The conceptual framework that underlies accounting principles
Introduction
The framework of accounting majorly covers the establishment of accounting principles. The fundamental characteristics, as well as the objectives systems provided within the framework, create the financial accounting principles that are useful to the end user. With the help of good judgment, these broad conceptual frameworks permit the accounting principles with the arguments for preliminary accounting management of new form of transactions. For instance, revenue associated with the sale of products on the internet didn’t exist during the dot-com escalation as the companies started to market their products on the internet. For that reason the existence of a conceptual framework that facilitated the definition of the fundamental assumptions of financial accounting dimension, rational accounting treatments can be followed while regulation created.
Some general standards and ideas oversee the accounting field. These general set of laws – applied to as crucial accounting guidelines and standards – form the core on which more complicated, comprehensive as well as authorized accounting guidelines are established.
Objectives of accounting concepts
The recording of nearly all business transaction shaped by the financial accounting principles in the business world. Sometimes the creation of these principles is almost arbitrary and seems no small task. Nonetheless, understanding the objectives of proper accounting rules gives knowledge into how these standards are made and make it simpler to remember them.
The main objective of financial reporting and establishment of accounting principle is to assist investors as well as potential creditors in making credit and investment decisions. Creditors and investors are comfortable that the transactions are accounted for in a similar manner, by having companies in a particular business area or industry follow a standard set accounting principles.
Financial statement users also benefit from financial accounting principles and statements as they can assess the uncertainty, amount as well as the timings of cash flows in the future. Unlike the financial accounting information which involves the recording of historical activities, accounting principles provide guidelines for portraying information about future cash flows. For instance, to provide information regarding a company’s sources as well as uses of cash, companies are required to a statement of cash flows as a major financial statement. This assists the financial users to determine if the rise in cash are as a result of investment in the company, operation or investing activities. Therefore, financial statement may perhaps be necessary for an investment decision.
Financial reporting and financial accounting principles are also beneficial to provide information regarding the economic resources of a company as well as any claims to the resources by other parties. Disclosing of all debts owed to other parties would not be in the best interest of a company seeking credit if it would not have been without the requirement of the accounting principles. Therefore, it is mandatory for organizations to record all liabilities owed to others. Additionally, financial statement users are allowed to make implication regarding the changes in the amounts owed to other companies as well as those owed to the company by the accounting principles the entail simultaneous presentation of numerous years of financial statements.
Accounting Concepts
There are for major concepts of accounting that are used to record transactions. These includes full disclosure, matching, revenue recognition and cost principle. These policies are categorized as conventions and concepts. These are the basis of preparing and maintaining of bookkeeping. Accountants are not inherently required to abide by the rules, but the policies should be stuck to as tightly as possible as they set values that should be met to ensure suitable comparability, accounting activity as well as understandability of the accounting data for various businesses. Below are the four major accounting concepts and a brief explanation.
Cost-Benefit Principle
The cost benefit concept implies the benefit of financial data to the users must not be outweighed by the value of providing financial data within the financial statements. This clearly shows that financial information is not free. Millions of dollars are spent each year in gathering as well as organizing financial information by companies to assemble into financial statements. Ideally, creditors and investors would like to know each piece of information concerning a company as possible. Sadly, this level of disclosure would place a massive financial trouble on the company. The cost-benefit concept is a common sense law.
Matching Principle
Matching concept is one of the essential principles of accounting. When it comes to matching principle, a company is obliged to record all the expenses related to its expenses within the earned period. Therefore, matching principle is at the focal point of accrual basis of accounting.
Since the net earnings are computed by deducting daily expenditure from revenues, it is vital to match expenses with revenue. The net earnings for a particular period may either be overvalued or undervalued if the daily expenditure is not appropriately documented in the right period, and so is the balance sheet balances related.
The difference between the cash basis of accounting and the accrual basis of accounting arise from matching principle. In spite of the actual payment of money for expenses as well as the actual receipt of cash from revenues, revenue and expenditures recognition is required.
Management of a company expected to apply the judgment to estimate the amount and timing of revenues and expenses, to implement the matching concept. Prudence principle, which is a related accounting theory, requires companies not to undervalued costs, overvalued revenues, overvalued assets as well as undervalued liabilities.
Full Disclosure Principle
The full disclosure concept states that information that would be valuable in decision-making or would have an effect on financial statement users should be revealed in the financial statements. This way creditors or investors can see a whole picture of the company before they choose to take any action.
The non-financial and financial information in the financial statement is as a result of the guide from full disclosure concept used by companies. The full disclosure concept states that the information disclosed should be understandable as well as make a difference to the financial statement users.
This information is can either be disclosed in the footnotes of the additional data or the balance sheet. Notes of the financial statements mostly enlighten the information presented in the main part of the report. The remarks are mostly used to enlighten an unclear entry on the profit and loss account. For example, explanations of contingencies and lawsuits might be mention in the footnote as well as accounting methods used for inventory.
On the other hand, companies use supplemental information as extra information to show potential investors. This information is often not very reliable but usually relevant. For example, in the supplemental information, the management might include the company’s financial position as well as its analysis of the financial statements.
These disclosures would be substantial for creditors, investors as well as other readers of the financial statement to appropriately view company’s overall financial position; even though, bad accounting can be made any amount of disclosures. Companies can’t be negligent with their financial records and disclose everything.
Revenue Recognition Theory
A critical query for some ventures is when returns should be recognized. Income is recognized when earned as well as when realized or realizable. This method has frequently been termed as the revenue recognition theory. When assets, products (goods or services), or merchandise are claimed for ready money or exchanged for ready money, profits are realized. When property held or received are easily claimed to ready money or readily convertible into money, the returns are deemed achievable. When assets are interchangeable or easily converted to money in a dynamic market at am the easily established price with no major extra charges, then they are easily convertible.
Characteristics of accounting data
When the financial reports are generated by the qualified experts, a certain level of expectation should be attained: the information should be verifiable, objective as well as reliable, the information should be consistent, and finally the information should also be comparable.
Verifiable, Reliable, and Objective
Accounting information should be verifiable, reliable as well as objective.
Verifiability is demonstrated when similar a result is obtained using similar measurements methods by independent measurers. For instance, would the same conclusion be reached about a set of financial statements by several independent auditors? The statements are deemed not verifiable when external parties using similar measurement techniques arrive at distinct conclusions.
Reliability: The information is deemed reliable when it is an accurate representation, verifiable, and is sensibly free of bias as well as error. Reliability is essential for persons who possess neither the expertise nor the time to appraise the accurate content of the information.
Consistency
The consistency concept of accounting refers to the principle that same accounting methods should be used by a company to record the same transactions over time. This means that companies should not leap amid accounting treatments as well as rules to influence any financial statement component or profits. Therefore, accounting techniques should be consistently used.
Consistency in accounting refers to the value of accounting data since it permits the customer or client to realize as well as evaluate financial statements. For instance, if a company alter accounting treatment every single year for their accounts receivable, comparing the receivable balances for the current year with the prior year would be difficult. Because each year would not be compared, each year follows clear rule or standard. This implies that both trend analysis, as well as ratio analysis, would not be accessible for creditors as well as investors to aid estimate the company’s present performance.
Comparability
It is a value of accounting data that deals with the utilization of financial data. Information reported in a similar fashion and is prepared using similar measurement techniques is considered comparable since it is the same and can be criticized sided by the side with other related financial data.
This is hugely significant to the financial statements client or customer. What good are they for if the other statements can’t be compared with financial statements? Comparing year to year performance of the company’s performance won’t be possible let alone two opponents’ balance sheets. Without the ability to benchmark as well as compare the books of accounts, the accounting data would be worthless.
Financial ratios wouldn’t exist if not for the concept of comparability. Comparing two companies’ financial data with ration analysis would be impossible since their financial data would not be compatible.
Lenders, investors, and other users expect that financial statements of companies within the same industry be compared. Comparability between the financial statements of various companies happens within the accepted accounting concepts.
Basic Assumptions
There the following are the major assumptions of the book keeping structure: going concern, economic assumption, the monetary unit as well as periodicity assumption.
Economic Assumption
The economic assumption implies that economic activity can be renowned with a specific unit of liability. The activity of a venture, for instance, can be distinctively and separately kept from any other business ventures and its owners.
The isolation of activities between given business enterprise does not solely apply. If we opt to describe the entity in this way, an entire industry, a department or division, and an individual could be deemed a distinct entity. Thus, the entity concept doesn’t refer to a lawful unit.
Subsidiaries and a parent are a separate lawful unit, but assimilating their dealings for reporting as well as accounting purposes doesn’t infringe the economic unit assumption.
The Going Concern
The assumption that the entity will have an extended life is depended on by most accounting methods. Experience indicates that companies have a quite high continuance rate, in spite of frequent business failures. Even though accountants don’t believe that entities will last forever, they do anticipate them to survive long enough to accomplish their commitments and objectives.
The insinuation of this theory is intense. The chronological cost concept would be of inadequate value if ultimate insolvency were assumed. Under a bankruptcy approach, for instance, asset values are more declared at net attainable price than at acquisition value. Amortization and depreciation policies are appropriate and justifiable only if we suppose a little permanence to the entity. If a liquidation method were embraced, the current and the noncurrent categorization of the assets, as well as the liabilities, would lose a lot of its importance. Classifying anything a long-term or fixed asset would be hard to justify. Certainly, the priority recording of liabilities in bankruptcy would be more sensible.
The assumption of the going concern is relevant mainly business circumstances. The assumption is inapplicable where liquidation appears imminent. Revaluation of assets as well as liabilities, in this case, provides data that closely estimates the business net realizable cost.
Monetary Unit Assumption
The monetary unit states that wealth is the familiar denominator of activities in the economy thus provides a suitable foundation for accounting analysis as well as measurement. The assumption implies that changes in the capital, as well as trading of goods and services to interested parties, are most effectively expressed in the monetary entity. The monetary entity is simple, universally accessible, significant, useful, as well as understandable. The basic assumption is that quantitative facts are valuable in communicating economic data as well as in making sensible decisions in line with the economy.
Periodicity Assumption
The measure of the results of enterprise activity is mostly accurate when measured at the point of the enterprise’s eventual liquidation. Investors, governments, business as well as various other user groups, on the other hand, can’t wait that long for such information. Therefore, economic and performance status need to be apprised on a timely basis to compare as well as evaluate firms, and undertake the suitable actions. Hence, periodic reporting of information is mandatory.
Time period (or periodicity) assumption implies that the enterprises’ economic activity can be separated into non-natural periods. These periods are commonly monthly, quarterly as well as yearly though vary.
It is more difficult to establish the appropriate net earnings for the period when the time period is shorter. A year’s results are likely to be more reliable that quarter’s results and a quarter’s outcome are likely to be more dependable that a month’s results. Although the quicker the information released, the more likely it is subject to flaws, investors demand and desire that information be swiftly processed and disseminated.
The time period definition is increasingly becoming a problem and more critical since products phases are shorter and become outdated more rapidly. Many think that real-time financial information with more online technology advances need to be offered to ensure that relevant information is available.
Conclusion
In conclusion, the conceptual framework majorly covers the establishment of accounting principles. These general set of laws – applied to as crucial accounting guidelines and standards – form the core on which more complicated, comprehensive as well as authorized accounting guidelines are established. The fundamental characteristics, as well as the objectives systems provided within the framework, create the financial accounting principles that are useful to the end user. With the help of good judgment, these broad conceptual frameworks permit the accounting principles with the arguments for preliminary accounting management of new form of transactions. For instance, revenue associated with the sale of products on the internet didn’t exist during the dot-com escalation as the companies started to market their products on the internet.
Financial statement users also benefit from financial accounting principles and statements as they can assess the uncertainty, amount as well as the timings of cash flows in the future. Unlike the financial accounting information which involves the recording of historical activities, accounting principles provide guidelines for portraying information about future cash flows. Financial statement users are allowed to make implication regarding the changes in the amounts owed to other companies as well as those owed to the company by the accounting principles the entail simultaneous presentation of numerous years of financial statements.
Reference: The conceptual framework that underlies accounting principles essay
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Gretchen Morgenson(2001), “Expert Advice: Focus on Profit,” New York Times, section 3, 14
Reed K. Storey and Sylvia Storey (1998), Special Report, The Framework of Financial Accounting and Concepts, 85–88.
William C. Norby (1982), The Financial Analysts Journal , 22.