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Final Accounts - Assignment 1, Task 1 - Accounting Concepts and Standards (DISTINCTION)
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Final Accounts - Assignment 1, Task 1 EXCELLENT DISTINCTION
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Final Accounts for Public LimitedCompanies
Task 1
This report will outline the accounting concepts and standards applied in the preparation
the financial statements for a public limited company (Company A). Also, this report will
contain a discussion and assessment of these concepts and standards, as well as the
adjustments and end-of-the-year financial statements (Statement of Comprehensive
Income; Statement of Financial Position) for the limited company A. Additionally, the report
will include an evaluation of the importance of financial statements to various stakeholders
of Company A.
Accounting Concepts and Standards
In order to prepare the financial statements for a limited company, there are different
accounting concepts and standards.
Accounti ng Concepts
For a company’s financial position to be ‘’true and fair’’, accountants follow certain rules
called Accounting Concepts that are divided into Fundamental and General Accounting
Concepts. All accountants use the Fundamental Accounting Concepts (Going Concern,
Consistency, Prudence, Accruals/Matching) in the preparation of the business accounts,
these main accounting concepts being recognised around the world. Instead, each
accountant chooses whether or not to use the General Accounting Concepts (Materiality,
Historical Cost, Money Measurement, Realisation, Business Entity, Dual Aspect).
Fundamental Accounti ng Concepts
Going Concern – The assumption that the business will continue its activity, thus the
accountants do not think that the business will go bankrupt in the future. For
example, when purchasing a certain fixed asset (e.g. a vehicle) the business
considers that they will use that vehicle and will have profit in the future. The
advantage is that the accountants will estimate the fair price for the assets of the
business. If this concept is not applied, there are a number of disadvantages: the
business will not be able to obtain loans from banks; the suppliers will no longer
send the goods/services just because they are afraid that the business is not able to
pay for them; the employees will not be motivated to continue working.
Consistency – The accountants use the same accounting techniques for a long time.
(e.g. the depreciation method used, the valuation of inventory etc.). They do not
change them without having a good reason to do it. The consistency of the
accounting methods will make the work of the accountant (he is already used to use
them) and will reduce the risk of mistakes. If the accountants would frequently
change the accounting techniques used, it would be much more difficult for owners,
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, managers, investors etc. to compare financial data from different time periods and
to evaluate the performance and the progress of the business.
Prudence – The accountants will recognize the profit or the revenue only when they
are achieved, when the financial data is certain. Instead, the liabilities will be
recorded when they are probable. The revenue should not be overestimated; the
liabilities/expenses should not be underestimated. The advantages of this concept
are: it creates a realistic image of revenue, assets, liabilities, expenses and it may be
lead to an increase in cash reserves (because of the lower profit). The drawback is
that the concept is favoured just for the expenses/liabilities.
Accruals/Matching – Accountants ensure that revenues and expenses are matched
in a certain accounting period. The income and the expenses will always be recorded
for the same period of time. The revenues and expenses are recorded in the financial
statements when they were incurred in, not when the revenues have been
received/the expenses have been paid. The advantage of this concept is that they
will find out the precise value of profit or loss of the business in that period of time,
because the amount of revenue and expenses are accurately recorded. The
drawback is that this concept may be affected by the inflation.
General Accounti ng Concepts
Materiality – The immaterial items (that are not important) should not be recorded
in the financial documents by the accountants, because they will lose time. The
financial statement must contain only significant, crucial financial data, the
advantage being that this information will help investors, suppliers, managers,
lenders, Government etc. to make a correct decision for the business. The financial
documents will not contain irrelevant data that can create confusion. Also, this
concept shows that a minor error that does not have any impact on the business can
be ignored (the aspect is not material enough to affect the financial statements of
the business), the benefit being that additional costs to prepare again the financial
documents will be avoided. The drawback of this concept is that the decision of
whether an item is relevant or not can be subjective.
Historical Cost – In the financial documents, the accountant will record the costs of
buying the assets of the business, not their current value (it is difficult to be found
out because of the different opinions). For example, if the business purchased a tract
of land with £20 000 in 1914 and its current value is £1 million, the registered value
in the financial documents is £20 000. Due to this concept, the value of the assets
will not be overestimated. Also, the confusion about the value of the assets will be
avoided, because different employees if the accounting department will provide
different estimates for the value of the assets. The drawback is that the inflation
could have greatly increased the assets’ value and this concept ignores it.
Money Measurement – In the business’ accounts, the accountant will record only
transactions that have monetary value. The accountants will never record aspects
such as: the skills, the qualifications and the knowledge of its employees, the
management performance etc. The advantage of recording only those transactions
that may be expressed in monetary terms is that the financial documents will show
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, the true value of the business assets. Aspects such as workers’ skills cannot be
assessed at a certain amount of money because they will never be sold. This concept
do not show the qualifications and skills of the managers of a business, issues with
the workforce, the competitors that can take away important customers etc.,
important aspects for the success of a company.
Realisation – The revenue is recognised by the accountant and recorded in the
financial documents when the sales take place. The exchange of goods/services
should happen before recognising the income. The advantage of recording the
revenue from transactions only when they are already realized is that the financial
statements will be as accurate as possible and based on something real, concrete.
The disadvantage may be the waiting time, the accountant has to wait for the sales
to be made, and he cannot prepare the financial books before.
Business Entity – The owner of the business is a totally separate entity from the
business. The business and its owner are different entities, the business being
considered an independent entity. If the owner invests a certain sum of money in his
own business, in the financial documents that amount of money is noted as a liability
of the company to the owner. The advantage of this concept is that the owner and
the business are different entities. For example, if the business has large debts to the
bank, it can only take the company’s assets, not those of the owner (e.g. his own
house, car etc.). The drawback is the owner cannot use the assets of the business
(cash/vehicle/equipment etc.) for his own purpose, because these will be noted as
expenses for the business.
Dual Aspect – Each transaction produces two different effects on financial accounts:
one debit and one credit. For example, if the business buys goods, in the financial
documents the accountant will record a decrease in cash (the business pays for
goods – liabilities) and an increase in assets (the business receives the goods). This
concept helps accountants to record transactions correctly in financial documents,
because both aspects of each transaction must be noted (one for debit side, one for
credit side). Also, this concept ensure the balance for the accounting books and
facilitates the work of the accountant who can check whether the transaction has
been properly recorded or not. Another advantage of this concept is that reduces
the financial mistakes which could cause major issues in the company’s accounts.
The disadvantage may be the time and the costs involved.
A similarity between Going Concern, Consistency and Accruals is they are accounting
assumptions, essential for the preparation of the financial statements. Based on these
accounting assumptions, other accounting concepts developed, becoming complementary
to each other. For example, Historical cost concept is true only if the Going Concern concept
is also true. If Going Concern assumption is not implemented, it does not make sense to
record the assets/liabilities at their historical cost.
Other similarity is between Realisation concept and Prudence concept, because both of
them show that the revenue is recognized after it is achieved, creating a real, accurate
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