Question

Discuss the conceptual framework of accounting according to: definition of accounting, purpose of accounting, difference between bookkeeping and accounting, users of accounting information, accounting assumptions, and accounting principles. Also discuss the major type of adjusting entries in detail.

Answer 1

Conceptual framework of accounting:

Construct an essay using the following key points and descriptions.

- Definition:
The American Institute of Certified Public Accountants (AICPA) defines accounting as: "the art of recording, classifying, and summarizing in a significant manner and in terms of money, transactions and events which are, in part at least of financial character, and interpreting the results thereof."

- Purpose:
To provide the information that is needed for sound economic decision making.

To accumulate and report on financial information about the performance, financial position, and cash flows of a business.

- Bookkeeping and Accounting:

Bookkeeping is mainly related to identifying, measuring, and recording, financial transactions. Accounting is the process of summarizing, interpreting, and communicating financial transactions which were classified in the ledger account

Objective - Book keeping, to keep the records of all financial transactions proper and systematic.
Objective - Accounting, To gauge the financial situation and further communicate the information to the relevant authorities.

Bookkeeping - Doesn't involve preparation of Financial statements
Accounting - Financial statements are prepared during the accounting process.

Bookkeeping - No special skill required.
Accounting - Special skill required

- Users of accounting information:

External users - Creditors, investors, government, trading partners, regulatory agencies, international standardization agencies, journalists, etc.
Internal users - Owners, directors, managers, employees of the company.

- Assumptions of accounting:

Going concern - the entity will continue to exist indefinitely and no plan of winding up in the near future.
Business entity - Business is treated as a unit or entity apart from its owners, creditors, managers, and others.
Money measurement - Every worth-recording event, happening or transaction is recorded in terms of money.
Consistency - Same method of accounting will be used from period to period, unless it can be replaced by a more relevant method.
Accrual - Transactions are recorded using the accrual basis of accounting, where the recognition of revenues and expenses arises when earned or used, respectively.

- Principles of accounting:

Revenue Recognition Principle - Concerned with the revenue being recognized in the income statement of an enterprise.
Matching Principle - The expenses incurred in an accounting period should be matched with the revenues recognized in that period.
Full Disclosure Principle - The financial statements must disclose all the relevant and reliable information which will be useful for the users.
Materiality Principle - An item is considered ‘material’ if it would affect or influence the decision of a reasonable individual reading the company's financial statements.

- Major type of adjusting entries:

1. Accrued revenues - Income generated in one accounting period, but don’t recognize it until a later period, it is necessary to make an accrued revenue adjustment.
Adjusting entry,

Accrued revenue
To Revenue

2. Accrued expenses - Expenses generated in one accounting period, but paid for later.
Adjusting entry,

Expense
To Accrued expense

3. Deferred revenues - Income paid in advance by a client is deferred revenue. When income received in advance, it becomes an obligation to perform the service or task for which the income is earned.
Adjusting entry,

Cash
To Deferred revenue

4. Prepaid expenses - Making payments for something up front—then recording the expense for the period it applies to. Expense is paid before it becomes due for payment.

Adjusting entry,

Prepaid expense
To Cash

5. Depreciation expenses - Non cash expense concerned with reducing the value of an asset, on the basis of its usage, wear and tear.
Depreciation
To Accumulated depreciation