Answer to Question #208059 in Economics for Joseph zimba

Question

Using hypothetical but realistic organizations, present different scenarios that may lead to a deviation from the proper use of the following accounting standards:

1. IAS 16 Property, plant and equipment

2. IAS 40 Investment Property

3. IAS 36 Impairment

4. IAS 37 Provisions, contingent assets and contingent liabilities

5. IAS 2 Inventories

6. IAS 38 Intangible assets 

7. IFRS 15 Revenue

8. IFRS 16 Leases

The entity that you create must have a name and actual transactions (with figures). Student groups are encouraged to be as creative and innovative as possible. The accounting standard in each case must first be explained in the groups own words, not as provided in the notes or plagiarised from literature, before a deviation may be discussed.

The example of deviation from the proper use of the standard must include recognition, measurement and de-recognition of the element in a particular case.

Answer 1

Accounting and financial reporting are based on the following basic principles:

Prudence (the principle of prudence in accounting) - the use of valuation methods in accounting, which should prevent the underestimation of the valuation of liabilities and costs and the overestimation of the assets and income of the enterprise. In other words, accounting should be carried out in such a way that the owners (managers) of the enterprise do not suddenly discover that they owe counterparties much more than they thought, the costs did not turn out to be much higher than what they expected, and the assets in their real value, in fact, they are priced at a much more modest amount. Therefore, accounting records must be maintained so as not to mislead users of financial information regarding the valuation of assets and the number of liabilities. This principle must be followed strictly.

Full coverage - the financial statements of the enterprise must contain all information about the actual and potential consequences of business transactions and events that can influence the decisions that are made on its basis. That is, when maintaining records, it is necessary to honestly inform interested parties about possible losses, events that can affect the financial condition of the enterprise, as well as other significant consequences. Actions aimed at willful misstatement of financial statements may even lead to criminal consequences for those who committed such actions.

Autonomy (the principle of autonomy of accounting) - each company is considered as a legal entity, separated from the owners, and therefore the personal property and obligations of the owners should not be displayed in the financial statements of the company. This provision is very clear - it is not worth adding the personal welfare of the owners to the property of the enterprise. The owner of an enterprise can have several businesses, have a small stake in the business, but at the same time be very wealthy, etc.

Consistency - constant (from year to year) use of the chosen accounting policy by the enterprise. A change in accounting policy is possible only in cases stipulated by national regulations (standards) of accounting and must be justified and disclosed in the financial statements. This means that the principles of reflecting business events should not change during the accounting period. This enables users of financial information to compare statements prepared for different dates.

 

Continuity (the principle of continuity of accounting) - the assessment of the assets and liabilities of the enterprise is carried out on the assumption that its activities will continue to occur. When forming the accounting and reporting methodology, we do not take into account the finiteness of the existence of the enterprise, we assume that it will always (or at least in the near foreseeable future) function normally, that is, it will not close down and will not significantly curtail its activities.

This is due to the fact that the reflection of the financial condition of the company at the reporting date in any case, only approximately describes the real state of affairs (why this is so - I will explain much later). Therefore, the description of the financial condition, based on the principle of continuity, also ensures the comparability of the financial statements of the enterprise.

This principle is also enshrined in international financial reporting standards, which establish that “financial statements are usually prepared on the assumption that the company is and will operate in the foreseeable future. Thus, it is assumed that the company is not going to and does not need to be liquidated or significantly reduced the scale of their activities ".

Accrual and correspondence of income and expenses - to determine the financial result of the reporting period, it is necessary to correlate the income of the reporting period with the expenses that were incurred to obtain this income. In this case, income and expenses are displayed in accounting and financial statements at the time of their occurrence, regardless of the date of receipt or payment of funds. This is one of the most fundamental points that are important for understanding the essence of accounting. Very often people who are not familiar with accounting equate profit and loss (respectively, income and expenses) with cash flow. In fact, this leads to serious misconceptions. If the enterprise has consumed water, gas, and electricity for a month, then documentary confirmation of this fact will become the basis for recognizing expenses in accounting. In this case, the fact of payment (or lack thereof) for the recognition of expenses will not matter.