Ten Key Concepts of Accounting - Literature review Example

Ten Key Concepts of Accounting February 25, Ten Key Concepts of Accounting Introduction The Accounting concepts ensure better financial report communication. The research delves on International Accounting Standard no. 1 accounting concepts .The research delves on some accounting concepts found in other IAS issuances. Accounting concepts assure users of universally comparable, understandable, reliable and relevant set of financial statement accounts. There are several key accounting concepts. International Accounting Standards (IAS) no. 1 states that the concepts guide the how the contents of the financial accounting reports should be constructed. The conceptual framework of accounting includes the objectives concepts of financial reporting group. The second group of concept accounting concepts represents the qualitative characteristics of useful financial information. The third group of conceptual accounting framework concepts includes description, recognition and measurement concepts of the financial reports’ elements (Alexander, 2008). Discussion In terms of the first objective accounting concept, the financial reports are prepared in order to present the financial data pertaining to the business entities’ periodic transactions. Consequently, the financial statement preparers implement the going concern accounting concept. The concept indicates that business entity is assumed to continue its business operations for several years, without any telltale signs of bankruptcy creeping into the doors of the business entity. When bankruptcy issues crop up, the going concern concept no longer applies to the business entity. The going concern concept indicates the entity has no plans of folding up or liquidating the business operations within the foreseeable future (Kieso et al., 2011). Relevance Accounting Concept . In terms of the qualitative characteristics group of financial concepts, the financial report accounts should comply with the relevance concept of financial accounting (Kolitz, 2009). Relevance means that financial data reported is material to the decision making process. The relevant financial data can significantly influence the decision makers’ choices. To be relevant, the financial data should comply with the materiality principle of financial accounting. The financial information is material if the data can change the decision makers’ choices. For example, the manager gathers data on whether to promote the cashier to treasury department manager. Information indicating that the cashiers incurred several cash count shortages may prod the managers to reject the proposal to promote the cashier. Completeness Accounting Concept. Further, the financial reports must comply with the completeness concept of accounting. The completeness concept requires the companies to record all transactions in their respective accounting periods. The income statement must present all sales done within the accounting period. The same statement requires that all expenses should be recorded in the year they are used, not during the year when the expense amounts are paid. The company must include all business transactions in the preparation of the financial reports to avoid being charged for fraud or lackluster financial report preparation. Neutral Accounting Concept. Furthermore, the financial reports must implement the neutral concept to f accounting (Morris, 2009). The financial reports serve the needs of several users. The customers use the financial reports to determine if the company will continue to operate for several years. The financial report indicating the company generated a four your net loss amount will impress on the current and future customers that the company is on the verge of bankruptcy. Consequently, the company may be forced to close shop within the next few years of business operations. When this happens, the current and future customers are forced to seek other suppliers of their needs and wants. The customers need neutral financial reports for their decision making activities. Additionally, the suppliers use the neutral financial statements as basis for approving the company’s credit application. The suppliers are prodded to disapprove the credit application when the companies’ financial statements show the company generated three years of net loss performances. Consequently, the suppliers need neutral financial reports for their decision making actions (Tiffin, 2007). Further, the community uses the neutral financial reports for its decision making activities. The communities use the financial reports as basis for applying for jobs in the company. The community uses the reports to determine if the company can sponsor any community activities. The financial statement showing that the company generated very high net profits will encourage the community to seek the company’s help for each community activities (Epstein, 2010). Furthermore, the employees use the neutral financial reports as basis for asking salary benefits. When the financial statements indicate the companies’ profits increased, the employees are encouraged to seek salary increases. On the other hand, the employees will not seek salary increases when the neutral financial statements show the company is on the brink of bankruptcy (Alexander, 2008). Additionally, the managers use the neutral financial statements as basis for their performance. The passing grade for the managers occurs when the income statement shows the company generated net profit during the accounting period. The layman’s term for net income is bottom line. When the manager generates the required bottom line, net profit, the manager receives a passing grade. On the other hand, the managers will get a lackluster failing grade when the neutral financial reports indicate the company generated a net loss during each accounting period. Gross loss occurs when the net sales or revenue amount is less than the cost of sales or cost of production. The net loss situation crops up when the total operating expense amount is more than the gross profit amount, if any (IASB, 2007). Comparability Accounting Concept. Moreover, the financial reports must comply with the comparability concept of accounting (Black, 2009). The business reports must allow comparison of two accounting reports. There are two major types of business comparisons. The first type is comparing the financial reports between two accounting periods. The company can compare the financial statements of two years. The manager can determine whether the current year sales amount is higher or lower than the prior year sales. The manager can determine whether the current year gross profit is higher or lower than the prior year gross profit. The manager can determine whether the current year net profit is higher or lower than the prior year net profit. The comparable financial reports guide the decision makers (Schutt, 2008). When the comparable financial statement shows that the current year sales is lower than the prior year sales, management can intervene in order to increase the current year’s sales. Management intervention may include advertising the benefits of buying the company’s products and services. Management can increase the current year’s lower gross profit figure by reducing the cost of sales amounts. Reducing may include buying cheaper inventories or cheaper raw materials. The company may also reverse the current accounting period’s net income decline by reducing operating expenses. Reducing operating expenses may include reducing salaries by retrenching redundant employees. Reducing expenses includes reducing gasoline expenses. Expense reduction also includes lessening the amount allocated to employee vacations and out of town trips (Kiesoetal, 2011). Additionally, the second type is comparing the financial reports between two competitors in the same market segment. The managers will use the financial reports to compare the business operations of the company and one or more of its competitors in the same market segment. For example, the manager of one grocery chain may compare the company’s own sales output with the sales output of another grocery chain located in the same city. Next, the same manager of one grocery chain may compare the company’s own gross profit performance with the gross profit performance of another grocery chain located in the same county. Third, the manager of one bookstore may compare the company’s own net profit performance with the net profit performance of another competitor bookstore located in the community (Kieso et al., 2011). Understandability Accounting Concept. Moreover, the financial reports should incorporate understandability concept of accounting. The users of the financial reports must understand what the preparer of the financial report intends to communicate to the financial statement readers. The concept requires that each account title pertains to only one specific aspect of the financial report. For example, the financial statement preparer must ensure that all sales collections include a debit to cash, not a debit to accounts payable. Likewise, For example, the financial statement preparer must ensure that all sales on accounts require a debit to accounts receivable, not a debit to furniture. To ensure understandability, the financial statement preparer must ensure all assets are not recorded as liabilities. Reliability Accounting Concept. Further, the financial reports must comply with the reliability concept of accounting. The financial statement accounts can be relied upon. For example, the company attaches the official receipts to the accounting records as basis for recording the day’s sales activities. The users of the financial reports can review the official receipts to ascertain that the recorded sales is reliable. The financial statement preparer must ensure that the totals of the account balances are reliable. All accounting computation errors and frauds should be eliminated. Bank statements can be used to prove that the financial report accounts indicate reliable cash in bank balances. The promissory note folder contains the customers’ promissory notes. The folder can be used to determine whether the reported notes receivable amount is reliable (Alexander, 2008). Verifiability Accounting Concept. Moreover, the financial reports should incorporate the verifiability concept of accounting. The users of the financial reports can verify the accuracy or trueness of the financial statement accounts. For example, the users of financial reports can verify whether the total cash in bank is true by obtaining a bank statement. The users of the financial statement can determine whether the company’s receivables total includes customer’s A’s total receivables balance by calling up customer A and verifying the veracity of the amount shown in the company’s balance sheet financial report (Kieso et al., 2011). Timeliness Accounting Concept. Likewise, the financial reports must obey the timeliness concept of accounting (Kieso et al., 2011). The company must ensure that all accounts are recorded in the time period incurred. Under the accrual basis of accounting, the sales account is recorded in 2012 because the customer received and used the purchased products during 2012. The company should not record the 2012 purchase in 2013, the date when the customer paid for the product bought. Likewise, the company should record the cost of sales amount during 2012, the date of products were bought. Instead, the company must record the cost of sales during 2013, the date when the products are purchased by the company’s current and future customers. Description /Definition Accounting Concept Additionally, the third group of accounting concepts includes description or definition concept of how the financial statement accounts are classified, calculated, and presented. The concept shows that assets include all accounts that are owned by the organization. The assets portion of the entity’s annual reports represents the company’s resources. The resources include cash, accounts receivable, inventory, supplies, land, buildings, office equipment and machines. Further, there are two major types of asset accounts. The first major account is the current asset account. The asset account represents the cash and cash equivalent account. The cash and cash equivalent account represents the coins and paper money collected from the company’s current and future customers. The current asset account represents the receivables account (Alexander, 2008). Furthermore, the receivable account represents the amounts collectible from the customers. To increase sales, companies often grant credit terms to the current and future customers. The customers are granted the credit privilege to pay their purchases at a future date. Consequently, the credit sales account is normally recorded as a debit to accounts receivable or notes receivable. To balance the debit amount, the company credits an equal amount to sales or revenues (Alexander, 2008). Additionally, the company may approve the customers’ notes receivable accounts. Sometimes customers are company risks (Black, 2009). The risky customers are those who may not be able to pay their accounts when the time for receivable collection arrives. Normally customers cannot pay their accounts on time. One of the reasons is that the customer may unexpectedly file for bankruptcy. When this happens, the company may not be able to collect the customers’ liabilities. To ensure payment, customers engage in notes receivable transactions. The customers submit a promissory note to the company. The note is stronger evidence that the customer has a liability to pay the company at a future date. Further, the inventory account represents the balances of stocks found at the end of the accounting period (Kieso et al., 2011). In the merchandising, grocery, restaurant, and other retail establishments, the inventory end represents the quantity of products that are not sold within the accounting period. The office inventory account will represent the quantity of office supplies left during the accounting period. The office supplies include bond paper inventory, pen inventory, stapler inventory and other office supplies. Likewise, the same concept describes revenues as representing the increases in the entities’ economic benefits (Kieso et al., 2011). The benefits may come from cash inflows generated from selling the company’s productions and services. The company income generating activities precipitate to increases in cash, receivables and other asset accounts. The company’s income generating activities can also reduce the company’s current liabilities and other liability accounts. When the company generates a sale, the cost of producing the sales is deducted from the sales amount. The result is classified as the gross profit. To compute net profits, the company deducts the operating and other expense accounts. Further, the same concept of accounting states that expense accounts include all activities that reduce the company’s economic benefits during one accounting period (Black, 2009). The electricity expense account represents the payment of the company use of electric power to run the business operations. The salary expense account represents the amount paid to employees hired by the company. The other expenses are the telephone expense and the transportation expenses. Other Accounting Concepts There are other accounting concepts described in other International Accounting Standards issuances. IAS no. 17 discusses the substance over form accounting concept. IAS no. 17 states the financial statement must record the property as a transfer of property and not as a rent. Initially, the parties recorded the transaction as lease, under the lease concept of accounting (Kieso et al., 2011). When the conditions show that the substance is transfer of ownership and the terms of the contract indicates the parties agreed to a rent or lease, the financial statement prepare the financial statement to indicate a sale (substance) or form (lease or rent). Further, International Accounting Standard no. 18, the substance over form accounting concept also applies (Kieso et al., 2011). The parties agreed to a sale and buy back contract. Initially, the parties recorded the transaction as a sale, under the sales concept. The seller is allowed to buy back the products sold. When the seller buys back the products, the seller generates no gain. Consequently, the sale (form) should be recorded as indicating there was no initial sale (substance). Conclusion Summarizing the above discussion, the accounting concepts assure better financial report declarations. International Accounting Standard no. 1 discusses many accounting concepts. The research includes examples of each accounting concept. Evidently, the Accounting concepts ensure better financial report communication. The research delves on IAS no 1 accounting concepts. The research delves on some accounting concepts found in other IAS issuances. Evidently, accounting concepts ensure communication of universally comparable, understandable, reliable and relevant set of accounts. References: Alexander, D. 2008, International Accounting, CCH Press, London. Black, G. 2009, Introduction to Accounting and Finance, Prentice Hall , London. Epstein, B. 2010, Wiley Interpretation of IFRS, J. Wiley & Sons, London. IASB. 2007, Guide to IFRS, Kluwer, London. Kiesoetal. 2011, Intermediate Accounting, J. Wiley & Sons, London . Kolitz, D. 2009, Concepts Based Introduction to Financial Accounting, Juta Press, London. Morris, G. 2009, Finance Directors Handbook, Elsevier, London. Schutt, A. 2008, Corporate Governance based on IAS/IFRS Accounting, Grin Press, London. Tiffin, R. 2007, Finance and Accounting Handbook, Thorogood Press, London. Read More