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|LO3: Apply knowledge of basic financial accounting principles, concepts and conventions requiring the ability to solve problems.
|LO4: Distinguish between rules-based and principles-based accounting systems.
Discuss the need for having rules to follow when recording financial information and preparing end of year financial statements.
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In this world of globalization, where businesses are no more restricted by the geographical boundaries, the stakeholders of the company are also spread far and wide. When a person invests his/ her hard earned money in the company, he would always want to get a summary of the workings of the company. Accounting is a subject, which has a common foundation but the applications and presentation of the same are different in different countries like IFRS, GAAP, etc. are different. This summary, which reflects the financial workings of the company, is referred to as financial statements. Accounting and bookkeeping is a method of recording the financial information in a manner that it reflects a true and fair view of the transactions.
As stated above the users of the financial statements are majorly the stakeholders. These stakeholders included the internal stakeholders like the directors and the employees as well as the external stakeholders like the creditors, shareholders, banks, etc. The financial statements should be such that a person with a basic accounting knowledge should understand it without any external help. In such a scenario with the stakeholders being situated far and wide even across the geographical boundaries, unless certain rules and principles are not adhered to, it would become very difficult to assume what the makers of the financial statement would have thought while making the statements. Thus, it is very important to follow certain rules and regulations so that the person referring to the profit and loss of the account and the balance sheet can very well understand the basics of the same. However, the makers of these policies have given an option to mention the deviations from these rules in the notes following the balance sheet, which can be referred to in case of any discrepancies from the accepted policies. This is particularly true for public limited companies. The governing bodies like the United States Securities and Exchange Commission strictly regulate the rules for these companies. All these steps are taken so that the investors, as well as the other stakeholders, are not cheated or deceived and get a clear view of the financial statement. (Richards Leigh, nd)
'There are a number of rules and concepts which are formulated by the governing bodies which that govern the field of accounting.' These are referred to as the basic accounting principles and guidelines, which form the basis on which more detailed rules and policies are based. (Accounting coach, n.d.) The most important rules would be discussed in details:
Going Concern: The going concern policies state that a person while preparing the financial statements would do considering that the company would carry on its operations for a foreseeable future and have no signs of liquidation.
It would fulfill its obligations, objectives, etc. and would continue its operations for a foreseeable future. No decisions of the company are taken with a view of the closure of the business in future. (Myaccountingcoach, n.d.)
Prudence: Prudence refers to the principle, which states that the expenses and revenues should be recorded at an amount, which is conservative in nature. A person while preparing the financial statement should not underestimate the expenses or liabilities on one side and also should not overestimate the revenues and assets. This principle of conservatism simply states recording the bad news more quickly than good news. (Basu Sudipta, 1997)