ACCRUAL BASIS ACCOUNTING

According to the accrual basis accounting system, transactions that change a company’s financial statements are recorded in the periods in which the events occur.

     Revenues will be recorded when earned rather than the cash is received.

     Expenses will be recorded when incurred rather than the cash is paid.

CASH BASIS ACCOUNTING

According to the cash-basis accounting system, revenue is recorded when cash is received and expense is recorded when cash is paid.

  Cash-basis accounting is not in accordance with GAAP

  Most Companies use accrual basis accounting

  Individuals and some small companies use cash-basis accounting

QUALITATIVE CHARACTERISTICS OF ACCOUNTING INFORMATION

Primary Qualitative Characteristics

Relevance

Accounting information is relevant if it makes a difference in a decision. Relevant information has either predictive or feedback value or both. In addition, to be relevant accounting information must be timely.

ü Predictive value: That helps users forecasting/predicting future events.

ü Feedback value: That confirms/corrects prior expectations/predictions.

ü Timeliness: Accounting information must be available to its users/decision makers before it loses its capacity to influence decisions.

Reliability

Reliability of accounting information means that the information is free from error and bias. To be reliable, accounting information must be verifiable, faithfully represented and neutral.

o  Verifiable: Accounting information is verifiable if we able to prove that the information is free from error and bias.

o  Faithfull representation: Accounting information must be factual.

o  Neutral: Accounting information must not to favor one set of users over another.

Secondary Qualitative Characteristics

Comparability

Comparability means accounting information of an enterprise can be compared with the accounting information of other different, but similar, enterprises. This characteristic of accounting information enables users to identify and understand similarities in, and differences among, items. Comparability results when different enterprises use the same accounting principles.

Consistency

Consistency means that a company uses the same accounting principles and methods, to similar events, from year to year or period to period. Consistency helps companies to present their accounting information in a consistent manner. It does not mean that an enterprise can't switch from one accounting method to another. If a new method is acceptable and is preferable, the company can switch. Hence, the enterprise should disclose the reasons and the effect of such type of change.

CONSERVATISM CONSEPT

Conservatism concept is another user constraint in the application of basic accounting principles. This principle holds that ‘when more than one accounting or measurement alternative is permissible for a transaction, the one having the least favorable immediate effect on net income or owners’ equity usually should be selected. We are to follow the concept, ‘anticipate all possible losses but no profit’ i.e., the principle ignores all unrealized gains and provides for all anticipated losses. For example, the rule of ‘lower of cost or market (LCM)’ in valuing inventories is still applied. It implies that the highest values of liabilities and expenses and the lowest values of assets and revenues should preferably be reported.

FULL DISCLOSURE PRINCIPLE

The full disclosure principle specifies that there should be complete and understandable reporting on the financial statements of all significant information relating to the economic affairs of the entity. To meet the requirements of this principle, all published financial statements are supported by a section called 'Notes to the Financial Statements’. Accounting information relating to a specific period must be complete and sufficient to make them useful and not misleading to the average users. 

HISTORICAL COST PRINCIPLE

Cost principle should be borne in mind when reading financial statements. Under this principle all goods and services purchased are recorded at cost and appear on the statements at cost. For example, if a business pays Tk. 50,000 for land to be used in carrying on its operations the purchase should be recorded at Tk. 50,000 although its salable price is Tk. 60,000. If five years later, the price of this land increase to Tk. 100,000 this makes no difference either. The land cost Tk. 50,000 and should continue to appear on the balance sheet at Tk. 50,000 even though its estimated market value is twice that.

MONETARY UNIT ASSUMPTION

In accounting records, a concern will include only the transactions that can be expressed in terms of money i.e. every business transaction has to measure in terms of money. Money has been regarded as the language of accounting. “Accounting focuses on the measurement and reporting, in monetary terms, of the flow of resources into and out of an organization, of the resources controlled by the organization, and of the claims against those resources”. Besides, Accounting is limited to the production of information expressed in terms of a monetary unit, it does not record and communicate other relevant but non-monetary information. It ensured uniformity and comparability of the information. 

REVENUE RECOGNITION PRINCIPLE

The revenue recognition principle states that revenue should be recognized as well as recorded when it is realized or realizable and when it is earned. In other words, companies shouldn't wait until revenue is actually collected to record it in their books. Revenue should be recorded when the business has earned the revenue. This is a key concept in the accrual basis of accounting because revenue can be recorded without actually being received.

PERIODICITY CONCEPT

Although a business concern will run for an unlimited period of time, the owner of the business and other related individuals want to know the performance and financial position of the business after certain interval. For this reason, we have to set up a specific period of time for which the profit or loss of the business would be calculated. This specific period is known as accounting period. In the interest of uniformity and comparability this date is usually decided at an equal interval. Accounting period may be one year, six months, three months, one month, a week or a day. So, financial statements of an enterprise are prepared and disclosed periodically showing performance of this period. 

GOING CONCERN CONCEPT

It is assumed that a business organization will continue its operations for unlimited future periods. It will not be liquidated; continuously performs its business. According to going concern concept, the values of assets are shown in the B/S and the cost of an asset is not treated as expense at the time of purchase of the asset. Therefore, the assets are for use in the business and are not for sale; their current market values are not particularly relevant and need not be shown.

BUSINESS ENTITY CONCEPT

According to the business entity concept, every business is separate and distinct from its owner or owners and from every other business. The records and reports of a business should not include either the transactions or assets of another business or the personal assets and transactions of its owner or owners. For this reason, capital is treated as a liability of the business. 

GAAP

GENERALLY ACCEPTED ACCOUNTING PRINCIPLES -GAAP

The accounting profession has developed some standards that are generally accepted and universally practiced. This common set of standards is known as Generally Accepted Accounting Principles-GAAP. Generally Accepted Accounting Principles (GAAP) may be described as broad rules adopted by the accounting profession as guides in measuring, recording, and reporting the financial affairs and activities of a business. They consist of a number of concepts, principles and procedure. Every business enterprise prepares its financial statements in accordance with the GAAP. GAAP are some accounting rules and regulations, which are to follow in preparing financial statements by the preparers of an enterprise. Auditors should follow the GAAP to scrutiny the statements whether those are prepared in accordance with the GAAP. Since the GAAP are generally acceptable to the preparers, auditors and other categories of users.

ACCOUNTING CYCLE

The sequence of accounting procedures used to record, classify, and Summarize accounting information is known as the Accounting Cycle. The term cycle indicates that these procedures must be repeated continuously to prepare new up-to-date financial statements at reasonable intervals. As a bookkeeper, you complete your work by completing the tasks of the accounting cycle. It’s called a cycle because the accounting workflow is circular: entering transactions, manipulating the transactions through the accounting cycle, closing the books at the end of the accounting period, and then starting the entire cycle again for the next accounting period. The accounting cycle has eight basic steps, which you can see in the following illustration. These steps are described in the list below.

1. Transactions: Financial transactions start the process. Transactions can include the sale or return of a product, the purchase of supplies for business activities, or any other financial activity that involves the exchange of the company’s assets, the establishment or payoff of a debt, or the deposit from or payout of money to the company’s owners.
2. Journal entries: The transaction is listed in the appropriate journal, maintaining the journal’s chronological order of transactions. The journal is also known as the “book of original entry” and is the first place a transaction is listed.
3. Posting: The transactions are posted to the account that it impacts. These accounts are part of the General Ledger, where you can find a summary of all the business’s accounts.
4. Trial balance: At the end of the accounting period (which may be a month, quarter, or year depending on a business’s practices), you calculate a trial balance.
5. Adjusting journal entries: You post any corrections needed to the affected accounts once your trial balance shows the accounts will be balanced once the adjustments needed are made to the accounts. You don’t need to make adjusting entries until the trial balance process is completed and all needed corrections and adjustments have been identified.
6. Worksheet: Unfortunately, many times your first calculation of the trial balance shows that the books aren’t in balance. If that’s the case, you look for errors and make corrections called adjustments, which are tracked on a worksheet.

Adjustments are also made to account for the depreciation of assets and to adjust for one-time payments (such as insurance) that should be allocated on a monthly basis to more accurately match monthly expenses with monthly revenues. After you make and record adjustments, you take another trial balance to be sure the accounts are in balance.

7. Financial statements: You prepare the balance sheet and income statement using the corrected account balances.
8. Closing the books: You close the books for the revenue and expense accounts and begin the entire cycle again with zero balances in those accounts.

As a businessperson, you want to be able to gauge your profit or loss on month by month, quarter by quarter, and year by year bases. To do that, Revenue and Expense accounts must start with a zero balance at the beginning of each accounting period. In contrast, you carry over Asset, Liability, and Equity account balances from cycle to cycle.

USERS OF ACCOUNTING INFORMATION

Accounting information helps users to make better financial decisions. Users of financial information may be both internal and external to the organization.

Internal users (Primary Users): Internal or primary users of accounting information include the following-

•   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.

Accounting information is presented to internal users usually in the form of management accounts, budgets, forecasts and financial statements.

External users (Secondary Users): External or secondary users of accounting information include the following-

• Creditors: for determining the credit worthiness of the organization. Terms of credit are set by creditors according to the assessment of their customers' financial health. Creditors include suppliers as well as lenders of finance such as banks.
• Tax Authorities: 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 suppliers which is necessary for them to maintain 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.
• Others: Other secondary users may be Prospective Investors, Creditors, Tax authorities, Regulatory agencies, Customers, Labor Unions, Economic planners, Competitors, Trade Associations, Reporting agencies
• External users are communicated accounting information usually in the form of financial statements. The purpose of financial statements is to cater for the needs of such diverse users of accounting information in order to assist them in making sound financial decisions.

Accountancy encompasses the recording, classification, and summarizing of transactions and events in a manner that helps its users to assess the financial performance and position of the entity. The process starts by first identifying transactions and events that affect the financial position and performance of the company. Once transactions and events are identified, they are recorded, classified and summarized in a manner that helps the user of accounting information in determining the nature and effect of such transactions and events.

Accounting is a very dynamic profession which is constantly adapting itself to varying needs of its users. Over the past few decades, accountancy has branched out into different types of accounting to cater for the different needs of the users.

OBJECTIVES OF ACCOUNTING

The purposes of accounting are to provide the information that is needed for sound economic decision making. The main purpose of financial accounting is to prepare financial reports that provide information about a firm's performance to external parties such as investors, creditors, and tax authorities. Briefly they are as follows-

To keep systematic records: Accounting is done to keep a systematic and permanent record of financial transactions. In the absence of accounting there would have been terrific burden on human memory which in most cases would have been impossible to bear.

To protect business properties: Accounting provides protection to business properties from unjustified and unwarranted us. This is possible on account of accounting supplying the information to the manager or the proprietor.

To ascertain the operational profit or loss: Accounting helps is ascertaining the net profit earned or loss suffered on account of carrying the business. This is done by keeping a proper record of revenues and expenses of a particular period. The profit and loss account is prepared at the end of a period and if the amount of revenue for the period is more than the expenditure incurred in earning that revenue, there is said to be a profit. In case the expenditure exceeds the revenue, there is said to be a loss.

To ascertain the financial position of business: The profit and loss account gives the amount of profit or loss made by the business during a particular period. However, it is not enough. The businessman must know about his financial position i.e., where he stands; what he owes and what he owns? This objective is served by the balance sheet or position statement.

To facilitate rational decision making by the management: Accounting these days has taken upon itself the task of collection, analysis and reporting of information at the required points of time to the required levels of authority in order to facilitate rational decision making.

Providing information to its users in useful format: The ultimate purpose of accounting is to provide information to different users. The users utilize the information in making informed economic decisions.

ACCOUNTING VS BOOK-KEEPING

Taking a few accounting courses and developing a basic understanding of accounting will qualify you for a job in bookkeeping. To work in accounting, you must have at least a bachelor's degree to become an accountant or, for a higher level of expertise, you can become a certified public accountant. Accountants are qualified to handle the entire accounting process, while bookkeepers are qualified to handle recording financial transactions. To ensure accuracy, accountants often serve as advisers for bookkeepers and review their work. Bookkeepers record and classify financial transactions, laying the groundwork for accountants to analyze the financial data. 

HISTORY OF ACCOUNTING

The name that looms largest in early accounting history is Luca Pacioli, who in 1494 first described the system of double-entry bookkeeping used by Venetian merchants in his Summa de Arithmetica, Geometria, Proportioni et Proportionalita. Of course, businesses and governments had been recording business information long before the Venetians. But it was Pacioli who was the first to describe the system of debits and credits in journals and ledgers that is still the basis of today's accounting systems. The industrial revolution spurred the need for more advanced cost accounting systems, and the development of corporations created much larger classes of external capital providers - share owners and bond holders - who were not part of the firm's management but had a vital interest in its results. The rising public status of accountants helped to transform accounting into a profession, first in the United Kingdom and then in the United States. In 1887, thirty-one accountants joined together to create the American Association of Public Accountants. The first standardized test for accountants was given a decade later, and the first CPAs were licensed in 1896.  The Great Depression led to the creation of the Securities and Exchange Commission (SEC) in 1934. Henceforth all publicly-traded companies had to file periodic reports with the Commission to be certified by members of the accounting profession. The American Institute of Certified Public Accountants (AICPA) and its predecessors had responsibility for setting accounting standards until 1973, when the Financial Accounting Standards Board (FASB) was established. The industry thrived in the late 20th century, as the large accounting firms expanded their services beyond the traditional auditing function to many forms of consulting. The Enron scandals in 2001, however, had broad repercussions for the accounting industry. One of the top firms, Arthur Andersen, went out of business and, under the Sarbanes-Oxley Act, accountants faced tougher restrictions on their consulting engagements. One of the paradoxes of the profession, however, is that accounting scandals generate more work for accountants, and demand for their services continued to boom throughout the early part of the 21st century.