Notes on A-level Principles of Accounts – Accounting Concepts & Principles
chart of concepts
basic assumptions
business entity
going concern
historical cost
prudence / conservation
money measurement
quantifiability
about presentation
about income recognition
relevance
materiality
consistency
relevance
accrual / matching
relevance
realization
objectivity
accounting bases
accounting polices
A. Functions of accounting
1. accounting
Accounting is the process of collecting, identifying, recording, posting,
classifying and summarizing the data, events and transactions, in terms of
money, into financial information and interpreting the financial information
for the decision making of a business
Book-keeping process:. 1. collecting, identifying and recording of data, events and transactions
2. entries into books of original entries
3. double entries (or posting) into ledger accounts
4. balancing off all accounts and prepare the trial balance
5. preparing and interpreting final accounts
2. financial statements
They include:
<i> trading account
<ii> profit and loss account
<iii> balance sheet
<iv> cash flow statement
They are prepared for the interested users of accounting information.
They serve to help the users to make economic (eg, investment) decisions.
They also form a basis for comparison of financial performances (between two
periods, and between companies doing similar business.
3. limitation of conventional financial statements
<i> They are prepared from the past transactions, events and data. They could not reflect
what had happened in the past and would not be a reliable and accurate indicator for
future planning of the business.
<ii> The accounting definitions, methods, techniques and policies used by
different companies may not be the same. This will affect the
comparability between 2 financial periods or between 2 companies in the
same industries.
<iii> Some concepts may conflict with the true and fair view.
(1) historical cost concept – market value of an asset is ignored
(2) stable money measurement concept – inflation is ignored
(3) …
This may also affect the comparability.
4. properties of accounting information/data
Good and useful accounting information may include the properties below:
(1) comparability (可作比較)
(2) completeness (完整, 完成)
(3) comprehensibility (易於理解)
(4) relevance (相關 – 符合用家所需)
(5) reliability (可靠)
(6) objectivity (客觀, 非因人而異)
(7) timeliness (及時, 不遲延)
5. non-financial statements
The Companies Ordinance of HK (公司條例) requires the following reports
to be prepared and disclosed.
(1) directors’ report, (2) auditors’ report, (3) chairman’s report
6. true and fair view
The Companies Ordinance of HK requires that the “true and fair view” must be followed in
preparing the accounting statements.
Otherwise, the users may have misunderstanding of the company’s performance, and
therefore may make wrong decisions. .
7. interested users of financial information
(1) shareholders (existing and potential) (現有股東, 準股東)
(2) employees (公司僱員)
(3) loan creditors (公司債權人)
(4) financial analysts and investment advisors (財經分析員/投資顧問)
(5) the government (Inland Revenues Department) (政府, 稅務局)
(6) the general public (市民大眾)
(7) others:- suppliers, customers, competitors (供應商, 顧客, 競爭者)
B. HKSSAP 1 – disclosure of accounting policies
SSAP stands for Statement of Standard Accounting Practice.
HKSSAP (2.101) is concerns about the disclosure of accounting policies.
1. Accounting concepts are basic assumptions (假定) and rules (規則) which
guide accountants (會計人員) in producing periodic financial accounts.
2. There are four fundamental accounting concepts as assumed in the HKSSAP.
When an accountant prepares financial accounts, he has to assume that:
(i) going concern (繼續經營)
The enterprise will continue in operational existence for the foreseeable
future. It will not liquidate (結業) or curtail (削減) significantly its scale of
operation/activities.
Historical cost concept thus arises – we record an asset at its cost, and not its
realised value or market value as there is no intention to sell it.
(ii) accrual (應收/應付) / matching (收支相符)
Revenues are recognised when they are earned in a financial period, and not
when cash is received.
Costs and expenses are recognised when they are incurred in a financial
period, and not when cash is paid.
Profit is calculated by matching the revenues earned with the expenses
incurred.
If more cash is paid on an expenses, prepayment should be made, and shown
on the balance sheet as an asset.
If less cash is paid on an expenses, accrual should be made, and shown on the
balance sheet as a liability.
The same treatments apply to revenues.
(iii) consistency (連貫)
Similar treatments must be given to similar items with a financial period, and
from one period to the next.
Once an accounting policy is adopted, we should not change it normally,
except that a new policy is believed to be better and necessary.
Even so, the
reason and nature of the change should be disclosed as a note in the financial
statements.
(iv) prudence / conservatism (穩健)
Revenues and profits should not be anticipated or overstated.
Expenses and losses should not be understated.
When two or more treatments are acceptable, we always choose one that can
reduce the profit. (This may contradict with the “true and fair view”.)
Provision should be made for all known liabilities or losses. (This may
contradict with the “accrual concept” or the “objectivity concept”.)
Realisation concept - A revenue is considered to be earned only when it is
realised. In the case of a sale, it is realised when
1. the transaction (earning process) is completed
2. the goods are delivered and invoiced
3. receipt is made or future payment is very certain
* NB: This concept is getting less and less important, but it is still useful in
accounting practice, especially in making provisions.
2. Accounting bases (方法) – They are defined in financial statements as the
methods developed for applying fundamental accounting
concepts to transactions and items.
Accounting policies (政策) – They are the accounting bases chosen by
management as being best suited for used in that business.
The polices (and their changes, if any) should be disclosed by way of notes to
the accounts. The explanations should be clear (清晰), fair (公平), and brief
(簡潔). They should normally be followed consistently.
<In the case of published accounts, the following policies must be disclosed:
- meaning of turnover,
- valuation of stock and work in progress,
- depreciation method
- treatment of amortisation of intangibles (research and development fund,
patents and trademarks, preliminary expense, goodwill … )
- instalment transactions (hire-purchase or credit purchase)
- leasing and rental transactions
C. More about accounting concepts
1. conservatism / prudence
meaning: (a) Revenues and profits should not be anticipated but recognised only
when they are realised in the form of cash or of other assets which
can be treated as cash.
(b) Provision should be made for any known liabilities at the end of the
financial period.
examples (a) Stock is valued at lower of cost and net realisable value.
(Stock is an asset for resale to earn a profit.)
(b) Provision is made for depreciation and doubtful debts.
2. going concern
meaning: (a) An enterprise will continue in operational existence for the
foreseeable future.
(b) An enterprise will not liquidate or curtail significantly its scale of
activities.
(c) The financial statements do not indicate assets at net realisable
value (market value).
examples (a) On the balance sheet, fixed assets are shown at their net book value,
ie, cost less accumulated depreciation.
(b) If the accountant has reasons to believe that the enterprise will
liquidate soon, he should indicate all assets at the NRV, and make
a note of the account.
3. historical cost
meaning: (a) All assets should be recorded at their cost.
This method is
consistent, simple and less costly.
(b) Historical cost is an objective and verifiable cost.
(c) Cost includes the purchase price and all expenses incurred in
bringing the asset to its present location and condition.
examples (a) Investment in shares is recorded at its cost, even though the share
prices change over time.
4. business entity
meaning: (a) The business and its owners are separate existence entity.
(b) The business transactions are separate from its owners’ private
transactions.
examples (a) Any payments for the owners’ personal expenses by the business
are treated as drawings, and not expenses.
5. materiality
meaning: (a) Any insignificant items and events may be disregarded, but
important information should be disclosed.
(b) If the information may affect the users in making decision, it is
regarded as material. A material item is regarded as an asset
and should be shown as a separate item on the balance sheet.
examples (a) Stationery involves small amount of capital expenditure, so it is
treated as an expense and to be written of in the profit and loss
account.
6. quantifiability / stable monetary measures
meaning: (a) We only record those transactions which are measurable in money
terms.
(b) The factor of “inflation” is ignored.
(c) This forms a common base for comparison.
examples (a) Expenses can be added or subtracted.
(b) The morale of the enterprise, the experience of the staff, the good
relationship with others are not recorded and reflected in accounts.
7. consistency
meaning: (a) Similar items should be treated by similar methods.
Such methods, once adopted, should not be change within an
accounting period or from one period to another.
(b) If a new policy is considered better and necessary, the nature and
reason for the change must be disclosed as a note to the accounts.
examples (a) depreciation method
(b) stock valuation method
8. accrual / matching
meaning: (a) Revenues and expenses are recognised as they are earned and
incurred, and not as money is received or paid.
(b) The profit and loss account is prepared on this basis.
(c) The revenues earned must be matched with the expenses incurred
in calculating the profit in an accounting period.
(d) If an expense has been paid but the related revenue has not been
earned, the cost should be carried forward as a prepayment.
If a revenue has been earned but the related expense has not been
paid, the cost should also be counted and carried forward as an
accrual.
(e) The cost of capital expenses (assets) should be spread over a period
of time during which the benefits are going to be received.
examples (a) Credit sales but not yet received should still be treated as an income
in the profit and loss account, and the receivable amount is treated
as an asset in the balance sheet.
9. objectivity
meaning: (a) Personal bias should be avoided by those who are responsible for
the preparation of the books and final accounts.
(b) Different accountants should arrive at similar (the same) treatment
of an item.
examples (a) The Companies Ordinance requires that the published accounts of
limited company should give a true and fair view.
(b) Directors’ suggestions which are “window dressing” and subjective
should not be considered.
10. timeliness
meaning: (a) The timeliness of the reported financial statements will provide a
true picture of the business for the users to make decisions in time.
(b) Timeliness may conflict with accuracy. They should be balanced
when the financial accounts are prepared.
examples (a) The amount of the proposed final dividends of ordinary shares will
be subjected to the timeliness of the reported statements.
PS:
1. An asset is anytime that can generate future benefit to the enterprise.
The asset is purchased not for resale at a profit, so the disposal of it is regarded as
an extraordinary item.
2. An extra-ordinary item:
- is not expect to recur frequently
- is material
- is out of management control (having no responsibility for the loss)
- is not included in the profit and loss account, but shown as a separate
item (not reducing the figure of net profit) to offer a true and fair view.
3. Depreciation is only the allocation of an asset’s cost over its estimated useful life.
It need not be an accurate valuation.
It is an expense of consuming the asset, and should be charged against profit
according to the matching concept.
It is a provision for known liability and the estimated amount should be shown on
the balance sheet according to the prudence concept.
4. An exceptional item is like an extraordinary item but it is within management
control. It is included in the profit and loss account, reducing the figure of net
profit. However, a note should be made to the accounts.
中五會考 – 會計准則 (概念、原理、假設、慣例…)
1. Objectively – It is the use of a method that everyone can agree to.
(客觀 – 應盡量採用大家都接受的方法, 避免爭論)
2. Consistency – Accounting keeps to the same method, except in special cases.
(Accounting tries not to change a method.)
(連貫 – 為方便用家比較業績, 應盡量避免更改沿用的方法)
3. Money measurement – Accounting only records transactions that are measurable
in money. (貨幣量度 – 只紀錄可用貨幣量度的事項)
4. Stable monetary measures – The value of money is assumed very stable.
(假定貨幣的幣值是非常穩定的)
5. Ouantifiability – It is the ability to make a measure of a transaction in money.
(量化 – 可以貨幣量度的能力)
6. Dual aspect – In a double entry system, accounting deals with both the debit and
credit aspects of a transaction. (記帳時須同時顧及左、右方的記錄)
7. Business entity – Accounting only records transactions that affect the business;
and not the owner’s private transactions.
(公司主體 – 只紀錄與公司有關的事項,不紀錄東主個人事項)
8. Accrual – Accounting records revenues when they are earned (not only when cash
is received). Accounting records expenses when they are incurred (not
only when cash is paid).
. (編製報表時須作調整, 不單以現金收支作準, 而以應收應付為基礎)
9. Prudence (conservatism) – Accounting tries not to overstate profits or revenues..
Accounting tries not to understate losses or expenses.
(小心穩健 – 不高估利潤/收入; 也不低估損失/使費)
10. Realisation – Accounting records a profit at the point at which the profit is earned
.
(not at a point at which cash is received). (真正賺到才入帳)
11. Going concern – A business is assumed to continue for a very long time.
(假定公司將長期經營下去)
12. Materiality – Accounting records a transaction as an asset only when it is
significant. For small amount items, they are only treated as
expenses. (金額大的支出, 才作資產處理, 否則只作使費)
**
Capital expenditure – It is the payment of
(資本開支 – 買入資產, 或資產增值)
1. buying an asset (cost price and other expense that
bring the asset to its present location and condition)
2. increasing the value of an existing asset
Revenue expenditure – It is the payment for daily running of the business.
It is an expense necessary to earn a profit.
(日常營運, 短期報銷, 以賺取收益的必要使費開支, 資產保值)