Explain how the fundamental accoungting concepts are used in preparing financial statement. Use examples to illustrate the application of the fundamental accounting concepts. Accouting is the language of business and it is used to communicate finance information.
In order for that information make sencse, accouting is based on 10 fundamental concepts. These fundamental concepts then form the basic for all of the Generally Accepted Accouting Principles (GAAP).And these are 10 fundamental concepts:the Business Entity Concept, Monetary Concept, Historical (Cost) Concept, Going Concern Concept, Dual Aspect Concept, Accrual Concept, The relisation Concept, Consevatism, Consistency, Materially In those fundamental accounting concepts above which I would apply and explain for 6 fundamantal accouting concept below which I think they are used in preparing the Financial Statements: 1. Going concern: -According to Dyson (2006) The going concern concept implies that the business will continue to operate for the fore-seeable future.It means that it is considered sensible to keep to the use of the historical cost concept when arriving at the valuation of assets.
And if the business decides to liquidate or become bankrupt then a different approach to valuation is required. -This value includes the liquidation value of a company’s tangible assets as well as the present value of its intangible assets (such as goodwill). The going-concern value is worked into the purchase price of a company, and is the main reason why the purchase price of a company tends to be higher than the current value of the assets of the company.For example, the liquidation value of Widget Corp. is $10 million. This sum represents the current value of inventory, buildings and other tangible assets that can be sold assuming that the company is completely liquidated. However, Widget Corp. ‘s going-concern value could very well be $60 million, as the company’s reputation of being the world’s leading widget producer and its ownership of patents and associated rights for widget production mean that the company should have a large steady stream of future cash flows.
2. Accrual concept When preparing the profit and loss account, revenue and profits, and matched with the associated costs and expenses incurred in earning them. This means that revenues and expenses are recognized when they are incurred rather than when the related cash is received or paid. Accrual of income is always measured over a period of time which is normally the accounting year. Expenses are costs incurred in earning revenue.
Those expenditures which may be charged against revenues for a period will be considered as operating expenses.The accrual concept is applied both in ascertaining the revenues for a period and ascertaining the expenses to be charged against the revenues. For example if a business has a year end of 30th June 19×3 and there had been an electricity charge of ? 60 for the six months to the end of December 19×2 , ? 30 for the quarter ending 31 March 19×3 , and an estimate of ? 20 has been made for the quarter ending 30 June 19×3 . The amount charged in the profit and loss account for the year end 30/06/x3, will be the charge for the 12 months ? 110, i. e. ?60 + ? 30 + ? 20. This estimate of ? 20 for the March/June quarter is known as an accrual.
. Monetary Concept: -Accounting uses money to express certain facts of a business and they can show a expression of the wealth of the business. 4. Consistency concept: – There should be consistency of treatment of like items within each accounting period and from one period to next. In other words, once you have chosen an accounting treatment, you should stick with it from one year to next.. It helps the user to make comparisons over time, and so to pick out useful trends.
Without consistency we cannot have comparability; and without comparability, financial reporting is rather meaningless.For example, a profit for the year of ? 100m may initially be perceived as good, but can only really be assessed by comparison with last year and/or budget for this year. Finally, it must be noted that the consistency concept does not preclude changes being made. Clearly, as time goes by, new accounting practices will develop. However, as these are adopted two things must happen.
First, they must be fully disclosed as a change in accounting policy. And second, the comparative figures for the previous year must be restated under the new policy so as to facilitate comparison. .
Materiality: -A very small mistake in the financial statements of an entity will not invalidate those statement . They should still be usable by anyone interested in entity. However, the key issue is obviously what we mean by ‘very small’. The concept of materiality applies the test of whether the financial statements still show a true and fair view.
The consistency concept says that when a business has once fixed a method for the accounting treatment of an item, it will enter all similar items that follow in exactly the same way. 6.Dual Aspect Concept -All business events are regarded as having a dual aspect. In all business transaction involves two entries, a debit entry and a credit entry. Each transaction involves two entries, a debit entry and a credit entry. Every debit must have a corresponding credit, the total debits must at any time equal the total credits.
Whether this be so or not is easily ascertained by means of Trial Balance. 2. Critically evaluate the role of financial accouting in aiding the decision making processes of 4 different non-management stakeholder group.
Your anwers should include an explanation of the nature of the decisions each of the stakeholders are likely to be taking in relation to their interactions with a business. I would chose 4 different non-management stakeholder groups below to critically evaluate the role of financial accouting in aiding the decision making processes: Investors: Investors are the people who invest the money for business so they are concerned about risk and return in relation to their investment. So they require informaiton to decide whether they should continue to invest in a business.They also need to beable to assess wether a business will be able to pay diviend, and to measure the performance of the business management overall. The key accouting information for an investor is therefore: -Information about growth-sales, volumees -Profitability (profit margins, overall level of profit) -Investment (amount invested, essets owned) -Comparative informmtion of competitors Lenders Lenders are the people who lend money in a business as : banks and loan stokholders so they require information that helps them determined whether loans and interest will be paid when due.
The key accouting information for lenders is therefore: -Cash flow -Security of assets against which the lending may be secured -Investment requirements in the business Creditors Suppliers and trade creditors requirement information that helps them Understand and assess the short-term liquidity of a business. They need to know is the business able to pay short-termdebt when it falls dua? Creditors will, therefore,be looking for information on: -Cash flow -Management of working capital -Payment policyThe purpose of financial accounting statements is mainly to show the financial position of a business at a particular point in time and to show the how that business has performed over a specific period. There are three important elements of finance accounting statement : the profit and loss account for reporting period, a balance sheet for the business at the end of the reporting period and a cash flow statement for the reporting period. Government and taxes department: They need to know about the information of Financial Statements of all the company or business who is running the business legal.There are many agencies and departments that are interested in accounting information. And through Financial statement they can know the profit the business make to levy taxes. The Inland Revenue needs information on business profitability in order to levy and collect Corporation Tax.
Customer & excise need accounting in formation to verify Value Added Tax (“VAT”) returns; local government needs similar information to levy local taxes and rates. Some agencies(e. g the Competition Commission and the Environment Agency) need information to support decisions about takeover and grants . for example investment analysts are an important user group-specifically for companies quoted on stock exchange. They also require very detailed financial and other information in order to analyse the competitive performance of a business and its sector.