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Running head: Financial Accounting

Financial Accounting

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Financial Accounting

Financial accountancy (or financial accounting) is the field of accountancy concerned with the preparation of financial statements for decision makers, such as stockholders, suppliers, banks, government agencies, owners, and other stakeholders. The fundamental need for financial accounting is to reduce principal-agent problem by measuring and monitoring agents' performance and reporting the results to interested users.

Financial accountancy is used to prepare accounting information for people outside the organization or not involved in the day to day running of the company. Managerial accounting contrasts with financial accounting in that managerial accounting is for internal decision making and does not have to follow any rules issued by standard-setting bodies.

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International Accounting Standards Board (IASB), have finally promulgated the quality International Financial Reporting Standards (IFRS) in 2005; giving a level playing field for many countries with respect to financial reporting. Countries around the world are now adjusting their national standards with that of IFRS. IFRS provides a global challenge to analyst, auditors and investors.

Accounting concepts are generally principles that encompass recording and measurement of accounting data within ethical and accounting rules and standards. Ethical rules or principles are mainly concerned with the judgment used or the flexibility used in maneuvering financial information in reporting financial data. The boundary data is mainly concerned with the nature and type of data used the elements of a certain financial data that should be reported by the company and the amount that should be retained by the company. Recording and measurement standards deal with the type of data that is to be measured and recorded by the company (McGraw hill 2005)

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The realization concept deals with recognition of revenues or sales. According to this principle of accounting a company can record or realize sales profit only when the company is sure that goods have been passed on to the customer. Thus the profit is said to have been earned or realized when the customer receives the goods and incurs a liability. However, companies can record or recognize revenue when goods are sold and not when an order is received from the customer or when the customer pays for the goods or services (williamson, 2001)

Realization concept is a recording and measurement rule. It only realizes increase in value of its assets (profit) when the ownership of the goods has been transferred to the customer. Many a times, sales personnel record sale of goods when goods have only been sent for sample testing; or when a customer places an order for delivery of goods, which they might cancel later. Therefore, accountants under this principle are required to record sales only when they have received an invoice or acceptance letter from the customer.

The matching concept or the accrual concept is also another recording and measurement concept. According to this concept the revenues and expenses are matched with one another. They are recorded as they are incurred or realized by the company in a given accounting period. The financial period when actual payment is received or given might be different from the period when these expenses or revenues are realized or incurred.

This principle stems from the fact that many business transactions are based on credit. Hence it would be incorrect if an income statement just states income as cash received less cash paid. By this method many of the credit-based transaction in the financial period will not be counted, thereby giving a misleading profit figure.

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Many companies receive their utility bills after they have consumed electricity or water. If the electricity bill for month of December, for instance is received in February, does not indicate that the company did not consume electricity in December to run its factories and machineries. The company has to account for the cost of electricity used in December.

The concept of prudence is actually based on the principle that revenues and profits are not estimated or anticipated. They are recorded in the profit and loss account when they are actually realized in form of profits or in form of assets. These profits are realized with certainty.

Moreover, provisions of liabilities and expenses are made whether or not they are realized with utmost certainty. These expenses and liabilities are predicted on the information or data available concerning the accounting period. Hence, companies record losses as soon as these losses are known to incur, but only record profits when they are realized in terms of cash or assets. 

This treatment minimizes the profits being reported in financial statements. Stock valuation, for instance, is estimated on lower of cost and net realizable value; meaning that the companies stock is valued at the lower value of either cost or at the net realizable value. (Bies, 2004)

Another application of the prudence concept is provision of doubtful debts. Debtors, which are likely or expected not to pay, are written off. Also, fixed assets are depreciated over the useful life of the assets. Moreover, if the realization of development expenditures is certain they are then deferred and recorded as intangible assets.

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The accounting conceptual framework for financial reporting both in the private and public companies is developed and governed by the Australian Accounting Standards Board (AASB); along with Public Sector Accounting Standards Board (PSASB), which works under the Australian Accounting Research Foundation.

A-IFRS is not similar with the conceptual framework of IFRS because of a number of factors which include the omission of transitional provisions in Standards for individuals because of enforcement of the AASB 1 ‘First-Time Adoption of Australian Equivalents to International Financial Reporting Standards’. Moreover there are additional reporting requirements for NGOs and there are increased disclosure requirements.

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There is not much difference in the accounting framework as compared to that of the IASB. The Australian accounting standard board (AASB) also follows the accrual basis of accounting.

By AASB the accrual accounting principle recognizes the financial transactions in the period in which they are incurred. In other words the revenues and expenses are matched with the financial period in which they are realized, without considering the actual payment or reception of the cash. (Porter, 2005)

The cash basis of accounting, fails to provide conclusive information concerning the financial health of the company. It gives incorrect conclusions regarding the assets owned by the company or the value of liability it has to pay off.

Moreover, the AASB also permits use of various standards or rules as the measurement criterion that can be effectively employed in making the financial reports. These measurement rules include, historical costing method, current costing, net market value, or present value. These measurement bases may or may not be used by the companies. Disclosure is required to be given if more than one measurement basis is used; such as in revaluation of non-current assets.

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The historical cost concept states that all assets must be recorded on the balance sheet at the cost at which they are purchased as oppose to the current market value of these assets. At the time of acquisition the cash or equivalent paid to acquire theses assets is stated as the cost price of these assets. Furthermore, the cost of acquisition also includes the expenditures that are incurred by the company to make the asset usable in the company to generate revenue. However, it should be noted that the value of the asset does not changes.

References

Porter, bruce: 2005, Deloitte A-IFRS vs IFRS, National Assurance & Advisory Services Report.

Bies, Susan: 2004, Fair Value Accounting, International Association of Credit Portfolio Managers General Meeting.

The underlying Principles: the building blocks (1994), McGraw Hill.

Williamson, Duncan: 2001, Accounting Concepts and Conventions.
 


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