• Accounting has many objectives,

including letting people and
organisations answer questions such
as :
how much profit or loss has the
business made?
 how much money does the company
owe?
Slide 1.11

THE OBJECTIVES OF ACCOUNTING

will the company have sufficient
funds to meet its commitments?
what is the value of the business
and what are its net assets?
to ensure proper record keeping,
and financial control
Slide 1.12

THE OBJECTIVES OF ACCOUNTING

what is the growth potential for the

business?
 to meet statutory and regulatory
requirements
what (if applicable) is the stock
market value of our shares and do
they represent good value for
investors and potential investors
Slide 1.13

THE OBJECTIVES OF ACCOUNTING

to aid planning and objective
measuring
 The primary objective of accounting is
to provide information for decision
making.
 The information is usually financial,
but can be given in volumes or Non
Financial.
Slide 1.14

REVISED DEFINITION ACCOUNTING

 Accounting is concerned with
recording data, classifying and
summarising data, and
communicating what has been
learned from the data to the various
users of accounts.
Slide 1.15

USERS OF ACCOUNTING INFORMATION

• Possible users of accounting
information include:
1. Managers of the company (Board
of directors).
2. Shareholders of the company
3. Trade contacts: i.e. (suppliers of
goods to the company on credit and
customers) .
Slide 1.16

USERS OF ACCOUNTING INFORMATION

4. Providers of finance to the

company: i.e. (lenders both short
and long term) .
5. The taxation authorities:
6. Employees of the company:
7. Financial analysts and advisers:
8. Government and their agencies
Slide 1.17

USERS OF ACCOUNTING INFORMATION

9. The public:
10.Competitors:
Slide 1.18

USERS OF ACCOUNTING INFORMATION

a)Managers of the company (Board
of directors):
appointed by the company’s owners
to supervise the day –to-day activities
of the company.
Slide 1.19

USERS OF ACCOUNTING INFORMATION

They need information about the
company’s financial position situation
as it is currently and as it is expected
to be in the future.
This is to enable them to manage the
business efficiently and to make
effective decisions.
Slide 1.20

USERS OF ACCOUNTING INFORMATION

b) Shareholders of the company: i.e.
the company‘s owners,
 want to assess how well the
management is performing.
 They want to know how profitable the
company‘s operations are and how
much profit they can afford to withdraw
from the business for their own use
Slide 1.21

USERS OF ACCOUNTING INFORMATION

c) Trade contacts: i.e. (suppliers of

goods to the company on credit and
customers)
include the suppliers who provide
goods to the company on credit and
customers who purchase the goods
or services provided by the company.
Slide 1.22

USERS OF ACCOUNTING INFORMATION

Suppliers want to know about the

company’s ability to pay its debts;
customers need to know that the
company is secure source of supply
and is in no danger of having to
close down.
Slide 1.23

USERS OF ACCOUNTING INFORMATION

d) Providers of finance to the company:
i.e. (lenders both short and long term)
might include a bank which allows the
company to operate an overdraft or
provides long –term finance by granting a
loan.
 The bank wants to ensure that the
company is able to keep up interest
payments, and eventually to repay the
amounts advanced.
Slide 1.24

USERS OF ACCOUNTING INFORMATION

e) The taxation authorities:

want to know about business profits in
order to assess the tax payable by the
company, including sales tax.
Slide 1.25

USERS OF ACCOUNTING INFORMATION

f) Employees of the company:

should have a right to information
about the company’s financial
situation, because their future careers
and the size of their wages and
salaries depend on it.
Slide 1.26

USERS OF ACCOUNTING INFORMATION

g) Financial analysts and advisers:
need information for their clients or
audience.
For example, stockbrokers need
information to advice investors; credit
agencies want information to advise
potential suppliers of goods to the
company, and journalists need
information for their reading public
Slide 1.27

USERS OF ACCOUNTING INFORMATION

h) Government and their agencies:

are interested in the allocation of
resources and therefore in the
activities of business entities.
They also require information in order
to provide a basis for national
statistics.
Slide 1.28

USERS OF ACCOUNTING INFORMATION

i) The public:
entities affect members of the public in a
variety of ways.
For example, they may make a substantial
contribution to a local economy by providing
employment and using local suppliers.
 Another important factor is the effect of an
entity on the environment, for example as
regards pollution.
Slide 1.29

USERS OF ACCOUNTING INFORMATION

j) Competitors:
competitors will compare their own
results with those of other companies.
A company would not wish to disclose
information which would be harmful to
its own business:
equally, it would not wish to hide
anything which would put it above its
competitors.
Slide 1.30

MANAGEMENT AND FINANCIAL ACCOUNTING

COMPARED

 Financial accounting
 Financial accounting comprises two
stages:
book-keeping, which is the recording
of day-to-day business transactions;
and
Slide 1.31

MANAGEMENT AND FINANCIAL ACCOUNTING

COMPARED
preparation of accounts,
 which is the preparation of
statements from the book-keeping
records;
 these statements summarise the
performance of the business –usually
over the period of one year.
Slide 1.32

MANAGEMENT AND FINANCIAL ACCOUNTING

COMPARED
 Financial accounts: are produced to
satisfy the information requirements of
external users.
 Management accounting seeks to
provide financial information in a form
which can help decision-making in a
business.
Slide 1.33

MANAGEMENT AND FINANCIAL ACCOUNTING

COMPARED
 Management accounts are produced
for internal purposes-they provide
information to assist managers in the
running of the business.
Slide 1.34

MANAGEMENT AND FINANCIAL ACCOUNTING

COMPARED
 Management accounting systems
produce detailed information often
split between different departments
within an organisation (sales,
production, finance etc.).
 Although much of the information
deals with past events and decisions
management accounts produce
information which is forward –looking.
Slide 1.35

MANAGEMENT AND FINANCIAL ACCOUNTING

COMPARED
 This information is used to prepare
budgets and make decisions about
the future activities of a business.
 They also compare actual
performance with budget and try to
take corrective action where
necessary.
Slide 1.36

MANAGEMENT AND FINANCIAL ACCOUNTING

COMPARED

 Financial accountants, however, are

usually solely concerned with
summarizing historical data, often
from the same basic records as
management accountants but in a
different way.
Slide 1.37

MANAGEMENT AND FINANCIAL ACCOUNTING

COMPARED
 This difference arises partly because
external users have different interest
from management and do not need
very detailed information.
 In addition, financial statements are
prepared under constraints (such as
international financial standards and
company law) which do not apply to
managements accounts.
 MANAGEMENT AND FINANCIAL
ACCOUNTING COMPARED

Financial Accounts Management accounts

• Prepared for • Prepared for

internal managers
external of an organisation.
individuals. • Aid management
in recording
• Show ,planning and
performance of a controlling
defined period organisation’s
activities.
 MANAGEMENT AND FINANCIAL
ACCOUNTING COMPARED
Financial Accounts Management accounts
 Legal requirements • Help the decision
for limited making process.
companies to
prepare FA No legal
• Format of published requirements to
FA determined by: prepare MA.
—Law  Format of MA at
—IASs discretion of
—IFRS management
 MANAGEMENT AND FINANCIAL
ACCOUNTING COMPARED
Financial Accounts Management accounts

• FA covers the • MA can focus on

business as a specific areas of an
whole. organisation’s
• FA information activities.
monetary (mostly). • MA incorporate
non-monetary
measures.
 MANAGEMENT AND FINANCIAL
ACCOUNTING COMPARED
Financial Accounts Management accounts

• Historic record and

• Historic picture of
future planning tool
past operations
Slide 1.42

THE MAIN FINANCIAL STATEMENTS OR

REPORTS

 The principle financial statements of

a business are :
i. the statement of financial position
(balance sheet)
ii. The cash flow statement
iii. and the income statement (trading
,profit and loss account)
Slide 1.43

THE STATEMENT OF FINANCIAL

POSITION

 This is simply a list of all the assets

owned and all the liabilities owed by a
business as at a particular date.
 It is a snapshot of the financial
position of the business at a particular
moment.
 Monetary amounts are attributed to
each of the assets and liabilities.
Slide 1.44

ASSETS

 Definition of an asset:

 An asset is a resource controlled by

the entity as a result of past events
and from which future economic
benefits are expected to flow to the
entity.
Slide 1.45

ASSETS
 An asset is something valuable which
a business owns or has the use of.
 Examples of assets are factories,
office buildings, warehouses, delivery
vans, lorries, plant and machinery,
computer equipment, office furniture,
cash and goods held in store awaiting
sale to customers
Slide 1.46

ASSETS
 Some assets are held and used in
operations for a long time.
 Such as office buildings, factories or
plant and machinery, such assets are
often referred to as fixed assets or
non-current assets.
Slide 1.47

ASSETS
 Other assets are held for only a short
time.
 Such as cash and goods held in the
stores awaiting sale to customers,
these assets are referred to as
current assets.
Slide 1.48

LIABILITIES
 Definition of a liability.

 A liability is a present obligation of the

entity arising from past events, the
settlement of which is expected to
result in an outflow of economic
benefits.
Slide 1.49

LIABILITIES
 A liability is something which is owed to
somebody else.
 A liability is the accounting term for the
debts of a business.
 Examples of liabilities are amounts owed
to a supplier for goods bought on credit,
amounts owed to a bank (or other
lender), a bank overdraft and amounts
owed to tax authorities (e.g. in respect of
sales tax).
Slide 1.50

LIABILITIES
 Some liabilities are due to be repaid
fairly quickly e.g. suppliers or bank
overdrafts; these are referred to as
current liabilities.
 Other liabilities may take some years
to repay (e.g. bank loan) these are
referred to as the long term liabilities
or non current liabilities.
Slide 1.51

CAPITAL AND EQUITY

 The amounts invested in a business

by the owner are amounts that the
business owes to the owner.
 This is a special kind of liability, called
capital.
 In a limited liability company, capital
usually takes the form of shares.
 Share capital is also known as equity.
Slide 1.52

EXAMPLE OF STATEMENT OF
FINANCIAL POSITION
 A statement of financial position used
to be called a balance sheet.
 The former name in apt because
assets will always be equal to
liabilities plus capital (or equity).
 A very simple statement of financial
position for a sole trader can be
shown as follows:
Slide 1.53

EXAMPLE OF STATEMENT OF FINANCIAL

POSITION
A TRADER
STATEMENT OF FINANCIAL POSITION AS AT 30 JUNE 2015
ASSETS K K
Non current assets
Plant and machinery 55,000

Current assets

Inventory 5,000
Receivables(from customers) 1,500
Bank 500
Total current assets 7,000

Total assets 62,000

Slide 1.54

EXAMPLE OF STATEMENT OF FINANCIAL

POSITION

Capital K
Balance brought forward 25,000
Profit for the year 10,400
Balance carried forward 35,400

Liabilities
Bank loan 25,000
Payables to suppliers 1,600
Total capital and liabilities 62,000
Slide 1.55

INCOME STATEMENT
 An income statement is a record of
revenue generated and expenditure
incurred over a given period.
 The statement shows whether the
business has had more revenue than
expenditure (a profit) or vice versa (loss).
 The period chosen will depend on the
purpose for which the statement is
produced
Slide 1.56

INCOME STATEMENT
 The income statement which forms part
of the published annual financial
statements of a limited liability company
will usually be for a period of a year,
commencing from the date of the
previous year’s statements.
Slide 1.57

INCOME STATEMENT
• INCOME
 Income is the increase in economic benefits
during accounting period.
 It can arise from inflows of assets, enhancement
of assets or decreases in liabilities.
 Income results in an increase in equity.

 (However, contributions from shareholders are

not income.)
Slide 1.58

INCOME STATEMENT
• EXPENSES
 Expenses are decreases in economic benefits
during an accounting period.
 It can arise from outflows of assets ,depletion of
assets or increases in liabilities.
 Expenses result in a decrease in equity.

 (However, distributions to shareholders are not

expenses)
Slide 1.59

INCOME STATEMENT

 A simple income statement for a sole

trader is shown as follows:
Slide 1.60

INCOME STATEMENT
A TRADER
INCOME STATEMENT FOR THE YEAR
ENDED 30 JUNE 2013 $

Revenue 150,000
Less: cost of sales -75,000
Gross profit 75,000
Other expenses -64,600

Net profit 10,400

Slide 1.61

PURPOSE OF FINANCIAL STATEMENTS

 Both the statement of financial position and
the income statement are summaries of
accumulated data.
 For example, the income statement shows
a figure for revenue earned from selling
goods to all customers.
 This is the total amount of revenue earned
from all the individual sales made during
the period
Slide 1.62

PURPOSE OF FINANCIAL STATEMENTS

 One of the jobs of an accountant is
to devise methods of recording such
individual transactions, so as to
produce summarised financial
statements from them.
 The statement of financial position
and the income statement form the
basis of the financial statements of
most businesses
Slide 1.63

DEFINITION OF A BUSINESS
 There are a number of different ways of looking
at a business.
 Some ideas are listed as follows:
A business is a commercial or industrial
concern which exists to deal in the
manufacturer, re-sale or supply of goods and
services.
A business is an organisation which uses
economic resources to create goods or services
which customers will buy.
A business is an organisation providing jobs for
people.
Slide 1.64

DEFINITION OF A BUSINESS
A business invests money in resources
(for example: buildings, machinery,
employees) in order to make even more
money for its owners.
Profit is the excess of revenue
(income) over expenditure.
 When expenditure exceeds revenue,
the business is running at a loss.
Slide 1.65

TYPES OF BUSINESS ENTITY

 There are three main types of business entity and

these are:
a)Sole traders
b)Partnerships
c)Limited liability companies
Slide 1.66

SOLETRADERS
 The term really reflects the ownership of
the entity;
 the main requirement is that only one
individual should own it.
 The owner would normally also be the
main source of finance and he would be
expected to play a reasonably active part
in its management
 The term sole trader refers to the
ownership of the business, sole traders
can have employees.
Slide 1.67

SOLETRADERS
 Sole trader entities usually
67 operate on a
very informal basis and some private
matters relating to the owner are often
indistinguishable from those of the
business.
 Sole trader accounts are fairly
straightforward and there is no specific
legislation that covers the accounting
arrangements.
 Examples include the local shopkeeper, a 8/12/2015
Slide 1.68

PARTNERSHIPS
 A partnership entity is very similar to a sole
68
trader entity except that there must be at least
two owners of the business.
 Partnerships often grow out of a sole trader
entity, perhaps because more money needs to
be put into the business or because the sole
trader needs some help.
 But it is also quite common for a new business
to begin as a partnership, e.g. when some
friends get together to start a business.
8/12/2015
Slide 1.69

PARTNERSHIPS
 The partners should agree
69 among themselves
how much money they will each put into the
business,
 what jobs they will do,
 how many hours they will work,
 and how the profits and losses will be shared.
 In the absence of any agreement (whether
formal or informal), the courts will deduce from
the way the partners having been conducting
business what the agreement was.
 Examples include an accountancy practice, a
medical practice and legal practice 8/12/2015
Slide 1.70

LIMITED LAIBILITY COMPANIES

 A company is an entity that has a separate
70
existence from that of its owners.
 In this course we are going to be primarily
concerned with limited liability companies.
 The term ‘limited liability’ means that the
owners of such companies are required to
finance the business only up to an agreed
amount.
 Once they have contributed that amount they
cannot be called on to contribute any more,
even if the company gets into financial
difficulties. 8/12/2015
Slide 1.71

LIMITED LAIBILITY COMPANIES

 Companies are incorporated to take
advantage of ‘limited liability’ for their
owners (shareholders).
 This means that, while sole traders
and partnerships are personally
responsible for the amounts owed by
their business, the shareholders of a
limited liability company are only
responsible for the amount to be paid
for their shares.
Slide 1.72

LIMITED LAIBILITY COMPANIES

 In law sole traders and partnerships are
not separate entities from their owners.
 However, a limited liability company is
legally a separate entity from its owners
and it can issue contracts in the
company’s name.
 For accounting purposes, all three
entities are treated as separate from
their owners.
 This is called the separate business
entity concept.
Slide 1.73

ADVANTAGES OF TRADING AS A
LIMITED LIABILITY COMPANIES
a) Limited liability makes investment less
risky than investing in a sole trader or
partnership.
• However, lenders to small company may
ask for a shareholder’s personal
guarantee to secure any loans.
b) It is easier to raise finance because of
limited liability and there is no limit on
the number of shareholders.
Slide 1.74
ADVANTAGES OF TRADING AS A LIMITED
LIABILITY COMPANIES
c) A limited liability company has a
separate legal identity from its
shareholders.
• So a company continues to exist
regardless of the entity of its owners.
• In contrast, a partnership ceases, and a
new one starts, whenever a partner joins
or leaves the partnership.
Slide 1.75

ADVANTAGES OF TRADING AS A LIMITED

LIABILITY COMPANIES
d. There are tax advantages to being a limited
liability company.
• The company is taxed as a separate entity
from its owners and the tax rate on companies
may be lower than the rate for individuals.
e) It is relatively easy to transfer shares from
one owner to another.
• In contrast, it may be difficult to find someone
to buy a sole trader’s business or to buy a
share in a partnership.
Slide 1.76

DISADVANTAGES LIMITED LIABILITY

COMPANIES
a)Limited liability companies have to
publish annual financial statements.
• This means that anyone (including
competitors) can see how well (or badly)
they are doing.
• In contrast, sole traders and partnerships
do not have to publish their financial
statements.
Slide 1.77

DISADVANTAGES LIMITED LIABILITY

COMPANIES
b) Limited liability company financial
statements have to comply with legal
and accounting requirements.
• In particular financial statements have to
comply with accounting standards.
• Sole traders and partnerships may
comply with accounting standards, but are
not compelled to do so.
Slide 1.78

DISADVANTAGES LIMITED LIABILITY COMPANIES

c) The financial statements of larger
limited liability companies have to be
audited.
• This means that the statements are
subject to an independent review to
ensure that they comply with legal
requirements and accounting standards.
• This can be inconvenient, time
consuming and expensive.
Slide 1.79

DISADVANTAGES OF LIMITED LIABILITY

COMPANIES

d) Share issues are regulated by law.

• For example it is difficult to reduce
share capital.
• Sole traders and partnerships can
increase or decrease capital as and
when the owners wish.
Slide 1.80

END OF UNIT ONE

Slide 1.81

UNIT ONE TWO

 Describe the role and function of accounting
concepts, standards and principles, including:
International Financial Reporting Standards
(IFRSs), and International Accounting
Standards (IASs).
 Identify and explain the four main
characteristics of useful information to users
namely relevance, reliability, understandability
and comparability.
 Identify and explain the sub-characteristics of
the four main characteristics
Slide 1.82

(ACCOUNTING STANDARDS)
• As different businesses use different
methods of recording transactions, the
result might be that financial accounts for
different businesses would be very
different in form and context.
• To get around this problem, various
standards for the preparation of accounts
have been developed over the years
which companies are required to follow,
and which underpin the whole world of
accounting.
Slide 1.83

(ACCOUNTING STANDARDS)
• We shall be looking at the layout of financial
accounts in later chapters, but here we are
concerned with general underlying rules.
• The main accounting principles and rules are
those laid down by the accounting profession
itself through both national and international
standards bodies.
• With regard to companies, there are also
various rules incorporated into legislation
(Companies Acts)and companies whose
shares are listed on the Stock Exchange are
subject to Stock Exchange rules
Slide 1.84

(ACCOUNTING STANDARDS)
• Note that the accounts of sole traders and
partnerships are not required to follow
these accounting rules, but since these lay
down the widely accepted principles of
accounting, it makes sense for them to do
so.
• (Most sole traders and many partnerships
also do not have the range of different
types of transactions which companies
have to deal with).
Slide 1.85

SETTING ACCOUNTING STANDARDS

• The International Accounting Standards
(IASs) are issued by the International
Accounting Standards Committee (IASC)
which was established in 1973.
• The need for the IASC arose because of
international investment, the growth of
multinational firms and the desire to have
common standards worldwide.
• The IASC became known as the International
Accounting Standards Board(IASB) under a
restructuring in 2000.
Slide 1.86

SETTING ACCOUNTING STANDARDS

• It is governed by a group of 19 individual
trustees, known as the IASC Foundation, with
diverse geographical and functional
backgrounds.
• The IASB's sole responsibility is to set
International Financial Reporting
Standards(IFRSs).
• As such , it is at the forefront of harmonisation
of accounting standards across the world.
• With the issuing by the IASB of new accounting
standards (IFRSs), there are currently both a
number of IFRSs and IASs in force.
Slide 1.87

INTERNATIONAL ACCOUNTING STANDARDS

 IAS 1:Presentation of Financial Statements
 IAS 2:Inventories
 IAS 7:CashFlowStatements
 IAS8:Accounting Policies, Changes in Accounting
Estimates and Errors
 IAS 10:Events After the Reporting Period
 IAS 16:Property, Plant and Equipment
 IAS 18:Revenue
 IAS 21: The Effects of Changes in Foreign
Exchange Rates
 IAS 33:EarningsperShare
Slide 1.88

INTERNATIONAL ACCOUNTING STANDARDS

 IAS 36:Impairment of Assets

 IAS 37: Provisions, Contingent Liabilities and
Contingent Assets
 IAS 38:IntangibleAssets
Slide 1.89

International Financial Reporting Standards

 None of the IFRSs impact on accounting items that you
will encounter at this level , but the following list is
presented here to give you an indication of the elements
covered.
 IFRS1 First-time Adoption of International Financial
Reporting Standards
 IFRS2 Share-based Payment
 IFRS 3 Business Combinations
 IFRS 4 Insurance Contracts
 IFRS 5 Non-current Assets Held for Sale and
Discontinued
 IFRS 6 Exploration for and evaluation of Mineral
 IFRS 7 Financial Instruments: Disclosures
 IFRS 8 Operating Segments.
Slide 1.90

QUALITATIVE CHARACTERISTICS OF
ACCOUNTING INFORMATION

 These characteristics are the

attributes that make the information
provided useful to users.
 The IASB states that they are four
principal characteristics –
understandability, relevance,
reliability and comparability.
 These are defined below as follows:
Slide 1.91

QUALITATIVE CHARACTERISTICS OF
ACCOUNTING INFORMATION

a)Understand ability:
• Information provided to users must not be
so complex that a user with a reasonable
knowledge of business and economic
activities and accounting, and a
willingness to study the information with
reasonable diligence, would not be able to
understand it.
Slide 1.92

UNDERSTAND ABILITY:
• Complex matters should not be left out of
financial statements simply due to its difficulty if
it is relevant information.
 The information in financial statements should
be presented in such a way that it can be
understood by users.
 For this to happen users are assumed to have
some business, economic and accounting
knowledge and to be able to apply themselves
to study the information properly.
Slide 1.93

QUALITATIVE CHARACTERISTICS OF ACCOUNTING

INFORMATION

b) Relevance:
 To be useful, information must be relevant to
the decision-making needs of users
 Relevance is closely related to its predictive
role –that is the extent to which the
information helps users to predict the
organisation's future and so make decisions
about it.
Slide 1.94

RELEVANCE:
 A sub characteristic to relevance is materiality
 –information is material and therefore
relevant if its omission or misstatement could
influence the economic decisions of users.
 Materiality depends on the size of the item or
error judged in the particular circumstances.
Slide 1.95

QUALITATIVE CHARACTERISTICS OF
ACCOUNTING INFORMATION
c) RELIABILITY
 Information has the quality of reliability when it is
free from material error and bias and can be
depended upon by users to represent faithfully that
which it either purports to represent or could
reasonably be expected to represent.
 Reliable information also requires several sub-
characteristics to be present as follows:
Slide 1.96

RELIABILITY
a) Faithful representation
• –information provided must represent
faithfully those transactions and other
events it purports to represent.
b) Substance over form
• –transactions need to be accounted for in
accordance with their substance not
merely their legal form.
• Substance is not always consistent with
legal form.
Slide 1.97

RELIABILITY
c) Neutrality –information must be neutral,
that is free from bias and provided in an
objective manner.
d) Prudence –
• as accountants have to contend with the
uncertainties that inevitably surround many
events and transactions, then a degree of
caution must be brought to bear when
making judgements on such events and
transactions.
• This degree of caution is required such that
assets or income are not overstated and
liabilities or expenses are not understated.
Slide 1.98

RELIABILITY
e) Completeness
• for information to be reliable it must
be complete within the bounds of
materiality and cost.
• An omission can cause information to
be false or misleading and thus
unreliable and deficient in terms of its
relevance.
Slide 1.99

QUALITATIVE CHARACTERISTICS OF
ACCOUNTING INFORMATION
d) COMPARABILITY:
• Users need to be able to compare financial
statements of a business through time in order to
identify trends in its financial position and
performance.
• Users also need to be able to compare one
business with another and, therefore, the
measurement and display of the financial effect
of transactions and other events must be carried
out in a consistent way for different entities.
• Thus, we have the need for accounting
standards from this characteristic.
Slide 1.100

OTHER FACTORS TO CONSIDER

In addition to the above qualitative factors other factors
to consider when preparing accounts include the
following:
a) Objectivity:
 This is often referred to as comprising verifiability or
faithful representation and neutrality.
 Financial statements must represent faithfully the effect
of transactions and other events if either does so or
could be expected to do so it should be based on
verifiable evidence.
Slide 1.101

OBJECTIVITY:
 Financial statements are not judged to be
neutral if by the selection or presentation of
information they influence the making of a
decision or judgement in order to achieve a
predetermined result or outcome.
 Example: Internally generated goodwill should
not be included in the balance sheet as a fixed
asset because its value cannot be determined
objectively
Slide 1.102

OTHER FACTORS TO CONSIDER

b) Materiality:
 Information is material if its omission or
misstatement could influence the economic
decisions of users taken on the basis of its
financial statements.
 Materiality depends on the size of an item or
error judged in the particular circumstances of
the omission or misstatement.
Slide 1.103

MATERIALITY
 Thus materiality provides a threshold or cut off
point rather than being a primary qualitative
characteristic that information must have if it is
to be useful.
 Materiality is applied to numerous items in
financial reports.
 Example: the amount of a trade debt written off
as irrecoverable would be disclosed by note
only if material.
Slide 1.104

OTHER FACTORS TO CONSIDER

c) Prudence.
 This is the inclusion of a degree of caution
in the exercise of the judgments needed in
making the estimates required under
conditions of uncertainty so that assets or
income are not overstated and liabilities or
expenses are not understated.
Slide 1.105

PRUDENCE.
 However prudence should not be carried so far
as to result in misleading financial statements
by taking the most pessimistic view possible of
all matters in doubt.
 Example: Stock at the balance sheet date
should be included at net realisable value if it is
likely to be saleable only at a figure below cost.
Slide 1.106

ACCOUNTING CONCEPTS
These are defined as basic
assumptions which underlie the
preparation of financial accounts of
business enterprises.
They include the following:
a)going concern concept
b)consistency concept
c)concept of prudence
Slide 1.107

ACCOUNTING CONCEPTS

d)accruals concept
e) materiality
f) dual action
g)Historical cost concept
Slide 1.108

GOING CONCERN CONCEPT

The assumption is made that the business
entity will continue in existence for the
foreseeable future.
 This is an important concept, as the value
placed on the assets of a continuing
business is different from the value placed
on the assets of a closing business.
Slide 1.109

GOING CONCERN CONCEPT

Stock is normally valued at cost price but if the
business were about to cease trading, then the resale
value of the stock would be more relevant, as the
owner will try to sell off the remaining stock.
• One obvious problem with this concept is that we can
never be entirely sure that the business will continue.
• The concept also applies to the significant curtailment
of any part of the business operation
Slide 1.110

CONSISTENCY CONCEPT
Once a business has decided which
accounting methods it is going to apply and
how it is going to interpret the various rules of
accounting, it should be consistent in these
matters from year to year.
 Consistency is necessary so that the results
of the business, as shown by the accounts,
may be compared from year to year.
Slide 1.111

CONSISTENCY CONCEPT

Changes should be adopted only if

the old methods, for a good reason,
can no longer apply, e.g. using the
same depreciation method.
Slide 1.112

CONCEPT OF PRUDENCE
The accountant should adopt procedures
which do not overstate or anticipate profits
and do not understate losses but which do
provide for all potential losses.
Profit should be included only when it is
reasonably certain that cash will be received.
Slide 1.113

CONCEPT OF PRUDENCE

Adopting the concept of prudence is a

measure against drawing money from
the business out of profits which may
not materialise, or when a loss arises
which had not been anticipated, e.g.
providing for bad debts.
Slide 1.114

ACCRUALS CONCEPT
Revenues and costs are recognised as
they are earned or incurred, and not when
the money is received or paid.

Slide 1.115

ACCRUALS CONCEPT
For example, if in year 1 a trader has only paid
three of four telephone bills, and in year 2 pays
the outstanding bill in addition to the four bills
received in year 2, then the outstanding bill
should be adjusted for (‘accrued’) in the
accounts of year 1, so that each year is
charged with the appropriate telephone costs
incurred, rather than with the amount actually
paid.
Slide 1.116

HISTORICAL COST
 Items are stated in accounts at historical
cost i.e. at the amount which the
business paid to acquire them.
 An important advantage of this
procedure is that the objectivity of
accounts is maximised.
 There is usually documentary evidence
to prove the amount paid to purchase an
asset or pay an expense.
Slide 1.117

MATERIALITY CONCEPT
If it would serve no useful purpose, i.e. it is not
worthwhile to record an item in a particular
way, or to show an item separately in the
accounts, then it should not be done.
If an item is ‘immaterial’, it may be that the
costs of recording it in a particular way
outweigh any benefit of doing so.
Slide 1.118

MATERIALITY CONCEPT
 Each business must quantify ‘materiality’
individually as, for example, an item
costing K50 might be material to a
business with a turnover of K1,000 and a
profit of K100, but not to a business with
a turnover of K5m and a profit of
K350,000.
 Also, other conventions may be ignored
if the cost of adopting them outweighs
the benefits.
Slide 1.119

DUAL ACTION CONCEPT

Every transaction involves an act of giving and
an act of receiving.
It is from this aspect of transactions that the
double entry system of bookkeeping was
developed.
For example if the business buys a new asset
for K10,000 then the business ‘receives’ the
asset and ‘gives’ K10,000
Slide 1.120

OTHER ACCOUNTING CONVENTIONS

a) Accounting bases
These are different accounting methods that have been
developed for expressing or applying the fundamental
accounting concepts, such as the calculation of
depreciation and the valuation of stocks.
b) Accounting policies
These are the specific accounting bases judged by
business enterprises to be the most appropriate to their
circumstances and adopted by them for the purpose of
preparing their financial accounts.
Slide 1.121

OTHER ACCOUNTING CONVENTIONS

c) Matching concept:
Income should be included in the accounts in the same
accounting period as the expenses relating to that
income.
d) Realisation concept
Transactions are recorded when the customer incurs
liability for the goods and services (normally liability is
incurred when the goods or services are actually
received).
Any profit on the transaction is not realised until that
time.
Slide 1.122

OTHER ACCOUNTING CONVENTIONS

e) Separate Determination
• the amount of each individual asset or liability
should be determined separately from all other
assets and liabilities e.g. 3 Machines
• concept prohibits the netting off of potential
liabilities and potential gains
f) The money measurement concept:
Accounting information is concerned with
transactions which can be measured in
monetary units
Slide 1.123

AFIN 102 ASSIGNMENT 1

 QUESTION ONE
 Explain , and illustrate with an example, the use of
each of the following accounting concepts:
•(i) Going concern
•(ii) Consistency
•(iii) Prudence
•(iv) Accrual
•(v) Historical cost
•(vi) Materiality
•(vii) Dual aspect (21 marks)
Slide 1.124

AFIN 102 ASSIGNMENT 1

 QUESTION TWO
 Qualitative characteristics are the attributes that
make the information provided in financial
statements of enterprises useful to users.
 There are four principal qualitative
characteristics described in the IASB’s
framework, namely: understandability,
relevance, reliability and comparability.
 Required :Describe and analyse each of these
four characteristics. (Total 25 marks)
Slide 1.125

AFIN 102 ASSIGNMENT 1

 QUESTION THREE
 The International Accounting Standards Board
(IASB) issues International Accounting
Standards (IASs) and is also responsible for the
Framework for the Preparation and Presentation
of Financial Statements.
 Required: Describe seven users of financial
statements as identified by the IASB in the
Framework for the Preparation and Presentation
of Financial Statements. Within your description,
comment on the needs of each user.
(14 marks)
Slide 1.126

END OF UNIT TWO