The Role of Accounting Conservatism

This assignment delves into the concept of accounting conservatism and its effects, particularly focusing on corporate investment during global financial crises. It analyzes research papers discussing how accounting conservatism influences financial contracting and firm-level investment risk. The exploration also extends to understanding the impact of financial constraints on income shifting by US multinationals.

Financial Account Principle

Table of Contents
INTRODUCTION...........................................................................................................................3
Report to Line Manager...............................................................................................................4
Client 1.............................................................................................................................................6
A. Preparation of Journal entries.................................................................................................6
B. Ledger accounts ......................................................................................................................8
C. Trial balance..........................................................................................................................16
Client 2...........................................................................................................................................17
A. Statement of Profit and Loss.................................................................................................17
B. Preparing balance sheet of Peter piper .................................................................................18
Client 3...........................................................................................................................................20
A. Producing Income statement.................................................................................................20
B. Preparing Statement of Financial Position ...........................................................................21
C. Consistency and Prudency concepts.....................................................................................26
D. Outlining purpose of depreciation.........................................................................................27
Client 4...........................................................................................................................................28
A. Preparation of Bank Reconciliation Statement ....................................................................28
B. Causes of varying bank records with accounting books.......................................................29
C. Producing Bank Reconciliation Statement............................................................................29
Client 5...........................................................................................................................................29
A. Sales ledger control account and Purchase ledger control account......................................29
B. Explaining meaning of control account................................................................................30
Client 6...........................................................................................................................................31
A. Meaning and features of suspense account...........................................................................31

B. Drafting trial balance.............................................................................................................31
C. Preparing journal entries.......................................................................................................32
D. Differentiating suspense and clearing account......................................................................32
CONCLUSION..............................................................................................................................33
REFERENCES..............................................................................................................................34
INTRODUCTION
Accounting plays crucial role in the company to prepare final accounts in effective
manner. Present report deals with preparation of financial statements of 6 clients and showing
financial position. Moreover, accounting principles and concepts are discussed in the report.
Accounting guidelines issued by various professional bodies are explained as well. Furthermore,
trial balance and ledger accounts are prepared for the clients. Moreover, sales and purchase
ledger control both are produced. Thus, it can be said that financial accounting principles
provides way to produce correct financial statements of the business.

Report to Line Manager
To: Line Manager
Subject: Importance of accounting regulations and concepts in the business and various
concepts for achieving growth of company.
Define financial accounting: - Financial accounting is a financial statement of a company. In
financial statement we include income statement and balance sheet of the company. It is the
process of recording, summarising, classifying and interpreting the financial statement of a
company. Financial accounting is the accounting activities of the company and it’s a
preparation of profit and loss accounts and balance sheet of a company. Company issue their
financial statement time to time and assess the statement regularly (Warren and Jones, 2018).
The main purpose of financial accounting is to forecast for the company, how to earn more
profits in future. Financial statement include cash flow, income statement, balance sheet,
retained earnings. In income statements include revenue and expenses of the company. Cash
flow include operating, investing and financing activities of the company. Balance sheet is a
statement of financial year it include assets, liabilities, capital equity etc. Financial statement
also shows the financial condition of a company. There are some principle regarding financial
accounting that is company report should be easy to understand and credible and comparable.
Financial accounting follow the common rules which is accounting standards. Financial
accounting is differ from managerial accounting and its forecast the financial reports of the
company and this reports shows to the stakeholders, regulators of the company. The IASB
(International Accounting Standards Board) objective is to provide financial information to
investor, shareholders and lenders. And then decision involves buying, selling, or holding
equity and to provide loans from credit.
Explain regulation relating to financial accounting: - The main purpose of financial
accounting is to forecast for the company. In the financial accounting prepared profit and loss
statement and statement of financial position of partnership to examine. The accounting
standards are designed for betterment of financial accounting. In accounting standards include
what transaction should be shown in financial statement (Mullinova, 2016). The main purpose
of creating accounts standards is to define proper accounting practice with in legal framework.
The necessity of accounting regulation is when an individual choose to start a business. The
need for accounting standards only becomes apparent when the key characteristics of the
various mediums through which business venture can be carried. Financial accounting
focusses on the following areas that is identification and recording of financial information. In
financial accounting the activities should be reported. In this include clarity, accuracy
materialistic data which helps in better to judge a report. Financial statement are prepared
under regulatory framework. First is professional regulation, in this its outline that
recommended methods that can be used to value inventory and to provide guidance on when
inventory should be recognised. The next international regulation, in this the main aim of the
IASC was to promote the company worldwide and compare consistency in financial
statements with other companies. ISAB main aim is to establish open participatory and
transparent due process, collaborate globally for standard setting community and to connect
with investors, regulators, business leaders and the global accountancy profession at every
stage of process. The ISAB has full control on developing and set its own technical aspects.
Describe accounting rules and principles: - The rules and concepts that govern in
accounting. The main purpose of accounting principle is the accounting is based on legalistic

accounting which is detailed or complicated. If any company distribute their financial
statements to the shareholder or to the public so its required to follow generally accepted
accounting principle for preparing financial statements (Libby, 2017). Some basic accounting
principle are:-
The business as a single entity concept:- The business is a single entity . Business all
activities are treated separately .A business can run long after the existence of its owner.
The specific currency principle: - All country have their own currency. Some companies
who conduct business in foreign currencies ant then convert the currencies in prevalent
exchange rate of currency.
The specific time period principle: - Financial statement prepare in a specific time period. In
income statement there is start date and end date. And balance sheet is prepare on a certain
date.
The Historical Cost Principle: - The prices which is items were bought and sold its valuation
is done in financial statements. The real value may changes in inflation and recession time.
The Full Disclosure Principle: - This principle focuses on all accounting scandals in news now
days. And company should reveal all the relevant aspects of the functioning.
The Recognition Principle: - In this principle companies reveals their income and expenses in
the same time period in which they were accrued.
The Non-Death Principle of Businesses:-
In this principle businesses will continue to function eternally and have no end date as such.
The Matching Principle: - In this principle the accrual system of accounting should be used for
every debit there should be credit.
The Principle of Materiality: - the report should be materialistic and accurate. There are
inaccuracy in records of financial accounting so the company note judge the right and not to
forecast (KHAJAVI and EBRAHIMI, 2017).
The Principle of Conservative Accounting: - In this principle expenses are recorded
immediately but incomes are recorded only when it comes in cash.
Explain the conventions and concepts relating to consistency and material disclosure:-
Conventions includes those customs or tradition which is help the accountants while preparing
the accounting statements. Some accounting conventions are:-
Convention of disclosure: - The term disclosure only implies that there is information which
is material to all which is invested in company. It implies that accounts should be prepared that
all material information is clearly disclosed to the reader. The idea behind this convention is
that nobody can misuse the reports of a company.
Convention of materiality: - In this convention only those items should recorded which is
significant and insignificant items should be ignored. This is used because of accounting will
be over burden. An item material for one concern may be immaterial for another (EBRAHIMI,
TALEBNIA, VAKILIFARD and NIKOUMARAM, 2017).
Convention of consistency: - This convention implies that accounting practices should remain
unchanged from one year to another. Consistency does not mean inflexibility. If introduction
of innovative techniques and changes become necessary, the change and its effect should be
clear.

Client 1
A. Preparation of Journal entries
Journal entries are prepared to record daily business transactions in chronological order
and as such, each and every information is effectively recorded in the accounting books. Another
aspect of journal entry is that transaction should be balanced on both sides which means that
debit and credit should be equal. These entries are then extracted to ledger accounts and as such,
it provides summary of individual accounts in ledger. Thus, recording transactions in the form of
journal entries is the first step for the preparation of financial statements of the trader. It help to
provide effective way of scrutinizing transactions for producing financials with much ease. The
journal entries for Alexandra Study is listed below-

B. Ledger accounts
This is the second stage for preparing financials of the business. The general ledger
account is used to record each and every information from journal entries in detailed manner. In
simple words, ledger provides detail transactions of each account analyzed in the first step. This
imparts to produce information for income statement and balance sheet with much ease. It
provides summary of accounts involved in the journal entries and as such, ledger is prepared.

C. Trial balance
The trial balance is used for testing mathematical accuracy of transactions. This is done
with a view to check whether debit and credit transactions in the ledger are accurate or not. This
means that any errors that may have remain in the ledger posting can be extracted with the help
of trial balance in the best possible manner (Christensen, Nikolaev and WITTENBERG‐
MOERMAN, 2016). Thus, trial balance help to rectify errors in effective manner. The trial
balance of the trader is listed below-

Client 2
A. Statement of Profit and Loss
The statement of profit and loss help to ascertain revenue made and expenses incurred for
a specific period. It provides clarity whether business is able to inject revenue by controlling
expenditures or not. The income statement is quite important for company to analyze various
expenses and revenue earned at a specified date. Generally, this financial statement is prepared at
the end of accounting period. Thus, comes to know the exact amount of all the costs incurred and
net income earned in the particular year. Statement of profit and loss for Peter Pipe is produced
below-
Particulars Amount
Sales revenue 1215000
Less: COGS -759360
Gross profit Earned 455640
Wages and Salaries 177500
wages and salaries outstanding 1220
Less: Indirect expenditures
Administration expenditures -17650
motor expenditures -87400
Costs of Advertising -13280

Heating and Lighting expenses -4950
Less: Prepaid expenses 8470
Depreciation -17250
premises depreciation -5400
Depreciation on vehicles -2800
Total indirect expenditures -318980
Net income 136660
B. Preparing balance sheet of Peter piper
Balance sheet is prepared for assessing amount of assets and liabilities usually at the end
of financial period. This imparts clarity to business regarding whether there are adequate amount
of assets with respect of liabilities. It is one of the main part of financials of the business and as
such, business is able to analyze assets and liabilities in the best possible manner. Furthermore, it
is derived from income statement prepared. Thus, balance sheet imparts clarity regarding
owners’ capital, liabilities and assets. In relation to this, Statement of Financial position for Peter
Pipe is generated below-

Client 3
A. Producing Income statement
Income statement is prepared with a view to analyze income generated and expenses
incurred in the particular year. It is also known as Profit and Loss statement as when income
exceeds expenses, then business earns profit and when earnings are lower than expenditures,
entity incurs loss. Thus, it help to assess whether business has earned profit or not in specific
period. Thus, firm comes to know regarding reducing or cutting down expenses so that more
income may be produced with much ease. The income statement for Raintree Ltd is produced
below-

B. Preparing Statement of Financial Position
The balance sheet provides clarity to business whether it has sufficient quantum of assets
at a particular time period or not (Kim and Zhang, 2016). The statement of financial position has
three main components such as assets, liabilities and owners’ or shareholder capital. Thus, total
assets should be more so that it may easily finance debt and equity in the best possible manner.
In simple words, balance sheet is also called as summary of various balance. Balance sheet of
organization is prepared below-

C. Consistency and Prudency concepts
Accounting Consistency: - Accounting consistency stated with to follow the method one
year to another and to follow continuously in future accounting periods. Any change in
techniques and policies will affect their items of financial statements.
Accounting Prudency: - in accounting Prudency is fundamental concept. Using this
concept that increases trustworthiness of the reports. It requires company go for a very less
favourable situation or the company record only realistic perspective about every event which is
used in financial statements. And this concept also stated that record all expenses at time it’s
done and all incomes recorded when it is realised.

D. Outlining purpose of depreciation
If a company make a large purchase and its items shows in balance sheet as assets. Assets
is long term investment by the company. Depreciation is related to company fixed assets.
Because fixed assets is used in a year and depreciation expenses is lying on it. Vehicle and
equipment are most common assets which is depreciated. Depreciation is a reduction in value of
any assets. The main purpose of depreciation is to match the cost of an assets to the revenue
earned from using this assets (Balakrishnan, Watts and Zuo, 2016).
Types of depreciation:-
1. Straight line method
2. Written down value method
3. units of production
4. sum of year digits
Mostly used method of depreciation is Straight line method and written down value method. In
straight line method the same amount is used in calculating for each accounting period. The
formula is using for calculating depreciation in straight line method is
Depreciation amount= (cost of assets- salvage value)/useful life of assets in a year
For example: - Assets value=100000
Depreciation rate=20%
1st year =100000*20/100=20000
2nd year=100000*20/100=20000
In Written down value method depreciation is charged on reducing balance of an assets and a
fixed rate. The formula is used in
D=1-n/ r/c
r= residual value of assets
n= useful life assets in a year
c= cost of assets

1st year =100000*20/100=20000
2nd year =80000*20/100=16000
Written down value method is appropriate for calculating depreciation because we get the
residual amount of an assets year by year at the time of sold the assets we get the scrap value of
this assets. And, in straight line method there is no residual value so we don't get scrap value.
Client 4
A. Preparation of Bank Reconciliation Statement
Bank Reconciliation Statement (BRS) is the summary of accounting records of business
with that of record of bank pass book. This is prepared because the transactions entered in
accounting book of business is not immediately entered in bank (Dyreng and Markle, 2016).
Thus, balances of both pass book and records of entity differs and as such, BRS is produced to
rectify the same. BRS is prepared below-

B. Causes of varying bank records with accounting books
The causes for varying business records with bank pass book are numerous. The balances
of bank and entity differs at the end of period. It includes cheque dishonored, deposits made but
not recorded in bank pass book. Interest charges and many other factors led to influence both
balances. Thus, through preparation of BRS, business may be able to analyze actual balance left
after carrying out expenditures.
C. Producing Bank Reconciliation Statement
BRS help to reconcile records of pass book balances with accounting records of the
entity. Thus, after reconciling balances, exact amount can be easily generated with much ease.
Various adjustments are made and as such, BRS is prepared reflecting true balances in pass book
and accounting records of firm in the best possible manner (Lara, Osma and Penalva, 2016).
Client 5
A. Sales ledger control account and Purchase ledger control account
Sales ledger control account is prepared with a view to reflect total debtors at a specified time in
effectual manner. In simple words, this control account shows how much amount remains
outstanding from the credit customers of the business. The sales ledger control account is
prepared below-

Purchase ledger control account is prepared to assess how much amount remains outstanding to
suppliers who have provided goods on credit to business. Thus, the same figure reflect business
has to pay to its creditors or suppliers. The control account is prepared-
B. Explaining meaning of control account
The control account means that it is an account opened for recording balances on various
subsidiary accounts (What is the purpose of control accounts?. 2018). This is produced in order
to check accuracy of balances of accounts. In simple words, it is prepared for analyzing whether
entries posted in general ledger are correct or not. Thus, subsidiary ledger is produced to
ascertain correct balance of financial statements. This is prepared as detail summary might not be

provided in accounts receivable or payables and as such, firm is able to ascertain accurate
balances.
Client 6
A. Meaning and features of suspense account
Suspense account: - Suspense account is an account which is open when in balance sheet the
proper amount could not be determined at the time that the transaction was recorded. The amount
which is shows in suspense account its only temporary basis. And after the amount should be
investigated and posted to the correct amount (Legenzova, 2016).
Features of suspense account:
 It is used on a temporary basis
 it is closed when the transaction should be match and correct entry should be posted
B. Drafting trial balance
Trial balance is prepared which provides arithmetical accuracy of transactions so that
debit and credit may be made equal. Furthermore, errors or mistakes can be rectified as well. The
trial balance is produced below-

C. Preparing journal entries
D. Differentiating suspense and clearing account
Difference between suspense account and clearing account:
Basis of difference Suspense Account Clearing account
Opening of account Suspense account occur when
the balance sheet not match.
Clearing account is to hold the
transaction for later posting
Closed account When uncertainties are
resolved the suspense account
is closed.
This account is used to record
utility expenses which is
closed in monthly.
CONCLUSION
Hereby it can be concluded that accounting plays important role in the business. The
financial statements are prepared such as income statement and balance sheet from the

accounting records maintained in the books of accounts. Moreover, financial accounting is quite
useful as all the transactions entered in and as such, business is able to prepare final accounts
with much ease.. The accounting concepts and rules also help accountants to prepare correct
financials.

REFERENCES
Books and Journals
Balakrishnan, K., Watts, R. and Zuo, L., 2016. The effect of accounting conservatism on
corporate investment during the global financial crisis. Journal of Business Finance &
Accounting. 43(5-6). pp.513-542.
Christensen, H. B., Nikolaev, V. V. and WITTENBERG‐MOERMAN, R.E.G.I.N.A., 2016.
Accounting information in financial contracting: The incomplete contract theory
perspective. Journal of accounting research. 54(2). pp.397-435.
Dyreng, S. D. and Markle, K. S., 2016. The effect of financial constraints on income shifting by
US multinationals. The Accounting Review. 91(6). pp.1601-1627.
EBRAHIMI, M., TALEBNIA, G.A., VAKILIFARD, H. and NIKOUMARAM, H., 2017. THE
EXPLAINING WORKING CAPITAL MANAGEMENT STRATEGY BY MARKOV
CHAIN MONTE CARLO.
KHAJAVI, S. and EBRAHIMI, M., 2017. MODELLING THE EFFECTIVE VARIABLES FOR
OF FINANCIAL STATEMENTS FRAUD DETECTION USING DATA MINING
TECHNIQUES.
Kim, J. B. and Zhang, L., 2016. Accounting conservatism and stock price crash risk: Firm‐level
evidence. Contemporary Accounting Research. 33(1). pp.412-441.
Lara, J.M.G., Osma, B. G. and Penalva, F., 2016. Accounting conservatism and firm investment
efficiency. Journal of Accounting and Economics. 61(1). pp.221-238.
Legenzova, R., 2016. A concept of accounting quality from accounting harmonisation
perspective. Economics and Business. 28(1). pp.33-37.
Libby, R., 2017. Accounting and human information processing. In The Routledge Companion to
Behavioural Accounting Research (pp. 42-54). Routledge.

Mullinova, S., 2016. Use of the principles of IFRS (IAS) 39" Financial instruments: recognition
and assessment" for bank financial accounting. Modern European Researches. (1). pp.60-64.
Warren, C. S. and Jones, J., 2018. Corporate financial accounting. Cengage Learning.
Online
What is the purpose of control accounts?. 2018 [Online] Available Through:
<https://www.accountingcoach.com/blog/accounts-receivable-control-account-subsidiary-
ledger>