TOPIC 5: APPLICATION IN ACCOUNTING THEORY

TOPIC 5: Application in Accounting Theory

1.      Definition of Accounting Theory

Purpose :

·         helps to evaluate practice for example methods and techniques used by an accountant should be valid or correct in terms of accounting theory

·         to eliminates unnecessary diversities in accounting treatment.

·         Assist in the development of accounting standards.

·         Provide coherent set of logical principles that form a genera frame of references for evaluating and developing new accounting practices.

Accounting Bodies

Malaysia	International
·         Malaysian Institute of Accountant (MIA) ·         Malaysian Institute of Certified Public Accountants (MICPA)	·         International Accounting Standards Board (IFRS) ·         International Federation of Accountants

 

2.      Categories of users

a)      Discover the users of accounting information

Internal Users

External Users

§  Management: for analyzing the organization's performance and position and taking appropriate measures to improve the company results. §  Employees: for assessing company's profitability and its consequence on their future remuneration and job security. §  Owners: for analyzing the viability and profitability of their investment and determining any future course of action

§  Creditor: for determining the credit worthiness of the organization. Terms of credit are set according to the assessment of their customers' financial health. Creditors include suppliers as well as lenders of finance such as banks. §  Tax Authourities: for determining the credibility of the tax returns filed on behalf of the company. §  Investors: for analyzing the feasibility of investing in the company. Investors want to make sure they can earn a reasonable return on their investment before they commit any financial resources to the company. §  Customers: for assessing the financial position of its supplier which is necessary for a stable source of supply in the long term. §  Regulatory Authorities: for ensuring that the company's disclosure of accounting information is in accordance with the rules and regulations set in order to protect the interests of the stakeholders who rely on such information in forming their decisions.

 

3.      Conceptual of framework

a)      Nature of conceptual of framework

§  a coherent system of inter-related objectives and fundamentals that should lead to consistent standards that prescribe the nature, function and limits of financial accounting and financial statements.”

§  (AT Foulks Lynch)

 

b)      Purpose of conceptual frame work

                                         i.            a framework for setting accounting standards;

                                       ii.            a basis for resolving accounting disputes;

                                     iii.            fundamental principles which then do not have to be repeated in accounting standards.

 

c)      Integrate the component of frame work

 

4.      Accounting Concept and Convention Application

Accounting Conventions
Monetary measurement	Accountants do not account for items unless they can be quantified in monetary terms. Items that are not accounted for (unless someone is prepared to pay something for them) include things like workforce skill, morale, market leadership, brand recognition, quality of management etc
Separate Entity	This convention seeks to ensure that private transactions and matters relating to the owners of a business are segregated from transactions that relate to the business.
Realisation	With this convention, accounts recognise transactions (and any profits arising from them) at the point of sale or transfer of legal ownership - rather than just when cash actually changes hands. For example, a company that makes a sale to a customer can recognise that sale when the transaction is legal - at the point of contract. The actual payment due from the customer may not arise until several weeks (or months) later - if the customer has been granted some credit terms.
Materiality	An important convention. As we can see from the application of accounting standards and accounting policies, the preparation of accounts involves a high degree of judgement. Where decisions are required about the appropriateness of a particular accounting judgement, the "materiality" convention suggests that this should only be an issue if the judgement is "significant" or "material" to a user of the accounts. The concept of "materiality" is an important issue for auditors of financial accounts

 

Accounting Concept
Going Concern	Accountants assume, unless there is evidence to the contrary, that a company is not going broke. This has important implications for the valuation of assets and liabilities.
Consistency	Transactions and valuation methods are treated the same way from year to year, or period to period. Users of accounts can, therefore, make more meaningful comparisons of financial performance from year to year. Where accounting policies are changed, companies are required to disclose this fact and explain the impact of any change.
Prudence	Profits are not recognised until a sale has been completed. In addition, a cautious view is taken for future problems and costs of the business (the are "provided for" in the accounts" as soon as their is a reasonable chance that such costs will be incurred in the future.
Matching (or "Accruals")	Income should be properly "matched" with the expenses of a given accounting period.

 

5.      Qualitative characteristic for the conceptual account

Criteria	What it means for the preparation of accounting information
Understandability	This implies the expression, with clarity, of accounting information in such a way that it will be understandable to users - who are generally assumed to have a reasonable knowledge of business and economic activities
Relevance	This implies that, to be useful, accounting information must assist a user to form, confirm or maybe revise a view - usually in the context of making a decision (e.g. should I invest, should I lend money to this business? Should I work for this business?)
Consistency	This implies consistent treatment of similar items and application of accounting policies
Comparability	This implies the ability for users to be able to compare similar companies in the same industry group and to make comparisons of performance over time. Much of the work that goes into setting accounting standards is based around the need for comparability.
Reliability	This implies that the accounting information that is presented is truthful, accurate, complete (nothing significant missed out) and capable of being verified (e.g. by a potential investor).
Objectivity	This implies that accounting information is prepared and reported in a "neutral" way. In other words, it is not biased towards a particular user group or vested interest

 

6.      Presentation of Financial Statement

a)      Nature

i.                    assets;

ii.                  liabilities;

iii.                equity;

iv.                 income and expenses, including gains and losses;

v.                   contributions by and distributions to owners in their capacity as owners; and

vi.                 cash flows.

 

b)      Outline – refer to Malaysian Financial Reporting Standards

 

c)      Component of Financial Statement

 

i.                    a statement of financial position as at the end of the period;

ii.                  a statement of comprehensive income for the period;

iii.                a statement of changes in equity for the period;

iv.                 a statement of cash flows for the period;

v.                   notes, comprising a summary of significant accounting policies and other explanatory information; and

vi.                 a statement of financial position as at the beginning of the earliest comparative period when an entity applies an accounting policy retrospectively or makes a retrospective restatement of items in its financial statements, or when it reclassifies items in its financial statements.

 

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 TIPS***TIPS***TIPS***

Here, I 'd like to share with you a tips how to answer the question required you to....

...Explain the accounting term...  
Eg 1:
Going Concern concept
Suggestion answer:  It's mean all the business entities will be carried out continuously for a lifetime (2.5 marks)

..those who answer such that, i'll give you full marks 2.5!!!

Eg 2:
Accrual Concept
Suggestion answer:  It is distinguish between receipts of cash and obligation to pay cash for benefits received (2.5 marks)

so... who wants to try next...?

Prudence Concept...

Anyone...???

Thank you Nazirul!
click at icon Edmodo below if you want to respond on this...

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Tips nak jawab soalan topic 5: Theory and application

example question;

DPI6 Enterprise buy a building at a price RM100,000 on January 1, 2012. As the value of the building has been increased to RM155,000 the Board proposed to record the building at the new value to increase their value.

Suggestion answer:

That action is wrong because it against the concept of historical cost. In this principle all transactions must be recorded at historical cost that is the price paid.

Keyword: wrong (2 marks), against the concept of historical cost (2 marks),
clarification on what historical cost... all transactions must be recorded at historical cost that is the price paid (1marks)

Okey... next example:

DPI6 Enterprise usually prepare their financial statements at the end of every financial year. Since business performance is not satisfactory for this year, the board proposed for the financial statements to be prepared for next year.

suggestion answer:

The action is wrong because it against the concept of the accounting period. As a business accounting period is determined based on one-year period, the preparation of financial statements shall be provided at the end of each accounting year.

Keyword: wrong (2 marks), against the concept of the accounting period (2 marks), preparation of financial statements shall be provided at the end of each accounting year.(1 marks)

Ok... why not you all try answer this next question...?

AZMEER Enterprise has inventories amounted to RM40,000 now has market value of RM50,000. To give a true and fair view of the company, the inventories had been recorded at RM50,000.

so, what do you think?