The Fundamental Accounting Concepts - Case Study Example

Financial ments: Preparation and Usefulness of XXXX XXXX Submitted By: XXXX Number: XXXX Number of words: 1225 (excluding References) Explain using various examples, how the fundamental accounting concepts are used in preparing financial statements. Accounting is the language used by businesses to communicate their financial information and performance to interested parties. Like every language accounting too has a set of concepts that it is based on. Accounting has a set of twelve fundamental concepts that form the basis of all accounting; these concepts are called the General Accepted Accounting Principles (GAAP). These concepts explain the meaning of all the figures that are found in the financial statements of a company (Dransfield, 2002). The main purpose of financial accounting is to provide general purpose financial statements, provision of information to management and others to make decisions, plan and for performance appraisal. To briefly explain the key concepts of accounting (Berry, 1996): Entity: Accounts are for the business not the owner of the business Money Measurement: Only the monetary aspects are expressed in the financial accounts. Going Concern: The assumption made by accounting is that the company will continue operations further, hence the company’s accounts do not give the liquidised value of the assets. Cost: The financial statements portray the cost of the assets at the buying price and not the current market value. However the accounts do take into account the depreciation costs and hence provide the net value of the assets. Dual Aspect: Accounting is based entirely on a formula: ‘Asset=Liability + Equity’. It is very important that all accounts follow this formula and the balace is always maintained. Objectivity: The most important aspect of accounting is that all accounts are based on information recorded not on anyone’s personal opinion. Time Period: All reports are prepared for a certain interval of time. These intervals could be the financial year or even quarter or even a month. Conservatism: Accounting always keeps a safety net while estimating expenses and incomes. It always understates the records to be able to cover for any uncertainty. Realization: All expenses are recorded only at the time of the actual payment and not at the time of entering into the contract. In short all incomes are recorded once received and expenses are recorded once realised. Matching: Every transaction has a matching transaction which is required to be passed to ensure the books re balanced. Consistency: All entities are required to choose one style of accounting and follow the same style for all the following years of operations. Materiality: All transactions are important within any company however not all moves can be accounted for. For example use of a pen provided by the company is not recorded for however the transaction where the pens are bought by the company will be recorded (Money Instructor, 2005). Fundamentals of Accounting and Financial Statements: The fundamentals of accounting play a very important role in all financial accounts. It is very evident in every account that all the fundamentals are followed to create the accounts. Every account is created on the measurement of money. The main idea of all the account is to provide the interested groups with financial information of the company (Gillespie, 1997). All accounts are made for a company which has a separate entity of its own and follow the assumption that the company will continue to exist for a long time. The reports mainly include the cost of all the asset, liabilities, and equity of the company, at cost. All accounts are made for a fixed period of time. Examples of the above – mentioned points are seen in the title of the different accounts: a) Balance Sheet: ‘Balance Sheet of XYZ, Ltd. for year ended 31 December 2006’ – provides the information of the company for the financial year ending 31 December 2006 i.e. from Jan 2006 till 31 December 2006 b) Cash Flow Account: ‘Cash flow account for ABC, Ltd. for 1January 2008 to 1 April, 2008’- provides the cash inflow and outflow of ABC ltd on a particular date for a fixed period of time. c) Profit and Loss Account: ‘Consolidated Profit and Loss Account of ABC Ltd., for the year ended 31December 2007’ –p provides all the transactions of the company between 1 January 2007 until 31 December 2007 and provides the profits or looses made by the company during the year (Arnold, 1985). Critically evaluate the role of financial reporting in aiding the decision-making processes of 4 different user groups. Your answer should include an explanation of the nature of the decisions each of their users are likely to be taking in relation to their interactions with a business. Financial reports are the best aid for a number of groups to help them make informed decisions. There are a number of different set of people who would be interested in having information of a company. There are a number of group of users that benefit from financial statements, however the main categories of people who benefit from the financial accounts of a company are: Management: Financial reports are very important to managers. The reports act as a decision making tool for managers. The management of a company have a number of decisions to make for the growth of the company. These decisions vary from recruiting of new employees till investing in land and building, etc. The implications of every decision made by the manager is very serious hence the managers need to ensure that every decision made is well informed and after proper analysis of the current situation of the company. The management is required to pay attention to every single detail and ensure the company does not move astray from its mission and vision. Thus the reports like the balance sheets and the cash flow allow managers to keep track of the funds available within the company at any given point in time. They also allow the management to access the current situation of the assets and liabilities of the company. This would allow managers to correctly make decisions keeping in mind all aspects of the business like the liquidity, assets and liabilities of the company (Arnold, 1985). Employees: The employees of the company also have financial interest in the business. This is due to the fact that employees would receive better bonuses based on the profits of the company and vice – versa. The reports enable employees and trade unions to understand how much job security they have. Also a number of employees have shares within the company which would make them interested in the company’s performance. Shareholders/ Stakeholders/Investors: Investors like share holders are interested in the company’s performance since they have a part of the ownership in the company. Investments are made in a company to receive a return in the form of dividends or in the form of higher share prices. Shareholders are normally the main users of the financial reports hence all the reports are designed to mainly cater to the shareholder’s/ investor’s needs (Dransfield, 2002). Suppliers: Suppliers that provide companies with goods on credit would want to ensure their funds and payments are safe and assured. Hence before getting into a contract of credit supplies the suppliers would ensure they check the company’s financial accounts. Hence the financial accounts help the suppliers get a clear view of the company’s financial position. The financial statements thus help provide information to employees, suppliers, investors, and the management. All these groups have a financial interest in the company and hence the reports provide these groups with the financial information of the company to make well informed decisions at all times. The decisions can vary from supplying goods to the company on credit, to buying of a land or making a large investment (Gillespie, 1997). References Arnold, J., Hope, T. and Southworth, A., 1985, Financial Accounting, 1st edn, Prentice Hall, Exeter Berry, A. and Jarvis, R., 1996, Accounting in a Business Context, 2nd edn, Chapman and Hall, London Dransfield, R., 2002, ‘Financial Information Made Easy’, Nelson Thornes, Cheltenham, UK Gillespie, I., Lewis, R. and Hamilton, K., 1997, Principles of Financial Accounting, 1st edn, Prentice Hall, Europe Money Instructor, 2005, ‘Fundamental concepts of accounting’, Accessed on 20 October 2008, Retrieved from http://www.moneyinstructor.com/lesson/accountingconcepts.asp Read More