In Australia, accounting and the way general financial statements are prepared is governed by various Assumptions, Principles and Accounting standards. This is so general purpose financial statements of a business fairly represent the financial position, performance, and cash flows of the business. This information is then used by different stakeholders such as creditors, employees, investors, lenders, business owners, analysts, and regulators to evaluate the business for decision making purposes by making businesses more comparable within the market.
Having accurate financial statements provides management and governing bodies of a business with one means of accountability to those who provide resources to that business, for example, creditors and lenders.
Overseeing the financial reporting process in Australia is the Financial Reporting Commission (FRC) who provide vast strategic direction to the Australian Accounting Standards Board (AASB) and is responsible for appointing members other than the Chairman to the AASB. This being said, the FRC is limited on involving themselves in the technical deliberations of the AASB under the Australian Securities and Investments Commission Act 2001.
The AASB is primarily regulated by the Australian Securities and investment Commission (ASIC) who is responsible for the enforcement of standards issued by the AASB under the Corporations Act 2001. ASIC has the ability to class orders and company specific orders which may give some companies relief from certain requirements of the Corporations Act 2001 where the company has satisfied the statutory requirements for the relief of the application of the AASB have been met. If the issue is considered more significant, ASIC may refer the issue back to the AASB for review.
Accounting processes in Australia are also required to comply with Generally Accepted Accounting Principles (GAAP) aka, Accounting Assumptions and are based off the International Financial Reporting Standards (IFRS). These principles/assumptions dictate how information is to be recorded for the financial statements to be considered a fair representation of a business’s financial position.
The Accrual Principle/Assumption dictates that transactions are recorded using the accrual basis of accounting. This is where the recognition of revenues and expenses arises when earned or used, respectively. If this principle/assumption is not true, businesses should instead use the cash basis of accounting to develop financial statements. For more on how to choose an appropriate accounting method please see the ATO link below.
The Conservatism Assumption is when revenues and expenses should be recognised when earned, however there is a bias toward the earlier recognition of expenses. If this assumption is not true businesses may be issuing overly optimistic financial results. All probable expenses must be recorded when they are discovered whereas revenues can only be registered when they are fully realised. When preparing the accounts, a high degree of verification must be used with a high degree of caution should be taken to ensure accounts are represented correctly.
Under the Consistency Assumption the same accounting method (Cash or Accrual) should be used from period to period, unless it can be replaced by a more relevant method for example if a business has reached the ATO threshold that requires the business to change from the Cash Basis to the Accrual Basis. If this assumption is not true, the financial statements produced over multiple periods will not be comparable.
The Economic Entity Assumption is a particular problem for small, family-owned businesses as it is where the transactions of a business and those of its owners should not be intermingled. It is impossible to develop accurate financial statements if this assumption is not true.
The Going Concern Assumption is when a business will continue to operate for the foreseeable future. If this assumption is not true deferred expenses should be recognised at once. One reason why a business may not be operating in the foreseeable future may be due to insolvency/bankruptcy.
The Reliability Assumption happens when only those transactions which can be adequately proven (via source documentation) should be recorded. If this assumption is not true, there is a good chance a business might be falsely accelerating the recognition of revenue to boost its short-term results.
The Time Period Assumption is where the financial results reported by a business should occur over a uniform and consistent period of time (monthly, quarterly, annually). If this is not the case, financial statements will not be able to be compared across reporting periods.
Having a general understanding of these regulations, principles, assumptions, and standards can assist in the overall financial health and growth of a business giving that business a better opportunity to succeed and invest back into their stakeholders and local community.
Please note: This article is presented from a theoretical perspective only and does not replace the advice of qualified Bookkeepers, Registered BAS Agents or Registered Tax Agents.
