Importance of a Financial Management - Essay Example

? Financial management Introduction Accounting is a systematic way of recording financial transaction, analysing them and then reporting them. It is a record where all business transactions/ activities are recorded. In accounting, the information regarding a certain business organization is recorded and can be presented to other parties who could need it. Among the people who could be interested with the records also referred to as the financial statement include; shareholders, creditors, investors as well as the directors among others. The financial statement contains important information that can be used in decision making (Stickney, 2010). They should who the business is currently progressing and how it is likely to perform in the future. Accounting has its objectives which it is supposed to fulfil. In order to fulfil these objectives, there are concepts and conventions that have to be followed and adhered to. This essay describes ten accounting concepts citing practical examples for each concept. The essay will distinguish between the concepts which are contained in IAS1 from those that are not contained in the IAS1. IAS1 accounting concepts Consistency The first concept of accounting is the consistency. The accounting records should be consistent. The financial statements of one financial year should be consistent with the financial statement of another financial year (Stickney, 2010). They should be easily comparable. There are instances where the methods used in the preparation of financial statement of a certain year are changed in the next financial year hence it becomes difficult to compare the two. This should only be done when the reason is very genuine and satisfactory. Otherwise, the methods should always be similar. A good real life example of the consistency concept is that of a company that uses straight line method in computing depreciation of assets. In all the subsequent years, straight line basis should be used in the computation. This will enable the comparison of depreciation in various financial years. Going Concern Under this concept, it is assumed that an entity should continue to operate for an indefinite period. Recording of assets in the financial statement should be on the basis of original costs rather than the market value (Stickney, 2010). In addition, the concept assumes that the assets will be useful in the business for an indefinite period of time. The idea is that there is no intention to sell the assets in the foreseeable future. In preparing the financial statement, the management is supposed to keep in mind that the business will be in operation for a long period of time and in case there are any plans that there are some assets which will be liquidated in the near future, disclosures should be made on the statements. A real life example of a going concern is where a business is being sold to another person. The business will be sold with all its operations, liabilities and assets as they were under the ownership of the previous owner. Nothing should be changed since under the going concern concept, the business is expected to continue as it is indefinitely. Accrual basis It is the requirement under IAS1 that the financial statements of a business entity should be prepared on the accounting accrual basis (Stickney, 2010). Only the cash flow is exempt from this requirement. This means that revenue is supposed to be recorded in the time it was earned. It does not matter when the money or the earnings will actually be received. In the case of expenses, they should be recognized in the year they were incurred and the time they have actually been paid does not matter. For instance, if the business issues goods on credit in a certain financial year, this transaction should be recorded in the financial statement of that year even if the money is to be received in subsequent year(s). Materiality In a business, there are transactions which have the ability to affect the decision making of the management (Stickney, 2010). Such transactions are referred to as material and they should be recorded carefully with no errors. In the others which have no major effect on decision making there is a provision for error. For instance, when recording depreciation of a fixed asset, it might affect the decision of the management in that when the economic life of the asset expires, the management might decide to buy a new asset. Therefore, depreciation should be recorded correctly. Concepts not in IAS1 Business entity A business entity and the owner are two different entities. The two should not be treated in a similar manner. In other words, a transaction that is made by the business owner in regard to his or her own personal interests should not be included in the financial statement of a business and vice versa (Stickney, 2010). The only transaction by the owner that can be included in the books of accounts is withdraws from the business or additions to the business. In the case of a company, the concept is even broader since the company is treated a ‘human being.’ A real example of this concept is the case where the owner of the business pays school fees for his or her children. This is an expense to him and cannot be shown in the business books of accounts. Monetary Unit Monetary units should be used to record all business transactions. The transactions should also be reported in this form. It is assumed that all the items that appear in the financial statements can be measured in monetary form (Stickney, 2010). However, there are some items which are not measurable in monetary units. In case of such items, they cannot be recorded in the books of accounts. Instead, a memorandum is written to record the units and report them. For instance, an asset like a vehicle is recorded in its monetary unit. For example a car worth $2000 is recorded as car on the items column and $2000 on the cash column. Accounting Period A business reporting should be done for a given period of time. The period could be one month, one year, half a year or even quarterly year. In case the business period is recorded for one year, that year is referred to as the financial year (Stickney, 2010). It is not the same as the calendar year in that the financial year can start on any month and run for twelve month. For instance, a business financial year might run from July of one calendar year to July of the next calendar year making twelve months. The financial report for such a business should be prepared as at July of every calendar year. Prudence Concept This concept is also referred to as the conservative concept. It cautions the accountants against overstating or understating financial statements items. An accountant is not supposed to overstate the assets and incomes of the business and understate the expenses and liabilities (Stickney, 2010). The effect of such an act will lead to exaggerated profits which might be misleading to the users of the financial statements. They will give the wrong indication about the performance of the business. In other words, the business organization should not record an asset at an amount that is higher than the amount that it expects to receive in case it sold the asset today. On the other hand, a liability should not be recorded on a mount that is lower than the exact amount that would be paid in case the liabilities are to be paid today. For instance, inventory should be recorded at the net realizable value (i.e.) the value that would be realized if the asset is sold. Matching concept Under this concept, it is expected that each entry in the books of account should have a corresponding matching entry. It applies mostly in the case of revenues and expenses. If revenue is recorded for a given financial period, there should be an expense that is equivalent recorded for the same period (Stickney, 2010). This is important since it indicates the exact profit that the business has made during that period. For instance, any cost that is incurred during the manufacture of goods should be indicated in the financial statement of the period in which it is sold. In case there is unsold goods that remain at the end of the year, their values are not included in the financial statement of that period. Realization concept Under this concept, if the market value of an asset changes, the change cannot be recognized in the books of accounts until the asset is sold (Stickney, 2010). In case of a liability, a change in the market value will only be recognized it the liability has been paid. In increase in the value of an asset will be recognized as a profit while an increase in the value of a liability is recognised as a loss. Revenue will only be realized when the asset has been sold. For instance, if a company receives an order to deliver a vehicle and is paid 25% in advance; the company then delivers the car after two weeks and is paid the remaining 75%, the revenue will only be realized when the car has been delivered. Conclusion Accounting is a professional whereby the accountant has to follow certain concepts. Accounting refers to the recording of business transactions in a systematic way and reporting them. Accounting concepts are categorized into two; those in the IAS1 and those that are not in IAS1. The concepts give guidance to the recording of the transaction and aid in making them acceptable worldwide. Reference List Stickney, C. P. 2010, Financial accounting: An introduction to concepts, methods, and uses, South-Western/Cengage Learning, Mason, OH. Read More