Financial Accounting

Financial
Accounting
Basics
Prof.Rupali More

ccounting
is
the
process of measuring
and recording the
financial value of the assets
and liabilities of a business and
monitoring these values as
they change with the passage
of time.
The basic concepts of
accounting as we understand
them
today
were
first
published in Italy in 1494 by
Luca Pacioli (1445 - 1517)1.
Pacioli was a Franciscan monk
whose life and work was
dedicated to the glory of God.
A
big
part
of
understanding the financial
side of your business consists
of nothing more than learning
the language of accounting.

Pacioli described the principles

of accounting in a section of his
book on applied mathematics
entitled Summa de Arithmetica,
geometria, proportioni et
Proportionalita.
1

Once you're familiar with basic

terms, you'll be well prepared
to make sense of basic written
reports and better able to
communicate
with
others
about
important
financial
information.

Accounting and
Book Keeping
Bookkeeping- is the tedious
part of the financial affairs of a
business. It involves the
systematic recording of the
amounts, dates and sources of
each revenue and expense
transaction.
Bookkeeping is concerned
with the systems that enable
the financial information to be
extracted in the transactions
that generate revenue and
incur expense in the business.
Accounting is the bigger
picture. It is the system that
keeps track of the data,
including people, and records

the transactions history, as

well as taking the information
that is obtained through the
bookkeeping
process
and
using that information to
analyse the results of the
business, as well as issues such
as taxation.
Some say you should think
of accounting as a giant sifter
and of bookkeeping as the
process of pouring the stuff
into the sifter. Bookkeeping

is essentially the starting

point of the accounting
process. Only with accurate
bookkeeping numbers can
meaningful accounting be
done.
Keeping track of your
business's finances may seem
overwhelming, it's not that
hard when you know the
basics.
Accounting has two basic
goals:

Accounting Basics

Keep track of your income

and expenses, thereby
improving your chances of
making a profit, and
Collect the necessary
financial information
about your business to
know what are your assets
and liabilities.

Sounds
pretty
simple,
doesn't it? And it can be,
especially if you remind
yourself of these two goals
whenever
you
feel
overwhelmed by the details of
keeping your financial records.

An appropriate recordkeeping system can determine

the survival or failure of a
business. Good record-keeping
systems can increase the
chances of staying in business
and the opportunity to earn
larger profits.

While a large inventory

allows goods to be delivered
when they are ordered, too
large an inventory represents
an excess investment. If your
inventory does not turn over
quickly, your business may
lose
profits
due
to
obsolescence, deterioration or
excess investment.

Complete records will keep

you in touch with your
business's
operations
and
obligations and help you see
problems before they occur.

MONITOR INVENTORY

CONTROL EXPENSES

Simple

Accurate

Keep receipts of every

payment to and every
expenditure from your
business.

Timely

Consistent

Understandable

Summarize your income

and expenditure records
on some periodic basis
(generally quarterly or
annually).

Reliable

Complete

Use your summaries to

create financial reports
that will tell you specific
information about your
business, such as how
much profit you are
making or how much your
business is worth at a
specific point in time.

Accounting records furnish

substantial information about
your volume of business, such
as how present and prior
volumes compare, the amount
of cash versus credit sales and
the level and status of accounts
receivable. In addition, good
accounting records help to
accomplish
the
following
tasks.

Whether you do your

accounting by hand on ledger
sheets or use accounting
software, these principles are
exactly the same.
2

Accounting records detail

the amounts owed to suppliers
and other creditors so that you
can plan the availability of
cash to meet your obligations.
Such records also provide
information
regarding
expenditures and allow you to
establish controls over them.
At all times, you must be
aware of your individual
expense requirements and how
they relate to the overall
picture.

The actual process of

keeping your books is easy to
understand
when
broken
down into three steps.

Keeping Records

The following criteria are

essential to a good recordkeeping system:

Importance of Keeping
Good Records

FULFILL PAYROLL
REQUIREMENTS

Payroll is one of the largest

expenses in a small business.
Adequate
payroll
records
should meet the requirements
of
the
government
and
regulatory agencies.

DETERMINE PROFIT
MARGIN

Good accounting records

will indicate a business's level
of profit, and provide specific
information on the profitability
of certain departments or lines
of goods within your business.

Financial Accounting
Such analysis is important to
avoid continuing product lines
far beyond their profitability.
In most cases, you can avoid
losses if you maintain current
records and analyze the
information from your records
on an ongoing basis.

IMPROVE CASH FLOW

Good accounting records

provide detailed reports of
cash availability, both on hand
and in the bank, and of cash
shortages or the diversion of
cash. Since cash is your most
liquid asset, you must carefully
account for it.

USE SUPPLIER DISCOUNTS

A cash budget will provide

the business owner with a
projection of the availability of
cash that may be used to pay
invoices as they become due.
Discounts from suppliers for
prompt payment can amount
to substantial savings. A twoper cent discount is common if
you pay the bill in full within
10 days; if not, full payment is
due within 30 days. In
business, this is commonly
referred to as "2/10, n/30"
where n = the net sum due. It
means you pay 2 percent less if
you pay within 10 days or you
pay full price within 30 days.
Take into account that this
discount is cumulative. If you
make timely payments for each
month of the year you will
gain a 24 percent benefit (2
percent 12 months).

MEASURE PERFORMANCE

Finally,
good
business
records help you measure your
business's performance by
comparing your actual results
with the figures in your budget
and those of other similar
businesses.
Comprehensive summaries
of your business's income and
expenses are the heart of the
accounting process. But they
can't legally be created in a
vacuum.
Each
of
your
business's sales and purchases
must be backed by some type
of record containing the
amount, the date and other
relevant information about
that sale. This is true whether
your accounting is done by
computer or manually.
From a legal point of view,
your method of keeping
receipts can range from slips
kept in a shoe box to a
sophisticated cash register
hooked into a computer
system. Practically, you'll want
to choose a system that fits
your business needs. For
example, a small service
business that handles only
relatively few jobs may get by
with a bare-bones approach.
But the more sales and
expenditures your business
makes, the better your receipt
filing system needs to be. The
bottom line is to choose or
adapt one to suit your needs.

The Accounting Cycle

The accounting cycle can be
described as follows:

A business transaction
occurs, giving rise to an
original document that is
recorded in a book of
original
entries called
a journal.

The totals from the journal

are summarized and
reported
in a book of
accounts, known as a
general ledger.

The general ledger

contains the individual
accounts maintained by
the business.

The individual accounts

are listed in the form of
debits
and credits,
known as the trial balance
of the general
ledger.

From this trial balance,

after making certain
adjustments, you prepare
the business's financial
statements.

JOURNAL

You derive the information

for each journal entry from
original source documents,
such as, sales slips, cash
register tapes, cheque stubs,
purchase invoices and other
items
that
record
your
business transactions. You may
need to create subsidiary
journals for specific, frequently
occurring types of transactions,
such as sales and expenses.

Accounting Basics

LEDGER

The summary and totals

from all journals are entered
into the general ledger. A
general ledger is a summary
book that records transactions
and balances of individual
accounts, and is organized into
five classes of individual
accounts.
An account is a collection of
financial information grouped
according to customer or
purpose. For example, if you
have a regular customer, the
collection
of
information
regarding
that
customer's
purchases,
payments
and
debts would be called his or
her "account." A written record
of an account is called a
statement.

TRIAL BALANCE

At the end of the fiscal year

or accounting period, the
individual accounts in the
general ledger are totaled and
closed.
The
balances
of
the
individual
accounts
are
summarized in the financial
statements.

FINANCIAL STATEMENTS

The main types of financial

statements are the balance
sheet
and
the
income
statement, also known as the
profit and loss statement. The
balance sheet is a report of a
business's financial condition
(assets, liabilities and capital)
at a specific moment in time
and the income statement is a
4

summary of profit and loss for

a specific period of time,
generally a month, quarter or
year. Other statements may be
prepared. For example, a cash
flow statement identifies the
sources and applications of
cash. Statements may also be
prepared
to
indicate
manufacturing expenses or
other special areas that are of
interest to you.

Making Entries in
Books of Account
A completed ledger is
really nothing more than a
summary
of
revenues,
expenditures, and whatever
else you're keeping track of
(entered from your receipts
according to category and
date). Later, you'll use these
summaries to answer specific
financial questions about your
business such as whether
you're making a profit, and if
so, how much.
You'll start with a blank
ledger page (a sheet with lines)
or, more often these days, a
computer file of empty rows
and columns. On some regular
basis like every day, once a
week or at least once a month
you should transfer the
amounts from your receipts for
sales and purchases into your
ledger. Called "posting," how
often you do this depends on
how
many
sales
and
expenditures your business
makes and how detailed you
want your books to be.

Generally speaking, the

more sales you do, the more
often you should post to your
ledger. A retail store, for
instance, that does hundreds of
sales amounting to thousands
or tens of thousands of dollars
every day should probably
post daily. With that volume of
sales, it's important to see
what's happening every day
and not to fall behind with the
paperwork. To do this, the
busy retailer should use a cash
register which totals and posts
the
day's
sales
to
a
computerized
bookkeeping
system at the push of a button.
A slower business, however, or
one with just a few large
transactions per month, such
as a small website design shop,
dog-sitting service or bicycle
repair shop, would probably
be fine if it posted weekly or
even monthly.
To get started on a handentry system, get ledger pads
from any office supply store.
Alternatively,
you
can
purchase
an
accounting
software program that will
generate its own ledgers as you
enter your information. All but
the tiniest new business are
well advised to use an
accounting software package
to help keep their books (and
micro-businesses can get by
with personal finance software
such as Tally). That's because
once you've entered your daily,
weekly or monthly numbers,
accounting software makes
preparing monthly and yearly

Financial Accounting
financial
easy.

reports

incredibly

Preparing
Financial
Statements
Financial
reports
are
important because they bring
together several key pieces of
financial information about
your business in one place.
Think of it this way -- while
your income ledger may tell
you that your business brought
in a lot of money during the
year, you may have no way of
knowing whether you turned a
profit without measuring your
income against your total
expenses. And even comparing
your monthly totals of income
and expenses won't tell you
whether your credit customers
are paying fast enough to keep
adequate cash flowing through
your business to pay your bills
on time. That's why you need
financial reports: to combine
data from your ledgers and
sculpt it into a shape that
shows you the big picture of
your business.
Balance Sheet
The balance sheet is a
"picture in time".
It is a
snapshot of a company's
financial position. The balance
sheet reflects where the
business stands at a given
moment in time.
If a company is to earn
money, it must produce
something to sell and it
must have assets to create that

product or service. To buy the

assets, the company must find
either lenders or investors. The
monies borrowed from lenders
are liabilities. The funds raised
from
investors
are
shareholders' equity.
Accordingly,
liabilities.

assets

ASSETS

Assets
are
economic
resources that are expected to
produce economic benefits for
its owners. Assets can be
buildings and machinery used
to manufacture products. They
can be patents or copyrights
that
provide
financial
advantages for their holder.
Let us begin with a look at a
few of the important types of
assets that exist.
Assets come in many forms.
Broadly, we classify assets in
four categories:

Fixed Assets

Investments

Current Assets

Fictitious assets

Fixed assets are those

tangible assets with a useful
life greater than one year.
Generally, fixed assets refer to
items such as equipment,
buildings, production plants
and property. On the balance
sheet, these are valued at their
cost.
Fixed assets are very
important to a company
because they represent long-

term illiquid investments that a

company expects will help it
generate profits.
Fixed assets are comprised
of
property,
plant
and
equipment, intangible assets
such as goodwill (discussed
soon), investments in other
companies
(e.g.
Coke's
investments in its bottling
companies), and other assets.
Current assets are those
which are expected to be
converted to cash within a
year. Examples include cash,
marketable
securities,
inventories which are goods in
production
but
not
yet
completed, accounts receivable
which are IOUs from buyers,
and prepaid expenses which
are expenses that have been
paid before they are due.

2 LIABILITIES
Liabilities are obligations a
company owes to outside
parties. They represent rights
of others to money or services
of the company. Examples
include bank loans, debts to
suppliers and debts to its
employees. On the balance
sheet, liabilities are generally
broken down into:

Share Capital

Reserves and Surplus

Long-term liabilities
(secured loans and
unsecured loans)

Current Liabilities

Contingent Liabilities

Accounting Basics
Current liabilities are those
obligations that the company
expects to pay within a year.
Current liabilities are those
obligations that are usually
paid within the year, such as
Accounts payable, interest on
long-term debts, taxes payable,
and
dividends
payable.
Because current liabilities are
usually paid with current
assets, as an investor it is
important to examine the
degree to which current assets
exceed current liabilities. The
most pervasive item in the
current liability section of the
balance sheet is Accounts
payable. Accounts payable are
debts owed to suppliers for the
purchase of goods and services
on an open account. Almost all
firms buy some or all of their
goods on account. Therefore,
you will often see Accounts
payable on most balance
sheets.
Long-term liabilities are
made up of long-term debt,
deferred taxes that will not be
paid in the upcoming year, and
the miscellaneous category of
other liabilities.
Shareholders'
equity
reflects
the
investors'
contributions to the company,
both from the sale of stock to
these investors and from the
retention of profits which are
not paid out as dividends.
Specifically, the capital stock
and capital in excess of par
value reflect the amounts
raised from equity offerings,
while the retained earnings
6

reflect the profits reinvested in

the business.

Both approaches lead to a

similar decision.

Profit and Loss Account

Goals of
Accounting

The income statement (or

statement of operations) is
included in the company
reports revenues, costs, and
profits are reviewed
First, there is the money
coming in sales. Then, there
is the money that has been
spent to generate these sales:
for production (cost of goods
sold), for operations (selling,
general and administrative
expenses),
for
borrowed
money (interest expense), for
the right to operate (tax
expense).
Whatever is left over after
the employees, the lenders and
the government have taken
their share is the net income.
This belongs to the investors in
the company, the stockholders.
Dividing the net income by
total
number
of
shares
outstanding determines the
earnings per share (eps).
Both these one-time gains
and this on-going equity
income have fluctuated widely
in recent years, raising the
question of how they should
be viewed by investors.
Although the numbers are
erratic, they shouldn't be
ignored. One approach is to
separate
the
bottling
investments from the basic
business and value them
separately. Another approach
is to treat all income the same.

The American Institute of

Certified Public Accountants
(AICPA) commissioned the
Trueblood Report in 1973: the
Trueblood committee study
group was asked to report on
the Objectives of Financial
Statements.
Trueblood discussed twelve
objectives
of
financial
reporting:

DECISION MAKING.

The basic objective of

accounting in general and
financial
accounting
in
particular
is to provide
information useful for making
economic decisions

PROVIDE INFORMATION

An objective of financial
statements is to serve primarily
those users who have limited
authority, ability or resources
to obtain information and who
rely on financial statements as
their principle source of
information
about
an
enterprises economic activities.

CASH FLOWS

Another objective of
Financial statements is to
provide
users
with
information useful to investors
and creditors for predicting,
comparing and evaluating
potential cash flows to them in

Financial Accounting
terms of the amount, timing
and related uncertainty.

EARNINGS

An objective of financial
statements is to provide users
with
information
for
predicting, comparing and
evaluating enterprise earning
power.

MANAGEMENT ABILITY

An objective of Financial
Statements is to supply
information useful in judging
management's ability to utilize
enterprise resources effectively
in achieving the primary
enterprise goal.

DISCLOSURE

An objective of financial
statements is to provide factual
interpretive information about
transaction and other events
which is useful for predicting,
comparing and evaluating
enterprise
earning
power.
Basic underlying assumptions
with respect to matters subject
to interpretation evaluation
prediction
or
estimation
should be disclosed

DETERMINE FINANCIAL
POSITION

An objective is to provide a
statement of financial position
useful for useful for predicting,
comparing and evaluating
enterprise earning power. This
statement
should
provide
information
concerning
enterprise transactions and
other events that are part of
incomplete earning cycles.

Current values should also be

reported when they differ
significantly from historical
costs. Assets and liabilities
should be grouped and
segregated
by
relative
uncertainty of amount and
timing
of
prospective
realization or liquidation.

FORECAST FUTURE
RESULTS

An objective is to provide a
statement of periodic earnings
useful
for
predicting,
comparing and evaluating
enterprise earning power. The
net result of completed
earnings cycles and enterprise
activities
resulting
in
recognizable progress toward
completion
of
incomplete
cycles should be reported.
Changes in values reflected in
successive
statements
in
financial position should be
reported, but not separately
since they differ in terms of
their certainty of realization.

ENABLE BUSINESS
ANALYSIS

Another objective is to
provide
a
statement
of
financial activities useful for
predicting, comparing and
evaluating enterprise earning
power. This statement should
report mainly on factual
aspects
of
enterprise
transactions
having
or
expected to have significant
cash
consequences.
This
statement should report data
that require minimal judgment

and interpretation
preparer.

by

the

10 FORECASTS
An objective of financial
statements is to provide
information useful for the
predictive process. Financial
forecast should be provided
when they will enhance the
reliability of users predictions.

11 SOCIAL CONCERNS
An objective of financial
statements is to report on those
activities of enterprises that
affect society which can be
determined and described or
measured and which are
important to the role of the
enterprise in its social events.
To a greater or lesser extent,
we can see evidence from
modern Annual reports and
Accounts in the UK that the
recommendations we see here
have found favour in the
accounting profession. Take a
look at any AR&A from any
company you like and see the
extent to which European and
American accountants have
adopted the kind of sentiments
spelled out by Trueblood (and
others).

Accounting Basics

Users of
Accounting
Information
1

SHAREHOLDERS,
INVESTORS AND SECURITY
ANALYSTS

Shareholders, investors and

security analysts have at least
two focus points:

Investment focus with the

emphasis on choosing a
portfolio of securities that
is consistent with the
preferences of the investor
for risk, return, dividend
yield, liquidity and so on.

Stewardship focus in
which the concern of
shareholders is with
monitoring the behaviour
of management and
attempting to affect its
behaviour in a way
deemed appropriate.

MANAGERS

Managers look for a variety

of
information,
including
information relating to their
own incentive contracts.
Managers also use financial
statement information in many
of their financing, investment
and operating decisions.

EMPLOYEES

Employees are interested in

financial
statement
information that helps to
inform
them
about
the
continued
and
profitable
operation of their employer.
8

LENDERS AND OTHER

SUPPLIERS

Many bank loans include

bond covenants that can result
in the bank restructuring the
existing loan agreement: again,
the Enron case is directly
relevant here. One effect of
incorporating such covenants
into the loan agreement is to
create a demand by the bank
for
successive
financial
statements of the business.

CUSTOMERS

Customers, and here we

mean
industrial
and
commercial customers rather
than domestic or high street
customers, have an interest in
monitoring the financial health
of an organisation: a long time
customer says it already has
reduced its orders sharply so
that it doesn't depend on the
company as the single source
for any products is the reaction
that Foster records vis--vis a
business in trouble and its
customers' reaction to that
event.

GOVERNMENT &
REGULATORY AGENCIES

Government
contracting:
paying suppliers on a cost plus
basis, monitoring government
suppliers and their potential
for earning excess profitability
Rate determination: rates of
return that a utility can earn
Regulatory
intervention:
whether a government back
loan guarantee to a financial

distressed organisation needs

support.

Accounting
Concepts and
Conventions
Accounting concepts and
conventions
as
used
in
accountancy are the rules and
guidelines
by
that
the
accountant lives. All formal
accounting statements should
be created, preserved and
presented according to the
concepts and conventions that
follow.

GOING CONCERN

This
concept
is
the
underlying assumption that
any accountant makes when he
prepares a set of accounts.
That the business under
consideration will remain in
existence for the foreseeable
future. In addition to being an
old concept of accounting, it is
now, for example, part of UK
statute law: reference to it can
be found in the Companies Act
1985. Without this concept,
accounts would have to be
drawn up on the 'winding up'
basis. That is, on what the
business is likely to be worth if
it is sold piecemeal at the date
of the accounts. The winding
up value would almost
certainly be different from the
going concern value shown.
Such circumstances as the state
of the market and the
availability of finance are
important considerations here.

Financial Accounting

ACCRUALS

Otherwise known as the

matching
principle.
The
purpose of this concept is to
make sure that all revenues
and costs are recorded in the
appropriate statement at the
appropriate time. Thus, when
a profit statement is compiled,
the cost of goods sold relevant
to those sales should be
recorded accurately and in full
in that statement. Costs
concerning a future period
must be carried forward as a
prepayment for that period
and not charged in the current
profit statement. For example,
payments made in advance
such as the prepayment of rent
would be treated in this way.
Similarly, expenses paid in
arrears must, although paid
after the period to that they
relate, also be shown in the
current
period's
profit
statement: by means of an
accruals adjustment.

CONSISTENCY

Because
the
methods
employed in treating certain
items within the accounting
records may be varied from
time to time, the concept of
consistency has come to be
applied more and more rigidly.
For example, because there can
be
no
single
rate
of
depreciation chargeable on all
fixed assets, every business has
potentially a lot of discretion
over the precise rate it chooses
to use. However, if it wishes, a
business may vary the rates at

which it charges depreciation

and alter the profits it reports
at the same time. Consider the
effects on profit of charging
depreciation at 15% this year
on 10,000 worth of fixed
assets and then charging
depreciation at 10% next year
on the same 10,000 worth of
fixed assets. This year you
would charge 1,500 against
profits and next year it would
be only 1,000, using the
straight
line method
of
providing for depreciation.
Because of these sorts of
effects, it is now accepted
practice that when a company
chooses to treat items such as
depreciation in a particular
way in the accounts it should
go on using that method year
after year. If it is NECESSARY
to change the method being
employed or the rates being
charged then an explanation of
the change and the effects it is
having on the results must be
shown as a note to the
accounts being presented.

PRUDENCE

Otherwise
known
as
conservatism. It is this concept
more than any other that has
given rise to the idea that
accountants are pessimistic
boring people!! Basically the
concept says that whenever
there
are
alternative
procedures or values, the
accountant will choose the one
that results in a lower profit, a
lower asset value and a higher
liability value. The concept is
summarised by the well

known phrase 'anticipate no

profit and provide for all
possible losses'. Thus, undue
optimism can never be part of
the make up of an accountant!
The danger is that if an
optimistic view of profits is
given then dividends may be
paid out of profits that have
not been earned.

OBJECTIVITY

The objectivity concept

requires an accountant to draw
up any accounts, and further
analysis, only on the basis of
objective
and
factual
information. Thus, this concept
attempts to ensure that if, for
example, 100 accountants were
to draw up a set of accounts for
one business, there would be
100
identical
accounting
statements prepared. Everyone
would be obtaining and using
only facts. The problem here is
that there are many aspects of
accounting
ensuring
that
objectivity
cannot
be
universally applicable in the
preparation of accounts. For
example, with fixed assets: the
cost of a van must be known at
its purchase: say 30,000.
However, how long will this
van be in service? I say five
years, my colleague could say
10 years. If I prepare the
accounts using the straight line
method
of
depreciation
calculation, I would provide
30,000 5 = 6,000 each year
for depreciation; my colleague
would charge 30,000 10 =
3,000
each
year
for
depreciation; and both of us

Accounting Basics
could be correct! The problem
is that with an issue such as
depreciation we are not always
able to be objective.

DUALITY

This is the very foundation

of the universally applicable
double entry book keeping
system and it stems from the
fact that every transaction has
a double (or dual) effect on the
position of a business as
recorded in the accounts. For
example, when an asset is
bought, another asset cash (or
bank)
is
also
and
simultaneously decreased OR
a liability such as creditors is
also
and
simultaneously
increased. Similarly, when a
sale is made the asset of stock
is reduced as goods leave the
business and the asset of cash
is increased (or the asset of
debtors is increased) as cash
comes into the business (or a
promise to pay is made and
accepted).
Every
financial
transaction behaves in this
dual way.

ENTITY

Otherwise known as the

'accounting entity' concept.
The idea here is that the
financial transactions of one
individual or a group of
individuals must be kept
separate from any unrelated
financial transactions of those
same individuals or group.
The
best
example
here
concerns that of the sole trader
or one man business: in this
situation you may have the
10

sole trader taking money by

way of 'drawings': money for
his own personal use. Despite
it being his business and
apparently his money, there
are still two aspects to the
transaction: the business is
'giving' money and the
individual is 'receiving' money.
So,
the
affairs
of
the
individuals behind a business
must be kept separate from the
affairs of the business itself.

COST

This concept is based on the

notion that only the costs paid
to acquire an asset are relevant
and thus should be the only
costs to be shown in the
accounts. For example, fixed
assets are shown on the
balance sheet at the price paid
to acquire them; that is, their
historic cost less depreciation
written off to date.
There is a problem in this
area. That is the one of value.
The accountant will rarely talk
of value in this context since
the use of such a term implies
personal bias. After all, the
value of an asset as far as I am
concerned may be different to
the value of the same asset as
far as you may be concerned.
The application of the cost
concept ensures that subjective
judgements play no part in the
drawing up of accounting
statements.

MONETARY
MEASUREMENT

The money measurement

concept is one of the simpler
concepts. It simply and clearly
states
that
only
those
transactions that are true
financial transactions may be
accounted for. That is, only
those transactions that may be
expressed in money values
(whatever the currency) are of
interest to the accountant.

10 MATERIALITY
We are concerned here with
the idea that accountants
should concern themselves
only with matters that are
significant because of their size
and should not consider trivial
matters. The problem, of
course, is in deciding what is
and what is not material: we
are concerned here with
RELATIVE IMPORTANCE. As
far as an individual is
concerned, the loss of a 10
would be important and
MATERIAL. As far as Chevron
or
Barclays
Bank
are
concerned, the loss of 10
could
be
considered
unimportant
in
many
circumstances and therefore
immaterial: please note I am
not suggesting that fraud or
carelessness in the handling of
money is acceptable!!

11 REALISATION
The realisation concept
helps the accountant to
determine the point at that he
feels that a transaction is

Financial Accounting
certain enough for the profit to
be made on it to be calculated
and taken to the profit and loss
account. Realisation occurs
when a sale is made to a
customer. The basic rule is that
revenue is created at the
moment a sale is made, and
not when the account is later
settled by cheque or by cash.
Thus, profit can be taken to the
profit and loss account on sales
made, even though the money
has not been collected. The sale
is deemed to be made when
the goods are delivered, and
thus profit cannot be taken to
the profit and loss account on
orders received and not yet
filled. An exception to this rule
would be a long term contract
that involve payments on
account before completion of
the work.

12 STABLE MONEY
Normal or historic cost
accounting
assumes
that
transactions occurring over a
period of time can be
measured in terms of a single,
stable measuring unit eg
Pounds, Dollars ... This means
that, in the UK, all accounts
are drawn up in Pounds; and
this year's balance sheet can be
compared with last year's
balance sheet. Consequently, if
fixed assets brought down
from last year were 1,000 and
a further 500 of fixed assets
were bought during this year,
we would say fixed assets
carried down from this year
were worth 1,000 + 500 =

1,500. All of this gives rise to

consistency but there is a
problem with reality inflation
means that very few currencies
are truly stable.
Many attempts have been
made at solving this problem,
incidentally, but, in the UK, for
example, all efforts have
proven useless. The only really
meaningful
accounting
directive ever enacted on this
subject was withdrawn by the
accounting bodies in the UK
several years ago.

CONCLUSIONS
These, then, are the basic
concepts and conventions on
which the accountant bases all
of his accounting work. We can
see evidence of such work in
the published annual reports
and accounts that all publicly
quoted companies are required
to prepare and publish. The
concepts and conventions also
apply to the millions of
businesses world wide that do
not publish their accounts.
When we look at the work
of an accountant we can see
evidence that he has followed
these
concepts
and
conventions: we will see
accrued expenses, we will see
that there is a statement to the
effect that the accounts have
been drawn up on the basis of
the going concern concept
and so on.
There are problems with
these
concepts
and

conventions, however, in that

some of them conflict with
each other. For example,
money
measurement
and
materiality
can
conflict,
consistency and materiality
can conflict.

Double Entry
System
The double entry system is
the standard system used by
businesses
and
other
organizations
to
record
financial transactions. Since all
business transactions consist of
an exchange of one thing for
another,
double
entry
bookkeeping using debits and
credits, is used to show this
two-fold effect. Debits and
credits are the device that
provide the ability to record
the entries twice and are
explained in more detail later
in this tutorial.
The double entry system
also has built-in checks and
balances. Due to the use of
debits and credits, the doubleentry system is self-balancing.
The total of the debit values
recorded must equal the total
of the credit values recorded.
This system, when used along
with the accrual method of
accounting, is a complete
accounting system and focuses
on the income statement and
balance sheet. It got its name
because each transaction is
recorded in at least two places
(accounts) using debits and
credits.