After studying this section you should be able to:
- state the main elements of financial accounting
- describe, and give a relevant business example of, the main accounting concepts
Elements and users of financial information
Stakeholders use financial information. They may be:
- internal (management and employees) or
- external, e.g. suppliers, customers, lenders.
In December 1999 the Accounting Standards Board (ASB) published its Statement of Principles for Financial Reporting. Although not a financial accounting standard as such, this influential Statement provides guidance in applying financial accounting standards, and identifies the key elements of financial statements as:
- Assets and Liabilities
- Ownership interest (the ‘accounting equation’ of Assets minus Liabilities)
- Gains and Losses (income and expenses)
- Contributions from owners (investments) and Distributions to owners.
Accounting concepts act as basic ‘rules’ for accountants to follow. One of the financial accounting ‘standards’, SSAP 2 (Disclosure of Accounting Policies), identifies four key concepts.
- Accruals – financial accounts are prepared not on a cash basis but on an earnings (accruals) basis. Sales and purchases are recognised in the period in which they are made, and not merely when the cash is received or paid. Therefore, a company with a financial year running January–December and making a credit sale in December 2001, but not receiving the cash until January 2002, will show the sale as increasing its 2001 profits.
- Prudence – where alternative procedures or valuations are possible, the one selected should give the most cautious presentation of the firm’s financial state. Losses therefore tend to be anticipated, but profits are never anticipated (this is why, for example, closing stock is valued at cost price rather than selling price: to value using the latter figure assumes the stock will be sold and a profit made).
- Going concern – the assumption is that the firm will continue for the foreseeable future. This means that its assets will normally be valued at their (historical) cost rather than at their break-up or resale value.
- Consistency – similar items should be given similar accounting treatment. If, therefore, it is the firm’s policy to use the straight-line depreciation method for existing vehicles, any new vehicle bought will be subject to the same treatment.
Other relevant accounting concepts
- The entity concept – accountants treat every business as an entity which is separate to, and distinct from, its owners.
- The money measurement concept – accounts only record and analyse those items that have a monetary value (thus, for example, the quality of management and other employees is not directly considered by accountants).
- The duality concept – every transaction has two effects (this forms the basis of double-entry book-keeping).
- The historical cost concept – items are normally stated in accounts at their historical cost, i.e. the cost that was paid for them (revaluation can take place,e.g. property is often shown at a higher value than its original cost).
- The materiality concept – only items that are sufficiently material (important) will affect the ‘true and fair view’ that must be given by accounts.
These concepts provide a degree of objectivity in financial accounting: using historical cost for all items is a good example of this. The materiality concept illustrates where financial accounts may still be subjective: what is ‘material’ in one firm may not be regarded as material by the accountant in another firm.