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A. Functions of accounting 1.

Accounting
Accounting is the process of collecting, identifying, recording, posting, Classifying and summarizing the data, events and transactions, in terms of money, into financial information and interpreting the financial information for the decision making of a business Book-keeping process:. 1. Collecting, identifying and recording of data, events and transactions 2. Entries into books of original entries 3. Double entries (or posting) into ledger accounts 4. Balancing off all accounts and prepare the trial balance 5. Preparing and interpreting final accounts

2. Financial statements
They include: <i> trading account <ii> profit and loss account <iii> balance sheet <iv> cash flow statement They are prepared for the interested users of accounting information. They serve to help the users to make economic (eg, investment) decisions. They also form a basis for comparison of financial performances (between two periods, and between companies doing similar business.

3. Limitation of conventional financial statements


<i> They are prepared from the past transactions, events and data. They could not reflect what had happened in the past and would not be a reliable and accurate indicator for future planning of the business. <ii> The accounting definitions, methods, techniques and policies used by different companies may not be the same. This will affect the comparability between 2 financial periods or between 2 companies in the same industries. <iii> Some concepts may conflict with the true and fair view. (1) historical cost concept market value of an asset is ignored (2) stable money measurement concept inflation is ignored (3) This may also affect the comparability.

4. Properties of accounting information/data


Good and useful accounting information may include the properties below: (1) Comparability (2) Completeness (3) Comprehensibility (4) Relevance (5) Reliability (6) Objectivity (7) Timeliness

5. Non-financial statements
The Companies Ordinance of HK requires the following reports to be prepared and disclosed. (1) directors report, (2) auditors report, (3) chairmans report

6. True and fair view


The Companies Ordinance of HK requires that the true and fair view must be followed in preparing the accounting statements. Otherwise, the users may have misunderstanding of the companys performance, and therefore may make wrong decisions. .

7. Interested users of financial information


(1) Shareholders (existing and potential) (2) Employees (3) Loan creditors (4) Financial analysts and investment advisors (5) The government (Inland Revenues Department) (6) The general public (7) Others: - suppliers, customers, competitors

B. HKSSAP 1 disclosure of accounting policies


SSAP stands for Statement of Standard Accounting Practice. HKSSAP (2.101) is concerns about the disclosure of accounting policies. 1 2 1. Accounting concepts are basic assumptions and rules which guide accountants in producing periodic financial accounts.

2. There are four fundamental accounting concepts as assumed in the HKSSAP. When an accountant prepares financial accounts, he has to assume that: (i) Going concern The enterprise will continue in operational existence for the foreseeable future. It will not liquidate or curtail significantly its scale of operation/activities. Historical cost concept thus arises we record an asset at its cost, and not its value or market value as there is no intention to sell it. (ii) Accrual / matching Revenues are recognized when they are earned in a financial period, and not when cash is received. Costs and expenses are recognized when they are incurred in a financial period, and not when cash is paid. Profit is calculated by matching the revenues earned with the expenses incurred.

If more cash is paid on expenses, prepayment should be made, and shown on the balance sheet as an asset. If less cash is paid on expenses, accrual should be made, and shown on the balance sheet as a liability. The same treatments apply to revenues. (iii) Consistency Similar treatments must be given to similar items with a financial period, and from one period to the next. Once an accounting policy is adopted, we should not change it normally, except that a new policy is believed to be better and necessary. Even so, the reason and nature of the change should be disclosed as a note in the financial statements. (iv) Prudence / conservatism Revenues and profits should not be anticipated or overstated. Expenses and losses should not be understated. When two or more treatments are acceptable, we always choose one that can reduce the profit. (This may contradict with the true and fair view.) Provision should be made for all known liabilities or losses. (This may contradict with the accrual concept or the objectivity concept.) Realization concept - A revenue is considered to be earned only when it is realized. In the case of a sale, it is realized when 1. The transaction (earning process) is completed 2. The goods are delivered and invoiced 3. Receipt is made or future payment is very certain * NB: This concept is getting less and less important, but it is still useful in Accounting practice, especially in making provisions. 2. Accounting bases They are defined in financial statements as the methods developed for applying fundamental accounting concepts to transactions and items.

Accounting policies They are the accounting bases chosen by management as being best
suited for used in that business. The polices (and their changes, if any) should be disclosed by way of notes to the accounts. The explanations should be clear fair and brief They should normally be followed consistently. <In the case of published accounts, the following policies must be disclosed: - meaning of turnover, 3 - valuation of stock and work in progress,

- depreciation method - Treatment of amortization of intangibles (research and development fund, Patents and trademarks, preliminary expense, goodwill ) - Installment transactions (hire-purchase or credit purchase) - leasing and rental transactions

C. More about accounting concepts


1. Conservatism / prudence Meaning: (a) Revenues and profits should not be anticipated but recognized only when they are realized in the form of cash or of other assets which can be treated as cash. (b) Provision should be made for any known liabilities at the end of the financial period. examples (a) Stock is valued at lower of cost and net realizable value. (Stock is an asset for resale to earn a profit.) (b) Provision is made for depreciation and doubtful debts. 2. Going concern meaning: (a) An enterprise will continue in operational existence for the foreseeable future. (b) An enterprise will not liquidate or curtail significantly its scale of activities. (c) The financial statements do not indicate assets at net realizable value (market value). examples (a) On the balance sheet, fixed assets are shown at their net book value, i.e., cost less accumulated depreciation. (b) If the accountant has reasons to believe that the enterprise will liquidate soon, he should indicate all assets at the NRV, and make a note of the account. 3. Historical cost meaning: (a) All assets should be recorded at their cost. This method is consistent, simple and less costly. (b) Historical cost is an objective and verifiable cost. (c) Cost includes the purchase price and all expenses incurred in bringing the asset to its present location and condition. examples (a) Investment in shares is recorded at its cost, even though the share prices change over time. 4. Business entity meaning: (a) The business and its owners are separate existence entity. (b) The business transactions are separate from its owners private transactions. examples (a) Any payments for the owners personal expenses by the business are treated as drawings, and not expenses. 5. Materiality

meaning: (a) Any insignificant items and events may be disregarded, but important information should be disclosed. (b) If the information may affect the users in making decision, it is regarded as material. A material item is regarded as an asset and should be shown as a separate item on the balance sheet. examples (a) Stationery involves small amount of capital expenditure, so it is treated as an expense and to be written of in the profit and loss account. 6. Quantifiability / stable monetary measures meaning: (a) We only record those transactions which are measurable in money terms. (b) The factor of inflation is ignored. (c) This forms a common base for comparison. examples (a) Expenses can be added or subtracted. (b) The morale of the enterprise, the experience of the staff, and the good relationship with others are not recorded and reflected in accounts. 7. Consistency meaning: (a) Similar items should be treated by similar methods. Such methods, once adopted, should not be change within an accounting period or from one period to another. (b) If a new policy is considered better and necessary, the nature and reason for the change must be disclosed as a note to the accounts. examples (a) depreciation method (b) stock valuation method 8. Accrual / matching meaning: (a) Revenues and expenses are recognized as they are earned and incurred, and not as money are received or paid. (b) The profit and loss account is prepared on this basis. (c) The revenues earned must be matched with the expenses incurred in calculating the profit in an accounting period. (d) If an expense has been paid but the related revenue has not been earned, the cost should be carried forward as a prepayment. If revenue has been earned but the related expense has not been paid, the cost should also be counted and carried forward as an accrual. (e) The cost of capital expenses (assets) should be spread over a period of time during which the benefits are going to be received. examples (a) Credit sales but not yet received should still be treated as an income in the profit and loss account, and the receivable amount is treated as an asset in the balance sheet. 9. Objectivity meaning: (a) Personal bias should be avoided by those who are responsible for the preparation of the books and final accounts.

(b) Different accountants should arrive at similar (the same) treatment of an item. examples (a) The Companies Ordinance requires that the published accounts of limited company should give a true and fair view. (b) Directors suggestions which is window dressing and subjective should not be considered. 10. Timeliness meaning: (a) The timeliness of the reported financial statements will provide a true picture of the business for the users to make decisions in time. (b) Timeliness may conflict with accuracy. They should be balanced when the financial accounts are prepared. examples (a) The amount of the proposed final dividends of ordinary shares will be subjected to the timeliness of the reported statements. 1. An asset is anytime that can generate future benefit to the enterprise. The asset is purchased not for resale at a profit, so the disposal of it is regarded as an extraordinary item. 2. An extra-ordinary item: - is not expect to recur frequently - is material - is out of management control (having no responsibility for the loss) - is not included in the profit and loss account, but shown as a separate item (not reducing the figure of net profit) to offer a true and fair view. 3. Depreciation is only the allocation of an assets cost over its estimated useful life. It need not be an accurate valuation. It is an expense of consuming the asset, and should be charged against profit according to the matching concept. It is a provision for known liability and the estimated amount should be shown on the balance sheet according to the prudence concept. 4. An exceptional item is like an extraordinary item but it is within management control. It is included in the profit and loss account, reducing the figure of net profit. However, a note should be made to the accounts. 1. Objectively It is the use of a method that everyone can agree to. 2. Consistency Accounting keeps to the same method, except in special cases. (Accounting tries not to change a method.)

3. Money measurement Accounting only records transactions that are measurable in money. 4. Stable monetary measures The value of money is assumed very stable. 5. Ouantifiability It is the ability to make a measure of a transaction in money. 6. Dual aspect In a double entry system, accounting deals with both the debit and credit aspects of a transaction. 7. Business entity Accounting only records transactions that affect the business; 5 and not the owners private transactions. 6 8. Accrual Accounting records revenues when they are earned (not only when cash 7 is received). Accounting records expenses when they are incurred (not 8 only when cash is paid). 9 . 9. Prudence (conservatism) Accounting tries not to overstate profits or revenues.. Accounting tries not to understate losses or expenses. 10. Realisation Accounting records a profit at the point at which the profit is earned (not at a point at which cash is received). 11. Going concern A business is assumed to continue for a very long time. 12. Materiality Accounting records a transaction as an asset only when it is significant. For small amount items, they are only treated as expenses. ** Capital expenditure It is the payment of 1. Buying an asset (cost price and other expense that bring the asset to its present location and condition) 2. Increasing the value of an existing asset Revenue expenditure It is the payment for daily running of the business. It is an expense necessary to earn a profit.