Bafs Notes
Bafs Notes
Financial statements should only record transactions and events that can be measured in
money terms.
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.
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.
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,
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
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
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
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.
Advertising expenses should not be a prepayment but should be expense because uncertain revenue
recognition: increase in sales volume is just an estimate.