Money measurement concept

Financial statements should only record transactions and events that can be measured in
money terms.

Going concern assumption

 an entity will continue its operation in the foreseeable future, and

 the entity has neither the intention nor the need to liquidate or reduce significantly its
scale of operation
Under the assumption, the assets of a business should be valued at historical cost.
When no longer hold, the non-current assets would be valued at their net realizable value /
liquidation value.
 Allow the classification of liabilities into current and non-current liabilities as it is
assumed that a business will remain in operation and pay its obligation when due. This
classification is useful for evaluating the financial position of a business.

Historical cost concept states that assets should be recorded at their original cost of purchase
or cost of production.
 Objectivity arises from a negotiated transaction between a buyer and a seller
 Verifiability results from the financial record of the transaction
L Assets measured by cost will likely be understated in periods of market boom.
Undervalued assets will lead to understated depreciation charges and profits will be
overstated as a result. The opposite will happen in periods of market downturn.

Business entity concept

In accounting, a firm and its owner(s) are separate entities. Therefore, transactions between
the firm and the owner(s) should also be recorded. (drawings) Transactions of an entity be
accounted for separately from the transactions of other entities, including those of its owners.
 It allows us to measure the financial performance and position of each entity
independently
L Sometimes it is not easy to define a separate entity, especially when there are several
business segments under the same ownership. There may be different interpretations as
to whether the business segments should be treated separately in terms of bookkeeping
and financial reporting.

Materiality
Refers to the impact of an item's nature and size on the company's financial operations.
Information is material if omitting it or misstating it could influence decisions that users make
on the basis of the reported financial information.
The calculator is insignificant in value in view of a multinational corporation's size of
operations, and hence it should be recorded as an expense in the year of purchase.
 Reduces administrative costs as it frees accountants from having to compute and report
every item in strict accordance with generally accepted accounting principles.
 Reduces the time users have to spend on reading financial statements.
L Hinders comparison of financial statements of businesses having different materiality
limits.

Objectivity principle requires that accounting information be based on facts and be verifiable.

Timeliness means that accounting information should be provided soon after the occurrence
of an event.

Consistency
Once an accounting policy or method has been adopted by a business, it should be followed
from period to period. A change is allowed only if the existing accounting practice is no
longer appropriate.
 Deters businesses from manipulating their financial results
 Maintains comparability in financial statements

Realization
Revenue should be recognized only when goods are dispatched and accepted by customers, or
the services have been provided, not when the monies are received.
Should recognize the service fee revenue on a time basis over the respective service period/
recorded as a liability/ deferred as unearned revenue.

Prudence concept.
It means that when choosing among accounting alternatives, the best choice is one that is least
likely to overstate assets and profits.
The company should adopt the lower of cost or net realizable value in the valuation of
inventory. (no matter how small the difference is.)

Accrual concept
Revenues and expenses are recognized and included in the financial statements when they are
earned or incurred, not when they are received or paid.

Matching
Links revenue with its relevant expenses or costs
The use of equipment could generate revenue for the business, the cost of the equipment
should therefore be allocated over its estimated useful life.

Expertise should not be asset because:

 Prudence concept: the future benefits arising from the intangible asset are uncertain
 Money measurement concept: professional knowledge cannot be quantified and expressed in
monetary terms with reasonable certainty
 Objectivity concept: the valuation is only a personal and subjective estimation

Capital expenditure and revenue expenditure

A revenue expenditure is expenditure that generates short term benefits only.
A capital expenditure is expenditure that generates long term benefits for an entity,
that is, benefits that will last for a number of accounting periods.
Capital expenditure must be one of the following:
1. GENERAL acquisition cost of a non-current asset bringing the asset to the

location and condition for use, that is, the cost is necessarily paid by anyone buying the asset, e.g.,
transportation, insurance on transportation, installation, supporting equipment required by the asset, licensing,

testing, salary on construction workers.

Non general acquisition cost: interest on money borrowed to finance the asset, repair cost for accidental

damage during installation (they are not necessary, so they fail the test)

Non acquisition cost: training cost is not doing with the asset itself, thus failing the test

2. Upgrade of non-current asset adding value to it

3. Expenses incurred in the formation of a company

Uses of bank reconciliation

 locating accounting errors either made by the bank or by the firm

 explaining differences at a given date between the balance of the bank account as shown in the
firm’s cash book and the balance of bank statement as prepared by the bank

 preventing fraud by employees

Advantages of marginal costing

 inventory valuations will not be distorted by the changes in current year’s fixed costs

 enables the company to concentrate on its controllable aspects by separating its fixed and
variable costs
  helps management to make production and sales decisions with the calculated marginal costs
information

Reasons for not maintaining goodwill account:

 Valuation of goodwill may be subjective and not reliable 
 Its relationship with future economic benefit is not easily identified and measurable

Why the use of the predetermined manufacturing overheads absorption rate is preferred to the use of
the absorption rate based on actual data when calculating product cost.
 The actual overhead absorption rate (OAR) cannot be calculated until the end of the period,
while predetermined OAR can be calculated prior to the accounting period using estimated or
budgeted figures for overheads and units of the absorption base chosen,
 which could provide more information for decision making on pricing and cost control and,
 it is less volatile than the use of the actual OAR as actual overheads is subjected to
fluctuations.

Why ratio comparison with past years of same company cannot reflect performance changes:
 Ratios may not reflect the reality of a business as accounting figures are not adjusted for price-
level changes.
 Analysis may not be comprehensive as only transactions expressed in monetary terms are
included in the financial statements, while qualitative information is ignored.

 Short run fluctuations of the company may be hidden through window dressing.

Advantages of reducing balance method

 even allocation of total fixed asset usage costs (depreciation and maintenance)
 appropriate matching of cost with benefits derived

Why open a current account?

 will not affect the initial investment made by the partners as transactions between partners and
the partnership during the year can be shown through the current accounts instead of the
capital accounts
 debit balance of the current account due to a partner's excessive drawings could be used as a
signal or warning to other partners

Advertising expenses should not be a prepayment but should be expense because uncertain revenue
recognition: increase in sales volume is just an estimate.

Functions of keeping books of original entry

  segregation of duties which could reduce frauds
 classify the transactions so as to facilitate the posting to the ledger accounts

Question type: Comment on changes in financial position/liquidity/profitability

Required: 1. General comment (improved/deteriorate/less profitable)
2. Rationale

Reasons to keep full set of accounting records:

 Serve as a control system to identify irregularities
 More informed decision making is possible
 Comparisons with results of previous years and other businesses are possible
 Information required by banks or other lenders is readily available