The concept of financial statement

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Introduction

Accounting identifies the transactions taking place in an organisation regularly and preparing relevant documents i.e. financial accounts. Reports such as the balance sheet, profit and loss account, income statement and the statement of cash flow, which shows or summarize the financial status and results of operations of a business entity are called financial statements. These statements are made on the basis of accounting standards, Companies Act, corporate governance and auditor’s report. European Union (EU) and stock exchange also regulate certain rules and regulations on the basis of which financial statements are made.

Companies Act 1985

The present British statutory requirements are contained in an Act of Parliament known as the Companies Act 1985 (CA85). This Act is a consolidating measure and it includes the earlier Companies Act 1948, 1967, 1976, 1980 and 1981 respectively. It lays down the minimum amount of information that must be given to company shareholders. The Act requires companies to issue profit and loss account and a balance sheet. The Act lays down the specific headings and wordings or accounting principles for the presentation of the information. The financial statements must show a ‘true and fair view’. The accounting principles of the CA85 are similar to the fundamental accounting concepts. The four concepts are embodied in the legislation under the heading ‘Accounting Principles’. A fifth principle was added requiring the separate determination of value of each asset and liability.

Fundamental Concepts of Accounting

Accounting policies are the specific accounting practice issued and consistently followed by a business enterprise or an organisation as being, in the opinion of the management appropriate to its conditions and most suited to present fair results and financial statements. The fundamental concepts of accounting are:

  1. The Going Concern Concept: This concept assumes that a business will continue in operational existence for the foreseeable future. It means that the profit and loss account and balance sheet are prepared on the assumption that there is no necessity to limit scale of operation significantly. There are certain conditions when going concern concept cannot be justified or valid. For e.g. if there is a strong possibility that lack of finance will result in the sale of significant part of the business. But in most cases financial statements are prepared on the basis of this concept and the directors justify the idea that such a basis is valid.

  1. The Accruals (or matching) Concept: The accruals or matching concept is the principle that the revenue and costs are recognised as they are earned or incurred, are matched with one another, and are dealt with in the profit and loss account of the period to which they relate, irrespective of the period of receipt or payment. It implies that the profit and loss account reflects changes in the amount of net assets that arise out of the transactions of the relevant period. Revenue and profits dealt with in the profit and loss account are matched with associated costs and expenses by including in the same account the costs incurred in earning them. This concept is conceptually simple and do not have any practical difficulties.
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  1. The Consistency Concept: It is the principle that there is uniformity of accounting treatment of like items, within each accounting period and from one accounting period to the next. For e.g. in the case of depreciation of fixed assets, there is more than one accepted accounting treatment. A business may use one method, another may use another. As far as consistency concept is concerned, once a business has selected a method, it should use this method consistently for all assets in that class and for all accounting periods. Only in this way users of financial statements can draw ...

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