INTRODUCTION TO FINANCIAL ACCOUNTING

These notes cover the following areas;

1. Accounting concepts and conventions
2. Accounting standards
3. Qualities of good accounting information
ACCOUNTING CONCEPTS AND CONVENTIONS
Introduction
Accounting has often been called the language of business. It records business transactions,
processes them and communicates information to users in form of the form of final accounts.
In order to make the results understandable by all stakeholders, there should be generally
accepted accounting principles.
Basic Assumptions
The basic assumptions of accounting are like the foundation pillars on which the structure of
accounting is based.
The four basic assumptions are as follows:
1. Accounting Entity Assumption: it is the assumption that a business is distinct and
separate from its owners, creditors and others. All the business transactions are recorded
in the books of accounts from the view point of the business. Even the proprietor is
treated as a creditor to the extent of his capital.
2. Money Measurement Assumption: its the assumption that a business will record only
the transaction that can be measured in terms of money.
3. Accounting Period Assumption: it the assumption that the life of a business can split
into small periods (usually 1 year) so as to assess it performance and financial position.
4. Going Concern Assumption: it is the assumption that the business will operate for the
foreseeable future and that there is neither intention nor the necessity to wind up the
business.
Basic Concepts of Accounting
These concepts guide how business transactions are reported. On the basis of the above four
assumptions the following concepts (principles) of accounting have been developed
(a) Dual Aspect Concept: All business transactions have two aspects - receiving benefit
and giving benefit. For example, when a business acquires an asset (receiving of benefit)
it must pay cash (giving of benefit).
(b) Revenue Realisation Concept: According to this concept, revenue is considered as the
income earned on the date when it is realised. Unearned or unrealised revenue should
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not be taken into account. The realisation concept is vital for determining income
pertaining to an accounting period. It avoids the possibility of inflating incomes and
profits.
(c) Historical Cost Concept: states that assets are recorded at the price paid to acquire
them and this cost is the basis for all subsequent accounting for the asset.
(d) Matching Concept: revenues earned during an accounting period should be matched
with the associated cost result of the business concern.
(e) Full Disclosure Concept: Accounting statements should disclose fully and completely
all the significant information. Based on this, decisions can be taken by various
interested parties. It involves proper classification and explanations of accounting
information which are published in the financial statements.
(f) Verifiable and Objective Evidence Concept: This principle requires that each
recorded business transactions in the books of accounts should have an adequate
evidence to support it. For example, cash receipt for payments made. The documentary
evidence of transactions should be free from any bias. As accounting records are based on
documentary evidence which are capable of verification, it is universally acceptable
Accounting conventions
The term convention is used to signify customs or traditions as a guide to the preparation of
accounting statements. Accounting conventions include;
(a) Prudence/Conservatism: Take into account unrealized losses, not unrealized
profit/gains. Assets should not be over-valued, liabilities under-valued. Provisions are
example of prudence or conservatism concept. Also under this prudence/conservatism
concept, stock/inventory is value at lower cost or market value. This concept guides
accountants to choose option that minimize the possibility of overstating an asset or
income
(b) Full disclosure: Financial statements should provide sufficient or relevant information
to influence users decision making.
(c) Consistency: According to this convention, accounting practices should remain
unchanged from one period to another. For example, if depreciation is charged on fixed
assets according to a particular method, it should be done year after year. This is
necessary for purpose of comparison.
(d) Materiality: The accountant should attach importance to material details and ignore
insignificant details otherwise accounting will be burdened with minute details. Only
items that are deemed significant for a given size of operation
Accounting bases
A basis of accounting can be defined as the time various financial transactions are recorded

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(a) Cash Basis of Accounting : Cash basis recognizes

- revenues when cash is received and
- Expenses in the form of expenditures when bills are paid (focus on cash movement).
(b) Accrual Basis of Accounting: Accrual basis recognizes
- revenue when goods or services have been provided and
- expenses when resources have been used (focus on when revenues are earned or
resources are consumed).
ACCOUNTING STANDARDS
These are authoritative statements of how particular types of transactions and other events
should be reflected in financial statements.
The purpose of a Standard
(a) prescribe concepts that guide the selection, application and disclosure of accounting
policies
(b) require specific disclosure to be made in relation to the accounting policies adopted in
preparing and presenting financial reports.
How does accounting standards add value to financial statements
(a) improving the quality and uniformity of reporting
(b) standardising accounting practice
(c) compelling members of the accounting profession to apply them
(d) having an avenue to cope with the changing accounting environment
(e) Adding to and consolidating accepted conventions and doctrines.
Advantages
(a) It provides the accountancy profession with useful working rules.
(b) It assists in improving quality of work performed by accountant.
(c) It strengthens the accountants resistance against the pressure from directors to use
accounting policy which may be suspect in that situation in which they perform their
work.
(d) It ensures the various users of financial statements to get complete crystal information
on more consistent basis from period to period.
(e) It helps the users compare the financial statements of two or more organisations engaged
in same type of business operation.
Disadvantages:
(a) Users are likely to think those statements prepared using accounting standards are
totally free from errors.
(b) The working rules may be rigid or bureaucratic to some user of financial statement.
(c) The more standards there are, the more costly the financial statements are to produce.

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QUALITIES OF GOOD ACCOUNTING INFORMATION

Accounting information should possess the following qualities before users can rely on it:
(a) Relevance: information is relevant if it can make a difference in a decision.
(b) Reliability: information is reliable if a user can depend on it to represent economic
conditions and events it purports to represent.
(c) Comparability: information is comparable if measured and reported in a similar
manner from period to period
(d) Timeliness: Accounting information is timely if it is made available early enough for its
use.
(e) Objectivity: Information is objectivity if it can be traced to documentary evidence and
complying with required regulations in its presentation. It should not be biased.
(f) Comprehensiveness: Accounting information must contain just enough details for good
understanding. The detail must neither be too little nor too much.

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