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Accounting Concepts

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Title: Accounting Concepts


1

Accounting Concepts
Andrew Graham Queens University School of Policy
Studies http//post.queensu.ca/grahama/
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Accounting is the fairest invention of the human
mind. - Goethe
3
"It's not the economy anymore, stupid. It's the
accounting."
Source Browning, E.S. and Jonathan Weil.
"Burden of DoubtfulStocks Take a Beating As
Accounting Worries Spread Beyond Enron." The
Wall Street Journal, January 30, 2002, pp. A1.
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The Accounting Module
  • The module will focus on
  • A set of principles for the creation of
    accounting practice
  • What is accounting
  • Users of accounting information
  • Financial accounting and Managerial accounting
  • Generally Accepted Accounting Principles
  • Accrual Accounting and Budgeting
  • A set of financial statements
  • Understanding financial statements
  • Using financial statements

6
A History of Accounting
  • Some scholars claim that writing arose in order
    to record accounting information.
  • Account records date back to the ancient
    civilizations of China, Babylonia, Greece, and
    Egypt.
  • The rulers of these civilizations used accounting
    to keep track of the cost of labour and materials
    used in building structures like the great
    pyramids.
  • The need for accounting has existed as long as
    there has been activity involving money or
    resources.

7
Accounts Table with Cuneiform Script, circa
2400 BC by Mesopotamian Bookkeeper
8
A History of Accounting
  • Accounting developed further as a result of the
    information needs of merchants in the city-states
    of Italy during the 1400s.
  • The monk Luca Pacioli, a mathematician and friend
    of Leonardo da Vinci, published the first known
    description of double-entry bookkeeping in 1494.

9
Double-Entry Accounting
  • Each financial event is called a transaction
  • The effect of a transaction is recorded in the
    accounts by an entry
  • Each entry will affect at least two parts of the
    accounting record to balance the record
  • This does not mean that the financial event is
    recorded twice rather it is balanced against
    either costs, increased or reduced liability,
    changes in inventory, etc.

10
Double Entry Accounting
  • The double-entry system provides checks and
    balances to ensure that your books are always in
    balance.
  • In double-entry accounting, every transaction has
    two journal entries a debit and a credit. Debits
    must always equal credits.
  • Because debits equal credits, double-entry
    accounting prevents some common bookkeeping
    errors. Errors that aren't prevented are easier
    to find. Double-entry accounting is the basis of
    a true accounting system.

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A History of Accounting
  • In the Industrial Revolution of the nineteenth
    century, the growth of corporations spurred the
    development of accounting.
  • The corporation ownersthe shareholderswere no
    longer necessarily the managers of their
    business.
  • Managers had to create accounting systems to
    report to the owners how well the company was
    performing

13
What is Accounting?
  • Accounting and its boundaries are dynamic in
    nature, always responding to new needs as they
    arise.
  • The boundaries of accounting are fuzzy and
    changeable as a result
  • Accounting is both an art and a science that
    involves judgement and molding information to the
    demands of the situation while being to claim
    objectivity and independence.

14
What is Accounting?
  • Identifies, measures and communicates financial
    information
  • Focuses on economic entities
  • Provides this information to interested parties,
    these being the users of financial information
  • Provides this information with the purpose to
    assist the organization in reaching its stated
    goals
  • Enhances the understanding of what is being
    measured as well as providing information for
    decision making.

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Managerial and Financial Accounting
  • Managerial Accounting Internal Focus.
  • Plan
  • Implement
  • Control
  • Financial Accounting External Focus.
  • Record events or transactions.
  • Report financial position and results of
    operations.

16
Managerial and Financial Accounting
  • Financial accounting has tended to concentrate on
    ensuring that their legislative and stakeholders
    interests of external users are met through
    reporting at clearly defined frequencies, with
    high level information oriented toward meeting
    their general information needs.
  • Management accounting will be highly flexible in
    format

17
Managerial and Financial Accounting
  • Management accounting information is designed to
    meet the needs as they emerge within the
    organization.
  • Financial accounting will be considerably less
    flexible in format, often conforming to
    government-wide reporting formats.

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Managerial and Financial Accounting
  • Both forms of accounting information have to
    derive from the same basic financial information,
  • They use the same chart of accounts and the same
    financial accounting technology that is in use in
    the organizations.
  • At times, internally reported information has to
    be reconciled with external reporting.

21
Chart of Accounts An example
  • Budgetary Accounts
  • Expenditures
  • Economic
  • Compensation of Employees
  • Use of Goods and Services
  • Consumption of Fixed Capital
  • Interest
  • Subsidies
  • Grants
  • Social Benefits
  • All Others

22
Chart of Accounts - Continued
  • Expenditures (continued)
  • Functional (10 major classes)
  • General Public Services
  • Defense
  • Public Order and Safety
  • Economic Affairs
  • Environmental Protection
  • Housing and Community Amenities
  • Health
  • Recreation, culture, and religion
  • Education
  • Social Protection

23
Chart of Accounts - continued
  • Revenues (4 major classes)
  • Taxes
  • Social Contribution
  • Grants
  • All Others
  • Assets
  • Liabilities
  • Net Assets

24
Managerial and Financial Accounting
  • External financial reporting requirements by law
    and generally set as a matter of governmental
    policy, even for the voluntary sector
  • Highly unlikely that it will be used actively
    within the organization why timeliness, level
    of generality, gathered for differing purposes
  • Senior levels of management, however, and also at
    the political level, the organization has to be
    able to explain and defend the financial reports
    as they are made public

25
The Financial Statements More to Follow
  • Balance Sheet - a snapshot of the resources,
    obligations, and
  • worth of an organization at a specific point in
    time ( think stock).
  • Income Statement - measures the cumulative
    resource inflows
  • and outflows for an organization over some
    specified period of
  • time. It is the reporting equivalent of an
    operating budget (think flow).
  • Cash Flow Statement - measures the cumulative
    cash inflows
  • and outflows for an organization over some
    specified period of
  • time. It is the reporting equivalent of a cash
    budget (think flow).

26
Users of Public Sector Financial Statements
  • The public who cares and why?
  • The opposition
  • Legislative auditors
  • Interest groups
  • Other governments in the country
  • Foreign governments
  • Foreign firms
  • International monitoring agencies
  • Credit rating organizations

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Users of Public Sector Financial Statements
  • Internal and external users of accounting
    information that is generated for an organization
    differ in their use of it in the following areas
  • Access
  • Frequency
  • Detail
  • Timing
  • Required expertise and understanding, and
  • Response

29
Users of Public Sector Financial Statements
  • Access
  • for internal users, it is direct, unlimited and
    detailed
  • for outsiders, it is summary, higher level

30
Users of Public Sector Financial Statements
  • Frequency
  • for internal users, as needed, depending on level
    of focus
  • for outside users, it is generally on a quarterly
    or annual basis
  • Detail
  • for internal users, as micro as needed,
  • for external users, higher level and generally
    summarized

31
Users of Public Sector Financial Statements
  • Timing
  • for internal users, the information is current or
    recent and focused on decision making and
    short-term adjustments
  • For external users, the information is
    retrospective and applicable for assessing
    performance against plans

32
Users of Public Sector Financial Statements
  • Required expertise
  • For internal users, the financial information is
    complex, requiring a detailed appreciation of its
    significance for operations, performance and
    results
  • For external users, it requires an understanding
    of the organization, but not in detail

33
Users of Public Sector Financial Statements
  • Response
  • Internally, the information will lead to action
    and decisions
  • Externally, it will depend on the perspective of
    the user, but it will generally be associated
    with forming a view of the performance of the
    organization

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GAAP
36
Generally Accepted Accounting Principles (GAAP)
  • Provide guidance on the creation of financial
    reports
  • Set out by the Canadian Institute of Chartered
    Accountants CICA Handbook
  • American and International equivalents
  • Originally focused on private sector accounting
    but now there are separate public and
    not-for-profit handbooks

37
Governments and GAAP
  • Does not have the force of law (in Canada
    recent American legislation imposes a form)
    created on basis of general acceptance
  • For senior governments in Canada, these standards
    are generally accepted in the true sense of
    that phrase. The federal, provincial and
    territorial governments are sovereign
    governments. They cant be forced to follow the
    standards. Yet, there is a very high voluntary
    compliance with the standards in the CICA PSA
    Handbook.

38
GAAP Principles
  • Entity Concept
  • Requires that you define the organizational
    component for which you are trying to account
  • The unit standards apart from other organization
    and individuals as a separate economic nut
  • From an accounting perspective, sharp boundaries
    are drawn around each entity so as not to confuse
    its affairs with those of other entities

39
GAAP Principles
  • Money Denominator/Stable Monetary Unit Concept
  • Requires that all items included on the
    financial statements be measurable in dollar
    (yen, Euro) terms
  • Generally ignores effect of inflation on value of
    currency unit within a specific time period
    unless it is material

40
GAAP Principles
  • Objective Evidence/ Reliability Principle
  • Require that values be based on an objective
    valuation of resources
  • Reliable data are verifiable
  • Verifiable by an independent observer

41
GAAP Principles
  • Cost Convention
  • When there is a dispute over value, cost is used
  • Acquired assets and services should be recorded
    at their actual or historical cost
  • Accounting records should maintain the historical
    cost of an asset for as long as the business
    holds the asset

42
GAAP Principles
  • Conservatism
  • Says that you should anticipate losses but not
    gains
  • Need to give due regard for risk and risk
    management
  • Role of prudence in predicting and reporting

43
GAAP Principles
  • Going Concern Concept
  • Assumes that the organization will continue in
    operation
  • Assume the business will remain in operation long
    enough to use existing assets for their intended
    purpose
  • Bankruptcy values may be lower

44
GAAP Principles
  • Materiality
  • Reporting only needs to contain the level of
    detail necessary for decision making
  • Don't need to be accurate to the penny or even
    the nearest 1,000 in some cases
  • A piece of information is material if it would
    affect a decision makers decision

45
GAAP Principles
  • Accrual Concept
  • Revenues are recorded when the organization is
    entitled to them
  • Expenses are recorded when resources are used to
    generate revenues

46
GAAP Principles Constraints on Providing
Financial Information
  • Benefits must exceed costs
  • Benefits of the information produced should
    exceed the costs of producing the information
  • Financial (and all managerial) information is not
    costless

47
What to look for to assure GAAP Compliance
A clean audit report on the financial
statements. This means that an external auditor
has expressed no reservations or concerns about
the information reported in the financial
statements, how the information is reported or
whether any information appears to be missing.
A note to the financial statements (generally
Note 1) outlines the accounting policies a
government has used in preparing the statements.
This note may also tell you if a governments
financial statements are prepared in accordance
with GAAP.
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