Accounting Concepts
Accounting
Accounting is the measurement, processing and
communication of financial information about economic entities such as
businesses and corporations. The modern field was established by the Italian
mathematician Luca Pacioli in 1494. Accounting, which has been called the
"language of business", measures the results of an organization's
economic activities and conveys this information to a variety of users,
including investors, creditors, management, and regulators. Practitioners of
accounting are known as accountants. The terms "accounting" and
"financial reporting" are often used as synonyms.
Accounting can be divided into several fields
including financial accounting, management accounting, external auditing, tax
accounting and cost accounting. Accounting information systems are designed to
support accounting functions and related activities. Financial accounting
focuses on the reporting of an organization's financial information, including
the preparation of financial statements, to external users of the information,
such as investors, regulators and suppliers; and management accounting focuses
on the measurement, analysis and reporting of information for internal use by
management. The recording of financial transactions, so that summaries of the
financials may be presented in financial reports, is known as bookkeeping, of
which double-entry bookkeeping is the most common system.
The history of accounting is thousands of years old
and can be traced to ancient civilizations. The early development of accounting
dates back to ancient Mesopotamia, and is closely related to developments in
writing, counting and money; there is also evidence for early forms of
bookkeeping in ancient Iran, and early auditing systems by the ancient
Egyptians and Babylonians. By the time of the Emperor Augustus, the Roman
government had access to detailed financial information.
Double-entry bookkeeping developed in medieval Europe,
and accounting split into financial accounting and management accounting with
the development of joint-stock companies. The first work on a double-entry
bookkeeping system was published in Italy, by Luca Pacioli. Accounting began to
transition into an organized profession in the nineteenth century, with local
professional bodies in England merging to form the Institute of Chartered Accountants
in England and Wales in 1880.
The professional world of accounting is governed by
general rules and concepts referred to as basic accounting principles and
guidelines. Together, they form the groundwork for the more complicated,
detailed and legalistic rules of accounting.
INTERNATIONAL FINANCIAL REPORTING
STANDARDS
The IFRS Foundation is a not-for-profit, public
interest organization established to develop a single set of high-quality,
understandable, enforceable and globally accepted accounting standards—IFRS
Standards—and to promote and facilitate adoption of the standards.
The International Financial Reporting Standards,
usually called the IFRS Standards, are standards issued by the IFRS Foundation
and the International Accounting Standards Board (IASB) to provide a common
global language for business affairs so that company accounts are
understandable and comparable across international boundaries. They are a
consequence of growing international shareholding and trade and are particularly
important for companies that have dealings in several countries. They are
progressively replacing the many different national accounting standards. They
are the rules to be followed by accountants to maintain books of accounts which
are comparable, understandable, reliable and relevant as per the users internal
or external. IFRS, with the exception of IAS 29 Financial Reporting in
Hyperinflationary Economies and IFRIC 7 Applying the Restatement Approach under
IAS 29, are authorized in terms of the historical cost paradigm. IAS 29 and
IFRIC 7 are authorized in terms of the units of constant purchasing power
paradigm.
IFRS began as an attempt to harmonize accounting
across the European Union but the value of harmonization quickly made the
concept attractive around the world. However, it has been debated whether or
not de facto harmonization has occurred. Standards that were issued by IASC
(the predecessor of IASB) are still within use today and go by the name
International Accounting Standards (IAS), while standards issued by IASB are
called IFRS. IAS were issued between 1973 and 2001 by the Board of the
International Accounting Standards Committee (IASC). On 1 April 2001, the new
International Accounting Standards Board (IASB) took over from the IASC the
responsibility for setting International Accounting Standards. During its first
meeting the new Board adopted existing IAS and Standing Interpretations
Committee standards (SICs). The IASB has continued to develop standards calling
the new standards "International Financial Reporting Standards".
Objective of
financial statements
Financial statements are a structured representation
of the financial positions and financial performance of an entity. The
objective of financial statements is to provide information about the financial
position, financial performance and cash flows of an entity that is useful to a
wide range of users in making economic decisions. Financial statements also
show the results of the management's stewardship of the resources entrusted to
it.
To meet this objective, financial statements provide
information about an entity's:
Assets;
Liabilities;
Equity;
Income and expenses, including gains and losses;
Contributions by and distributions to owners in their
capacity as owners; and
Cash flows.
This information, along with other information in the
notes, assists users of financial statements in predicting the entity's future
cash flows and, in particular, their timing and certainty.
The following are the
general features in IFRS:
Fair presentation and compliance with IFRS: Fair
presentation requires the faithful representation of the effects of the transactions,
other events and conditions in accordance with the definitions and recognition
criteria for assets, liabilities, income and expenses set out in the Framework
of IFRS.
Going concern: Financial statements are present on a
going concern basis unless management either intends to liquidate the entity or
to cease trading, or has no realistic alternative but to do so.
Accrual basis of accounting: An entity shall recognize
items as assets, liabilities, equity, income and expenses when they satisfy the
definition and recognition criteria for those elements in the Framework of
IFRS.
Materiality and aggregation: Every material class of
similar items has to be presented separately. Items that are of a dissimilar
nature or function shall be presented separately unless they are immaterial.
Offsetting: Offsetting is generally forbidden in IFRS.
However certain standards require offsetting when specific conditions are
satisfied (such as in case of the accounting for defined benefit liabilities in
IAS 19 and the net presentation of deferred tax liabilities and deferred tax
assets in IAS 12).
Frequency of reporting: IFRS requires that at least
annually a complete set of financial statements is presented. However listed
companies generally also publish interim financial statements (for which the
accounting is fully IFRS compliant) for which the presentation is in accordance
with IAS 34 Interim Financing Reporting.
Comparative information: IFRS requires entities to
present comparative information in respect of the preceding period for all
amounts reported in the current period's financial statements. In addition
comparative information shall also be provided for narrative and descriptive
information if it is relevant to understanding the current period's financial statements.
The standard IAS 1 also requires an additional statement of financial position
(also called a third balance sheet) when an entity applies an accounting policy
retrospectively or makes a retrospective restatement of items in its financial
statements, or when it reclassifies items in its financial statements. This for
example occurred with the adoption of the revised standard IAS 19 (as of 1
January 2013) or when the new consolidation standards IFRS 10-11-12 were
adopted (as of 1 January 2013 or 2014 for companies in the European Union).
Consistency of presentation: IFRS requires that the
presentation and classification of items in the financial statements is
retained from one period to the next unless:
It is apparent, following a significant change in the
nature of the entity's operations or a review of its financial statements, that
another presentation or classification would be more appropriate having regard
to the criteria for the selection and application of accounting policies in IAS
8; or IFRS standard requires a change in presentation.
Qualitative
characteristics of financial information
Fundamental qualitative characteristics of financial
information include:
- Relevance
- Faithful
representation
- Enhancing
qualitative characteristics include:
- Comparability
- Verifiability
- Timeliness
- Understandability
Elements of financial
statements
The elements directly related to the measurement of
the statement of financial position include:
Asset: An asset is a resource controlled by the entity
as a result of past events and from which future economic benefits are expected
to flow to the entity.
Liability: A liability is a present obligation of the
entity arising from the past events, the settlement of which is expected to
result in an outflow from the entity of resources embodying economic benefits,
i.e. assets.
Equity: Nominal equity is the nominal residual
interest in the nominal assets of the entity after deducting all its
liabilities in nominal value.
The financial performance of an entity is presented in
the statement of comprehensive income, which consists of the income statement
(Statement of Profit/Loss) and the statement of other comprehensive income
(usually presented in two separate statements). Financial performance includes
the following elements (which are recognized in the income statement or other
comprehensive income as required by the applicable IFRS standard):
Revenues: increases in economic benefit during an
accounting period in the form of inflows or enhancements of assets, or decrease
of liabilities that result in increases in equity. However, it does not include
the contributions made by the equity participants (for example owners, partners
or shareholders).
Expenses: decreases in economic benefits during an
accounting period in the form of outflows, or depletions of assets or
incurrences of liabilities that result in decreases in equity. However, these
don't include the distributions made to the equity participants.
FINANCIAL ACCOUNTING STANDARDS
BOARD
The Financial Accounting Standards Board (FASB) is a
private, non-profit organization standard setting body whose primary purpose is
to establish and improve generally accepted accounting principles (GAAP) within
the United States in the public's interest.
Mission
The FASB's mission is "to establish and improve
standards of financial accounting and reporting that foster financial reporting
by nongovernmental entities that provides decision-useful information to
investors and other users of financial reports."
The FASB accomplishes its mission "through a
comprehensive and independent process that encourages broad participation,
objectively considers all stakeholder views, and is subject to oversight by the
Financial Accounting Foundation's Board of Trustees."
Description
The FASB is not a governmental body. The SEC has legal
authority to establish financial accounting and reporting standards for
publicly held companies under the Securities Exchange Act of 1934. Throughout
its history, however, Commission policy has been to rely on the private sector
for this function to the extent that the private sector demonstrates ability to
fulfill the responsibility in the public interest.[12]
History
In 1973 the FASB began their Conceptual Framework
project to develop a sound theoretical basis for the development of accounting
standards in the United States.
In 1984, the FASB formed the Emerging Issues Task
Force (EITF). This group was formed in order to provide timely responses to
financial issues as they emerged. This group includes 15 people from both the
private and public sectors coupled with representatives from the FASB and an
SEC observer. As issues emerge, the task force considers them and tries to
reach a consensus on what course of action to take. If that consensus can be
reached, they issue an EITF Issue and FASB doesn't get involved. An EITF Issue is
considered just as valid as a FASB pronouncement and is included in the GAAP.
On September 18, 2002 in Norwalk, Connecticut the FASB
met with the International Accounting Standards Board (IASB) and together
issued a Memorandum of Understanding on a convergence project. regarding
International Financial Reporting Standards (IFRS) outlining plans to converge
IFRS and US GAAP into in the "development of the highest quality
compatible accounting standards that could be used for both domestic and cross-border
financial reporting." As part of the project, FASB began to move away from
the principle of historical cost to fair value.
In 2006 the FASB—the United States "accounting
standard setter"—implemented SFAS 157 which established new standards for
disclosure regarding fair value measurements in financial statements. Critics argued that it contributed to the
crisis.
In May 2015 the SEC acknowledged that "investors,
auditors, regulators and standard-setters" in the United States did not
support mandating International Financial Reporting Standards Foundation (IFRS)
for all U.S. public companies. There was "little support for the SEC to
provide an option allowing U.S. companies to prepare their financial statements
under IFRS." However, there was support for a single set of globally
accepted accounting standards. The IFRS—a nonprofit accounting
organization—develops and promotes the International Financial Reporting
Standards (IFRSs) through the International Accounting Standards Board (IASB),
which it oversees. For ten years the FASB and IASB collaborated on a
"common objective not only to eliminate differences between IFRS and U.S.
GAAP wherever possible, “but also to achieve convergence in accounting
standards that stood the test of time."
By 2015 FASB and International Accounting Standards
Board (IASB) were again planning meetings after a hiatus of several years. The
United States has little interest in adopting the IFRS standards as was the
original plan in 2002. The US FASB already uses GAAP as a rate regulation
standard.
What is the
difference between GAAP and IFRS?
The standards that govern financial reporting and
accounting vary from country to country. In the United States, financial
reporting practices are set forth by the Financial Accounting Standards Board,
or FASB, and organized within the framework of the generally accepted
accounting principles, or GAAP. More than 100 countries around the world have
adopted the international financial reporting standards, or IFRS, which aim to
establish a common global language for company accounting affairs. While the
Securities and Exchange Commission, or SEC, has openly expressed a desire to
switch from GAAP to IFRS, development has been slow.
Some accountants consider methodology to be the
primary difference between the two systems; GAAP is rules-based and IFRS is
principles-based. This disconnect manifests itself in specific details and
interpretations; IFRS guidelines provide much less overall detail than GAAP.
Consequently, the theoretical framework and principles of the IFRS leave more
room for interpretation and may often require lengthy disclosures on financial
statements. On the other hand, the consistent and intuitive principles of IFRS
are more logically sound and may possibly better represent the economics of
business transactions.
Perhaps the most notable specific difference between
GAAP and IFRS involves their inventory treatments. IFRS rules ban the use of
last-in, first-out, or LIFO, inventory accounting methods. GAAP rules allow for
LIFO. Both systems allow for the first-in, first-out method, or FIFO, and the
weighted average cost method. GAAP does not allow for inventory reversals,
while IFRS permits them under certain conditions.
Types of Accounting
As a result of economic, industrial, and technological
developments, different specialized fields in accounting have emerged.
The famous branches or types of accounting include:
financial accounting, managerial accounting, cost accounting, auditing,
taxation, AIS, fiduciary, and forensic accounting.
1. Financial Accounting
Financial accounting involves recording and
classifying business transactions, and preparing and presenting financial
statements to be used by internal and external users.
In the preparation of financial statements, strict
compliance with generally accepted accounting principles or GAAP is observed.
Financial accounting is primarily concerned in processing historical data.
2. Managerial Accounting
Managerial or management accounting focuses on
providing information for use by internal users, the management. This branch
deals with the needs of the management rather than strict compliance with
generally accepted accounting principles.
Managerial accounting involves financial analysis,
budgeting and forecasting, cost analysis, evaluation of business decisions, and
similar areas.
3. Cost Accounting
Sometimes considered as a subset of management
accounting, cost accounting refers to the recording, presentation, and analysis
of manufacturing costs. Cost accounting is very useful in manufacturing
businesses since they have the most complicated costing process.
Cost accountants also analyze actual and standard
costs to help managers determine future courses of action regarding the
company's operations.
4. Auditing
External auditing refers to the examination of
financial statements by an independent party with the purpose of expressing an
opinion as to fairness of presentation and compliance with GAAP. Internal
auditing focuses on evaluating the adequacy of a company's internal control
structure by testing segregation of duties, policies and procedures, degrees of
authorization, and other controls implemented by management.
5. Tax Accounting
Tax accounting helps clients follow rules set by tax
authorities. It includes tax planning and preparation of tax returns. It also
involves determination of income tax and other taxes, tax advisory services
such as ways to minimize taxes legally, evaluation of the consequences of tax
decisions, and other tax-related matters.
6. Accounting Information Systems
Accounting information systems (AIS) involves the
development, installation, implementation, and monitoring of accounting
procedures and systems used in the accounting process. It includes the
employment of business forms, accounting personnel direction, and software
management.
7. Fiduciary Accounting
Fiduciary accounting involves handling of accounts
managed by a person entrusted with the custody and management of property of or
for the benefit of another person. Examples of fiduciary accounting include
trust accounting, receivership, and estate accounting.
8. Forensic Accounting
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