Basic Issues Of Financial Accounting

1) What is accounting?
Accounting is a way of recording, analyzing and summarizing transactions of an entity. It is an information
system that identifies records and communicates the economic events of an organization to interested users.

2) Types of business entity:

There are three main types of profit-making business entity-
Sole Traders:
A sole trader is a person who carries business for his own profit, bearing all risks.
Examples-
local shopkeeper,
plumber,
hairdresser.

Partnerships:
Partnerships occur when two or more person decide to share the risks and rewards of a business together.
Examples-
accountancy,
medical,
legal practice.
Limited Liability Company:
Limited liability companies are registered to take advantage of limited liability for their members.

3) The objective of financial statements:

The Framework states that:
'The objective of financial statements is to provide information about the financial position, performance and
changes in financial position of an entity that is useful to a wide range of users in making economic decisions.'

5) Who demand particular information?

Additional financial statements are prepared for the benefit of other user groups, who may demand particular
information is given below:
NBR will receive information to make tax assessments.
A Bank might demand a cash flow forecast as a pre-condition of granting an overdraft.
ICAB is responsible for issuing BASs and BFRSs and these require companies to publish certain additional
information. Accountants are placed under an obligation to ensure that company financial statements conform
to the requirements of BAS/BFRS, where relevant.

6) Who needs financial information under

BFRS: Or, Who needs financial information?
The BFRS Framework sets out the following people are likely to be interested in financial information:
Investors/shareholders are interested to know their risk and return of investment to determine whether they
can buy hold or sell shares.
Employees need information about the stability and profitability of their employers.
Lenders need information about companies financial statements to determine their loans and interest
repayments ability, when it will be due.
Governments and their agencies need information to regulate the activities of entities and determine taxation
policies.
Suppliers and other creditors, Customers, Public

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07) Qualitative characteristics of accounting information:
The Framework states that the following qualitative characteristics of accounting information are given bellow:
Relevance:
Accounting information is relevant where it helps users to evaluate past and present events, and predict future
events. Information's relevance is affected by its nature and materiality.
Understandability:
Understandability is the quality of information that enables users to perceive its significance.
Reliability:
Information is reliable if it is free from error and can be depended on users to represent faithfully. As well as
faithful representation and accuracy, reliable information is:
- Accounted for on the basis of a transaction's economic substance rather than its legal form.
- Prudent-
- Neutral (unbiased)
- Complete within the bounds of materiality and cost.
Comparability:
Information will be produced on a consistent basis, so that valid comparisons can be made with information
from previous periods and other entities.

08) Capital expenditure:

Amount spent to acquire or upgrade productive assets to increase the capacity or efficiency of a firm for more
than one accounting period is called capital expenditure (such as buildings, machinery and equipment,
vehicles).

09) Revenue expenditure:

Amount spent for trade purpose or to maintain the existing earning capacity of long-term assets is called
revenue expenditure. Revenue expenditure is charged to the income statement to generate profit or loss
during a financial year.

10) Capital income:

Capital income is income that comes from the sale of capital investment assets.

11) Revenue income:

Revenue income is income that comes from the sale of goods, service provides or business investment (such
as sales revenue, service revenue, interest, dividends etc).

12) Components of financial statements

A complete set of financial statements should include: [IAS 1.10]
a statement of financial position (balance sheet) at the end of the period
a statement of comprehensive income for the period (or an income statement and a statement of
comprehensive income)
a statement of changes in equity for the period
a statement of cash flows for the period
notes, comprising a summary of accounting policies and other explanatory notes

14) Objective of Accounting Standards

The basic objective of Accounting Standards is:
To bring about standardization in presentation
To ensure the comparability among the financial statements
To ensure similarity of accounting treatments around the world.

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13) Elements of Financial Statements
The elements of a balance sheet or the elements that measure the financial position are as follows:
a) Asset:
Asset is a resource:
Controlled by the entity as a result of past events and
From which future economic benefits are expected to flow to the enterprise.
b) Liability:
A liability is a present obligation of the entity arising from the past events, the settlement of which is expected
to result in an outflow of resources from the business economic benefits.
c) Equity/Owners equity/Capital:
Equity is the residual interest in the assets of the entity after deducting all its liabilities. Equity is also known
as owners equity.
The elements of an income statement or the elements that measure the financial performance are as follows:
a) Income:
Income is:
Increase in economic benefits during an accounting period in the form of inflows or increases of assets
Decreases of liabilities resulting in creases in equity.
b) Expenses:
Expenses are:
Decreases in economic benefits during an accounting period in the form of outflows or
depletion of assets or increases in liabilities resulting in decreases in equity.

15) Balance Sheet

A Balance Sheet is a statement of the financial position of a business which states the assets, liabilities, and
owners' equity at a particular point in time and is used to calculate the net worth of a business. The balance
sheet must follow the following formula:
Assets= Liabilities + Shareholders' Equity

16) Income Statement:

Income statement is a record of income recognized and expenditure incurred over a given period. It is a record
of the entity's financial performance over a period of time.

17) Relationship between the income statement and the balance sheet:

Net profit is the profit for the period. For a sole trader it is transferred to the balance sheet as an
addition to the proprietor's capital.
Drawings are appropriations of profit and not expenses. They must not be included in the income
statements.
The Income statement shows the sales, costs of sales and expenses incurred during the period. The
Balance sheet shows the assets and liabilities of the business.

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