2.0
ACCOUNTING PRINCIPLES, CONCEPTS AND CONVENTIONS
The following are the Accounting Principles, Conventions and Concepts that
form the bases of application of the contents of these IPSASs Accrual
Guidelines.
2.1
Prudence
Preparation of financial statements requires the use of professional judgment
in the adoption of accounting policies and estimates. Prudence requires that
accountants should exercise a degree of caution in the adoption of policies
and significant estimates such that the assets and income of the entity are not
overstated whereas liability and expenses are not under stated. The rationale
behind prudence is that an entity should not recognize an asset at a value that
is higher than the amount which is expected to be recovered from its sale or
use. Conversely, liabilities of an entity should not be presented below the
amount that is likely to be paid in the future.
Example:
When inventory is recorded at the lower of cost or net realizable value
(NRV) rather than the expected selling price, this ensures profit on the sale
of inventory is only realized when the actual sale takes place.
2.2
Neutrality
Information contained in the financial statements must be free from bias. It
should reflect a balanced view of the affairs of the entity. Information may
be deliberately biased or systematically biased.
2.2.1 Deliberate Bias occurs where circumstances and conditions cause
management to intentionally misstate the facts in the financial statements.
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Example:
a. Managers of entities that are required to pay operating surpluses to
Government may deliberately increase their expenditure to reduce
their surpluses.
b. Managers of entities facing serious liquidity problems may decide to
window dress the financial statements in a manner that improves the
entity's liquidity ratios in order to hide the gravity of the situation.
2.2.2 Systematic bias occurs where an entity’s accounting systems have
developed an inherent tendency of favouring one outcome over the other
over time.
2.3
Faithful Representation
Information presented in the financial statements should faithfully represent
the transactions and events that occur during the period. Faithful
representation requires that transactions and events should be accounted for
in a manner that represents their true economic substance rather than the
mere legal form.
2.4
Substance over Form
This concept prescribes that in order to present a true and fair view of the
affairs of an entity, the economic substance of transactions and events must
be captured in the financial statements rather than just their legal form.
Substance over form concept entails the use of judgment on the part of the
preparers of the financial statements. Whereas legal aspects of transactions
and events are of great importance, they may have to be lowered at times in
order to provide more useful and relevant information to the users of
financial statements.
The principle of Substance over legal form is central to the faithful
representation and reliability of information contained in the financial
statements. In this regard, the responsibility is placed on the preparers of the
financial statements to actively consider the economic reality of transactions
and events to be reflected in the financial statements.
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Example:
A machine is leased to entity X for the entire duration of its useful life.
Although entity X is not the legal owner of the machine, it may be
recognized as an asset in its statement of financial position since the entity
has control over the economic benefits that would be derived from the use of
the asset. This is an application of the accounting concept of substance over
legal form, where economic substance of a transaction takes precedence over
its legal aspects. This is in line with Finance Lease arrangement.
2.5
Single Economic Entity Concept
Single Economic Entity Concept is critical to consolidation of financial
statements. Consolidated financial statements of a group of entities are
prepared on the basis of single economic entity concept.
The Concept suggests that entities associated with each other through the
virtue of common control operate as a single economic unit and therefore the
consolidated financial statements of a group of entities should reflect the
essence of such arrangement.
Consolidated financial statements of a group of entities must be prepared as
if the entire group constitutes a single entity in order to avoid the
misrepresentation of the scale of group's activities.
It is therefore necessary to eliminate the effects of any inter-entity
transactions and balances during the consolidation of group accounts such
as:
a.
b.
c.
Inter-entity sales and purchases
Inter-entity payables and receivables
Inter-entity payments such as dividends, royalties & head office charges
Inter-entity transactions must be eliminated as if the transactions had not
occurred in the first place. Examples of adjustments that may be required to
eliminate the effects of inter-entity transactions include:
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a.
b.
2.6
Elimination of inter-entity transfers (remittance of revenue by entities to
the Treasury) by member entities of a group;
Elimination of excess or deficit depreciation expense in respect of a fixed
asset purchased from a member entity at a price that was higher or lower
than the net book value (carrying amount) of the asset in the books of the
seller.
Full Disclosure
All relevant material facts must be fully disclosed in the financial statements
in line with the relevant IPSAS provisions. Some information, such as a
contingent liability, is easily communicated with a footnote, while other
information, such as the effect of inflation, requires more complex
procedures.
2.7
Materiality
Information is material if its omission or misstatement could influence the
economic decisions of users taken on the basis of the financial statements.
Materiality therefore relates to the significance of transactions, balances and
errors contained in the financial statements. It defines the threshold or cutoff
point after which financial information becomes relevant to the decision
making needs of the users. Information contained in the financial statements
must therefore be complete in all material respects to present a true and fair
view of the affairs of the entity.
Materiality can be relative to the size, Nature and/or particular circumstances
of individual entities.
Example:
Size: A default by a customer who owes ₦1,000 to an entity having net
assets worth ₦10 million is immaterial to the financial statements of the
entity. However, if the amount of default was, say, ₦2 million, the
information would have been material to the financial statements; the
omission of which could cause users to make incorrect business decisions.
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Nature: If an entity is planning to curtail its operations in a geographic
segment which has traditionally been a major source of revenue for the
entity in the past, then this information should be disclosed in the financial
statements as its non disclosure will be misleading to users.
Materiality is linked closely to other accounting principles such as
Relevance, Reliability and completeness.
2.8
Reliability
Information is reliable if a user can depend upon it to be materially accurate
and if it faithfully represents the information that it purports to present.
Significant misstatements or omissions in financial statements reduce the
reliability of information contained in them.
Example:
An entity is being sued for damages by a rival entity, settlement of which
could threaten the financial stability of the entity. Non-disclosure of this
information would render the financial statements unreliable.
Reliability of financial information is enhanced by the use of the following
accounting concepts and principles:
2.9
Relevance
The relevance of information is a critical factor in the decision making needs
of the user. Information is relevant if it helps users of the financial
statements in predicting future trends of the business (Predictive Value) or
confirming or correcting any past predictions they have made (Confirmatory
Value). Same piece of information which assists users in confirming their
past predictions may also be helpful in forming future forecasts.
Relevance is affected by the materiality of information contained in the
financial statements because only material information influences the
economic decisions of its users.
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2.10
Completeness
Reliability of information contained in the financial statements is achieved
only if complete financial information is provided, relevant to the business
and decision making needs of the users. Therefore, information must be
complete in all material respects.
Incomplete information reduces not only the relevance of the financial
statements, it also decreases its reliability since users will be basing their
decisions on information which only presents a partial view of the affairs of
the entity.
2.11
Timeliness
Timeliness principle here refers to the need for accounting information to be
presented to the users in time to fulfill their decision making needs.
Timeliness of information is highly desirable since information that is
presented timely is generally more relevant to users. Conversely, delay in
provision of information tends to render it less relevant to the decision
making needs of the users.
2.12
Comparability
Accounting information is comparable when accounting standards and
policies are applied consistently from one period to another, from one region
to another and from one entity to another.
The comparability of financial statements is important because it allows us
to compare a set of financial statements with those of prior periods and those
of other entities.
2.13 Consistency
This concept requires that accounting policies be applied consistently from
period to period and changed only when there are valid reasons for such a
change.
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2.14
Understandability
Transactions and events must be accounted for and presented in the financial
statements in a manner that is easily understandable by the users.
2.15 Accrual Basis
Financial statements are prepared under the Accrual Basis of Accounting
which requires that income and expense must be recognized in the
accounting periods to which they relate. An exception to this general rule is
the cash flow statement whose main purpose is to present the cash flow
effects of transaction during an accounting period.
Under Accrual Basis of Accounting, income must be recorded in the
accounting period in which it is earned. Therefore, accrued income must be
recognized in the accounting period in which it arises rather than in the
subsequent period in which it will be received.
Expenses, (in the same view) must be recorded in the accounting period in
which they are incurred. Therefore, accrued expense must be recognized in
the accounting period in which it occurs rather than in the following period
in which it will be paid.
2.16 Measurability Concept
The concept of measurability means that only transactions and events that
are capable of being measured in monetary terms are recognized in the
financial statements. All transactions and events recorded in the financial
statements must be reduced to a unit of monetary currency. Where it is not
possible to assign a reliable monetary value to a transaction or event, it shall
not be recorded in the financial statements.
However, any material transactions and events that are not recorded for
failing to meet the measurability criteria should be disclosed in the notes to
the financial statements.
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2.17
Going Concern
Going concern is one of the fundamental assumptions in accounting and the
basis upon which financial statements are prepared.
Financial statements are prepared on the assumption that an entity will
continue to operate in the foreseeable future without the need or intention on
the part of management to liquidate the entity or to significantly curtail its
operational activities. It is assumed that the entity will realize its assets and
settle its obligations in the normal course of the business.
In assessing whether the going concern assumption is appropriate, those
responsible for the preparation of financial statements take into account all
available information about the future, which is at least, but is not limited to,
twelve months from the approval of the financial statements.
The assessments of the going concern assumption here are not predicated on
the solvency test usually applied to business enterprises. There may be
circumstances where the usual going concern tests of liquidity and solvency
appear unfavorable, but other factors suggest that the entity is nonetheless a
going concern.
Example:
a. In assessing whether a government is a going concern, the power to levy
rates or taxes may enable some entities to be considered as going
concerns, even though they may operate for extended periods with
negative net assets/equity; and
b. For an individual entity, an assessment of its statement of financial
position at the reporting date may suggest that the going concern
assumption is not appropriate. However, there may be multi-year funding
agreements or other arrangements in place that will ensure the continued
operation of the entity.
The determination of whether the going concern assumption is appropriate is
primarily relevant for individual entities rather than for a government as a
whole.
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2.16 Matching Concept
Matching Concept means that expenses incurred by an entity must be
charged in the same accounting period in which the revenue relating to the
expenses is earned.
2.17 Periodicity Concept
Periodicity Concept requires that activities which occur in accounting period
be recorded within a prescribed or specific time period in the financial
statements. For instance, Public Sector Entities in Nigeria has a common
accounting period from January to December each year.
2.18 Duality Concept
Duality Concept also known as dual aspect principle is the basis of the
double entry accounting. The double entry accounting requires that for every
debit entry of a transaction, there must be a corresponding credit entry and
vice versa.
Note:
In a case where application of one accounting concept or principle leads to
a conflict with another accounting concept or principle, accountants must
consider what is best for the users of the financial information. An example
of such a case would be the trade-off between Relevance and Reliability; or
Timeliness and Reliability. Information is more relevant if it is disclosed
timely. However, it may take more time to gather reliable information.
Whether reliability of information may be compromised to ensure relevance
of information is a matter of judgment that ought to be considered in the
interest of the users of the financial information.
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