RECAP LECTURE 9

RECAP LECTURE 9

1. BUSINESS ENTITY2. GOING CONCERN3. CONSISTENCY4. MATERIALITY5. PRUDENCE

A REVIEW OF FINANCIAL ACCOUNTING

MATERIALITY

• INFORMATION IS MATERIAL IF ITS OMISSION OR MISSTATEMENT COULD INFLUENCE THE ECONOMIC DECISIONS OF USERS TAKEN ON THE BASIS OF THE FINANCIAL STATEMENT

A REVIEW OF FINANCIAL ACCOUNTING

MATERIALITY• INFORMATION CONTAINED IN THE FS MUST

THEREFORE BE COMPLETE IN ALL MATERIAL ASPECTS IN ORDER FOR THEM TO PRESENT A TRUE AND FAIR VIEW OF THE AFFAIRS OF THE ENTITY

• MATERIALTY IS RELATIVE TO THE SIZE AND PARTICULAR CIRCUMSTANCES OF INDIVIDUAL COMPANIES

A REVIEW OF FINANCIAL ACCOUNTING

MATERIALITY• EXAMPLE

• A DEFAULT BY A CUSTOMER WHO OWES ONLY RS 1000 TO A COMPANY HAVING NET ASSETS OF WORTH RS 10 MILLIONS IS IMMATERIAL TO THE FS OF THE COMPANY.

• HOWEVER IF THE AMOUNT OF DEFAULT WAS 2 MILLION, THE INFORMATION WOULD HAVE BEEN MATERIAL TO THE FS, OMISSION OF WHICH COULD CAUSE USERS TO MAKE INCORRECT BUSINESS DECISIONS

A REVIEW OF FINANCIAL ACCOUNTING

PRUDENCE

• MEANS THAT NORMALLY ACCOUNTANT WILL TAKE THE FIGURE WHICH WILL UNDERSTATE RATHER THAN OVERSTATE THE PROFITS

• VERY OFTEN AN ACCOUNTANT HAS TO MAKE A CHOICE AS TO WHICH FIGURE HE WILL TAKE FOR A GIVEN ITEM.

A REVIEW OF FINANCIAL ACCOUNTING

PRUDENCE

• THE PRUDENCE CONCEPT MEANS THAT NORMALLY HE WILL TAKE THE FIGURE WHICH WILL UNDERSTATE RATHER THAN OVERSTATE THE PROFIT.

• ACCOUNT FOR ALL FUTURE LOSSES AND• DO NOT ACCOUNT FUTURE GAINS

A REVIEW OF FINANCIAL ACCOUNTING

PRUDENCE• EXAMPLES• LAW CASE IN A COURT, LEGAL ADVISOR VIEW

60% CHANCES TO LOOSE – MAKE A PROVISION

• BOOKING IN A HOTEL (WEEDING HALLS)

A REVIEW OF FINANCIAL ACCOUNTING

• CATEGORIES OF ACCOUNTS

A REVIEW OF FINANCIAL ACCOUNTING

CATEGORIES OF ACCOUNTS• IN FINANCIAL ACCOUNTING 5 CATEGORIES OF

ACCOUNTS MAY BE IDENTIFIED1. ASSET ACCOUNT2. LIABILITY ACCOUNT3. EQUITY ACCOUNT4. REVENUE ACCOUNT5. EXPENSE ACCOUNT

A REVIEW OF FINANCIAL ACCOUNTING

ASSET ACCOUNT

• AN ASSET IS ANY RESOURCE THAT ALLOWS A FIRM TO CONDUCT ITS BUSINESS.

• A TANGIBLE ASSET HAS A PHYSICAL EXISTENCE, AS IN THE CASH OR MACHINE

• AN INTANGIBLE ASSET HAS NO PHYSICAL EXISTENCE. EXAMPLE: PATENTS ON PRODUCTS, COPYRIGHTS, GOODWILL

A REVIEW OF FINANCIAL ACCOUNTING

ASSET ACCOUNT• IN DEVELOPING FINANCIAL RECORDS, ASSETS

ARE TYPICALLY DIVIDED INTO 3 AREAS;1. CURRENT ASSETS2. FIXED ASSETS3. INTANGIBLE ASSETS

A REVIEW OF FINANCIAL ACCOUNTING

ASSETS ACCOUNT

1. CURRENT ASSETS:• ALL ASSETS THAT WILL BE CONVERTED INTO

CASH WITHIN CURRENT ACCOUNTING PERIOD OR WITHIN THE NEXT YEAR AS A RESULT OF THE ORDINARY OPERATIONS OF THE BUSINESS

A REVIEW OF FINANCIAL ACCOUNTING

ASSET ACCOUNT

2. FIXED ASSETS:• RESOURCES THAT THE FIRM WILL USE TO

GENERATE REVENUE. THESE ASSETS WILL NOT BE CONVERTED INTO CASH IN THE CURRENT ACCOUNTING PERIOD UNLESS THEY ARE DAMAGED, BECOME OBSOLETE.

A REVIEW OF FINANCIAL ACCOUNTING

ASSET ACCOUNT

3. INTANGIBLE ASSET:• RESOURCES THAT DO NOT REPRESENT

PHYSICAL PROPERTY OR SECURITIES

A REVIEW OF FINANCIAL ACCOUNTING

LIABILITY ACCOUNT

• A LIABILITY IS A DEBT OF THE BUSINESS. THESE ARE NORMALLY DIVIDED INTO 3 AREAS;

1. CURRENT LIABILITIES2. LONG-TERM LIABILITIES3. OBLIGATIONS UNDER CAPITAL LEASES

A REVIEW OF FINANCIAL ACCOUNTING

LIABILITY ACCOUNT

1. CURRENT LIABILITIES:• DEBTS OF THE FIRM THAT MUST BE PAID

DURING THE CURRENT ACCOUNTING PERIOD, NORMALLY ONE YEAR

2. LONG-TERM LIABILITIES:• DEBTS OF THE FIRM THAT WILL NOT BE PAID

DURING THE NEXT YEAR

A REVIEW OF FINANCIAL ACCOUNTING

LIABILITY ACCOUNT

3. OBLIGATIONS UNDER CAPITAL LEASES:

ALSO CALLED FINANCIAL LEASES, A CAPITAL LEASE IS A LONG-TERM AGREEMENT TO RENT AN ASSET UNDER TERMS SUCH THAT THE AGREEMENT CANNOT BE CANCELED BY EITHER PARTY.

THE ECONOMIC CONSEQUENCE OF SUCH AN AGREEMENT IS THE SAME AS THOUGH THE COMPANY HAD BORROWED MONEY AND PURCHASED THE ASSETS

A REVIEW OF FINANCIAL ACCOUNTING

EQUITY ACCOUNT

EQUITY IS A TERM USED TO REPRESENT THE OWNERSHIP RIGHTS IN A COMPANY.THER TERM CAPITAL IS USED TO REPRESENT OWNERSHIP RIGHTS IN A BANK.IN A CORPORATION, THREE MAJOR TYPES OF EQUITY ACCOUNTS MAY BE IDENTIFIED;

A REVIEW OF FINANCIAL ACCOUNTING

EQUITY ASSCOUNT

1. PREFERRED STOCK2. COMMON STOCK3. RETAINED EARNINGS

A REVIEW OF FINANCIAL ACCOUNTING

EQUITY ACCOUNT

1. PREFERRED STOCK:An equity security that is given a preference over other stock of a corporation with respect to dividends and return of the stockholders investment if the firm is liquidated

A REVIEW OF FINANCIAL ACCOUNTING

EQUITY ACCOUNT

2. Common Stock:• A security representing the residual ownership

of a corporation

A REVIEW OF FINANCIAL ACCOUNTING

EQUITY ACCOUNT

3. Retained Earnings:The ownership rights that occur because the firm has retained income earned in prior periods and has reinvested such income.

A REVIEW OF FINANCIAL ACCOUNTING

REVENUE ACCOUNT

• A revenue is an inflow of assets, not limited to cash, in exchange for goods sold or services rendered.

• The term sales is commonly used in place of the term revenues. Two types of revenue accounts are commonly found.

A REVIEW OF FINANCIAL ACCOUNTING

REVENUE ACCOUNT

1) Operating Revenues: Inflows from sales of goods or performance of services in the firm’s main operating areas.

2) Other income: Inflows from investments or others sources not considered part of the firm’s normal operations.

A REVIEW OF FINANCIAL ACCOUNTING

EXPENSE ACCOUNT

• An expense is the consumption of any asset while conducting the business of the firm.

• It may be represented by the payment of cash for materials, labor or other costs associated with goods sold or services rendered.

A REVIEW OF FINANCIAL ACCOUNTING

EXPENSE ACCOUNTFour types of expense accounts are commonly identified:1) Cash Expenses: Cost must be paid in cash

shortly after they are incurred

2) Noncash Expenses: Costs that reflect the decline in the value of assets that are consumed during the course of business

A REVIEW OF FINANCIAL ACCOUNTING

EXPENSE ACCOUNT3) Interest Charges: When the firm borrows money, it must pay interest on the debt. The interest payments are an expense of the business.4) Taxes other than income taxes: A cash expense when firms must pay state, local, real estate, sales and other taxes

A REVIEW OF FINANCIAL ACCOUNTING

CATEGORIES OF ACCOUNTS• IN FINANCIAL ACCOUNTING 5 CATEGORIES OF

ACCOUNTS MAY BE IDENTIFIED1. ASSET ACCOUNT2. LIABILITY ACCOUNT3. EQUITY ACCOUNT4. REVENUE ACCOUNT5. EXPENSE ACCOUNT