KENYA SCHOOL OF REVENUE ADMINISTRATION

MOMBASA CAMPUS

POST GRADUATE DIPLOMA IN TAX ADMINISTRATION

REG. NO: HDB336-C016-2262/2017

NAME: TERRENCE CHANZU OSCAR

BRT 3101: FINANCIAL ACCOUNTING 1

Instructor: MUMIA B.J.

TAKE AWAY CAT ONE

Discuss any ten accounting concepts/principles and their importance in Financial

Accounting.

There are a number of various accounting concepts and principles. They include;

1) Prudence concept 7) Accruals concept

2) Going concern concept 8) Separate determination concept

3) Materiality concept 9) Assumption of stability of currency

4) Substance over form 10) Dual aspect concept

5) Business entity concept (Separate 11) Time interval concept

business entity) 12) Money measurement concept

6) Consistency concept 13) Historical cost concept

1. The Prudence Concept

Under the prudence concept, do not overestimate the amount of revenues recognized or

underestimate the amount of expenses. You should also be conservative in recording the

amount of assets, and not underestimate liabilities. The result should be conservatively-stated

financial statements.

This concept states that the accountant should always exercise caution when dealing with

uncertainty while, at the same time, ensuring that the financial statements are neutral – that

profits and losses are neither overstated nor understated. (Frank Wood – 10th edition 2005).

Its importance in Financial Accounting is that the accountant is required to write down fixed

assets when their fair values fall below their book values, but which do not allow you to write

up fixed assets when the reverse occurs.

The going concern principle is the assumption that an entity will remain in business for the

foreseeable future. Financial statements are prepared on the assumption that the business will

remain in operation in future periods.

Under this principle, revenue and expense recognition may be deferred to a future period,

when the company is still operating. Otherwise, all expense recognition in particular would

be accelerated into the current period. An entity is assumed to be a going concern if there is

lack of significant information to the contrary. (Nishimura, 2003).

This concept importance to Financial Accounting implies that financial statements do not

represent a company’s worth if its assets were to be liquidated, but rather that the assets will

be used in future operations. This concept also allows businesses to spread (amortize) the cost

of an asset over its expected useful life.

3. Materiality Concept

The materiality concept of accounting states that all substantial items must be properly

reported in financial statements. It is relative in size and importance. An item is considered

material or important if its inclusion or omission significantly impacts the decision of the

users of financial statements. (F. Wood, 2005)

Its importance to financial accounting is that it enables users of financial information make

decisions as transactions should be recorded when not doing so might alter the decisions

made by a reader of a company's financial statements. This tends to result in relatively small-

size transactions being recorded, so that the financial statements comprehensively represent

the financial results, financial position and cash flows of a business.

Materiality constitutes various factors as;

financial statements.

b) Cumulative effect: accountants not only take into account the individual amounts but

also the cumulative effect of all immaterial amounts.

c) Nature of the item: depends on the cash amount as well as nature of the item or event.

4. Consistency Concept

Once a business chooses to use a specific accounting method, it should continue using it on a

go-forward basis. By doing so, the financial statements prepared in multiple periods can be

reliably compared.

Each business should try to choose the methods which give the most reliable picture of the

business. This cannot be done if one method is used in one year and another method in the

next year. The consistency concept says that when a business has once fixed a method for the

accounting treatment of an item, it will enter all similar items that follow in exactly the same

way. (Frank Wood, 2005).

This is important in Financial Accounting as it’s easier for users to compare past and current

financial statements, therefore make informed decisions.

5. Accruals Concept

The accruals concept says that net profit is the difference between revenues and the expenses

incurred in generating those revenues (Frank Wood, 2005).

consumed. This concept means that a business may recognize sales, profits and losses in

amounts that vary from what would be recognized based on the cash received from customers

or when cash is paid to suppliers.

It is the most fundamental principle of accounting which requires recording revenues when

they are earned and not when they are received in cash, and recording expenses when they

are incurred and not when they are paid.

It is important in financial accounting as it results in accurate reporting of net income, assets,

liabilities and retained earnings which improves analysis of the company’s financial

performance and financial position over different periods.

6. Substance over form

This concept states that accounting should show a transaction in accordance with its real

substance which is, basically, how the transaction affects the economic situation of the

business and will not reflect the exact legal position concerning that transaction. This is

because legal form of a transaction can differ from its real substance. (Frank Wood, 2005).

7. Dual Aspect concept

This concept is the basis of the fundamental accounting equation: Assets = Liabilities +

Capital.
This states that there are two aspects of accounting, one represented by the assets of the

business and the other by the claims against them. The concept states that these two aspects

are always equal to each other.

This is equation forms the most fundamental aspect of Financial accounting; therefore its

importance is utmost.

8. Time Interval concept

It states that financial statements are prepared at regular intervals of one (fiscal/calendar)

year. For internal management purposes they may be prepared far more frequently, possibly

on a monthly basis or even more meaningful period.

This makes presentation of financial statements to relevant users for decision making all the

more crucial at the required time.

9. Separate Business Entity concept

The transactions of a business are to be kept separate from those of its owners. By doing so,

there is no intermingling of personal and business transactions in a company's financial

statements. Accounts are kept for entities and not the people who own or run the

company/business.

The business entity concept implies that the affairs of a business are to be treated as being

quite separate from the non-business activities of its owner(s). The items recorded in the
books of the business are, therefore, restricted to the transactions of the business (Frank

Wood, 2005).

10. Money Measurement concept

This concept states that for an accounting record to be made it must be able to be expressed in

monetary terms. For this reason, financial statements show only a limited picture of the

business.

Accounting information has traditionally been concerned only with those facts covered by (a)

and (b) which follow:

a) It can be measured in monetary units, and

b) Most people will agree to the monetary value of the transaction.

This limitation is referred to as the money measurement concept, and it means that

accounting can never tell you everything about a business. For example, accounting does not

show the following:

c) Whether the business has good or bad managers,

d) Whether there are serious problems with the workforce,

e) Whether a rival product is about to take away many of the best customers,

f) Whether the government is about to pass a law which will cost the business a lot of

extra expense in future. (Frank Wood, 2005)

Distinguish between financial accounting and management accounting;

1. Users

Financial accounting: Is the preparation and presentation of financial information to

relevant users existing outside/without the business such as as creditors, bankers,

government, customers. Another objective of financial accounting is to give complete

financial picture of the enterprise to shareholders/stakeholders.

Management accounting: It aims at preparing and reporting the financial data to the

management on regular basis. Management is entrusted with the responsibility of taking

appropriate decisions, planning, performance evaluation, control, management of costs and

cost determination among others.

Therefore, management accounting is more concerned with preparing and presenting

financial information to parties within the organization itself. Users include Top, middle and

lower level managers. (Britton & Waterston, 2013).

2. Measurement

Financial accounting: Here, accounting information is always expressed or measured in

terms of money/monetary values. This is because the final recipients of the necessary

information are only interested in the financial position of the business or its bottom line.

Management accounting: Management accounting may adopt any measurement unit like

labour hours, machine hours or product units for the purpose of analysis. This is because the
consumers of this information are interested in increasing production/revenues while

minimising costs. (Britton & Waterston, 2013).

3. Conventions and principles

Financial accounting: It is a discipline by itself and has its own principles, policies and

conventions to adhere to. Among these are discussed above i.e. money measurement concept,

going concern concept, historical cost concept.

Management accounting: It makes use of other disciplines like economics, management,

information system, operation research etc. (Nishimura, 2003).

4. Information and data

Financial accounting: focuses on historical data. This mean its information prepared through

the use of past events that took place in running the business.

Management accounting: focuses on the future. This means that its presented information is

geared toward future improvements to be made by management in order to streamline

organizational processes. (Britton & Waterston, 2013)

5. Time interval

Financial accounting: Here, data is presented for a definite period, say one (fiscal/calendar)

year or a quarter in accordance with the time interval accounting concept.

Management accounting: Here, reports are prepared on continuous basis, monthly or

weekly or even daily and are presented to users on request. (Britton & Waterston, 2013).

6. Aggregation

Financial accounting reports on the results of an entire business.

product, product line, customer, and geographic region. (Mumia B. J, 2018)

7. Efficiency

Financial accounting reports on the profitability (and therefore the efficiency) of a business.

Managerial accounting reports on specifically what is causing problems and how to fix

them. (Mumia B. J, 2018)

8. Proven information

Financial accounting requires that records be kept with considerable precision, which is

needed to prove that the financial statements are correct.

Managerial accounting frequently deals with estimates, rather than proven and verifiable

facts. (Mumia B. J, 2018)

An Accountant in his presentation remarked to participants in a tax forum that

“Financial Accounting is based on accruals basis while other branches of Accounting

like Tax Accounting are based on cash basis”. Discuss the validity of this statement with

justifications.

Financial accounting is mostly known as accrual-based accounting. Under the accrual

method, businesses record revenue from sales and expenses from purchases when and as they

are earned and incurred. This is regardless of whether cash from sales has been collected or

cash for purchases has been paid. To determine the sale or purchase transaction date for

recording, business entities must determine the completeness of the sale or purchase.

Recording doesn’t take place until the completion of the sale or purchase orders.

Tax accounting often is referred to as cash-based accounting, and thus focuses primarily on

actual cash receipts and cash payments, rather than their related sale or purchase transactions.

Companies don't record a sale or purchase transaction at the time of the transaction until cash

is received or paid later. (Jay Way, 2007)

Business Impact

The accrual-based financial accounting and the cash-based tax accounting can impact a small

business differently. While financial accounting can accurately track business transactions as

they are taking place, it doesn't show a business's actual cash reserve situations. A small

business using the accrual method may report a good level of income in its accounting books

but may be low on cash at its bank account if customers haven't paid yet. The cash-based tax

accounting allows a small business to follow its cash situations more closely. But on the other

hand, the cash-based method may mislead on a business's profitability if customers all pay

their bills in a single period, causing a jump in cash receipts. (Jay Way, 2007).
Tax Impact

The election of an accounting method for business recording and financial reporting will have

a tax impact on a small business because the same accounting method often is also used for

preparing tax returns. Depending on the time of the year when a business transaction occurs

and when the monetary settlement takes place, a small business may pay more or less on

taxes for its current tax year. For example, using cash accounting, if a small business didn't

make cash payment for a current-year purchase until next year, it could not declare a tax

deduction on the purchase expense and thus would pay more taxes for the current tax year.

(Jay Way, 2007).

References

1. Nishimura, A. (2003). The Control Functions of Accounting and Management

2. Jay Way (MBA), (2007). Financial Reporting Accounting vs. Tax Accounting 3(1) . Retrieved
16 March 2018, from Chron Web site: http://smallbusiness.chron.com/financial-reporting-
accounting-vs-tax-accounting-15390.html

3. Mumia B. J. (2018). BRT 3101: Financial Accounting 1, week 1 notes. [PowerPoint

4. Frank, W. & Alan, S. (2005). Accounting Concepts: Underlying accounting concepts.,

5. Britton, A., & Waterston, C. (2013). Financial accounting. Harlow: Financial Times Prentice
Hall.