003 Caaccst Ch01 Amndd Hs RP Sec
003 Caaccst Ch01 Amndd Hs RP Sec
003 Caaccst Ch01 Amndd Hs RP Sec
Introduction to accounting
Contents
Contents
Introduction
Examination context
Topic List
1 The purpose of accounting information
2 The main financial statements
3 The regulation of accounting
4 Qualitative characteristics of accounting information
5 Capital and revenue items
Summary and Self-test
Technical reference
Answers to Self-test
Answers to Interactive questions
Introduction
Practical significance
Since your role as a Chartered Accountant will be concerned with the maintenance of financial records and
preparation of financial statements, the contents of this chapter are fundamental to what you do.
Working context
In the work you are doing at this stage in your career it is very helpful to know what you are helping to
produce (financial information in the form of financial statements) and what is going to be done with it.
Syllabus links
The material in this chapter will be developed further in this paper, and then in the Financial Accounting
paper later in the Professional Stage and Financial Reporting paper in the Advanced Stage.
Examination context
Exam requirements
In the exam you may be required to:
Identify capital as opposed to revenue expenditure
Distinguish between the different qualitative characteristics
Identify the principles that relate to each qualitative characteristic
Identify the different interests of stakeholders
Section overview
Accounting is a way of recording, analysing and summarising the transactions of an entity.
The three main types of business entity are sole traders, partnerships and companies.
Users who need financial information include: managers, owners, customers, suppliers, lenders,
employees, National Board of Revenue (NBR) and Customs, financial analysts and advisers, the
government and the public at large.
Managers and (present and potential) owners are the prime users of published financial statements.
People need financial information on a company to make economic decisions, to assess managers'
stewardship of the company's resources, and to assess the level, timing and certainty of its future cash
flows.
Why do businesses need to produce accounting information in the form of financial statements? If a
business is being run efficiently, why should it have to go through all the bother of accounting procedures in
order to produce financial information? The Framework states that:
'The objective of financial statements is to provide information about the financial position,
performance and changes in financial position of an entity that is useful to a wide range of users in
making economic decisions.'
In other words, a business should produce information about its activities because there are user groups
who want or need to know that information in order to make economic decisions.
When making economic decisions, users need to assess:
The ability of the business to generate cash, and
The timing and certainty of cash flows.
Whether the business can generate cash of the right amount determines whether it can:
Pay its employees and suppliers
Meet interest payments
Repay loans
Pay something to its owners
Bangladesh Accounting Standard 1 (BAS 1) Presentation of Financial Statements adds two other functions to
BAS Framework's statements:
To show the results of management's stewardship of the resources entrusted to it, and
To help users of financial statements in predicting the entity's future cash flows and, in particular,
their timing and certainty.
Large businesses are of interest to a greater variety of people and so we will consider the case of a large
public company, whose shares can be purchased and sold on a stock exchange.
Government agencies are interested in the efficient allocation of resources and therefore in the
activities of enterprises. They also require information in order to provide a basis for national
statistics.
The public. Business entities affect members of the public in a variety of ways. For example, they may
make a substantial contribution to a local economy by providing employment and using local suppliers.
Another important factor is the effect of an entity on the natural environment, for example as regards
pollution.
Accounting information is summarised in financial statements to satisfy the information needs of these
different groups. Not all will be equally satisfied.
Managers of a business need the most information, to help them make planning and control decisions.
They have greater access to business information, because they are able to review internally produced
statements. Managers can obtain extra information through the cost and management accounting
system.
In addition to management information, additional financial statements are prepared for the benefit of other
user groups, who may demand particular information.
or sell shares. Shareholders are also interested in information which enables them to assess the ability
of the entity to pay dividends.
Employees and their representative groups need information about the stability and profitability of
their employers, so they can assess the entity's ability to provide remuneration, retirement benefits
and employment opportunities.
Lenders need information that enables them to determine whether their loans, and the interest
attached to them, will be paid when due.
Suppliers and other creditors need information that enables them to determine whether amounts
owing to them will be paid. Trade creditors are likely to be interested in an entity over a shorter
period than lenders, unless they are dependent upon the continuation of the entity as a major
customer.
Customers need information about the entity's continuance, especially when they have a long-term
involvement with, or are dependent on, the entity.
Governments and their agencies have the needs listed in section 1.4. They also require
information in order to regulate the activities of entities, and determine taxation policies.
Public. Members of the public have the needs listed in section 1.4, that is they wish to see how the
company will be able to continue employing local people and using local suppliers. Financial statements
may assist the public by providing information about the trends and recent developments in the
prosperity of the entity and the range of its activities.
The Framework does not identify managers primarily as users of financial statements but instead as being
primarily responsible for their preparation and presentation.
Section overview
The main financial statements include a balance sheet, an income statement, a cash flow statement
and notes.
BAS 1 Presentation of Financial Statements sets out the form and content of the income statement and
balance sheet.
BAS 1 Presentation of Financial Statements (and the Framework) identifies a complete set of financial
statements as comprising a balance sheet, an income statement, a statement of changes in equity,
a cash flow statement, and notes.
Definitions
Balance sheet: A list of all the assets controlled and all the liabilities owed by a business as at a particular
date: it is a snapshot of the financial position of the business at a particular moment. Monetary amounts
are attributed to assets and liabilities. It also quantifies the amount of the shareholders' interest in the
company: equity.
Equity: The amount invested in a business by the owners.
Assets and liabilities are explained in more detail in Chapter 2. However, the sum of the assets will always
be equal to the sum of the liabilities plus equity/capital.
The Framework gives a useful analysis of what factors affect a company's financial position at any one time:
(a) The economic resources it controls (cash, labour, materials, machinery, skills)
(b) Its financial structure (whether it is funded by owners, lenders, suppliers, or by all three)
(c) Its liquidity (short-term availability of cash) and solvency (long-term access to funds)
(d) Its adaptability to changes in its operating environment
The Framework also sets out how information about three of these features can be used by users.
Economic resources To predict the entity's ability to generate cash in the future
Financial structure To predict future borrowing needs
To predict how future profits and cash flows will be distributed among
owners and lenders
To predict how successfully it will be able to raise future finance
Liquidity/solvency To predict its ability to meet financial commitments as they fall due
Definition
Income statement: A record of income recognised and expenditure incurred over a given period.
It is a record of the entity's financial performance over a period of time. The statement shows whether
the business has had more revenue than expenditure (a profit) or vice versa (a loss).
The accounting period chosen will depend on the purpose for which the statement is produced. The
income statement which forms part of the published annual financial statements of a limited liability
company will usually be for the period of a year, commencing from the date of the previous year's
financial statements. On the other hand, management might want to keep a closer eye on a company's
profitability by making up quarterly or monthly statements.
The Framework sets out how information about the business's financial performance, i.e. its profits, is
needed by users.
To assess potential changes in the economic resources it uses in the future (information about
variability of performance is potentially important here)
To predict the business's capacity to generate cash flows from its existing resource base
To judge how effectively the business might employ additional resources.
The link between the balance sheet and the income statement is provided by the cash flow statement
and the statement of changes in equity. These are covered later in your professional studies.
The only note that is covered in this exam syllabus is the summary of accounting policies, which we
will see later.
Section overview
Financial statements are regulated by legislation, the application of judgement using established
accounting concepts, accounting and financial reporting standards, commonly used accounting
practices and the need for fair presentation (or a true and fair view).
3.1 Legislation
Limited liability companies are required by the Companies Acts to prepare and publish financial statements
annually. Their form and content are regulated by legislation but must comply with accepted accounting
standards. For limited liability companies this means compliance with BAS and BFRS.
Other examples of areas where the judgement of different people may vary are as follows.
Valuation of buildings in times of changing property prices.
Research and development (R&D): is it right to treat this only as an expense? In a sense it is an
investment to generate future revenue.
Brands such as 'Snickers' or 'iPod'. Are they assets in the same way that a fork lift truck is an asset?
Working from the same data, different groups of people may produce very different financial statements,
but if judgement is completely unregulated, there will be no comparability between the financial statements
of different organisations. This will be all the more significant in cases where deliberate manipulation occurs,
in order to present financial statements in the most favourable light.
We shall come back to accounting concepts and conventions in Chapter 7.
The Companies Acts require that the financial statements should give a true and fair view of the
state of the affairs of the company and to explain its transactions.
In terms of BAS 1, financial statements should present fairly the financial position and performance,
and the cash flows, of the entity. This requires faithful representation of the effects of transactions.
Section overview
Ideally financial information will be relevant, understandable, reliable and comparable.
What type of information then should financial statements contain? What should its main qualities be from
the user's point of view? The following is a summary of the qualitative characteristics of useful
accounting information according to the Framework.
Relevance. Accounting information is relevant where it helps users evaluate past and present events,
and predict future events. Information's relevance is affected by its nature and materiality. (We
shall come back to materiality; for now you can think of it as 'important'). It may become less relevant
if there is undue delay in its reporting.
Understandability. Information may be difficult to understand because it is incomplete, but too
much detail can also cause difficulties. Users are assumed to have a reasonable knowledge of business
and economic activities, and to be diligent.
Reliability. Information is reliable if it is free from error and can be depended upon by users to
represent faithfully what it is reasonably expected to represent. As well as faithful representation and
accuracy, reliable information is:
– Accounted for on the basis of a transaction's economic substance rather than its legal
form
– Prudent – a degree of caution is exercised in making estimates where conditions of uncertainty
exist
– Neutral (unbiased)
– Complete within the bounds of materiality and cost.
Comparability. Information should be produced on a consistent basis, so that valid comparisons can
be made with information from previous periods and with information produced by other entities (for
example, the financial statements of similar companies operating in the same line of business).
We shall look in more detail at these qualities, and how they might be undermined, in Chapter 7.
Section overview
Capital and revenue income and expenditure must be distinguished from each other.
Definition
Capital expenditure: Expenditure which results in the acquisition of long-term assets, or an
improvement or enhancement of their earning capacity.
Long-term assets are those which will be kept in the entity for more than one year.
Capital expenditure is not charged as an expense in the income statement (although a 'depreciation'
charge will usually be made to write off the capital expenditure gradually over time; depreciation
expense is shown in the income statement).
Capital expenditure on long-term assets appears in the balance sheet.
Definition
Revenue expenditure: Expenditure which is incurred either
For trade purposes. This includes purchases of raw materials or items for resale, expenditure on
wages and salaries, selling and distribution expenses, administrative expenses and finance costs, or
To maintain the existing earning capacity of long-term assets.
Revenue expenditure is charged to the income statement of a period, provided that it relates to the trading
activity and sales of that particular period.
Capital expenditure can include costs incurred in bringing a long-term asset to its final condition and
location, such as legal fees, duties and carriage costs borne by the asset's purchaser, plus installation costs.
Repair, maintenance and staff costs in relation to long-term assets are revenue expenditure.
Definition
Capital income: Proceeds from the sale of non-current assets.
The profits (or losses) from the sale of long-term assets are included in the income statement for the
accounting period in which the sale takes place. For instance, the business may sell machinery or property
which it no longer needs.
Definition
Revenue income: Income derived from
The sale of trading assets, such as goods held in inventory
The provision of services
Interest and dividends received from business investments
Summary
Accounting
Business entity
Sole trader Partnership Company
Record (Chapter 3)
Analyse (Chapter 4)
Summarise (Chapter 5)
Accounting Information:
financial statements
Managers
Accounting Accounting Make Shareholders
Assess
concepts Standards economic Customers
stwewardship
(Chapter 7) (Chapters 7 & 12) decisions Suppliers
Lenders
Employees
Framework:
Legislation GAAP Estimate Government
qualitative characteristics
cash flows Analysts
Public
Substance Faithful
Materiality Neutrality
Form representation
Prudence Completeness
Self-test
Answer the following questions.
1 An entity’s transactions are recorded first in
A Books of original entry
B Ledger accounts
C The income statement
D The balance sheet
2 Liability for the debts of the business does not fall on
A A sole trader
B Partners in a general partnership
C A limited liability company
D Shareholders
3 According to the BFRS Framework and BAS 1 which of the following does not represent an objective
of financial statements?
A To provide information to investors in making economic decisions
B To provide information to managers in making business decisions
C To show the results of management’s stewardship of the resources entrusted to it
D To help users predict the entity’s future cash flows
4 Which TWO of the following issues in an entity’s financial statements are identified by the Framework
as being of interest to the public?
A Whether the entity has paid a dividend
B Whether the entity will repay a loan when it falls due
C Whether the entity will continue to be able to employ people
D Whether the entity will continue
E Whether the entity patronises local suppliers
5 A balance sheet is best described as:
A A snapshot of the entity’s financial position at a particular point in time
B A record of an entity’s financial performance over a period of time
C A list of all the income and expenses of the entity at a particular point in time
D A list of all the assets and liabilities of the entity over a period of time
6 In applying fundamental accounting concepts the preparers of financial information are also using
A Legislation
B Accounting standards
C Judgement
D Financial reporting standards
7 Which of the following is not a source of the accounting rules embodied in in GAAP?
A The Companies Acts
B Commonly used accounting practices
C Listing requirements of Dhaka Stock Exchange
D Accounting requirements of an entity’s US parent company
8 Which of the following factors have not influenced financial reporting?
A National legislation
B Economic factors
C International Accounting standards
D GAAP
9 Accounting for a transaction’s economic substance rather than its strict legal form is a feature of:
A Relevance
B Understandability
C Reliability
D Comparability
10 Which of the following is an item of capital expenditure?
A Cost of goods sold
B Purchase of a machine
C Repairs to a machine
D Wages cost
Now, go back to the Learning Objectives in the Introduction. If you are satisfied that you have achieved
these objectives, please tick them off.
Technical reference
To help users of the financial statements in predicting the entity’s future cash flows BAS Framework
and, in particular, their timing and certainty paras 16/17
Answers to Self-test
1 A Books of original entry form the primary record of transactions. These are analysed and posted
to the ledger accounts and summarised in the income statement and balance sheet
2 D Sole traders and partners bear full liability for the debts of the business entity, as does a limited
liability company itself. The liability of the shareholders for the debts of a company is, however,
limited
3 B BAS Framework identifies A as the objective, and BAS 1 identifies C and D. The use of accounting
information by managers is not identified as an objective in either document; instead managers
are identified in the BAS Framework is being primarily responsible for the preparation and
presentation of financial statements
4 C, E According to the Framework, A is of interest to investors; B is of interest to lenders, D is of
interest to customers
5 A A balance sheet is a list of assets and liabilities which represent the entity’s financial position at a
particular point in time. D is wrong because it refers to ‘a period of time’; C refers to income and
expenditure, not assets and liabilities; B defines the income statement
6 C Many figures in financial statements are derived from the application of judgement in putting
fundamental accounting concepts into practice
7 D GAAP relates to generally accepted accounting practice; the rules applied as a result of internal
requirements can therefore not be part of GAAP
8 B Economic factors do not influence the development of financial reporting; all the others do (see
section 3)
9 C
10 B This results in the acquisition of a long-term asset. All the others are revenue expenditure