Accounting concepts/conventions and policies

1. Accounting concepts/conventions and policies • Always on the exam!! MCQ?

2. Background / development • Accounting practice has developed over hundreds of years • Certain practices have developed over time….”concepts”…now “conventions” • The “statement of principles” operates alongside them

3. The Financial Reporting framework consists of 2 elements • The conceptual framework • Generally accepted accounting practice (rules and regs!)…ACCOUNTING STANDARDS

4. Accounting concepts / conventions can be viewed as ideological practices that have developed over time that underpin accounting They help determine which transactions are recorded and how.

5. Accounting Concepts / conventions • Business Entity • Duality • Money Measurement • Realization • Substance over form • Prudence • Consistency • Matching (Accruals) • Going concern

6. Important Concepts • SSAP 2 described 4 concepts as “Fundamental” • Going Concern • Consistency • Prudence • Accruals

7. Important Concepts • FRS 18 replaced SSAP 2 in Dec 2000 • Emphasises 2 particular concepts • Going Concern & Accruals • Prudence & consistency merely “desireable” elements of statements

8. Advantages of a Conceptual Framework • Move away from ‘fire fighting’ • Avoid inconsistencies between standards • Determine how profit should be measured • Reduce number of standards, emphasis on principles • Combat interference, justify procedures

9. ASB’s Statement of Principles (1999) Finally published in March 1999. Principles that should underlie the preparation and presentation of financial statements. True and fair view important.

10. 8 chapters in S.O.P: 1 The objectives of financial statements 2 The reporting entity 3 The qualitative characteristics of financial information 4 The elements of financial statements 5 Recognition in financial statements 6 Measurement in financial statements 7 Presentation of financial information 8 Accounting for interests in other entities The first 4 are the most important for 1.1 studies

11. 2.1.1 Purpose of the SoP ASB Develop future, and review existing, a/c standards. Reduce the number of alternative a/c treatments. PREPARERS Apply a/c standards. Deal with topics not covered by a/c standards. AUDITORS Assist in forming an opinion on whether fin state conform with a/c standards. TO ASSIST USERS In interpreting the information in financial statements.

12. Elements of Financial Statements • AssetsProbable future economic benefits obtained or controlled by an entity as the result of past transactions or events • Liabilities • Probable future sacrifice of economic benefits arising from present obligations to transfer assets or provide services in the future as a result of past transactions or events • Owners interest • The residual interest in the assets of an entity that remains after deducting its liabilities

13. Chapter 3 – Qualitative Characteristics of Financial Information (S.O.P) • RELEVANCE • RELIABILITY • COMPARABILITY • UNDERSTANDABILITY

14. Characteristics of Useful Information Relevant Reliable Comparable Understandable Influences economic decisions Complete and faithful representation Similarities and differences can be discerned &evaluated Significance of information can be perceived

15. Part 2 Generally Accepted Accounting Principles (GAAP)

16. Statutory Requirements: Company Law; EC Law; Directives • Stock Exchange Regulations: Listing Rules (“Yellow Book”) • Accounting Standards: SSAPs; FRSs; UITF Abstracts

17. The companies act and accounting standards • The two are essentially separate • But……. • CA requires companies to include a note to the accounts saying that they have been prepared in accordance with applicable accounting standards • Or giving details of any departures

18. The Standard Setting Process Financial Reporting Council (FRC) Accounting Standards Board (ASB) Review Panel Issues: Discussion Drafts FRED FRS Urgent Issues Task Force (UITF) Issues: Abstracts

19. FRS 18 Revisited • FRS 18 replaced SSAP 2 in Dec 2000 • Emphasises 2 particular concepts • Going Concern & Accruals • FRS 18 provides detailed practical implementations of the concepts outlined in the S.O.P

20. FRS 18 and Accounting Policies • FRS 18 requires that the specific accounting policies adopted by an organisation are properly disclosed. • The Accounting Policy chosen should be the one that gives a true and fair view

21. FRS 18 and Accounting Policies • Accounting policies are the principles, bases and practices applied by an organisation. • They are how an organisation chooses to recognise, measure and present components of financial information • e.g a policy to depreciate office equipment rather than not depreciate it

22. FRS 18 and Accounting Policies • Estimation Techniques are the specific methods adopted to estimate (measure) the monetary amounts for the components of financial statements. • E.g straight line or reducing balance • E.g increasing bad debt provision from 5 to 7%

23. Accounting policies and Estimation techniques The distinction is an important one in practice: Changes in accounting policies are dealt with as prior-year adjustments. Changes in estimation techniques are only reflected in the profit and loss account for the year of change.

24. Choosing an accounting policy involves making a selection of three factors: • Whether or not to recognise elements as a result of the transaction – recognition criteria. • How to attribute a monetary amount to the elements that are recognised – measurement bases. • Where to present the elements in the financial statements.

25. Estimation techniques are the methods adopted by an entity to arrive at the estimated monetary amounts (corresponding to the measurement bases selected) for elements of the financial statements.

26. Change in Accounting policy? • FRS 18 says that a change of accounting policy has occurred where there has been a change to any one of the components of the definition: • Recognition criteria • Measurement basis • Method of presentation

27. eg 1: change in depreciation method • This decision does not involve a change in any of the three key criteria: • The fixed assets are still carried at cost less accumulated depreciation. • The depreciation is still allocated to individual accounting periods so as to reflect the consumption of economic benefits. • Fixed assets and depreciation are presented in the same way in the balance sheet and the profit and loss accountrespectively.

28. eg2: change in stock valuation from wac to fifo This involves a change in the basis used to measure stocks from average cost to historical cost and as such represents a change in accounting policy.

29. eg 3: a company decides to capitalise finance costs incurred building a factory instead of writing them off • Recognition – the costs are now included as part of an asset. • Presentation – the costs are now presented in the balance sheet rather than the profit and loss account. • This decision represents a change in accounting policy

30. Essential Reading for next week • Read over consolidated accounts in your study pack!!!