The Basic Concepts Upon Which Financial Accounting is Based
Terms of Reference
To prepare a short report, which will explain the basic concepts upon
which financial, accounting is based. The need for accounting
standards and why companies must comply with them.
The Need for Accounting Standards
In order for the Profit and Loss and Balance Sheets accounts to make
sense to users who rely on them for their decision making purposes,
there has to be consistency in the way items are treated in the
financial statements. Without this agreement it would be impossible to
use them to compare business performance. Limited companies have a
statutory duty to comply with these rules and it is the job of the
qualified auditor to check this compliance. Partnerships and sole
traders are also often bound by these rules because of professional or
trade association standards or because of the conditions attached to
loans. The rules govern two aspects of accounting:
Å¸ The accounting treatments allowed for any individual event or
transaction. For example the rules state that stock must be valued at
"the lower of cost and net realizable value". This means that valuing
stock at selling price is not normally allowed.
Å¸ Disclosure requirements, which tell us the permitted layouts [called
formats] for the balance sheet and profit and loss, account items.
These rules are called Accounting Standards. In order for auditors to
be satisfied that the balance sheet and profit and loss account
provide a "true and fair view" of actual transactions they will
examine internal controls, which must be operating effectively in the
business. These controls need to be installed and maintained by
management for the purposes of safeguarding the recording of all
financial operations and auditors test their effective operation.
What are accounting standards?
Accounting standards are authoritative statements of how particular
types of transaction and other events should be reflected in financial
statements. Accordingly, compliance with accounting standards will
normally be necessary for financial statements to give a true and fair
Accounting standards issued by the Accounting Standards Board are
designated "Financial Reporting Standards" (or FRSs). Those issued by
its predecessor bodies, and adopted by the Board when it was created
in 1990, are designated "Statements of Standard Accounting Practice"
(or SSAPs). Adoption by the Board gave the SSAPs the status of
"accounting standards" within the terms of Part VII of the Companies
Act 1985. The Board reviews these SSAPs individually as appropriate
opportunities arise during the course of its work: so far, of the 22
SSAPs adopted in 1990, four have been withdrawn and superseded by
FRSs. For example the statement that talk about the disclosure of