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Terms
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- Accounting entity
- The financial affairs of the busines are separate and distinct from that of the owner and other entities. Therefore the financial statements only include assets, liabilities, income and expenses of an entity
- Application of Accounting entity
- For example, taking goods home is recorded as drawings, not a business expense as the owner's personal transactions/personal use must be kept separate from business transactions
- Monetary
- In order to report an item in accounting we need to assign a dollar value to it. All transactions, assets, liabilities, expenses, incomes and equity are recorded in NZD amounts (in same currency)
- Application of Monetary
- Therefore if a transaction cannot be given in NZD amounts, it will not be recorded in the financial statements. For example, the number of years a business has been trading, the quality of staff will not appear in the financial statements of the business
- Going Concern
- It is assumed that the business will continue its present operations into the foreseeable future
- Application of Going Concern
- Management has no intention of liquidating or has identified any circumstances for the entity to stop trading; if such an intention exists it needs to be disclosed in the financial statements
- Period Reporting
- In the case of a going concern, in order to provide timely information it is assumed that the entities economic activity can be divided into nominated time periods
- Application of Period Reporting
- It is necessary in order to measure profit or financial performance and financial position on an regular basis. The business owner can't wait until the business ends to see if s/he has made a profit when the business is not planning to end in the foreseeable future.
- Accrual Basis
- The effects of transactions are recognised when they occur and reported in the financial statements of the periods in which they relate
- Application of Accrual Basis
- The amount owing for sales wages will be added to the sales wages expense reported in the income statement for this period as this amount relates to this period. The amount owing for sales wages will be reported in the as Accrued Expenses, a current liability in the Balance Sheet on balance day because this represents a future outflow of economic benefits as the wages must be paid. The amount owing for dividends received will be added to the dividends received income reported in the income statement for this period as this amount relates to this period. The amount owing for dividends received will be reported as Accrued income, as current asset in the balance sheet on balance day because this represents future economic benefits as the shares are owed by the entity who is entitled to receive the divident
- Historical Cost
- All transactions are recoded at the amount of cash paid or payable at the time of the transaction
- Application of Historical Cost
- All PPE are recorded at their purchase price and not their current market value as this price can easily be confirmed though source documents Eg: invoice for purchase of equipment
- Relevance
- Information is relevant when it influences the economic decisions of the users
- Relevant information influences decision making by having a:
- Predictive role- Information must be helpful in making predictions about the future. Budgets are a good example of having a predictive role as they are used to help us form predictions about what is likely to happen in the future Eg: expected income to be received. Confirmatory role- Must tell us something about the accuracy of earlier expectations. Budgets again are good as a tool to show confirmatory role as the actual results need to be compared to the budgeted results. Eg: Expected income is compared to actual income received Material influence- An item is considered to be material if it is of such nature or size that it is likely to influence users of financial reports in making decisions
- Application of materiality aspect of relevance
- During the year a business purchased $10,000 of stationary. on balance day it had $50 unused. Technically this $50 of stationary is an asset and should be recorded as such. However, since the amount of $50 is too small compared to the total assets to influence users' decisions it is expensed this year. This this because the $50 is not material in size when compared to total assets and is therefore not relevant in users decision making
- Reliability
- Information is reliable when it is free from error or bias and be depended upon by users to faithfully represent that which it is expected to represent
- Reliable information must be:
- Representationally faithful- The information corresponds to the underlying transactions, so the reports are stating the truth. Source documents provide faithful representations as they provide proof of the amount reported and that the transaction has taken place Neutral- The information is free from bias. If the owner prepares their own accounts then they are probably not going to be neutral as the owner will attempt to make their business appear better than it is
- Understandability
- Information is understandable when the users might reasonably be expected to comprehend its meaning. It is assumed that uses have some reasonable knowledge of accounting, the business'activity and the environment in which it operates.
- Comparability
- Information in a financial report is comparable when users are able to identify similarities and differences between that information and information in other reports. Comparisons are made between different entities and of the same entity over different time periods. For reports to be comparable, the user must be informed of the accounting policies used. If reports of the same entity are to be compared they must be prepared on a consistent basis. This means that the same methods and time period are followed from year to year. Any changes must be disclosed in and the effects of the changes are also disclosed