ACCA Applied Knowledge · Financial Accounting

Key principles and concepts of accounting: formula sheet

Full chapter guide

Key formulas

Purpose of general purpose financial statements: Information on financial position + performance + cash flows → decisions by users; Learn this chain. Most exam answers are a version of it.
Primary users (Conceptual Framework): Existing and potential investors + lenders + other creditors; These are the users the statements are mainly aimed at. Other users find them useful but are not the main target.
Three questions for any user: Who is the user? → What decision do they make? → What information do they need?; Use this to structure any answer on user needs.
Internal vs external users: Internal = managers and directors; External = everyone outside who relies on published statements; Internal users can request tailored information. External users generally cannot.
Going concern: Business expected to continue → assets and liabilities measured on a continuing basis; If the business is not a going concern, the basis of preparation must change and this must be disclosed.
Accruals: Profit = income earned in the period − expenses incurred in the period; Timing of cash received or paid is irrelevant to when income and expenses are recognised.
Business entity: Business assets and liabilities ≠ owner's personal assets and liabilities; Owner's private spending is treated as drawings, not an expense.
Money measurement: Record only items that can be measured reliably in money; Staff skills, reputation and morale are not recorded in the ledgers.
Historical cost: Asset recorded at cost at the date of acquisition; Other bases such as revaluation are permitted by some standards.
Prudence: Caution under uncertainty; no deliberate understatement of assets or income, or overstatement of liabilities or expenses; Prudence supports neutrality, which requires an unbiased presentation.
Materiality: Item is material if omitting or misstating it could influence users' decisions; It depends on size and nature, and is a judgement not a fixed percentage.
Substance over form: Account for economic reality, not only legal form; Examples: sale and repurchase arrangements, leases.
Fundamental characteristics: Relevance + Faithful representation; Both are needed. Information that is irrelevant or does not faithfully represent is not useful.
Enhancing characteristics: Comparability, Verifiability, Timeliness, Understandability; Memory aid: CVTU. They improve useful information but cannot make useless information useful.
Relevance components: Predictive value and/or confirmatory value; materiality; Materiality is entity-specific and is part of relevance, not a separate characteristic.
Faithful representation components: Complete + Neutral + Free from error; Free from error does not mean exact. Estimates can still be faithful if described clearly.
Cost constraint: Benefits of information should justify the cost of providing it; A pervasive constraint on reporting, not a characteristic.
Accounting equation: Assets − Liabilities = Equity; Equity is the residual. It is not a separate pot of cash.
Definition of an asset: Asset = present economic resource + controlled by the entity + result of past events; An economic resource is a right with the potential to produce economic benefits. Control matters more than legal ownership.
Definition of a liability: Liability = present obligation + to transfer an economic resource + result of past events; A future intention or plan is not a present obligation.
Income and expenses: Income = ↑ assets or ↓ liabilities that ↑ equity; Expenses = ↓ assets or ↑ liabilities that ↓ equity; Exclude contributions from owners (income) and distributions to owners (expenses).
Change in equity: Closing equity = Opening equity + Income − Expenses + Contributions − Distributions; Use this to link profit, share issues and dividends to equity.
Recognition criteria: Recognise if the item meets the definition AND recognition gives relevant information AND a faithful representation; Cost constraint also applies. Uncertainty can mean an item is not recognised.
Historical cost: Asset value = amount paid (or fair value of consideration given) at acquisition; Not adjusted for price changes. Depreciation still applies to cost.
Inventory measurement (IAS 2): Inventory = lower of cost and net realisable value (NRV); Applied item by item or by groups of similar items.
Net realisable value (IAS 2): NRV = estimated selling price − estimated costs to complete − estimated costs to sell; Use estimates at the reporting date. NRV is an IAS 2 measure. It is related to, but not the same as, realisable value in the Conceptual Framework, which is the amount obtainable on disposal net of transaction costs and has no deduction for costs to complete.
Profit under capital maintenance: Profit = closing capital − opening capital (after removing owner contributions and distributions); The meaning of capital depends on the concept used.
Financial capital maintenance (money): Profit = closing net assets − opening net assets − capital introduced + drawings; Measured in nominal money units, so inflation is ignored.
Financial capital maintenance (constant purchasing power): Profit = closing net assets − opening net assets × (1 + inflation rate) − capital introduced + drawings; Opening capital is restated for general inflation. Drawings and capital introduced are taken at nominal value. This is a simplification, because strictly they would be restated for inflation if made during the year.
IFRS Foundation: Oversees, appoints and funds; does not set standards; Governance and oversight body. Do not pick it as the standard-setter.
IASB: Develops and issues IFRS Accounting Standards; The standard-setting body. Follows due process and consults publicly.
IFRS Interpretations Committee: Issues interpretations where application is unclear; Deals with specific application issues, not new standards.
IFRS Advisory Council: Advises the IASB on priorities and views of stakeholders; Advisory only. It has no power to issue standards.
IAS vs IFRS: IAS = older standards; IFRS = standards issued by the IASB; Both are part of IFRS Accounting Standards and both are in force unless withdrawn.
Five fundamental ethical principles: Integrity, Objectivity, Professional competence and due care, Confidentiality, Professional behaviour; Memory aid: I-O-P-C-P. Learn the meaning of each, not just the names.
Directors' responsibility: Directors prepare the financial statements; auditors give an opinion on them; The auditor does not prepare the statements and does not take over the directors' responsibility.
Audit opinion test: True and fair view (or fair presentation) in accordance with the applicable framework; Audit gives reasonable assurance, not a guarantee or certification of accuracy.
Five threats to the principles: Self-interest, Self-review, Advocacy, Familiarity, Intimidation; Each threat is dealt with by safeguards or by refusing the engagement.
External vs internal audit: External: independent, reports to shareholders, opinion on financial statements. Internal: appointed by management, reviews controls and risk.; Use this contrast for any compare question.

Quick revision

Financial statements aim to give useful information to existing and potential investors, lenders and other creditors.
Going concern assumes the business will continue operating for the foreseeable future.
The accruals basis records items when they occur, not when cash moves.
The two fundamental qualitative characteristics are relevance and faithful representation.
Enhancing characteristics are comparability, verifiability, timeliness and understandability.
An asset is a present economic resource controlled by the entity as a result of past events.
A liability is a present obligation to transfer an economic resource as a result of past events.
Equity is the residual interest in assets after deducting liabilities.
Income is an increase in assets or a decrease in liabilities that increases equity, other than contributions from equity holders. Expenses are a decrease in assets or an increase in liabilities that decreases equity, other than distributions to equity holders.
Common measurement bases include historical cost, current cost, fair value and value in use.
IFRS Accounting Standards are issued by the IASB and aim to improve consistency between entities.
External auditors give an opinion on whether financial statements give a true and fair view or are fairly presented.
The fundamental ethical principles are integrity, objectivity, professional competence and due care, confidentiality, and professional behaviour.

Common mistakes

Treating managers as external users of published financial statements. Fix: Managers are internal users. They have access to detailed management accounts and can ask for any information they need.
Giving the same generic need (profit) for every user. Fix: Tailor it. Lenders focus on ability to repay, suppliers on short-term liquidity, employees on stability, investors on returns and growth.
Confusing going concern with accruals Fix: Going concern is about the business continuing. Accruals is about matching income and expenses to the period they relate to.
Thinking prudence means always choosing the lowest profit Fix: Prudence is caution under uncertainty. It does not permit deliberate understatement, because that would breach neutrality.
Treating reliability, prudence or materiality as separate qualitative characteristics. Fix: Use the current list of six. Materiality sits inside relevance. Prudence supports neutrality. Reliability was replaced by faithful representation.
Mixing up the fundamental and enhancing groups. Fix: Remember: only relevance and faithful representation are fundamental. The other four are enhancing.
Treating dividends or drawings as an expense Fix: Dividends and drawings are distributions to owners. They reduce equity but are not expenses and do not reduce profit.
Treating a share issue as income Fix: The Framework excludes contributions from holders of equity claims from income. A share issue increases equity directly.
Treating current cost and realisable value as the same thing. Fix: Ask which side of the market. Current cost is the price to buy or replace. Realisable value is the price to sell, after costs.
Saying historical cost is always the basis used. Fix: Remember inventory at lower of cost and NRV, revalued assets at fair value, and some financial instruments at fair value.

Exam tips

Always link the user to a decision. Marks go to the reason, not just the name of the user.
Know who counts as internal and external. Objective tests often use this as a trap.
In multiple response questions, select exactly the number asked. Test each option on its own.
Watch for wording such as 'primary users'. The answer is investors, lenders and other creditors.
Keep answers short and specific. One user, one need, one reason is usually enough.
Learn one-line definitions and one example for each concept. Most questions are matching tasks.
In multiple response questions, count how many options you must select and check each against the definition.
Watch for similar terms: prudence versus neutrality, and going concern versus accruals.