Financial accounting must be very straightforward as the financial statements are either right or wrong.
The measurement of accounting information is not a straightforward process. It involves making judgements about the value of assets owned by, or liabilities owed by an entity. Accounting is also about accurately measuring how much profit or loss has been made by a company in a particular period. As I will discuss in my essay, the measurement of accounting information often necessitates subjective judgement to come to a conclusion.
IAS 1 Presentation of Financial Statements dictates the general requirements for the presentation of financial statements, including guidelines for their ...view middle of the document...
The deduction of expenses is processed in the same way. Companies record overheads when they are incurred, even if they are not yet paid for.
Cash-basis accounting presents a much more accurate picture of the actual cash available. A huge disadvantage of accrual accounting is that it records expenses and revenue even when no cash exchanges hands, which can sometimes give a false impression of the financial position of the company. For example, an interior design service business employs accrual accounting to record expenses and revenues incurred during a particular contract. It shows that the business is making a steady monthly profit of €1,000. However, although it records a profit, the company will not be able to complete the contract as it will eventually run out of cash and therefore, not be able to meet its payroll. Had it used the cash-basis method, this predicament would have been identified.
However, using cash-basis does not allow for overheads and revenues to be carefully matched on a month-to-month basis. Accrual accounting provides companies with a better idea of how much it is spending on monthly operations and the profit it is making. Nonetheless,
In conclusion, while cash-basis accounting is quite straightforward and easily understood, despite its complexity, the accrual method’s accounting approach to events in real-time is much more representative of the true state of a business' condition when used in conjunction with cash flow statements.
A vast majority of entities use accounting estimates in their preparation of financial statements. These estimations are used where management cannot determine or measure precisely the carrying amounts of assets and liabilities and their associated expenses or income for the period. Examples include the valuation of land where it is accounted for at a re-valued cost and the useful life of non-current assets.
Accounting estimates involve a good judgment of expected future remunerations and obligations relating to assets and liabilities based on information that best reflects the conditions and circumstances that exist at the reporting date.
By its nature, estimates are subjective and may entail frequent amendments in the future. These revisions must be distinguished correction of errors which transpire due to not utilising information that was available at the time of preparation of financial statements. A major estimate made by many companies is that of depreciating non-current assets.
IAS16 defines depreciation as "the systematic allocation of the depreciable amount of an asset over its useful life”.
For example, Cindy’s Cotton Candy Company earns €20,000 profit per year. During 2012, the business purchases a €15,000 cotton candy machine with an asset life of five years. If the machine was to be realised a one-time expense, this would discourage investors as the business would have only made €5,000 at the end of 2012 – experiencing a 75% drop in profits.