Accountancy

Accountancy (profession) or accounting (methodology) is the measurement, statement or provision of assurance about financial information primarily used by managers, investors, tax authorities and other decision makers to make resource allocation decisions within companies, organizations, and public agencies. The terms derive from the use of financial accounts. Accounting is the discipline of measuring, communicating and interpreting financial activity. Accounting is also widely referred to as the "language of business".[1] Financial accounting is one branch of accounting and historically has involved processes by which financial information about a business is recorded, classified, summarized, interpreted, and communicated; for public companies, this information is generally publicly-accessible. By contrast management accounting information is used within an organization and is usually confidential and accessible only to a small group, mostly decision-makers. Tax Accounting is the accounting needed to comply with jurisdictional tax regulations. Practitioners of accountancy are known as accountants. There are many professional bodies for accountants throughout the world. Many allow their members to use titles indicating their membership or qualification level. Examples are Chartered Certified Accountant (ACCA or FCCA), Chartered Accountant (FCA, CA or ACA), Management Accountant (ACMA, FCMA or AICWA), Certified Public Accountant (CPA) and Certified General Accountant (CGA). Auditing is a related but separate discipline, with two sub-disciplines: internal auditing and external auditing. External auditing is the process whereby an independent auditor examines an organization's financial statements and accounting records in order to express an opinion as to the truth and fairness of the statements and the accountant's adherence to Generally Accepted Accounting Principles (GAAP), or International Financial Reporting Standards (IFRS), in all material respects. Internal auditing aims at providing information for management usage, and is typically carried out by auditors employed by the company, and sometimes by external service providers. Accounting/accountancy attempts to create accurate financial reports that are useful to managers, regulators, and other stakeholders such as shareholders, creditors, or owners. The day-to-day record-keeping involved in this process is known as bookkeeping. Accounting scholarship is the academic discipline which studies accounting/accountancy.

Modern accounting/accountancy Accounting is the process of identifying, measuring and communicating economic information so a user of the information may make informed economic judgments and decisions based on it. Accounting is the degree of measurement of financial transactions which are transfers of legal property rights made under contractual relationships. Non-financial transactions are specifically excluded due to conservatism and materiality principles.

At the heart of modern financial accounting is the double-entry bookkeeping system. This system involves making at least two entries for every transaction: a debit in one account, and a corresponding credit in another account. The sum of all debits should always equal the sum of all credits, providing a simple way to check for errors. This system was first used in medieval Europe, although claims have been made that the system dates back to Ancient Rome or Greece. According to critics of standard accounting practices, it has changed little since. Accounting reform measures of some kind have been taken in each generation to attempt to keep bookkeeping relevant to capital assets or production capacity. However, these have not changed the basic principles, which are supposed to be independent of economics as such. In recent times, the divergence of accounting from economic principles has resulted in controversial reforms to make financial reports more indicative of economic reality.

History of accounting Early history Accountancy's infancy dates back to the earliest days of human agriculture and civilization (the Sumerians in Mesopotamia), when the need to maintain accurate records of the quantities and relative values of agricultural products first arose. Simple accounting is mentioned in the Christian Bible (New Testament) in the Book of Matthew, in the Parable of the Talents (Matt. 25:19). The Islamic Quran also mentions simple accounting for trade and credit arrangements (Quran 2: 282). Twelfth-century CE Arab writer Ibn Taymiyyah mentioned in his book Hisba (literally, "verification" or "calculation") detailed accounting systems used by Muslims as early as in the mid-seventh century CE. These accounting practices were influenced by the Roman and the Persian civilizations that Muslims interacted with. The most detailed example Ibn Taymiyyah provides of a complex governmental accounting system is the Divan of Umar, the second Caliph of Islam, in which all revenues and disbursements were recorded. The Divan of Umar has been described in detail by various Islamic historians and was used by Muslim rulers in the Middle East with modifications and enhancements until the fall of the Ottoman Empire.

Luca Pacioli and the birth of modern accountancy The first book on accounting was written by a Croatian merchant Benedetto Cotrugli, who is also known as Benedikt Kotruljević, from the city of Dubrovnik. During his life in Italy he met many merchants and decided to write Della Mercatura et del Mercante Perfetto (On Trade and the Perfect Merchant) in which he elaborated on the principles of the modern double-entry bookkeeping. He finished his lifework in 1458. However, his work was not published until 1573, as a result of which his contributions to the field have been overlooked by the general public.[citation needed]

Painting of Luca Pacioli, attributed to Jacopo de' Barbari

For this reason, Luca Pacioli (1445 - 1517), also known as Friar Luca dal Borgo, is credited for the "birth" of accounting. His Summa de arithmetica, geometrica, proportioni et proportionalita (Summa on arithmetic, geometry, proportions and proportionality, Venice 1494), a synthesis of the mathematical knowledge of his time, includes the first published description of the method of keeping accounts that Venetian merchants used at that time, known as the double-entry accounting system. Although Pacioli codified rather than invented this system, he is widely regarded as the "Father of Accounting". The system he published included most of the accounting cycle as we know it today. He described the use of journals and ledgers, and warned that a person should not go to sleep at night until the debits equaled the credits! His ledger had accounts for assets (including receivables and inventories), liabilities, capital, income, and expenses — the account categories that are reported on an organization's balance sheet and income statement, respectively. He demonstrated year-end closing entries and proposed that a trial balance be used to prove a balanced ledger. His treatise also touches on a wide range of related topics from accounting ethics to cost accounting.

Post-Pacioli The first known book in the English language on accounting was published in London, England by John Gouge (or Gough) in 1543. It is described as A Profitable Treatyce called the Instrument or Boke to learn to know the good order of the kepyng of the famouse reconynge, called in Latin, Dare and Habere, and, in English, debtor and Creditor. A short book of instructions was also published in 1588 by John Mellis of Southwark, England, in which he says, "I am but the renuer and reviver of an ancient old copies printed here in London the 14 of August 1543: collected, published, made, and set forth by one Hugh Oldcastle, Schoolmaster, who, as reappeared by his treatise, then taught Arithmetics, and this booke in Saint Ollaves parish in Marko Lane." Mellis refers to the fact that the principle of accounts he explains (which is a simple system of double entry) is "after the former of Venice".

A book described as The Merchants Mirrour, or directions for the perfect ordering and keeping of his accounts formed by way of Debitor and Creditor, after the (so termed) Italian manner, by Richard Dafforne, accountant, published in 1635, contains many references to early books on the science of accountancy. In a chapter in this book, headed "Opinion of Book-keeping's Antiquity," the author states, on the authority of another writer, that the form of book-keeping referred to had then been in use in Italy about two hundred years, "but that the same, or one in many parts very like this, was used in the time of Julius Caesar, and in Rome long before." He gives quotations of Latin book-keeping terms in use in ancient times, and refers to "ex Oratione Ciceronis pro Roscio Comaedo"; and he adds: "That the one side of their booke was used for Debitor, the other for Creditor, is manifest in a certain place, Naturalis Historiae Plinii, lib. 2, cap. 7, where hee, speaking of Fortune, saith thus: Huic Omnia Expensa. Huic Omnia Feruntur accepta et in tota Ratione mortalium sola. Utramque Paginam facit." An early Dutch writer appears to have suggested that double-entry book-keeping was even in existence among the Greeks, pointing to scientific accountancy having been invented in remote times. There were several editions of Richard Dafforne's book - the second edition in 1636, the third in 1656, and another in 1684. The book is a very complete treatise on scientific accountancy, beautifully prepared and containing elaborate explanations. The numerous editions tend to prove that the science was highly appreciated in the 17th century. From this time on, there has been a continuous supply of literature on the subject, many of the authors styling themselves accountants and teachers of the art, and thus proving that the professional accountant was then known and employed.

Accountancy qualifications and regulation Main article: Accountant The expectations for qualification in the profession of accounting vary between different jurisdictions and countries. Accountants may be certified by a variety of organizations or bodies, such as the Association of Accounting Technicians (AAT) [2], British qualified accountancy bodies including Association of Chartered Certified Accountants (ACCA) and Institute of Chartered Accountants, and are recognized by titles such as Chartered Certified Accountant (ACCA or FCCA) and Chartered Accountant (UK, Australia, New Zealand, Canada, India, Pakistan, South Africa, Ghana), Certified Public Accountant (Ireland, Japan, US, Singapore, Hong Kong, the Philippines), Certified Management Accountant (Canada, U.S.), Certified General Accountant (Canada), or Certified Practicing Accountant (Australia). Some Commonwealth countries (Australia and Canada) often recognize both the certified and chartered accounting bodies. The majority of "public" accountants in New Zealand and Canada are Chartered Accountants; however, Certified

General Accountants are also authorized by legislation to practice public accounting and auditing in all Canadian provinces, except Ontario and Quebec, as of 2005. There is, however, no legal requirement for an accountant to be a paid-up member of one of the many Institutes and other bodies which are effectively a form of professional trade union. Unlike the Law Society, which can legally stop a solicitor from practicing, accountancy institutes do not have such authority. However, auditors are regulated.

The "Big Four" accountancy firms The "Big Four auditors" are the largest multinational accountancy firms. • • • •

PricewaterhouseCoopers KPMG Deloitte Touche Tohmatsu Ernst & Young

These firms are associations of the partnerships in each country rather than having the classical structure of holding company and subsidiaries, but each has an international 'umbrella' organization for coordination (technically known as a Swiss Verein). Before the Enron and other accounting scandals in the United States, there were five large firms and were called the Big Five: Arthur Andersen, PricewaterhouseCoopers, KPMG, Deloitte Touche Tohmatsu and Ernst & Young. On June 15, 2002, Arthur Andersen was convicted of obstruction of justice for shredding documents related to its audit of Enron. Nancy Temple (Andersen Legal Dept.) and David Duncan (Lead Partner for the Enron account) were cited as the responsible managers in this scandal as they had given the order to shred relevant documents. Since the U.S. Securities and Exchange Commission does not allow convicted felons to audit public companies, the firm agreed to surrender its licenses and its right to practice before the SEC on August 31, 2002. A plurality of Arthur Andersen joined KPMG in the US and Deloitte & Touche outside of the US. Historically, there had also been groupings referred to as the "Big Six" (Arthur Andersen, plus Coopers & Lybrand before its merger with Price Waterhouse) and the "Big Eight" (Ernst and Young prior to their merger were Ernst & Whinney and Arthur Young and Deloitte & Touche was formed by the merger of Deloitte, Haskins and Sells with the firm Touche Ross). Enron turned out to be only the first of a series of accounting scandals that enveloped the accounting industry in 2002. This is likely to have far-reaching consequences for the U.S. accounting industry. Application of International Accounting Standards originating in International Accounting Standards Board headquartered in London and bearing more resemblance to UK than current US practices is often advocated by those who note the relative stability of the UK accounting system (which reformed itself after scandals in the late 1980s and early 1990s). Accounting reform of a far more comprehensive sort is advocated by those who see issues with capitalism or economics, and seek ecological or social accountability.

The field of finance refers to the concepts of time, money and risk and how they are interrelated. The term "finance" may thus incorporate any of the following: • • • • • •

The study of money and other assets The management and control of those assets Profiling and managing project risks The science of managing money The industry that delivers financial services As a verb, "to finance" is to provide funds for business or for an individual's large purchases (car, home, etc.).

Contents [hide] • • •

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1 The main techniques and sectors of the financial industry 2 Personal finance 3 Corporate finance o 3.1 Capital o 3.2 The desirability of budgeting  3.2.1 Capital budget  3.2.2 Cash budget o 3.3 Management of current assets  3.3.1 Credit policy  3.3.1.1 Advantages of credit trade  3.3.1.2 Disadvantages of credit trade  3.3.1.3 Forms of credit  3.3.1.4 Factors which influence credit conditions  3.3.1.5 Credit collection  3.3.1.5.1 Overdue accounts  3.3.1.5.2 Effective credit control  3.3.1.5.3 Sources of information on creditworthiness  3.3.1.5.4 Duties of the credit department  3.3.2 Stock  3.3.3 Cash  3.3.3.1 Reasons for keeping cash  3.3.3.2 Advantages of sufficient cash o 3.4 Management of fixed assets  3.4.1 Depreciation  3.4.2 Insurance 4 Shared Services 5 Finance of states 6 Financial economics 7 Financial mathematics 8 Experimental finance 9 Quantitative behavioral finance 10 Intangible Asset Finance

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11 Related professional qualifications

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12 External links

[edit] The main techniques and sectors of the financial industry Main article: Financial services

An entity whose income exceeds its expenditure can lend or invest the excess income. On the other hand, an entity whose income is less than its expenditure can raise capital by borrowing or selling equity claims, decreasing its expenses, or increasing its income. The lender can find a borrower, a financial intermediary such as a bank, or buy notes or bonds in the bond market. The lender receives interest, the borrower pays a higher interest than the lender receives, and the financial intermediary pockets the difference. A bank aggregates the activities of many borrowers and lenders. A bank accepts deposits from lenders, on which it pays the interest. The bank then lends these deposits to borrowers. Banks allow borrowers and lenders, of different sizes, to coordinate their activity. Banks are thus compensators of money flows in space. A specific example of corporate finance is the sale of stock by a company to institutional investors like investment banks, who in turn generally sell it to the public. The stock gives whoever owns it part ownership in that company. If you buy one share of XYZ Inc, and they have 100 shares outstanding (held by investors), you are 1/100 owner of that company. Of course, in return for the stock, the company receives cash, which it uses to expand its business in a process called "equity financing". Equity financing mixed with the sale of bonds (or any other debt financing) is called the company's capital structure. Finance is used by individuals (personal finance), by governments (public finance), by businesses (corporate finance), as well as by a wide variety of organizations including schools and non-profit organizations. In general, the goals of each of the above activities are achieved through the use of appropriate financial instruments, with consideration to their institutional setting. Finance is one of the most important aspects of business management. Without proper financial planning a new enterprise is unlikely to be successful. Managing money (a liquid asset) is essential to ensure a secure future, both for the individual and an organization.

[edit] Personal finance Main article: Personal finance

Questions in personal finance revolve around

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How much money will be needed by an individual (or by a family) at various points in the future? Where will this money come from (e.g. savings or borrowing)? How can people protect themselves against unforeseen events in their lives, and risk in financial markets? How can family assets be best transferred across generations (bequests and inheritance)? How do taxes (tax subsidies or penalties) affect personal financial decisions? How does credit affect an individual's financial standing? How can one plan for a secure financial future in an environment of economic instability?

Personal financial decisions may involve paying for education,financing durable goods such as real estate and cars, buying insurance, e.g. health and property insurance, investing and saving for retirement. Personal financial decisions may also involve paying for a loan.

[edit] Corporate finance Main article: Corporate finance

Managerial or corporate finance is the task of providing the funds for a corporation's activities. For small business, this is referred to as SME finance. It generally involves balancing risk and profitability, while attempting to maximize an entity's wealth and the value of its stock. Long term funds are provided by ownership equity and long-term credit, often in the form of bonds. The balance between these forms the company's capital structure. Short-term funding or working capital is mostly provided by banks extending a line of credit. Another business decision concerning finance is investment, or fund management. An investment is an acquisition of an asset in the hope that it will maintain or increase its value. In investment management – in choosing a portfolio – one has to decide what, how much and when to invest. To do this, a company must: • • •

Identify relevant objectives and constraints: institution or individual goals, time horizon, risk aversion and tax considerations; Identify the appropriate strategy: active v. passive – hedging strategy Measure the portfolio performance

Financial management is duplicate with the financial function of the Accounting profession. However, financial accounting is more concerned with the reporting of historical financial information, while the financial decision is directed toward the future of the firm.

[edit] Capital Main article: Financial capital

Capital, in the financial sense, is the money that gives the business the power to buy goods to be used in the production of other goods or the offering of a service.

[edit] The desirability of budgeting

[edit] Capital budget This concerns fixed asset requirements for the next five years and how these will be financed.

[edit] Cash budget Working capital requirements of a business should be monitored at all times to ensure that there are sufficient funds available to meet short-term expenses. The cash budget is basically a detailed plan that shows all expected sources and uses of cash. The cash budget has the following six main sections: 1. Beginning Cash Balance - contains the last period's closing cash balance. 2. Cash collections - includes all expected cash receipts (all sources of cash for the period considered, mainly sales) 3. Cash disbursements - lists all planned cash outflows for the period, excluding interest payments on short-term loans, which appear in the financing section. All expenses that do not affect cash flow are excluded from this list (e.g. depreciation, amortisation, etc) 4. Cash excess or deficiency - a function of the cash needs and cash available. Cash needs are determined by the total cash disbursements plus the minimum cash balance required by company policy. If total cash available is less than cash needs, a deficiency exists. 5. Financing - discloses the planned borrowings and repayments, including interest. 6. Ending Cash balance - simply reveals the planned ending cash balance.

[edit] Management of current assets

[edit] Credit policy Credit gives the customer the opportunity to buy goods and services, and pay for them at a later date.

[edit] Advantages of credit trade • •

Usually results in more customers than cash trade. Can charge more for goods to cover the risk of bad debt.

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Gain goodwill and loyalty of customers. People can buy goods and pay for them at a later date. Farmers can buy seeds and implements, and pay for them only after the harvest. Stimulates agricultural and industrial production and commerce. Can be used as a promotional tool. Increase the sales.

[edit] Disadvantages of credit trade • • • • •

Risk of bad debt. High administration expenses. People can buy more than they can afford. More working capital needed. Risk of Bankruptcy.

[edit] Forms of credit • • • • • • •

Suppliers credit: Credit on ordinary open account Installment sales Bills of exchange Credit cards Contractor's credit Factoring of debtors

[edit] Factors which influence credit conditions • • • • • • • • •

Nature of the business's activities Financial position Product durability Length of production process Competition and competitors' credit conditions Country's economic position Conditions at financial institutions Discount for early payment Debtor's type of business and financial position

[edit] Credit collection [edit] Overdue accounts • • • • •

Cards arranged alphabetically in card index system Attach a notice of overdue account to statement. Send a letter asking for settlement of debt. Send a second or third letter if first is ineffectual. Threaten legal action.

[edit] Effective credit control • • • •

Increases sales Reduces bad debts Increases profits Builds customer loyalty

[edit] Sources of information on creditworthiness • • • • • •

Business references Bank references Credit agencies Chambers of commerce Employers Credit application forms

[edit] Duties of the credit department • • • • • • • • •

Legal action Taking necessary steps to ensure settlement of account Knowing the credit policy and procedures for credit control Setting credit limits Ensuring that statements of account are sent out Ensuring that thorough checks are carried out on credit customers Keeping records of all amounts owing Ensuring that debts are settled promptly Timely reporting to the upper level of management for better management.

[edit] Stock Purpose of stock control • • • •

Ensures that enough stock is on hand to satisfy demand. Protects and monitors theft. Safeguards against having to stockpile. Allows for control over selling and cost price.

Stockpiling Main article: Cornering the market

This refers to the purchase of stock at the right time, at the right price and in the right quantities. There are several advantages to the stockpiling, the following are some of the examples: • • • • •

Losses due to price fluctuations and stock loss kept to a minimum Ensures that goods reach customers timeously; better service Saves space and storage cost Investment of working capital kept to minimum No loss in production due to delays

There are several disadvantages to the stockpiling, the following are some of the examples: • • • •

Obsolescence Danger of fire and theft Initial working capital investment is very large Losses due to price fluctuation

Rate of stock turnover

This refers to the number of times per year that the average level of stock is sold. It may be worked out by dividing the cost price of goods sold by the cost price of the average stock level. Determining optimum stock levels • • • •

Maximum stock level refers to the maximum stock level that may be maintained to ensure cost effectiveness. Minimum stock level refers to the point below which the stock level may not go. Standard order refers to the amount of stock generally ordered. Order level refers to the stock level which calls for an order to be made.

[edit] Cash [edit] Reasons for keeping cash • • • •

Because cash is the king in finance, as it is the most liquid asset. The transaction motive refers to the money kept available to pay expenses. The precautionary motive refers to the money kept aside for unforeseen expenses. The speculative motive refers to the money kept aside to take advantage of suddenly arising opportunities.

[edit] Advantages of sufficient cash • • • • • •

Current liabilities may be catered for. Cash discounts are given for cash payments. Production is kept moving. Surplus cash may be invested on a short-term basis. The business is able to pay its accounts timeously, allowing for easilyobtained credit. Liquidity

[edit] Management of fixed assets

[edit] Depreciation Depreciation is the decrease in the value of an asset due to wear and tear or obsolescence. It is calculated yearly to ensure realistic book values for assets.

[edit] Insurance Main article: Insurance

Insurance is the undertaking of one party to indemnify another, in exchange for a premium, against a certain eventuality. Uninsurable risks • • • • •

Bad debt Changes in fashion Time lapses between ordering and delivery New machinery or technology Different prices at different places

Requirements of an insurance contract •

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Insurable interest o The insured must derive a real financial gain from that which he is insuring, or stand to lose if it is destroyed or lost. o The item must belong to the insured. o One person may take out insurance on the life of another if the second party owes the first money. o Must be some person or item which can, legally, be insured. o The insured must have a legal claim to that which he is insuring. Good faith o Uberrimae fidei refers to absolute honesty and must characterise the dealings of both the insurer and the insured.

[edit] Shared Services There is currently a move towards converging and consolidating Finance provisions into shared services within an organization. Rather than an organization having a number of separate Finance departments performing the same tasks from different locations a more centralized version can be created.

[edit] Finance of states Main article: Public finance

Country, state, county, city or municipality finance is called public finance. It is concerned with

• • • •

Identification of required expenditure of a public sector entity Source(s) of that entity's revenue The budgeting process Debt issuance (municipal bonds) for public works projects

[edit] Financial economics Main article: Financial economics

Financial economics is the branch of economics studying the interrelation of financial variables, such as prices, interest rates and shares, as opposed to those concerning the real economy. Financial economics concentrates on influences of real economic variables on financial ones, in contrast to pure finance. It studies: •

Valuation - Determination of the fair value of an asset o How risky is the asset? (identification of the asset appropriate discount rate) o What cash flows will it produce? (discounting of relevant cash flows) o How does the market price compare to similar assets? (relative valuation) o Are the cash flows dependent on some other asset or event? (derivatives, contingent claim valuation)

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Financial markets and instruments o Commodities - topics o Stocks - topics o Bonds - topics o Money market instruments- topics o Derivatives - topics

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Financial institutions and regulation

Financial Econometrics is the branch of Financial Economics that uses econometric techniques to parameterise the relationships.

[edit] Financial mathematics Main article: Financial mathematics

Financial mathematics is a main branch of applied mathematics concerned with the financial markets. Financial mathematics is the study of financial data with the tools of mathematics, mainly statistics. Such data can be movements of securities—stocks and bonds etc.—and their relations. Another large subfield is insurance mathematics.

[edit] Experimental finance Main article: Experimental finance

Experimental finance aims to establish different market settings and environments to observe experimentally and provide a lens through which science can analyze agents' behavior and the resulting characteristics of trading flows, information diffusion and aggregation, price setting mechanisms, and returns processes. Researchers in experimental finance can study to what extent existing financial economics theory makes valid predictions, and attempt to discover new principles on which such theory can be extended. Research may proceed by conducting trading simulations or by establishing and studying the behaviour of people in artificial competitive market-like settings.

[edit] Quantitative behavioral finance Main article: Quantitative behavioral finance

Quantitative Behavioral Finance is a new discipline that uses mathematical and statistical methodology to understand behavioral biases in conjunction with valuation. Some of this endeavor has been lead by Gunduz Caginalp (Professor of Mathematics and Editor of Journal of Behavioral Finance during 2001-2004) and collaborators including Vernon Smith (2002 Nobel Laureate in Economics), David Porter, Don Balenovich, Vladimira Ilieva, Ahmet Duran, Huseyin Merdan). Studies by Jeff Madura, Ray Sturm and others have demonstrated significant behavioral effects in stocks and exchange traded funds. The research can be grouped into the following areas: 1. Empirical studies that demonstrate significant deviations from classical theories. 2. Modeling using the concepts of behavioral effects together with the non-classical assumption of the finiteness of assets. 3. Forecasting based on these methods. 4. Studies of experimental asset markets and use of models to forecast experiments.

[edit] Intangible Asset Finance Main article: Intangible asset finance

Intangible asset finance is the area of finance that deals with intangible assets such as patents, trademarks, goodwill, reputation, etc.

accounting concept and conventions In drawing up accounting statements, whether they are external "financial accounts" or internallyfocused "management accounts", a clear objective has to be that the accounts fairly reflect the true "substance" of the business and the results of its operation. The theory of accounting has, therefore, developed the concept of a "true and fair view". The true and fair view is applied in ensuring and assessing whether accounts do indeed portray accurately the business' activities. To support the application of the "true and fair view", accounting has adopted certain concepts and conventions which help to ensure that accounting information is presented accurately and consistently. Accounting Conventions The most commonly encountered convention is the "historical cost convention". This requires transactions to be recorded at the price ruling at the time, and for assets to be valued at their original cost. Under the "historical cost convention", therefore, no account is taken of changing prices in the economy. The other conventions you will encounter in a set of accounts can be summarised as follows: Monetary measurement

Accountants do not account for items unless they can be quantified in monetary terms. Items that are not accounted for (unless someone is prepared to pay something for them) include things like workforce skill, morale, market leadership, brand recognition, quality of management etc.

Separate Entity

This convention seeks to ensure that private transactions and matters relating to the owners of a business are segregated from transactions that relate to the business.

Realisation

With this convention, accounts recognise transactions (and any profits arising from them) at the point of sale or transfer of legal ownership - rather than just when cash actually changes hands. For example, a company that makes a sale to a customer can recognise that sale when the transaction is legal - at the point of contract. The actual payment due from the customer may not arise until several weeks (or months) later - if the customer has been granted some credit terms.

Materiality

An important convention. As we can see from the application of accounting standards and accounting policies, the preparation of accounts involves a high degree of judgement. Where decisions are required about the appropriateness of a particular accounting judgement, the "materiality" convention suggests that this should only be an issue if the judgement is "significant" or "material" to a user of the accounts. The concept of "materiality" is an important issue for auditors of financial accounts. Accounting Concepts Four important accounting concepts underpin the preparation of any set of accounts:

Going Concern

Accountants assume, unless there is evidence to the contrary, that a company is not going broke. This has important implications for the valuation of assets and liabilities. Consistency Transactions and valuation methods are treated the same way from year to year, or period to period. Users of accounts can, therefore, make more meaningful comparisons of financial performance from year to year. Where accounting policies are changed, companies are required to disclose this fact and explain the impact of any change. Prudence Profits are not recognised until a sale has been completed. In addition, a cautious view is taken for future problems and costs of the business (the are "provided for" in the accounts" as soon as their is a reasonable chance that such costs will be incurred in the future. Matching (or Income should be properly "matched" with the expenses of a given accounting "Accruals") period. Key Characteristics of Accounting Information There is general agreement that, before it can be regarded as useful in satisfying the needs of various user groups, accounting information should satisfy the following criteria: Criteria

What it means for the preparation of accounting information

Understandability This implies the expression, with clarity, of accounting information in such a way that it will be understandable to users - who are generally assumed to have a reasonable knowledge of business and economic activities Relevance

This implies that, to be useful, accounting information must assist a user to form, confirm or maybe revise a view - usually in the context of making a decision (e.g. should I invest, should I lend money to this business? Should I work for this business?)

Consistency

This implies consistent treatment of similar items and application of accounting policies

Comparability

This implies the ability for users to be able to compare similar companies in the same industry group and to make comparisons of performance over time. Much of the work that goes into setting accounting standards is based around the need for comparability.

Reliability

This implies that the accounting information that is presented is truthful, accurate, complete (nothing significant missed out) and capable of being verified (e.g. by a potential investor).

Objectivity

This implies that accounting information is prepared and reported in a "neutral" way. In other words, it is not biased towards a particular user group or vested interest