If you are pursuing a career in finance, with your sights set on either the ACCA (Association of Chartered Certified Accountants) or CA (Chartered Accountant) designation, you must know how to do the technical things to be a successful applicant for either designation. However, even more important than being technically proficient is being able to demonstrate that you understand the underlying Accounting Concepts.
It is worth noting that in the realm of Professional Examinations, there is no place for rote learning. As a candidate preparing for either the ACCA Financial Accounting (FA) Syllabus or significant portions of the CA Foundation Topics, Examiners are looking for your ability to apply "core principles" to solve complex problems that exist in real life.
Thus, we have outlined below the seven most important Accounting Concepts, which, together, provide the foundation for Financial Reporting Fundamentals.
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The Accounting Equation & Double Entry System
Every transaction you make in business has a "dual effect" - or the "alphabet" of the Financial World. In Double Entry Bookkeeping, the "Accounting Equation" is always in balance, so the system works.
Assets = Liabilities + Equity
For example, when a Company receives a loan, Cash (an Asset) increases while Debt (Liability) also increases. If you want to learn more about how these equations relate to Financial Statements, you could look at our Guide on the Balance Sheet of a Company.
Why is This Important?
As a Candidate preparing to sit for your CA exam, it is critical to be proficient at this concept, as it is the basis for every Journal Entry and Trial Balance you will ever generate.
The Accrual vs. Cash Basis
A common question posed to new graduates in an accounting interview often deals with explaining the difference between accrual accounting and cash accounting.
Cash Accounting: A transaction is recorded only when money changes hands.
Accrual Accounting: Revenue is recorded when it is earned, and expenses are recorded when they are incurred, regardless of when cash is received or paid.
International Financial Reporting Standards (IFRS) and Generally Accepted Accounting Principles (GAAP) require the use of the accrual basis of accounting for professional reporting purposes. As you'll see in the ACCA Financial Reporting Exam Format and Syllabus, accruals are included in almost every examination session.
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The Going Concern Assumption
The Going Concern concept assumes that a company will continue to operate for the foreseeable future, usually at least 12 months.
A company that operates as a Going Concern will report asset values at cost minus accumulated depreciation. If it is not operating as a Going Concern, the company must value its assets at their break-up value (Net Realizable Value). The topic is an area that examiners have shown to be of significant importance in Audit papers.
Prudence (Conservatism) vs. Optimism
The Principle of Prudence is that you should never overstate your assets or income and that you should never understate your liabilities or expenses. Prudence refers to exercising caution.
NOTE: Although recent professional standards, such as IFRS 9, have placed a greater emphasis on "Neutrality," Prudence still is an important concept with respect to Expected Credit Losses (ECLs) or legal contingencies.
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When Do the Small Numbers Matter?
Accounting materiality is a guiding principle of what can influence a user’s financial decision-making based on the information provided therein. For larger firms with hundreds of billions of dollars in revenue, a $500 discrepancy would be deemed ‘immaterial’ and thus would not materially affect their financial statements or how they operate as an entity or with respect to their stakeholders. Conversely, for smaller start-up companies with limited revenue and assets, a $500 discrepancy would be quite substantial.
Revenue Recognition
The most complex concept you will be introduced to within accounting is perhaps Revenue Recognition. Under IFRS 15, Revenue is initially recognized using a 5-Step process:
Identify the contract.
Identify performance obligations.
Determine the transaction price.
Allocate the price to obligations.
Recognize revenue when (or as) obligations are satisfied.
Revenue Recognition is an area of significant opportunity for individuals pursuing the CFA as compared with the CAIA or CA Final level qualifications.
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The Matching Principle
As one would imagine, Accounting will require that Businesses continually match Expenses against the Revenue generated. In particular, if you think of matching Expenses with Related Revenues, this is why Businesses adhere to the concept of Depreciation; it is done to assist Businesses match the Total Cost of an Asset (i.e., the cost of purchasing the machine) with the total Revenue it generates over time.
For example, Inventory is recorded at the point of sale. In other words, you do not recognize an Asset (Inventory) until it is sold. If you would like to Learn more about this and other Inventory metrics, read this article on a Good Inventory Turnover Ratio.
How to Study These for Exams?
If you want to truly grasp the core accounting principles, you can’t just rely on reading through the textbook once. Here are three helpful hints that will make preparing for the CA examination and being successful with ACCA that much easier.
Bridge the Gap: It is important to be aware of the significant differences between IFRS and GAAP. While many of the same concepts exist between both, their application can differ.
Practice Mock Exams: Just like traders utilize NCFM Mock Tests to become better at performing trades, accounting students should practice past papers in order to learn about how the concepts will be asked in the form of "Word Problems."
Stay Informed on Compliance: Subjects such as Know Everything About TDS or How To Calculate Capital Gains Tax in India are often viewed at a very specific level through compliance; therefore, it tests the student's conceptual understanding and depth.
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Conclusion
The first step to becoming a finance professional on a global level is mastering those accounting concepts. If you aspire to rise to the ranks of being amongst the top Auditors or work in Investment Banking, the concepts and principles you mastered will still serve you well.
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