QN 1: WRITE A DESCRIPTIVE DISCUSSION ABOUT THE ACCOUNTING

PRINCIPLES/ CONCEPTS.

ACCOUNING PRINCIPLES AND CONCEPTS

Accounting principles refer to the rules and guidelines followed by companies while
reporting their financial data. Through these rules, experts can examine the financial
data by standardizing accounting methods. These principles ensure that the quality of
the financial information reported by companies is improved.

The aim of accounting principles is to compare multiple financial statements on the

same level. For this comparability, it is mandatory that these accounting principles
have been followed to same set of accounting standards.

Basic Principles of Accounting.

1) Accrual Principle

It is one of the important accounting concepts and principles that mandate the
recording of transactions in the time period in which they occur. It is regardless of the
time when actual cash flows for the transactions are received. Through the accrual
principle, one can gain an accurate insight into the financial status of a business. Most
large-scale businesses adopt an accrual system to determine the cash flow of the
business operations. Along with this, revenues and related expenses are recorded in
the same time period of reporting.

2) Consistency principle

According to this principle, when a company adopts a specific accounting method of

reporting or documentation, it should then stay consistent with that method. The aim
of this basic accounting principle is to make financial statements comparable across
industries and companies. This principle has two issues associated with it. First, the
principle is not properly followed when many people are recording data and compiling
reports. To combat this issue, organizations need to have a set method internally. The
second issue is related to switching between the financial reporting methods. Some
organizations do this in order to manipulate the data to their advantage.

3) Conservatism Principle

This principle gives you a realistic perspective of unexpected situations. According to

this principle, one should recognize expenses and liabilities at the early stages even if
there is uncertainty about the outcome. However, the principle recognizes revenues
and assets when there is an assurance of its receival. This principle can be applied to
recognizing the estimates. The conservatism principle is the foundation of lower cost
or market rule. As per this rule, one should record inventory at a lower end of its
current market value or at its acquisition cost.

4) Cost Principle (historical Cost)

This is another name for the cost principle. Whenever a business acquires an asset, its
initial value is recorded in its financial reports of the business. This value might not be
improved in the market value of inflation. It is also not updated to reflect
any depreciation or even appreciation. This value is known as the cost principle. As
per the principle, companies keep a record of their tangible assets without reflecting
the market value. Through this principle, companies can assess the actual cost of using
financial services for calculating the historical cost principles of the assets of the
company.

5) Economic Entity Principle

This principle requires companies to be treated as a separate financial and legal entity.
This means that the recorded activities of the business entity must be kept separate
from the recorded activities of the owner and other entities. These may include either
a sole trader, limited liability partnership, or general partnership.

6) Matching Principle

This is a concept in accounting that states that companies must report their expenses
and revenues simultaneously. The revenues and expenses are matched on an income
statement for a specific period. It is a part of the accrual accounting method that
provides an accurate representation of operations on the income statement. This
principle is quite useful for investors as investors can match revenue and expenses to
get a better sense of the finances of a business. Along with the income statement, there
is a need to assess the cash flow statements as well.

7) Materiality Principle

This states that any item that may impact the decision-making process of an investor
must be recorded. These details must be recorded in length in the financial statements
using Generally Accepted Accounting Principles (GAAP). The material principle
states that the accounting standard can be ignored if the end result is small. It is an
important principle for deciding if a transaction should be recorded as a part of closing
process.

8) Full Disclosure Principle

This states that each piece of information should be included in the financial statement
of an entity. This is necessary since it might affect the reader’s perspective of
understanding the statement. It is important to only disclose information about events
that have a material impact on the financial position of an entity. As per the full
disclosure principle, it may also include those items that cannot be quantified.
Businesses are also liable to report existing accounting policies and any changes in
them as well.

9) Going Concern Principle

This states that a company will complete its recent plans, meet its financial obligations
and use its existing assets. This process of continuing operations indefinitely must go
on until the company has any evidence on the contrary. Through this principle, the
company continues to make money to avoid going bankrupt. In case, the company is
unable to adopt this principle properly, the chance of liquidation and bankruptcy
increases.

10) Monetary Unit Principle

According to this principle, business transactions should be recorded only when they
can be expressed as currency. Accountants should avoid recording non-quantifiable
entities in the financial accounts. Whenever a transaction or an event occurs, it is first
converted into money. After that, it is recorded in the financial accounts of a business.
It ensures that every accounting record is measurable in monetary terms by currencies.

11) Reliability Principle

This principle ensures that every transaction, business activity, event is reliable when
presented in the financial statement. Information should be associated with objective
evidence and it can be checked, reviewed, and verified. This makes the information
more reliable. Along with this, the information should be accurate and have a
transparent representation. This makes the information reliable for its users. This
principle ensures every financial statement and business accounting records are
accurate.

12) Objectivity Principle

This is the concept of considering financial statements as solid evidence. These

statements should not be biased or opinionated. While constructing financial
statements, these statements should be helpful in evaluating the financial results,
financial position and cash flow of an entity. This principle of accounting must be
from the viewpoint of an auditor as well. In case an auditor is auditing a business that
he has worked with, then the audit report might not be free from bias as per the
relationship with the business owner

QN2: WRITE COMPREHENSIVE NOTES ABOUT THE FOLLOWING:

I. Trial Balance
II. Errors that don’t affect a trial balance
 III. Circumstances where the trial balance doesn’t balance
IV. Provisions and their adjustments
V. Pre-payments
VI. Accruals
VII. Depreciation
VIII. Balance Carried Down
IX. Balance Carried Forward
X. Financial Statements
XI. Suspense Accounts
XII. Classification in Accounting

TRIAL BALANCE

This is a list of debit and credit balances extracted from the ledger aimed at checking
the accuracy of the accounting process.

Accounts with more balances on the ledger will appear on the trial balance.

All asset accounts (except with bank in case of an overdraft), expense account and
drawings account are expected to have a debit balance i.e. credit balances on these
accounts means that the accounting process was erred.

All liability, revenue/ income, capital and reserve accounts are expected to have a
credit balance .i.e. a debit balance on these accounts means that the accounting
process was erred.

The accounting equation rule states that there must be equal debit and credit for every
financial transaction. If the total in the debit column doesn’t equate to the total value
in the credit column, there would be an error in the nominal ledger accounts.

I) ERRORS THAT DON’T AFFECT A TRIAL BALANCE.

A trial balance only checks the sum of debits against the sum of credit. This isn’t a
guarantee of no errors.

The following are the errors that may arise in a trial balance which do not affect the
trial balance:

1) ERROR OF ORIGINAL ENTRY.

This is when a wrong amount is posted to an account. These errors would also be
reflected in any other accounts related to the transaction .i.e. all those involved
accounts would be in balance but for the wrong transactions.

2) ERROR OF DUPLICATION.

This is when the accounting entry is duplicated .i.e. it is debited and credited twice for
the same entry.
 3) ERROR OF OMISSION.

This is when an entry was not made though a transaction had occurred for that
period .i.e. invoice that get lost/ those that are not properly recorded.

4) ERROR OF ENTRY REVERSAL.

This is when the accounting entry was posted in the wrong direction .i.e. the debit was
recorded as credit and vice-versa.

5) ERROR OF PRINCIPLE.

This occurs when an accounting principle is applied in error .i.e. purchase is posted as
an expense instead of an asset.

An operating expense are day to day expenses that wouldn’t include a fixed asset.
Asset purchase are to be recorded on the balance sheet and the operating expense are
to be recorded on the income statement.

6) ERROR OF COMMISSION.

This is an error that occurs when an accountant records a debit or credit to the
correct amount but to the wrong ledger .i.e. the money received from a debtor is
credited from the debtors account but it is debited to the wrong Debtor.

7) COMPENSATING ERROR.

This is when one error has been compensated by an offsetting entry that is also in
error.

CIRCUMSTANCES WHERE THE TRIAL BALANCE DOESN’T BALANCE.

If the trial balance doesn’t balance, the debit and credit balances don’t equate.

1) ONE- SIDED ENTRY.

This is where the same amount were not entered in debit and credit while recording in
the ledger.

2) INCORRECTLY RECORDED BALANCE.

The ledger account balance was incorrectly recorded .i.e. a wrong figure at the wrong
side of the trial balance.

3) OMMITTED ACCOUNTS.

This is where a ledger account was accidentally left out of the trial balance.

4) TWO ENTRIES ON ONE SIDE.

This is where a transaction was entered as two debits/ two credits.

5) JOURNAL POSTING ERROR.

This is where an error occurred when a journal was posted.

6) ACCOUNT CONFIGURATION ERROR.

This is where there was an error with configuration of the accounts.

PROVISIONS.

An accounting provision is an amount of money a company sets aside to pay for

future expenses or liabilities They are important for ensuring that financial statements
provide a true and fair view of a company's financial position. Provisions are typically
measured at the best estimate of the expenditure required to settle the present
obligation. This might involve judgment and assumptions based on historical data and
future expectations. Financial statements should disclose the nature of the provisions,
the expected timing of any outflows, and the uncertainties involved.

Examples of Provisions in accounting

Bad debt is one of the most common types of provisions. It is calculated to cover the
cost of debts that are expected to remain unpaid during an accounting period.

The other examples of provisions are

 Doubtful debts
 Depreciation
 Pension
 Restructuring liabilities
 Income taxes
 Guarantee (product warranties)

Adjustment in Provisions:

Provisions may need to be reviewed and adjusted at each reporting period to reflect
the current best estimate.

II) PRE-PAYMENTS.

Prepayments are payments made in advance of receiving goods or services, or early

repayments of loans: This may include:

 Paying for goods or services in advance

 A prepayment is a payment made to a supplier before they provide goods or
services. For example, paying for a subscription annually in
advance. Prepayments are shown as current assets on a business's balance
sheet. When the expense is used, the prepayment is moved from the balance sheet
to the profit and loss account.

 Repaying a loan early

A prepayment is when a borrower pays back a loan in part or in full before the
due date. This is often done to take advantage of lower interest rates through
refinancing

SUSPENSE ACCOUNTS.

This is a temporary account in a business’s general ledger used to store transactions

that need more information to be properly classified. These include;

1) Incomplete Transactions.

This is created when a journal entry has missing information.

2) Unclear Payments

This is when a business receives a payment but doesn’t know what it’s for. This
payment is placed in the suspense account until the issue is resolved.

3) Unknown Recipients.

This is created when a business receives an invoice without an address for payment.

4) Fixed Assets on Payment Plans.

This is created when a business buys a fixed asset on a payment plan and doesn’t
receive it until it’s fully paid off.

5) Partial Payment.

This is when a business receives a partial payment that doesn’t match up to the
invoice.

FINANCIAL STATEMENTS.

Financial statements are a set of documents that show a company’s financial status at
a specific point in time.
Financial statements may be prepared for different timeframes. Annual financial
statements cover the company’s latest fiscal year. Companies may also prepare
interim financial statements on a monthly, quarterly or semi-annual basis.

Interim statements sometimes include fewer components than year-end statements.

For example, they may lack a cash flow statement and a statement of retained
earnings.

Financial statements generally give information for both the latest period and the prior
period to make comparisons easier. For example, a financial statement
covering January 1 to December 31, 2021, would include the statements for both that
year and the previous year—January 1 to December 31, 2020.

The financial statements may be prepared according to different accounting rules,

depending on the specificities of the Company.

ELEMENTS OF A FINANCIAL STATEMENT.

1) Balance sheet

This shows what the company owns and how much it owes at the end of the period. It
is based on the equation:

Assets = Liabilities + Shareholders’ Equity (Capital)

2) Income statement

This shows the profitability of the company. It details how much money the company
has earned and spent. The income statement is also sometimes referred to as a profit-
loss statement or an earnings statement.

An income statement shows:

 The revenue from selling products or services

 The expenses to generate the revenue and manage the company

 The net income (or profit) that remains after the expenses

 The profit and loss on non-core activities, excluding current operations

3) Cash flow statement

The cash flow statement, sometimes called a statement of changes in financial

position, shows how money, including cash equivalents, has moved through a
company during that period. Cash equivalents consist of short-term investments that
are highly liquid and easily convertible to cash. They are usually held for less than
three months.

4) Statement of retained earnings

The statement of retained earnings shows the cumulative earnings of a company after
any dividends or distributions to shareholders. This statement also shows the change
in retained earnings between the opening and closing periods of each balance sheet. It
may also show adjustments from related-party transactions.

ADJUSTMENTS OF A FINANCIAL STATEMENT.

These are made at the close of an accounting period to rectify errors, record
unaccounted income or expenses, and maintain the integrity of financial records to
prepare comprehensive financial statements. This ensures financial data accurately
reflects the financial position and performance of a company

Why should adjustments be made?

Adjustments may be made for various reasons. One common reason is the

1) Accruals. This requires companies to record revenues and expenses when they
are earned or incurred, rather than when cash is received or paid. This means
some transactions may not have been recorded during the accounting period
and adjustments need to be made to accurately present a company’s financial
position.

2) Errors. This may include mathematical mistakes or incorrect classification of

items in the financial statements and errors from forgotten entries to resource
misallocations, require accounting adjustments to maintain the income
statement’s accuracy. For example, if a purchase were mistakenly classified as
an expense instead of an asset, an adjusting entry would need to be made to
correct this error.

3) Changes in estimates. Some items on a company’s balance sheet, such as

accounts receivable and inventory, may require estimates for their fair value. If
these estimates change over time, adjustments must be made to accurately
reflect the fair value of these line items on the financial statements.

Types of accounting adjustments

Types of adjustments in accounting include accruals, deferrals, estimates,

and depreciation/amortization.

1) Accruals

Accruals occur when revenues or expenses have been earned or incurred but not
recorded in the books. One common example of an accrual adjustment is accrued
expenses, such as accrued rent. With accrued expenses, costs have been incurred but
the invoice has not been received, or it’s been received by not recorded. If a company
has work performed during the period, but an invoice has not been received by the end
of the period, the company would accrue the expense to record the amount owed.
These adjustments help ensure all expenses are properly matched with their
corresponding period.

2) Deferrals

These are recorded items that need to be adjusted because they do not represent actual
revenues or expenses for the period. Deferral adjustments often involve prepaid
expenses and unearned revenues.

Prepaid expenses are payments made in advance for goods or services that will be
used up over time, such as insurance premiums or rent payments. Adjustments for
prepaid expenses recognize the used portion of the good or service as an expense in
the current period, while the portion of the payment representing the unused goods or
services can remain on the balance sheet as an asset until it is used.

Unearned revenue occurs when a company receives payment from customers for
goods or services it has not yet provided, or earned. This is where customers pay
upfront for the use of the product over a period of time. The unearned revenue must be
adjusted over time as revenue is recognized based on how much of the product or
service has been delivered. For example, a company may require full payment at the
beginning of a three-year software subscription. The company would record the
receipt of the cash payment but the revenue would be deferred and adjusting entries
would be made to recognize the revenue evenly over the term of the contract.

3) Estimates

Assets such as accounts receivable and inventory frequently use estimates to

accurately reflect their value. As actual transactions occur or additional information is
known, a company will adjust its financial position. For example, a company may
record a bad debt provision for accounts or invoices they deem to be uncollectible. If
they learn of a customer filing bankruptcy or receive payment for an invoice, they
previously determined to be uncollectible, they would need to adjust their estimate.

4) Depreciation and amortization

Depreciation is a process by which a company accounts for the deterioration of a fixed

assets value over time. Amortization refers to the spreading of the costs of long-term
intangible assets over their useful lives. Both of these methods are used to match the
expense with the revenue generated from using the asset.

BALANCE CARRIED DOWN

In accounting, the balance carried down (c/d) is the balance at the end of an
accounting period that is used to start the next period. It can be written on both the
debit and credit side of an account
BALANCE BROUGHT FORWARD.

Balance brought forward, also known as balance forward, is the ending balance from a
previous period that is carried over to the beginning of the next period. It is an
important aspect of financial management and invoices because it shows the total
amount due, including interest payments, overpaid, or zero balance

CONTRA-ENTRY.

Contra entry refers to opposing transactions (debit and credit) involving cash and bank
accounts. When there is a contra entry, it means that both transactions offset each
other. In most cases, contra-entry refers to transfers or adjustments within the same
entity

CLASSIFICATION IN ACCOUNTING.

There are three different classes of accounting which are Financial Accounting, Cost
Accounting, and Management Accounting. All three have their own characteristics
and use. Further, they have different results as well as recording and maintenance

1) Financial Accounting

Financial Accounting is the process of recording, summarizing, and reporting various

transactions that occur over a period of time during the course of business.

We gather and convert all the daily transactions into financial statements, balance
sheets, income statements, and cash flow statements.

In the preparation of the above, financial accounting uses a bunch of accounting

principles. These contain different rules and assumption set out for the preparation of
financial statements.

2) Cost Accounting

Cost accounting is a process of recording, summarizing, analyzing, and allocating the

cost over the process of manufacturing a product or providing services.

This helps management to determine the cost involved in manufacturing a product or

services by use of different cost accounting method. Further, it helps management to
make organization cost-efficient and capable. Cost accounting acts as a controlling
tool.

Elements of Cost Accounting.

These include:
  Material
 Labor
 Other expenses

Different Types of Cost Accounting.

 Fixed Cost. This means that the cost does not vary with the quantity of
production, like Salary or fixed wage.
 Variable Cost. This varies with a change in the quantity of production like
material cost and labor cost will increase with the increased level of production.
 Semi-variable Cost. This contains two elements of costs one is fixed and
another one is variable. In this type of cost fixed part remains the same up to a
certain level of production but changes after crossing that certain level and
variable varies with the changed level of production.
 Opportunity Cost. This is the cost of not earning profit from the opportunity of
manufacturing a new product and sale due to limited resources. Or we can say
with the limited resources an organization has to forgo profit of the other
product in addition to the existing.
 Sunk Cost. This is the cost with cannot be recovered once occurred like for
producing certain product machinery is required and purchased. Now, we
cannot recover the cost of machinery whether we carry out production or not.
3) Management Accounting

Management Accounting or Managerial Accounting helps managers to make and

implement business policies for better results. They use financial accounting
information for this purpose.

Management accounting is a different analysis tool for analyzing accounting

information and to draw out best for the company.