Development of Accounting, Functions of Accounting Today, Financial Accounting to External Parties - Essay Example

Course name: Accounting theory Student’s name Lecturer’s name: GD Donleavy 7th June 2011 DOCO14.PDF (Answers) Development of Accounting Accounting can be defined as the system of summarizing, classifying and recording financial data so that economic decisions can be made by the users of the data by relying on the data (Perry and Nöelke, 2005). The development of accounting can be traced back to the use of clay tokens which were used to keep records of animals and goods traded in the market. Accounting has developed to include keeping records of big companies. History has revealed that accounting begun more than 22000 years ago and it has grown from one level to the other throughout history. The rise of trade and agriculture during early civilization made people to start using clay tokens as records of tools, animals, grain and food items which people exchanged with others. Hence, people subtracted or added clay stones every time they exchanged their goods with others as a way of record keeping. Later, in 3000BC the abacus tool for calculating and counting was made by the Chinese and it made accounting simple. Accounting continued to grow in significance because more goods particularly from agriculture were exchanged in large quantities making it hard to count clay stones when goods were exchanged with others. After barter trade, the use of coins started and accounting developed further to include recording of money in books. Hence, single bookkeeping entry started. Increase in money from trade made double-bookkeeping entry to start in order to record big transactions. Luca Pacioli made accounting more formal after by writing a book on how double-entry was to be done. The industrial revolution which is the rise of industries made accounting to be a profession because big transactions were to be recorded. Cost accounting started during the industrial revolution as the owners of the industries wanted to know how to reduce costs of their businesses. The importance of accounting has continued to be experienced even today as more industries and private businesses have started to grow. The need to understand the profits of the industry or the company and the costs or expenses of the industry or the company has seen accounting developed in significance. Main functions of accounting profession today The first function of the accounting profession today is to tell the loss or the profit made by the business. This is done by recording all the transaction that take place in the business. The second function of the accounting profession today is to enable the business owners to know the amount of goods they have sold on credit. This means that accounting profession helps to record those people who have not paid for the goods (debtors) and the goods that the business owner has no paid for (creditors) (Perry and Nöelke, 2005). The third function of accounting profession today is to enable the business to pay tax. This is because the tax is calculated from the business records. The fourth function is to enable the businesses to know how they can increase their profits. Accounting records helps the business owner to know whether to reduce expenses or stop some other trade activities in order to increase profits. As the businesses grow it has many things such as assets and liabilities. Accounting profession helps to know the assets of the business and those things that belong to other people but used in the business (liabilities). Accounting is a product or outcome of regulation It is true that accounting is a product or outcome of regulation because accounting is made up of rules, principles and standards which must be adhered to by every accounting practitioner. In addition, accounting reports must be prepared following the laid down laws, rules and principles otherwise such reports would not be regarded as proper accounting records. In 1938, the New York Stock Exchange (NYSE) said that all disclosures of different companies must adhere to GAAP standards or the General Accepted Accounting Principles which is a standard or principle of accounting that must be followed in every company in America when preparing accounting reports. Further, other countries such as England have also their standards or regulations which guide the way accounting reports are prepared and disclosed to the interested people such as investors or shareholders. Today, there are numerous guidelines which are used in accounting practice and every country has its guidelines on how to perform accounting procedures. The International Financial Reporting Standard (IFRS) is another accounting regulation widely used in many countries. It contains many rules which must be used by accountants when preparing different accounting reports. It is therefore true to say that accounting is a product or outcome of regulation because no single accounting report can be prepared by an accountant without following the accounting regulations or rules and standards within the specific countries of the world. It is important to realize that accounting just like many other professions evolves from one level to the other. In addition, new scandals such as stealing from the company and increasing the salaries of the company directors and chief executive officers without the knowledge of the investors will continue to be seen on daily basis. This means that even after passing the Sarbanes-Oxley Act in 2002 more accounting regulations are needed to deal with new scandals that may be evolving in companies today. For example, the above Act does not involve private companies which mean that new regulations or legislations are needed to provide guidelines on how private companies are managed. It is therefore true that even though the Sarbanes-Oxley Act was passed new regulations need to be formed because fraud and other activities which amount to stealing from companies will continue to be witnessed in the today and in the future and one regulation cannot be used to prevent such crimes. Understanding financial accounting to external parties External parties include the banks, government agencies, prospective investors and the creditors. One of the fundamental “overarching concepts” important for understanding financial accounting to external parties mentioned above is completeness. Completeness means that all information that external parties require in order to make decisions must be provided. This includes all the information about the business activities that have taken place in the year. Completeness means that the accounting statements such as profit and loss account, balance sheet, cash flow statements should be explained in order to ensure that the external parties understand what the accountant has recorded in the above accounts. This means that notes explaining every accounting record should be attached to the records so that external parties can read the notes as they also go through the financial records. For example, the accountant can include notes that explain about the activities that made the business to incur losses or get profit. Hence, completeness is a fundamental concept that would make it possible for the external parties to understand financial accounting. Sustainability reporting Sustainability reporting can be defined as the method of reporting where information about the performance of the organization in the society, the performance of the organization towards the environment and the performance of the organization economically are taken into consideration (Herzig & Schaltegger, 2006). Sustainability reporting should be included to financial accounting because it helps in satisfying the needs of the external parties such as government agencies that deal with environment. For example, when the government agency responsible for the environment sees how the organization has been involved in the protection of the environment then the government agency is satisfied that the organization follows the environment regulations. When the communities discover that the organization has also participated in making the community better through corporate social responsibility (CSR), then the communities are satisfied that the organization supports the members of the society and in return the members of the community supports the organization (Herzig &Schaltegger, 2006). The shareholders are interested in the performance of the organization economically and thus the shareholders get satisfied that their resources are used well in the organization. Hence, sustainability reporting which includes economic, social and environment information should be included in financial accounting. In order to include sustainability reporting in financial accounting, the financial reports should include such issues as the organization’s corporate social responsibility (CSR), dividends that the organization gives to the shareholders and the method of protecting the environment that the organization has used to prevent pollution to the environment. Sustainability reporting is therefore important because it helps to change the image of the organization from negative to positive image when the external parties read how the organization has done to the communities or the society and how the organization has also been careful to protect the environment. It should be include in financial accounting. DOCO13.PDF (Answers) Statements of opinions 1. It is important to know that most adjectives, all values and all judgments are statements of opinion. Again, statements that use the words such as must, should, ought are said to be statements of opinions. a) Canberra is 320 kms from Sydney- This factual claim can be fairly seen as a statement of opinion because it contains the value “320 kms”. This means that the statement is an opinion of the distance one is likely to cover from Canberra to Sydney. b) Depreciation was $1757 thousand for ABD Pty Ltd- Again this statement contains values 1757. Since all values are statement of opinion then this statement is also a statement of opinion. c) Smoking leads to lung cancer- This is a statement of judgement, that is, it judges smoking negatively. Since all judgements are statements of opinion then this I also a statement of opinion. d) Sales revenue for TR Ltd was $4.5 million- All values are statements of opinion. Since this factual statement contains a value “4.5” million then it can be said to be a statement of opinion. e) The fair value of MN’s equipment was 3.6 million after accounting for impairment of 1.2 million- This statement contains the adjective “fair: as well as values such as 3.6 million and 1.2 million. Since, some adjectives such as “fair” and all values are statements of opinions then this statement is an opinion. 2. Given that the consumer index 5 years ago was $250 and last year end was $300 it means that inflation has gone up by 300-250= 50 50/250 x 100 = 20% divided by 5 years = 4% per year. Hence, under CPP XER would cost 100= 234 120=? 120x 234 = $280.8 million 100 234-46 = $188 million due to depreciation Under CCA, XER would cost Sales = 188-46 million Cost = 234 million It would cost = $142 million Under FVA The asset or XER would be reported at the price it would be sold. Hence, under FVA XER would cost $188 million due to depreciation. 3. Heuristic of availability Heuristic of availability is based on how best an example is brought to the mind of the people. b) This exemplifies heuristic of availability because the example of XZC making a bid 4% higher than the one offered results into a prediction of increasing a bid by 5%. c) This exemplifies heuristic of availability in that raising the id by 2% is based on the prediction that the firm acquired by the competitor has similar assets and sales structure. 4. Qualities of good accounting that engender the most trust over time Reliability- This is because the information contained in the financial statements is relied upon by many people to make rational decisions and thus reliability requires that such information be free from bias, errors, and misstatements because availability of such issues would cause great harm to the users and the users would not trust the financial statements again. 5. b) Weighting prospective gains of a few dollars more than prospective losses of the same amount because when people are given an investment in which they can make losses and also they can make gains, people tend to base their choice of the investment on the gains they will make and not the losses they will make. 6. They include environmental, economic and social categories. The social category refers to the manner in which the society and labour benefits from the business practices of an organization or company. The environmental category refers to the manner in which the company adopts environmental regulations and avoid pollution to the environment. The economic category refers to the manner in which the value of the organization in terms of profit affects its trading environment. 7. It helps us understand the enforcement of accounting regulations because the theory is based on the fact that people come together and agree that the rules they form or make will be abiding to all of them without leaving some people or treating some people as superior than others. This means that under social contract theory everybody is bound by the rules they set (Ankerl, 1980). The theory also says that when people make the rules they also accept to perform duties explained in the rules in such a manner that they do not cause harm to others and the rules help to prevent violence among the people bound by the rules (Ankerl, 1980). Accounting regulations are rules formed by the people in the accounting profession and they unite all the accounting professionals all over the world. These rules are supposed to prevent conflicts of accounting processes between countries and every accountant is bound by these rules. 8. PEAD matters in assessing the value relevance of accounting reports because once the accounting report announcement is made the announcement makes the earnings from stock to drift to another direction either for a long period or short period of time (Bernard & Thomas, 1989). Hence, PEAD helps to know in which direction the earnings from stock may drift to once the announcement is made. This also helps to prevent surprises to the shareholders in terms of the earnings they may begin to realize once the announcement of financial reports is made. Hence, if the accounting reports would cause the stock or shares to change in earnings from being profitable to less profitable then PEAD matters because it helps to determine how the prices of the stocks would drift whether low or high (Bernard & Thomas, 1989). 9. The first main criticism of conventional accounting is that conventional accounting makes the accumulation and concentration of wealth to be in the hands of a few members of the society. The second criticism is that conventional accounting uses principles which do not help in distributing wealth equally and thus it is unsuitable for calculations of the wealth of the nation which is supposed to be distributed equally to all the citizens. The third criticism is that conventional accounting has bad and negative effects on the society, environment and also to the members of the society and hence it cannot be used as good method of accounting reporting. 10. a) Clean surplus accounting- it means that the income statement reflects all the changes that are not related to shareholders transactions. b) The market for lemons-this reflects the asymmetry in the information held by the sellers and the buyers particularly when the buyer has less knowledge about the product than the seller (Akerlof, 1970). c) Level 3 fair value- This includes the level where inputs that are not observable are grouped in order to ensure that liabilities and assets are measured fairly when no data from the market is available. d) Decoupling- This refers to the absence of pressure on the environment when an economy grows from one level to the other. e) The debt covenant hypothesis- This is a hypothesis that states that the company’s management would likely to adopt accounting policies that shifts earnings reported into the current period from the future period. References Akerlof, George A. (1970). "The Market for 'Lemons': Quality Uncertainty and the Market Mechanism". Quarterly Journal of Economics (The MIT Press) 84 (3) Ankerl, Guy. (1980). Toward a Social Contract on a Worldwide Scale. Geneva: ILO. Bernard, V., & Thomas, J. (1989). Post-Earnings-Announcement Drift: Delayed Price Response or Risk Premium? Journal of Accounting Research, 27, 1-36. Herzig, C., Schaltegger, S. (2006). Corporate Sustainability Reporting. An Overview, in: Schaltegger, S.; Bennett, M. & Burritt, R. (Eds.) (2006): Sustainability Accounting and Reporting. Dordrecht: Springer, 301-324. Perry, J. and Nöelke, A. (2005). "International Accounting Standard Setting: A Network Approach," Business and Politics: Vol. 7: Iss. 3, Article 5. Read More