FINANCIAL ACCOUNTING MIDTERM

DEFINITION OF ACCOUNTING:
 Accounting is the art of recording, classifying and summarizing in a significant manner and in
terms of money transactions and events which are in part at least of a financial character and
interpreting the results thereof or communicating the results of the business transactions.

ACCOUNTING CONCEPTS AND PRINCIPLES

1. ACCOUNTING CONCEPTS:
 Accounting concepts are basically the assumptions on which we base our accounting records.
They are things that we assume which in certain cases may not necessary be correct or true.
For example; in accounting the data is recorded in term of currency ignoring the time value of
money concept that is the currency loses its value with time in reality while the accounting
record ignores it. Finally, we can say that accounting concepts are the basic assumptions on
which accounting records and statements are based. These concepts provide the general
framework in which an accountant operates. Following are the basic accounting concepts
which are explained and discussed in detail.

1. The Cost Concept:

 The cost concept is based upon the idea that everything that is acquired for the business
purposes should be recorded at its cost. Any asset that is reflected in the balance sheet is
reported at its initial cost. Finally, we can say that cost concept states that all acquisitions of
items should be recorded and retained in books at cost. If a balance sheet shows an asset at a
certain value it should be assumed that this is its cost.

2. The Business Entity Concept:

 The account record must be prepared in a manner that it affects a separate individuality that it
is treated as a single unit separate from its owners. The point where the business firms and the
owners are treated is the capital invested by the owners in the firm. Finally, we can say that
this concept states that a business is an entity in itself and it should be treated as a separate
person which is different from its owner.

3. Unit Of Measurement Concept:

 One of the accounting concepts is that every transaction must be measured and recorded in
terms of a currency unit. Like, in Pakistan every business must record its transactions in
Pakistani rupees. However, in case of multinational firms they can repair their consolidated
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accounting record in the currency of a country where the head office is located. Finally, we can
say that all accounting records are made in terms of monetary units only. All transactions are
measured in money units and recorded in the books of accounts in terms of money which is
generally the currency used in the country. Example as previous stated.

4. Going Concern Concept:

 As a general idea it will be more appropriate that the accounting data is prepared at the close
of a business, but the business is taken as a going concern and the decision makers are
interested to compare and evaluate the accounting record on a regular basis that the
accounting data shall be prepared on the regular basis. However, if the business is about to
close down within a determinable time the accounting record is to be prepared not at the cost
but rather at the liquidation. Finally, we can say that this concept states that all records are
made on the assumption that the business will continue for foreseeable future. Unless it is
known that the business will close down at a determinable time all transactions are recorded in
the routine manner and there is no need for any special valuation or adjustment. However, if it
is known that the business is about to close down within a determinable time the accounting
record is to be prepared not at the cost but rather at the liquidation.

5. Dual Aspect Of Accounting Records:

 This concept is related or adopted the double entry system that suggests that every transaction
has a dual effect on the accounting records that every debit has credit entry. Finally, we can say
that this concept relates to the idea of double entry bookkeeping. Every transaction affects the
business in at least two aspects these two aspects are equal and opposite in nature. This
concept is based on the assumption that a business unit never truly owns anything. Anything
that it has namely assets, it owes it either to outsiders namely liabilities or to the owner who is
also a separate person or capital.

2. ACCOUNTING PRINCIPES:
 Principles of accounting are the term refers to the rules that have been developed by adhering
to the concepts of accounting. These rules give uniformity to the financial statements. Finally
we can say that the term accounting principles refer to rules that have emerged from use of
the basic accounting concepts. Adherence to these rules ensures that accounting records are
maintained on more or less the same basis by all businesses units and can therefore be relied
upon and used for comparisons. The following are more significant account principles which
are explained and discussed.
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1. Principle Of Objective Evidence:

 This principle or rule suggests that any accounting transaction has to be supported by
documentary evidence. For example; the accounting entry of a sale has to be supported by
cash memos. Similarly, credit sale needs a document called a bill and a bank withdrawal needs
a document of a check or cheque. Eventually, this principle states that no accounting record
should be made unless it is supported by independently verifiable evidence in writing means;
all transactions should be evidenced by a written document such as cash memos, credit sales
by invoices, payments by bank through cheques etc.

2. Period Principle:
 This principle refers to the idea that all financial statements have to be prepared periodically. In
accounting a period is usually a year. The accounting year may be a calendar year or it may be
financial year this depending upon company’s policy. Finally, we can say that information is
needed by all concerned on a regular basis and should therefore be prepared on an ongoing
basis. For the purpose of having a reliable and comparable set of financial statements, the
performance and position of a business unit is measured at the end of pre-determined periods
called accounting periods.

3. Principles of Matching Incomes and Costs:

 This principle refers to the rule that all revenues and cost related to a period must be recorded
during that period. That is when revenues are generated have to be recorded in the period of
its generation and the costs incurred to materialize these revenues have to be recorded as well.
Finally, we can say that it is important that revenues and costs that are included in the income
statement of a particular period do really belong to that period and correspond to each other.
If we include any revenue in a particular period we should be sure that it has been earned in
the period in whose income statement it is included and whatever costs have been incurred for
the purpose of earning that revenue are in included in the expenses for the period in which the
credit for the income is taken.

4. Accrual Principle:
 This principle is in fact related to the matching principle. This principle suggests that some
expenses during a period must be reported in that period. The indirect expenses which are also
referred to as supported expenses has to be supportive expense has to be recorded in the
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period of availability for example the company consumers energy in the form of electricity
during a certain period to make some sales and the bill is paid in the next period. The
accounting rule now suggests that it has to be recorded in the period of consumption not in the
period of payment. Finally, this principle relates to such expenses that are not specifically
related to the source of revenue but are incurred by the business for its existence or general
conduct. It states that if an expense has been incurred in a particular accounting period it
should be included as an expense in that period’s income statement whether or not such an
expenses has been paid for.

5. Conservatism or Prudence Principle:

 This principle states that a business should display a good degree of caution in booking incomes
and expenses. It is considered wise to book an income only when it is realized but to book an
expense as soon as a reasonable likelihood of it becoming payable is reached.

6. The Consistency Principle:

 This principle states that the accounting records must be prepared in consistency that is the
company must not change one of its accounting policy adopted previously. For example, the
accounting allows the companies to follow any depreciation method charged on its fixed
assets. Once adapted any of these methods shall be follow in the coming periods by the
company.

7. The Materiality Principle:

 This principle states that this should be done only to the extent that it is material. Unnecessary
details should be avoided as the cost of going into such details is often greater than the benefit
of the exercise. Optional

8. The Principle of Adequate Disclosure:

 This principle is of the view that all the accounting policies being followed by the company have
to be disclosed in details in the shape of footnotes to the financial statements. Example; can be
in the shape of detailed depreciation schedule adapted asset wise.

ADVANTAGES OF ADHERING TO ACCOUNTING CONCEPTS AND PRINCIPLES

 Following are some of the advantages of adapting the accounting principles.
1. The accounting records prepared in the light of accounting principles are more accurate and
reliable.
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2. The financial statements, so prepared are looked credible by the outside agencies like
financial institutions government departments and so on.
3. Companies often are interest to compare their performance against their competitors, so
that they may improve their performance if under performed and may bring some changes
in their strategies.
4. Following laid down rules makes the job of an accounting easier. He is saved the trouble of
making subjective decisions. For example having a laid down policy on what is considered
material for the purposes of booking expenses or capitalization can save a lot of hassle for
the accounting staff. Once the capitalization limit is set it makes accounting much simple.

CHAPTER TWO
Bank Reconciliation
 Bank reconciliation statement is a schedule prepared the accountant on periodical basis
explaining any differences between the bank statement and the company’s record. Be
informed that the bank record transactions in the company’s account with the bank and the
company maintains the cash record in its own books at the end of each month the accountant
compares the balance shown with the bank and the balance per cash its own books of if there
is the difference between the tries to find out the reasons of these differences once the
reasons are identified the accountant prepares a separate statement to reconcile the balances.
 In other words, a statement showing the reasons or causes of differences between cash book
and pass book is called Bank Reconciliation Statement. Abbreviated as “BRS” (Bank
Reconciliation Statement.)

REASONS FOR DIFFERENCES BETWEEN BANK STATEMENT

AND ACCOUNTING RECORDS
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 The balance of the end of a period does not agree with the balance show in the accounting
records. Some of the reasons or causes are given as below:
1. When the company issues checks or cheque, it is record in the accounting records of the
company but, the check may not be presented for the payment during the period of its
issue to the bank presenting in the both balances to be out.
2. The company records the cash deposited with the bank that may not be deposited or
received with the bank, hence, the balances will be out.
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3. Some of the banks provide interest on the checking and it is credited every monthly. The
company comes to know about such credits through bank statement. Similarly, a
customer of company may directly deposit cash in the company’s bank account without
informing the company. Hence, the balance will be out or is out.
4. Sometimes a cheque received by the company from its customer deposited with the bank
for collection may be returned unpaid due to the insufficient funds available in the
customer’s account. Such transactions have already be recorded by the company as
collected, but in reality it is not.
5. The banks usually deduct its charges from the customer’s account direct. The customer
comes to know about the debit entry in its account through bank statement such debits
make the balances out. In summary, main reasons are: