1.

Business Entity Concept

Financial accounting is based on the premise that the transactions and balances of a business entity are to be accounted for separately from its owners. The business entity is therefore considered to be distinct from its owners for the purpose of accounting. Therefore, any personal expenses incurred by owners of a business will not appear in the income statement of the entity. Similarly, if any personal expenses of owners are paid out of assets of the entity, it would be considered to be drawings for the purpose of accounting much in the same way as cash drawings. The business entity concept also explains why owners' equity appears on the liability side of a balance sheet (i.e. credit side). Share capital contributed by a sole trader to his business, for instance, represents a form of liability (known as equity) of the 'business' that is owed to its owner which is why it is presented on the credit side of the balance sheet.

What is a Going Concern?

Going concern is one the fundamental assumptions in accounting on the basis of which financial statements are prepared. Financial statements are prepared assuming that a business entity will continue to operate in the foreseeable future without the need or intention on the part of management to liquidate the entity or to significantly curtail its operational activities. Therefore, it is assumed that the entity will realize its assets and settle its obligations in the normal course of the business. It is the responsibility of the management of a company to determine whether the going concern assumption is appropriate in the preparation of financial statements. If the going concern assumption is considered by the management to be invalid, the financial statements of the entity would need to be prepared on break up basis. This means that assets will be recognized at amount which is expected to be realized from its sale (net of selling costs) rather than from its continuing use in the ordinary course of the business. Assets are valued for their individual worth rather than their value as a combined unit. Liabilities shall be recognized at amounts that are likely to be settled.

What are possible indications of going concern problems?

Deteriorating liquidity position of a company not backed by sufficient financing arrangements. High financial risk arising from increased gearing level rendering the company vulnerable to delays in payment of interest and loan principle. Significant trading losses bieng incurred for several years. Profitability of a company is essential for its survival in the long term.

Aggressive growth strategy not backed by sufficient finance which ultimately leads to over trading. Increasing level of short term borrowing and overdraft not supported by increase in business. Inability of the company to maintain liquidity ratios as defined in the loan covenants. Serious litigations faced by a company which does not have the financial strength to pay the possible settlement. Inability of a company to develop a new range of commercially successful products. Innovation is often said to be the key to the long-term stability of any company. Bankruptcy of a major customer of the company.

Test Your Understanding

Which of the following may affect the going concern status of an entity? *High Gearing Ratio (Proportion of Long Term Debt to Equity) - :- Gearing ratio above industry norms makes the entity vulnerable to delays in repayment of loan installments and interest with the ultimate risk of liquidation. short term running finance *Availability of short term running finance:-Availability of short term running finance may help an entity to overcome unanticipated cash flow shortage in the short term. -

*Successive trading losses:Although in the short run, a loss making company may survive due to sound liquidity position, long term profitability is essential to maintain long term liquidity and hence the going concern status of the company.

Money Measurement Concept in Accounting

Definition Money Measurement Concept in accounting, also known as Measurability Concept, means that only transactions and events that are capable of being measured in monetary terms are recognized in the financial statements. Explanation All transactions and events recorded in the financial statements must be reduced to a unit of monetary currency. Where it is not possible to assign a reliable monetary value to a transaction or event, it shall not be recorded in the financial statements. However, any material transactions and events that are not recorded for failing to meet the measurability criteria might need be disclosed in the supplementary notes of financial statements to assist the users in gaining a better understanding of the financial performance and position of the entity. Recognition Criteria The recognition criteria defined by IASB and FASB require that the elements of financial statements (i.e. assets, liabilities, income and expense) must only be recognized in the financial statements if its cost or

value can be measured with sufficient reliability. Therefore, an entity shall not recognize an element of financial statement unless a reliable value can be assigned to it. In many cases however the preparers of financial statements are unable to arrive at a precise amount to be recognized in the financial statements and must resort to the use of reasonable estimates in arriving at an approximate value. The use of reasonable estimates is a very important component in the preparation of financial statements and as long as forming estimates do not involve a high degree of subjectivity and uncertainty they do not undermine the reliability of financial information. Where a significant element of financial statement is not recognized because of the inability to measure its monetary value with sufficient reliability, it may be disclosed in the supplementary notes of financial statements to enhance the users' understandability and completeness of the presented financial information. Examples of Application Skills and competence of employees cannot be attributed an objective monetary value and should therefore not be recognized as assets in the balance sheet. However, those transactions related to employees that can be measured reliably such as salaries expense and pension obligations are recognized in the financial statements. Where it is not possible to measure reliably the amount of settlement of a legal claim against the company, no liability is recognized in the financial statements. Instead, the nature and circumstances surrounding the lawsuit are disclosed in the supplementary notes to the financial statements if considered material. IAS 38 Intangible Assets and ASC 350 Intangibles - Goodwill and Other require that internally generated goodwill shall not be recognized as an asset in the balance sheet. This is due to the difficulty in identifying and measuring the cost of internally generated goodwill as distinct from the cost of running the day to day operations of the business. However, IFRS 3 Business Combinations and ASC 805 Business Combinations permit purchased goodwill to be recognized as an asset in the financial statements since the cost of purchased goodwill is usually determinable objectively as the amount of consideration paid in excess of the value of other identifiable assets of the acquired business.

Test Your Understanding

ABC United is a professional football club. Which of the following transactions and events may be recognized in the financial statements of ABC United? *The estimated fair value of the Club's football players taking into account the skill level, experience and form of individual players:- The skills, experience and talent of football players should not be recognized by ABC United since any attempt to place a monetary value on them would be highly subjective and therefore not capable of being measured reliably. *Staff costs comprising of wages, salaries and similar expenses of ABC United employees :Staff costs such as wages and salaries must be recognized as expense as the amount of such costs is easily determinable.

*Government sponsored technical training and assistance provided to employees of ABC United free of charge :- IAS 20 Accounting for Government Grants specifically prohibits recognition of all forms of government assistance that cannot reasonably have a monetary value placed upon them. *The cost of acquisition of player rights by ABC United :- Cost of acquisition of player rights must be recognized as an intangible asset by ABC United as the amount of cost can be determined reliably.