Accounting Concepts

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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
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"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

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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.

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Accounts Table with Cuneiform Script, circa
2400 BC by Mesopotamian Bookkeeper
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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.

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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.

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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

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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.

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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.

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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

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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.

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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

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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

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Chart of Accounts - continued

• Revenues (4 major classes)
• Taxes
• Social Contribution
• Grants
• All Others
• Assets
• Liabilities
• Net Assets

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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

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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).

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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

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Users of Public Sector Financial Statements

• Access
• for internal users, it is direct, unlimited and
  detailed
• for outsiders, it is summary, higher level

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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

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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

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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

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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
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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

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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.

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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

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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

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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

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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

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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

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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

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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

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GAAP Principles

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

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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

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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.