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Accounting is a system of identification, measurement and transmission of information which is used to make reasonable assessments and decisions by users of this information. This system provides users with information about the economic activity of a business entity.
Usually, the internal and external users of this information are distinguished. The internal users are administration and specialists of the enterprise; the external users, which have direct financial interest, include current and potential investors, lenders and suppliers. Also the users with an indirect financial interest are subdivided. They are: tax office, federal, state, city regulators (for example, the Securities Commission), bodies of economic planning (Presidential Advisory Board on the economy), other user groups of users, such as trade unions and community organizations.
Management and financial accounting are distinguished in practice. Management Accounting covers all kinds of information for internal use of firm leadership. Financial accounting includes the information which in addition to using by firm leadership is provided to external firm users in financial reports.Â The requirement of common principles (Generally Accepted Accounting Principles) for the formation and reporting information apply only to financial accounting and reporting.
Generally Accepted Accounting Principles (GAAP) is a system that has a hierarchical structure.Â The first level is presented by officially established principles - FASB and previous organizations documents.Â This is mandatory accounting standards. The second level is documents (industry manuals, technical papers) adopted by the authorized accounting bodies (FASB and AICPA) and approved in established procedure.Â They set out certain
accounting principles and describe the current practice. The third level is a common practice and documents (the interpretation of AICPA) generally accepted in the sense that they represent the main method of accounting in a particular industry or situation. The fourth level is methods recommended by other documents or accounting literature.
Conceptual framework of accounting
In 1976 FASB developed a conceptual framework of financial accounting and reporting which is reflected in Statements of Financial Accounting Concepts (SFAC), which include:
SFAC No. 1.Â Objectives of Financial Reporting By Business Enterprises; SFAC No.Â 2.Â Qualitative Characteristics of Accounting Information; SFAC No. 3.Â Elements of Financial Statements of Business Enterprises; SFAC No. 5.Â Recognition and Management in Financial Statements of Business Enterprise; SFAC No. 6, which replaces and expands SFAC No. 3, Elements of Financial Statements.
SFAC No. 1 defines the purpose of financial reporting as follows: Financial reporting should provide useful information for actual and potential investors, lenders and its other users to make decisions about investing, lending, etc. The information presented in financial reports must be complete and available to the perception of individuals competent in the field of business and those wishing to explore this information with reasonable diligence. The information provided in financial statements should be useful for deciding whether to invest resources in the enterprise. Also it should make it possible to determine the likelihood, amount and time receipt of future cash flows. Another objective is to reflect truthfully the state of the economic resources of the enterprise and
The qualitative characteristics (SFAC No. 2) are attributes of accounting information that are able to improve its usefulness.Â These qualitative characteristics are: stability over time; prevalence, i.e. the possibility of application in all
companies, realizing the function of accounting; Feasibility, i.e., suitability for application and sensitivity to objective monitoring.
SFAC No. 6 defines the structure of information required by users.Â As basic elements of financial statements FASB calls the assets, liabilities, equity, income and expenses. Professor of Stanford University's John Kenning gave one of the first most comprehensive definitions of the elements of balance. He believed that the assets are "Any future service in money or convertible into money, the right, which lawfully and fairly guarantees the income of some person or group of persons. "Â
The same approach is adopted by the current standard. SFAC 6 defines assets as "probable future economic benefits obtained as a result of past transactions or events" and controlled by the economic unit.Â In American practice asset: can bring benefits to the enterprise that is capable of directly or indirectly create growth funds; is under the control of the company; is the result of past events.
The same document defines liability as "probable future sacrifices of economic benefits arisen from present obligations to transfer assets or provide services to other entities in the future, as a result of past transactions or events. "Â It is important to note that liability can include not only legal, but also moral, so-called "fair" commitments.
The equity of enterprise is regarded as a residual interest of owners of businesses in case of liquidation, and is defined as the difference between the carrying amounts of assets and liabilities of the enterprise. The equity does not exist in isolation from the assets and payables as it represents a residual interest.
Revenues are considered as "inflows of assets or settlement
of liabilities during a period from delivering or producing goods, rendering services, or performing other activities that constitute the entities major or central operations."
The expenses are the use or consumption of goods and services for income generation.Â SFAC No. 6 defines expenses as "outflows of assets or incurrence of liabilities during a period from delivering or producing goods, rendering services, or performing other activities that constitute the entities major or central operations "
In addition to describing these key elements of financial statements SFAC No. 6
reveals a number of concepts. Other gains are the increase of capital of the company's owners which is not associated with its main activity or additional contributions
owners. Other losses are reduction of owner's capital as a result of operations that are not
the main activity of the company, payment of dividends or the exemptions of
Investment by owners is the increase in net assets resulting from investment
assets of the company owners.Â Investment by do not form income.
Distribution to Owners owners is a decrease in net assets resulting from their transmission to
external parties, such as owners or shareholders.Â Payments to owners are not
expenses of the company.