Issues in Accounting Practices

1. Issues in Accounting Practices Instructor: Adnan Shoaib

2. Course Brief • Accounting History, Context of Accounting, and Accounting Profession • Accounting of the corporation is studied in this course. • Working and issues Related to • Net Assets • retained earnings • dividends and earnings per share • long-term debt and debt vs. equity financing • cash flow and its analysis • traditional financial statement analysis • cost-volume-profit relationships through break-even analysis, • absorption vs. variable costing for control and product pricing decisions • gross profit analysis, and demand elasticity effects on total revenues and pricing.

3. Textbooks and Reading • Donald E. Kieso, Jerry J. Weygandt, Terry D. Warfield Intermediate Accounting (John Wiley & Sons, Inc. 2012) • George J. Benston, et al.Worldwide Financial Reporting: The Development of Future of Accouting Standards (Oxford University Press) • Elliott B and Elliott J Financial Accounting & Reporting (Financial Times/Prentice Hall, 6th ed, 2001).

4. Lesson 1: Accounting History

5. “Accounting is the fairest invention of the human mind.” - Goethe

6. Introduction • The activity of accounting has been around for several thousand years • Much of what we know about the daily lives of ancient peoples comes from accounting records, such as inventories and sales records, found at archeological sites • Generally the history of accounting throws light on economic and business history

7. Introduction • Some scholars claim that writing arose in order to record accounting information • Account records date back to the ancient civilizations of China, Babylonia, Greece, and Egypt • The rulers of these civilizations used accounting to keep track of the cost of labour and materials used in building structures like the great pyramids • The need for accounting has existed as long as there has been activity involving money or resources

8. Ancient Accounting • Key ingredients of double entry bookeeping were not found together • Problems of record keeping, control and verification of financial transactions • In an illiterate society it is essential to keep accounting records • Double entry bookeeping - key ingredients • Private Property 2. Capital 3. Commerce 4. Credit 5. Writing 6. Money 7. Arithmetic

9. Accounting In Mesopotamia • Flourishing of Chaldaean-Babylonian & Sumerian civilizations • Development of the valley • Most transactions were recorded & subscribed by the parties during this period

10. Accounting In Ancient Egypt, China, Greece and Rome • Governmental accounting similar to Mesopotamians • Records were kept & verified by internal verification system • Egypt - Accounting never progressed beyond simple list-making • China - Used accounting as a mean of evaluating efficiency

11. Accounting In Ancient Egypt, China, Greece and Rome • Greece - Use of “Public Accountants” Introduction of coined money about 600 B.C. • Rome - Elaborate system of checks & balances Use of annual budgets

12. Medieval Accounting • According to Michael Chatfield, “Medieval Accounting laid the foundations for the doctrines of stewardship and conservatism, and the medieval era created the conditions for the rapid advance in accounting technology that occurred during the Renaissance.”

13. Italian Renaissance • Innovative Italians – Fathers of modern accounting • Extensive business records were kept • Use of capital & credit on large scale developed • Evolutionary trend towards double entry bookkeeping was underway

14. Luca Pacioli and The Summa • A mathematician and merchant • Did not invent double-entry accounting but spread the knowledge • Pacioli stated that a merchant’s responsibilities were: • To give glory to God in their enterprises • To be ethical in all business activities • To earn profit • Summa - First surviving accounting textbook written by Pacioli in 1494

15. Characteristics of Summa • Three things needed by one who wished to carry on business diligently Cash, Good Accountant & Good Order • Pacioli explained the opening inventory • Pacioli's account book system is three account books-that is, a day book the journal and the ledger • All things pertaining to a transaction must be written in the day book • Pacioli described debit and credit

16. Double Entry Accounting • Invention of the “Debit” and “Credit” concepts from the Italian terminology • Debit Comes from the Italian “debito” which comes from the Latin “debita” which means: “Owed to the proprietor or an asset of the proprietor” • Credit comes from the Italian “credito” which comes from the Latin “credo” which means: “Trust or belief (in the proprietor) or owed by the proprietor ”

17. Double Entry Accounting • Each financial event is called a transaction • The effect of a transaction is recorded in the accounts by an entry • Each entry will affect at least two parts of the accounting record to balance the record • This does not mean that the financial event is recorded twice – rather it is balanced against either costs, increased or reduced liability, changes in inventory, etc.

18. Pacioli's System: Memorandum, Journal & Ledger • Memorandum – Pacioli’s equivalent of a day book • Journal – Merchant's private account book • Ledger – Most like its modern equivalent

19. 19th Century • Due to industrial revolution - Mass production became possible • Businesses expanded in: • Physical size, • Degree of mechanization, and • Number of employees • Government regulation and taxation also increased • Businesses began operating as corporations to bring in funds from “outsiders” • Stocks • Bonds

20. European Congresses of Accounting • World fair at St. Louis • Three major events • Invitation thither of third Olympic games • Change in social sciences from German influences • Accountants Congress

21. Accountants Congress • Promoted by Montgomery of New York and Wilkinson of Illinois • Held in St. Louis, USA in 1904 • Series of conferences were initiated after it in various countries

22. Spain • Conferences of today preceded by Spanish Fairs • Barcelona - 1929 a congress of the Brussels-based AIC jointly with the Association of Accountants in Catalonia • 150 delegates from 14 countries and five governments, and from 60 professional bodies • Agenda included • Final Account formats • Costing procedures • Public accounting • Regulated auditing

23. Central Europe • Russian and other East European accountants learned much from attendance at congresses • long series of annual conferences of German Business Professors • World Accountants' Conference in Berlin in 1938 • International Bureau of Accountancy

24. Italy • Italian Unification in 1870 • nine Italian accountants' congresses held between 1879 and 1895 • Publicity and respect was achieved however for Italian accountants

25. France • Congress of French accountants to Paris in 1880 - Theme was the Unification of Accounting • Rivalry of accountants in 1895 - 250 essays on accounting subjects were submitted • International congress of accountants in Paris in 1948 • 43 countries were represented • Congress sought to establish an elite Academie de comptabilite and also an Institut international de comptabilite

26. The Low Countries • 1926 - Second world congress of accountants in Amsterdam • Belgian accountants played a unique role through the remarkable leadership of Paul Otlet. • Development of Decimal Classification and Coding • 1926 - AIC held its congress again in Brussels • Central School of International Accounting

27. Advancement in Accounting • Requirement & standardization of reports • 20th and early 21st centuries • Double-entry accounting spread throughout the world • Accountants in each country adapted accounting practices to suit their: • Cultures • Laws & regulations • Capital market structures • Environments

28. Advancement in Accounting • National differences in accounting rules and practices render financial statements of companies based in different countries UNCOMPARABLE • Major advance in accounting: • Development of international accounting standards • Harmonization of accounting and reporting

29. Current criticisms and concerns about financial reporting  • Off balance sheet items  • Leasing transactions • Securitization transactions • Creation of unconsolidated entities • Pension obligations • Intangible Assets • Items not included in the profit and loss account  • Under existing accounting standards in some jurisdictions, a company that pays for goods and services through the use of its own shares, options on its shares, or instruments tied to the value of its shares may not record any cost for those goods and services

30. Accounting Issue Preamble • What is important to ship navigators is the giant mass that lies below the icebergs.  If we make an analogy that the financial statements contain only what appears above the surface, over 99% of the accounting theory disputes have centered on the top of the icebergs.

31. Harmonization • IAS believes that harmonization can best be pursued by focusing on financial statements that are prepared for the purpose of providing information that is useful in making economic decisions.

32. Examples of Economic Decisions • decide when to buy, hold or sell an equity investment; • assess the stewardship or accountability of management; • assess the ability of the enterprise to pay and provide other benefits to its employees; • assess the security for amounts lent to the enterprise; • determine taxation policies; • determine distributable profits and dividends; • prepare and use national income statistics; or • regulate the activities of enterprises.

33. IAS’ Framework • Financial statements are most commonly prepared in accordance with an accounting model based on recoverable historical cost and the nominal financial capital maintenance concept. • Other models and concepts may be more appropriate in order to meet the objective of providing information that is useful for making economic decisions although there is presently no consensus for change. • This Framework has been developed so that it is applicable to a range of accounting models and concepts of capital and capital maintenance.

34. Concepts of Capital • A financial concept of capital is adopted by most enterprises in preparing their financial statements. Under a financial concept of capital, such as invested money or invested purchasing power, capital is synonymous with the net assets or equity of the enterprise. • Under a physical concept of capital, such as operating capability, capital is regarded as the productive capacity of the enterprise based on, for example, units of output per day.

35. Revenue IAS-18 • Revenue is the gross inflow of economic benefits during the period arising in the course of the ordinary activities of an enterprise when those inflows result in increases in equity, other than increases relating to contributions from equity participants.

36. Measurement of revenue • Revenue should be measured at the fair value of the consideration received or receivable.

37. IAS-18 • Fair value is the amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm's length transaction.

38. Investors • The providers of risk capital and their advisers are concerned with the risk inherent in, and return provided by, their investments. They need information to help them determine whether they should buy, hold or sell. Shareholders are also interested in information which enables them to assess the ability of the enterprise to pay dividends.

39. Employees • Employees and their representative groups are interested in information about the stability and profitability of their employers. They are also interested in information which enables them to assess the ability of the enterprise to provide remuneration, retirement benefits and employment opportunities.

40. objective of financial statements • The objective of financial statements is to provide information about the financial position, performance and changes in financial position of an enterprise that is useful to a wide range of users in making economic decisions.

41. Underlying Assumptions • Accrual Basis • the effects of transactions and other events are recognised when they occur (and not as cash or its equivalent is received or paid) and they are recorded in the accounting records and reported in the financial statements of the periods to which they relate. • Going Concern • The financial statements are normally prepared on the assumption that an enterprise is a going concern and will continue in operation for the foreseeable future.

42. Qualitative characteristics • Understandability • An essential quality of the information provided in financial statements is that it is readily understandable by users. For this purpose, users are assumed to have a reasonable knowledge of business and economic activities and accounting and a willingness to study the information with reasonable diligence.

43. Qualitative characteristics • Relevance • Information has the quality of relevance when it influences the economic decisions of users by helping them evaluate past, present or future events or confirming, or correcting, their past evaluations.

44. Conclusion • Today, accounting is generally regarded as being the systematic development and analysis of information about the economic affairs of an organization. In fact, one of the most important purposes of accounting is to communicate relevant information between and among producers and users of such information