Convention of conservatismIn business, investment, and accounting, the principle or convention of conservatism has at least two meanings.

In investment and finance, it is a strategy which aims at long-term capital appreciation with low risk. It can be characterized as moderate or cautious and is the opposite of aggressive behavior.

In accounting, it states that when choosing between two solutions, the one that will be least likely to overstate assets and income should be selected.

According to this concept "expected losses are losses but expected gains are not gains". On the basis of this concept closing stock is valued at cost price or market price, whichever is lower. Provision for bad and doubtful debts are maintained.

DepreciationDepreciation refers to two very different but related concepts:

1. the decrease in value of assets (fair value depreciation), and2. the allocation of the cost of assets to periods in which the assets are used (depreciation with

the matching principle).

The former affects values of businesses and entities. The latter affects net income. Generally the cost is allocated, as depreciation expense, among the periods in which the asset is expected to be used. Such expense is recognized by businesses for financial reporting and tax purposes. Methods of computing depreciation may vary by asset for the same business. Methods and lives may be specified in accounting and/or tax rules in a country. Several standard methods of computing depreciation expense may be used, including fixed percentage, straight line, and declining balance methods. Depreciation expense generally begins when the asset is placed in service. Example: a depreciation expense of 100 per year for 5 years may be recognized for an asset costing 500.

Going concern

Definition of the 'going concern' concept

The 'going concern' concept directs accountants to prepare financial statements on the assumption that the business is not about to go broke or be liquidated (i.e. where the business closes and sells all the assets for whatever price they can get).[1]

So, unless there is significant evidence to the contrary, accountants will base their valuations and their reporting of financial data on the assumption that the business will remain in existence for an indefinite period.

An indefinite period means the foreseeable future or long enough for the business to meet its objectives and to fulfill its commitments. It is important to note that the 'going concern' concept does not imply or guarantee that the business is profitable and will remain so for the foreseeable future.

So, the 'going concern' concept assumes that the business will remain in existence long enough for all the assets of the business to be fully utilized. Utilized assets means obtaining the complete benefit from their earning potential. (i.e. if you recently purchased equipment costing $5,000 that had 5 years of productive/useful life, then under the going concern assumption, the accountant would only write off one year's value $1,000 (1/5th) this year, leaving $4,000 to be treated as a fixed asset with future economic value for the business). The 'going concern' concept supports the assumption that when a business buys assets like land, equipment, and buildings, it does so with the intent that these assets will produce income over a number of years. In other words, the business did not purchase these assets with the intention to close operations soon after and then resell these assets.

The opposite view to this 'going concern' assumption is that the business will cease trading shortly and that all the assets will be sold off within the current year.[1]

Generally accepted accounting principles

Generally Accepted Accounting Principles (GAAP) refer to the standard framework of guidelines for financial accounting used in any given jurisdiction; generally known as accounting standards. GAAP includes the standards, conventions, and rules accountants follow in recording and summarizing, and in the preparation of financial statements.

The term "GAAP" is an abbreviation for Generally Accepted Accounting Principles (GAAP). GAAP is a codification of how CPA firms and corporations prepare and present their business income and expense, assets and liabilities on their financial statements. GAAP is not a single accounting rule, but rather the aggregate of many rules on how to account for various transactions. The basic principles underlying GAAP accounting are set forth below.

When preparing financial statements using GAAP, most American corporations and other business entities use the many rules of how to report business transactions based upon the various GAAP rules. This provides for consistency in the reporting of companies and businesses so that financial analysts, banks, shareholders and the SEC(Securities & Exchange Commission) can have all reporting companies preparing their financial statements using the same rules and reporting procedures. This allows for an "apples to apples" comparison of any corporation or business entity with another. Thus, if company A reports $1,000,000 of net income, using GAAP, then the public and other users of financial statements can compare that net income to another company that is reporting $500,000 of net income, using GAAP.

The rules and procedures for reporting under GAAP are complex and have developed over a long period of time. Currently there are more than 150 "pronouncements" as to how to account for different types of transactions, ranging from how to report regular income from the sale of goods, and its related inventory values, to accounting for incentive stock optiondistributions. By using consistent principles, all companies reporting under GAAP report these transactions on their financial statements in a consistent manner.

The various rules and pronouncements come from the Financial Accounting Standards Board (FASB) which is a non-profit organization that the accounting profession has created to promulgate the rules of GAAP reporting and to amend the rules of GAAP reporting as occasion requires. The more recent pronouncements come as Statements of the Financial Accounting Standards (SFAS). Changes in the

GAAP rules can carry tremendous impact upon American business. For example, when FASB stopped requiring banks to mark their assets (loans) to the lower of cost or market (i.e. value of a foreclosed home loan), the effect on a bank's "net worth" as defined by GAAP can change dramatically. While generally neutral, there is some pressure on the FASB to yield to industry or political pressure when it makes its rules.

Nonetheless, since all companies report using the same set of rules, knowing the rules of GAAP reporting can tell the user of financial statements a great deal. The study of accounting, in large part, entails learning the many rules and promulgations set forth by FASB and how to apply those rules to actual business events.

The Basic PrinciplesPrinciples derive from tradition, such as the concept of matching. In any report of financial statements (audit, compilation, review, etc.), the preparer/auditor must indicate to the reader whether or not the information contained within the statements complies with GAAP.

Principle of regularity: Regularity can be defined as conformity to enforced rules and laws.

Principle of consistency: This principle states 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.

Principle of sincerity: According to this principle, the accounting unit should reflect in good faith the reality of the company's financial status.

Principle of the permanence of methods: This principle aims at allowing the coherence and comparison of the financial information published by the company.

Principle of non-compensation: One should show the full details of the financial information and not seek to compensate a debt with an asset, revenue with an expense, etc. (see convention of conservatism)

Principle of prudence: This principle aims at showing the reality "as is": one should not try to make things look prettier than they are. Typically, revenue should be recorded only when it is certain and a provision should be entered for an expense which is probable.

Principle of continuity: When stating financial information, one should assume that the business will not be interrupted. This principle mitigates the principle of prudence: assets do not have to be accounted at their disposable value, but it is accepted that they are at their historical value (see depreciation and going concern).

Principle of periodicity: Each accounting entry should be allocated to a given period, and split accordingly if it covers several periods. If a client pre-pays a subscription (or lease, etc.), the given revenue should be split to the entire time-span and not counted for entirely on the date of the transaction.

Principle of Full Disclosure/Materiality: All information and values pertaining to the financial position of a business must be disclosed in the records.

Principle of Utmost Good Faith: All the information regarding to the firm should be disclosed to the insurer before the insurance policy is taken.

International accounting standards and rules

Many countries use or are converging on the International Financial Reporting Standards (IFRS), established and maintained by the International Accounting Standards Board. In some countries, local accounting principles are applied for regular companies but listed or large companies must conform to IFRS, so statutory reporting is comparable internationally, across jurisdictions.

Mark-to-market accounting

Mark-to-market or fair value accounting refers to accounting for the fair value of an asset or liability based on the current market price, or for similar assets and liabilities, or based on another objectively assessed "fair" value.[citation needed] Fair value accounting has been a part of Generally Accepted Accounting Principles (GAAP) in the United States since the early 1990s, and has been used increasingly since then.[citation needed]

Mark-to-market accounting can change values on the balance sheet as market conditions change. In contrast, historical costaccounting, based on the past transactions, is simpler, more stable, and easier to perform, but does not reflect current fair value. It summarizes past transactions instead. Mark-to-market accounting can become inaccurate if market prices change unpredictably. Buyers and sellers may claim a number of specific instances when this is the case, including inability to both accurately and collectively value the future income and expenses, often due to unreliable information, over-optimistic, and over-pessimistic expectations.[citation needed]

FIFO and LIFO accounting

FIFO and LIFO Methods are accounting techniques used in managing inventory and financial matters involving the amount of money a company has tied up within inventory of produced goods, raw materials, parts, components, or feed stocks. These methods are used to manage assumptions of cost flows related to inventory, stock repurchases (if purchased at different prices), and various other accounting purposes.

FIFO stands for first-in, first-out, meaning that the oldest inventory items are recorded as sold first but do not necessarily mean that the exact oldest physical object has been tracked and sold.

LIFO stands for last-in, first-out, meaning that the most recently produced items are recorded as sold first. Since the 1970s, some U.S. companies shifted towards the use of LIFO, which reduces their income

taxes in times of inflation, but with International Financial Reporting Standards banning the use of LIFO, more companies have gone back to FIFO. LIFO is only used in Japan and the U.S. [1]

The difference between the cost of an inventory calculated under the FIFO and LIFO methods is called the LIFO reserve. This reserve is essentially the amount by which an entity's taxable income has been deferred by using the LIFO method

Revenue recognition

The revenue recognition principle is a cornerstone of accrual accounting together with matching principle. They both determine theaccounting period, in which revenues and expenses are recognized. According to the principle, revenues are recognized when they are realised or realisable, and are earned (usually when goods are transferred or services rendered), no matter when cash is received. Incash accounting – in contrast – revenues are recognized when cash is received no matter when goods or services are sold.

Cash can be received in an earlier or later period than obligations are met (when goods or services are delivered) and related revenues are recognized that results in the following two types of accounts:

Accrued revenue: Revenue is recognized before cash is received. Deferred revenue: Revenue is recognized after cash is received.

Matching principle

The matching principle is a culmination of accrual accounting and the revenue recognition principle. They both determine theaccounting period, in which revenues and expenses are recognized. According to the principle, expenses are recognized when obligations are (1) incurred (usually when goods are transferred or services rendered, e.g. sold), and (2) offset against recognized revenues, which were generated from those expenses (related on the cause-and-effect basis), no matter when cash is paid out. In cash accounting—in contrast—expenses are recognized when cash is paid out, no matter when obligations are incurred through transfer of goods or rendition of services: e.g., sale.

If no cause-and-effect relationship exists (e.g., a sale is impossible), costs are recognized as expenses in the accounting period they expired: i.e., when have been used up or consumed (e.g., of spoiled, dated, or substandard goods, or not demanded services). Prepaid expenses are not recognized as expenses, but as assets until one of the qualifying conditions is met resulting in a recognition as expenses. Lastly, if no connection with revenues can be established, costs are recognized immediately as expenses (e.g., general administrative and research and development costs).

Prepaid expenses, such as employee wages or subcontractor fees paid out or promised, are not recognized as expenses (cost of goods sold), but as assets (deferred expenses), until the actual products are sold.

The matching principle allows better evaluation of actual profitability and performance (shows how much was spent to earn revenue), and reduces noise from timing mismatch between when costs are incurred and when revenue is realized.

Double-entry bookkeeping system

A double-entry bookkeeping system is a set of rules for recording financial information in a financial accounting system in which every transaction or event changes at least two different nominal ledger accounts.

The name derives from the fact that financial information used to be recorded using pen and ink in paper books – hence "bookkeeping" (whereas now it is recorded mainly in computer systems) and that these books were called journals and ledgers (hence nominal ledger, etc.) – and that each transaction was entered twice (hence "double-entry"), with one side of the transaction being called a debit and the other a credit.

It was first codified in the 15th century by Luca Pacioli. In deciding which account has to be debited and which account has to be credited, the golden rules of accounting are used. This is also accomplished using the accounting equation: Equity = Assets −Liabilities. The accounting equation serves as an error detection tool. If at any point the sum of debits for all accounts does not equal the corresponding sum of credits for all accounts, an error has occurred. It follows that the sum of debits and the sum of the credits must be equal in value.

Double-entry bookkeeping is not a guarantee that no errors have been made – for example, the wrong ledger account may have been debited or credited, or the entries completely reversed.

Accounting entries

In the double-entry accounting system, each accounting entry records related pairs of financial transactions for asset, liability, income, expense, or capital accounts. Recording of a debit amount to one account and an equal credit amount to another account results in total debits being equal to total credits for all accounts in the general ledger. If the accounting entries are recorded without error, the aggregate balance of all accounts having positive balances will be equal to the aggregate balance of all accounts having negative balances. Accounting entries that debit and credit related accounts typically include the same date and identifying code in both accounts, so that in case of error, each debit and credit can be traced back to a journal and transaction source document, thus preserving an audit trail. The rules for formulating accounting entries are known as "Golden Rules of Accounting". The accounting entries are recorded in the "Books of Accounts". Regardless of which accounts and how many are impacted by a given transaction, the fundamental accounting equation A = L + OE will hold, i.e. assets equals liabilities plus owner's equity.

Debits and credits

Main article: Debits and credits

Double-entry bookkeeping is governed by the accounting equation. If revenue equals expenses, the following (basic) equation must be true:

assets = liabilities + equity

For the accounts to remain in balance, a change in one account must be matched with a change in another account. These changes are made by debits and credits to the accounts. Note that the usage of these terms in accounting is not identical to their everyday usage. Whether one uses a debit or credit to increase or decrease an account depends on the normal balance of the account. Assets, Expenses, and Drawings accounts (on the left side of the equation) have a normal balance of debit. Liability, Revenue, and Capital accounts (on the right side of the equation) have a normal balance of credit. On a general ledger, debits are recorded on the left side and credits on the right side for each account. Since the accounts must always balance, for each transaction there will be a debit made to one or several accounts and a credit made to one or several accounts. The sum of all debits made in each day's transactions must equal the sum of all credits in those transactions. After a series of transactions, therefore, the sum of all the accounts with a debit balance will equal the sum of all the accounts with a credit balance.

Debits and credits are numbers recorded as follows:

Debits are recorded on the left side of a T account in a ledger. Debits increase balances in asset accounts and expense accounts and decrease balances in liability accounts, revenue accounts, and capital accounts.

Credits are recorded on the right side of a T account in a ledger. Credits increase balances in liability accounts, revenue accounts, and capital accounts, and decrease balances in asset accounts and expense accounts.

Debit accounts are asset and expense accounts that usually have debit balances, i.e. the total debits usually exceeds the total credits in each debit account.

Credit accounts are revenue (income, gains) accounts and liability accounts that usually have credit balances.

  Debit Credit

Asset Increase Decrease

Liability Decrease Increase

Income (revenue) Decrease Increase

Expense Increase Decrease

Capital Decrease Increase

Double entry example

In this example the following will be used:

Books of prime entry (Books of original entry)

Sales Invoice Daybook (records customer invoices) Bank Receipts Daybook (records customer & non customer receipts) Cash book Return inwards day book Return outwards day book Purchase Invoice Daybook (records supplier invoices) Bank Payments Daybook (records supplier & non supplier payments)

The books of prime entry are where transactions are first recorded. They are not part of the double-entry system, but may be expanded by the computer as a debit to one account and a credit to another account. For example, a cash receipts transaction may cause a debit (increase) to a cash account and a credit (decrease) to an accounts receivable account.

Ledger Cards

Customer Ledger Cards Supplier Ledger Cards General Ledger (Nominal Ledger) Bank Account Ledger Trade Creditors Ledger Trade Debtors LedgerPurchase invoice daybook

Purchase Invoice Daybook

Date Supplier Name Reference Amount Electricity Widgets

10 July 2006 Electricity Company PI1 1000 1000  

12 July 2006 Widget Company PI2 1600   1600

------- ------- -------

Total 2600 1000 1600

==== ==== ====

Credit Debit Debit

Trade Electricity Widgets

control a/c a/c a/c

Each individual line is posted as follows:

The amount value is posted as a credit to the individual supplier's ledger a/c The analysis amount is posted as a debit to the relevant general ledger a/c

From example above:

Line 1 – Amount value 1000 is posted as a credit to the Supplier's ledger a/c ELE01-Electricity Company

Line 2 – Amount value 1600 is posted as a credit to the Supplier's ledger a/c WID01-Widget Company

The totals of each column are posted as follows:

Amount total value 2600 posted as a credit to the Trade creditors control a/c Electricity total value 1000 posted as a debit to the Electricity General Ledger a/c Widget total value 1600 posted as a debit to the Widgets General Ledger a/c

Double-entry has been observed because Dr = 2600 and Cr = 2600.

Bank payments daybookThe payments book is not part of the double-entry system.

Bank Payments Daybook

Date Supplier Name Reference Amount Suppliers Wages

17 July 2006 Electricity Company BP701 1000 1000

19 July 2006 Widget Company BP702 900 900

28 July 2006 Owner's Wages BP703 400 400

------- ------- -------

Total 2300 1900 400

==== ==== ====

Credit Debit Debit

Bank Trade Wages

Account Creditors control a/c

control a/c

Keys: PI = Purchase Invoice, BP = Bank Payment

Each individual line is posted as follows:

The amount value is posted as a debit to the individual supplier's ledger a/c. The analysis amount is posted as a credit to the relevant general ledger a/c.

From example above:

Line 1 – Amount value 1000 is posted as a debit to the Supplier's ledger a/c ELE01-Electricity Company.

Line 2 – Amount value 900 is posted as a debit to the Supplier's ledger a/c WID01-Widget Company.

The totals of each column are posted as follows:

Amount total value 2300 posted as a credit to the Bank Account. Trade Creditors total value 1900 posted as a debit to the Trade creditors control a/c. Other total value 400 posted as a debit to the Wages control a/c.

Double-entry has been observed because Dr = 2300 and Cr = 2300.

The daybooks are the key documents (books) to the double entry system. From these daybooks we create the ledger accounts. Each transaction will be recorded in at least two ledger accounts.

Accrual

Accrual (accumulation) of something is, in finance, the adding together of interest or different investments over a period of time. It holds specific meanings in accounting, where it can refer to accounts on a balance sheet that represent liabilities and non-cash-based assets used in accrual-based accounting. These types of accounts include, among others, accounts payable, accounts receivable, goodwill,deferred tax liability and future interest expense.[1]

For example, a company delivers a product to a customer who will pay for it 30 days later in the next fiscal year, which starts a week after the delivery. The company recognizes the proceeds as a revenue in its current income statement still for the fiscal year of the delivery, even though it will get paid in cash during the following accounting period.[2] The proceeds are also an accrued income (asset) on the balance sheet for the delivery fiscal year, but not for the next fiscal year when cash is received.

Similarly, a salesperson, who sold the product, earned a commission at the moment of sale (or delivery). The company will recognize the commission as an expense in its current income statement, even though s-/he will actually get paid at the end of the following week in the next accounting period. The commission is also an accrued expense (liability) on the balance sheet for the delivery period, but not for the next period the commission (cash) is paid out to her/him.

Accrued expenses and accrued revenues

The term accrual is also often used as an abbreviation for the terms accrued expense and accrued revenue that share the common name word, but they have the opposite economic / accounting characteristics.

Accrued revenue: Revenue is recognized before cash is received. Accrued expense: Expense is recognized before cash is paid out.

Accrued revenue (or accrued assets) is an asset, such as unpaid proceeds from a delivery of goods or services, when such income is earned and a related revenue item is recognized, while cash is to be received in a latter period, when the amount is deducted from accrued revenues.

In the rental industry, there are specialized revenue accruals for rental income which crosses month end boundaries. These are normally utilized by rental companies who charge in arrears, based on an anniversary of a contract date. For example a rental contract which began on 15 January, being invoiced on a recurring monthly basis will not generate its first invoice until 14 February. Therefore at the end of the January financial period an accrual must be raised for 16 days worth of the monthly charge. This may be a simple pro-rata basis (e.g. 16/31 of the monthly charge) or may be more complex if only week days are being charged or a standardized month is being used (e.g. 28 days, 30 days etc.).

Accrued expense is a liability with an uncertain timing or amount, the reason being no invoice has been received yet.[3] The uncertainty of the accrued expense is not significant enough to qualify it as a provision. An example of an accrued expense is a pending obligation to pay for goods or services received from a counterpart, while cash is to be paid out in a latter accounting period when the amount is deducted from accrued expenses.

In the United States of America, this difference is best summarized by IAS 37 which states:

"11 Provisions can be distinguished from other liabilities such as trade payables and accruals because there is uncertainty about the timing or amount of the future expenditure required in settlement. By contrast:

"(a) trade payables are liabilities to pay for goods or services that have been received or supplied and have been invoiced or formally agreed with the supplier; and

"(b) accruals are liabilities to pay for goods or services that have been received or supplied but have not been paid, invoiced or formally agreed with the supplier, including amounts due to employees (for example, amounts relating to accrued vacation pay). Although it is sometimes necessary to estimate the amount or timing of accruals, the uncertainty is generally much less than for provisions.

"Accruals are often reported as part of trade and other payables, whereas provisions are reported separately."

To add to the confusion, some legalistic accounting systems take a simplistic view of “’accrued revenue”’ and “’accrued expenses”’, defining each as revenue / expense that has not been formally invoiced. This is primarily due to tax considerations, since the act of issuing an invoice creates, in some countries, taxable revenue, even if the customer does not ultimately pay and the related receivable becomes uncollectable.

Accounting period

Accounting period in bookkeeping is the period with reference to which accounting books of any entity are prepared.

It is the period for which books are balanced and the financial statements are prepared. Generally, the accounting period consists of 12 months. However the beginning of the accounting period differs according to the jurisdiction. For example one entity may follow the regular calendar year, i.e. January to

December as the accounting year, while another entity may follow April to March as the accounting period.

The International Financial Reporting Standards even allows a period of 52 weeks as an accounting period instead of a proper year.[1]

In some of the ERP tools there are more than 12 accounting periods in a financial year. They put one accounting period as "Year Open" period where all the carried over balances from last financial year are cleared and one period as "Year Close" where all the transactions for closed for the same financial year. Accounting is an art of recording classifying and summarising the financial positions of the company. It is done by the accountant.

Accountant

An accountant is a practitioner of accountancy (UK) or accounting (US), which is the measurement, disclosure or provision of assurance about financial information that helps managers, investors, tax authorities and others make decisions about allocating resources.

The Big Four auditors are the largest employers of accountants worldwide. However, most accountants are employed in commerce, industry and the public sector.[1]

Comparison of cash and accrual methods of accounting

The two primary accounting methods of the cash basis and the accruals basis (the difference being primarily one of timing) are used in three environments: in economics, to calculate US public debt,[1], in financial reporting, as well in tax environment, in order to calculatetaxable income for U.S. federal income taxes and other income taxes.

According to the Internal Revenue Code, a taxpayer may compute taxable income by:

1. the cash receipts and disbursements method;2. an accrual method;3. any other method permitted by the chapter; or4. any combination of the foregoing methods permitted under regulations prescribed by the

Secretary [of the Treasury].[2]

As a general rule, a taxpayer must compute taxable income using the same accounting method he / she uses to compute income in keeping his / her books.[3] Also, the taxpayer must maintain a consistent method of accounting from year to year. Should he / she change from the cash basis to the accrual basis (or vice versa), he / she must notify and secure the consent of the Secretary.[4]

Convergence of accounting standards

The convergence of accounting standards refers to the goal of establishing a single set of accounting standards that will be used internationally, and in particular the effort to reduce the differences between the US Generally Accepted Accounting Principles (US GAAP), and the International Financial Reporting Standards (IFRS).[1] Convergence in some form has been taking place for several decades,[2] and efforts today include projects that aim to reduce the differences between accounting standards.[3]

Convergence is driven by several factors, including the belief that having a single set of accounting requirements would increase the comparability of different entities' accounting numbers, which will contribute to the flow of international investment and benefit a variety of stakeholders.[4][1] Criticisms of convergence include its cost and pace,[5] and the idea that the link between convergence and comparability may not be strong.[