applay principle of professional practice .pdf

Training, Teaching and Learning Materials (TTLM)
TTLM Development Manual Date: September,2017
Compiled by: Business & Finance Department
ADMAS UNIVERSITY
The Ethiopian TVET-System
ACCOUNTS AND BUDGET SERVICELEVEL IV
Unit of Competence Apply Principles of Professional Practice to Work in the
Financial Services Industry
Module Title Applying Principles of Professional Practice to Work in the
Financial Services Industry
LG Code: EIS ABS4 04 0812
TTLM Code: EIS ABS4M 04 0812
Learning Guide

INTRODUCTION
Welcome to the module “Apply Principles of Professional Practice to
Work in the financial services industry”. This learner’s guide was prepared to
help you achieve the required competence in “Accounts and Budget Support Level
IV”. This will be the source of information for you to acquire knowledge attitude
and skills in this particular occupation with minimum supervision or help from
your trainer.
Summary of Learning Outcomes
After completing this learning guide, you should be able to:
Lo1:- . . Identify the scope, sectors and responsibilities of the industry
Lo2:- . Identify and apply financial services industry guidelines, procedures and
legislation
Lo3:- Identify sustainability issues for the financial services industry
Lo4:- Manage information
Lo5:- Plan work to be completed taking into consideration time, resources and other
constraints
Lo6:- . Plan work to be completed taking into consideration time, resources
and other constraints
Lo7:- . Develop and maintain personal competency
How to Use this TTLM
o Read through the Learning Guide carefully. It is divided into sections
that cover all the knowledge, skills and attitude that you need.
o Read Information Sheets and complete the Self-Check at the end of
each section to check your progress
o Read and make sure to Practice the activities in the Operation Sheets.
Ask your trainer to show you the correct way to do things or talk to
more experienced person for guidance.
o When you are ready, ask your trainer for institutional assessment and
provide you with feedback from your performance.
o

Lo1:- Identify the scope, sectors and responsibilities of the
industry
Factor that Influence Accounting
a. Legal system
 Tax and pension laws
 Overtime proclamations
 Commercial code etc.
b. Socio - Political culture
 Political situation of one country affects accounting. For example In
Ethiopia in the current situation land is not an asset for an individual
etc.
c. Business economy
d. Users of accounting information
e. Professional Accounting Association
Conceptual Framework for Financial Accounting and Reporting
1.2.1 Definition
The conceptual framework is a coherent system of interrelated objectives and
fundamentals that can be lead to consistent standards and that prescribes the nature,
function and limits of financial accounting and financial statements.
1.2.2 Importance
The importance of conceptual frame work is as follows:-
 Defines the boundaries of accounting
 Assists accounting and others in selecting the most appropriate
methods for reporting activities of an enterprise.

 Provides description of current practice and a frame of reference for
resolving new issues.
 Provides a basis for developing new standards and for revising
existing one.
Objectives
of
Financial accounting
Qualitative Elements
Characteristics of financial
of accounting statements
Information
Recognition and
Measurement guide lines
Conceptual Framework
Objectives of financial reporting and financial statements
Objectives of financial reporting relate to the type of information that is helpful far
external users in investment and credit decision making. The major interest being
"who needs, what kind of information and for what purposes"

In general FASB suggested for the following information to be disclosed in general
purpose financial reporting in order to provide decision makers with better
information that, in tern enables efficient allocation of scarce resources:
 Information for rational decision in investment, credit and other decisions.
 Information for assessing cash flow prospects of the enterprise
 Information about enterprises resources and climes against resources.
 Information about enterprises performance and earning;
 Information about how funds are obtained and used
 Explanations and interpretations to help users understand the financial
information provided.
 Information that enables owners to assess how well management has
discharged it stewardship responsibility over entrusted resources.
In response eight objective of financial reporting are identified enlisted from more
general to specific as follows:
I. Financial reporting should provide information that is useful to present
and potential investors and creditors and other users in making rational
investment, credit, and similar decisions.
II. Financial reporting should provide information to help present and
potential investors and creditors and other users in assessing the amounts,
timing, and uncertainty of prospective cash receipts from dividends of
interest and the proceeds from the sale redemption or maturity of
securities or loans.

III. Financial reporting should provide information about the economic
resources of an enterprise, the claims to those resources and the effects of
transaction, events, and circumstances that change resources and claims
to those resource:
IV. Financial reporting should provide information about an enterprise's
financial performance during a period. Investors and creditors often use
information about the past to help in assessing the prospects of an
enterprise.
V. Financial reporting should provide information about an enterprise's
performance provided by measures of earnings and its components.
VI. Financial reporting should provide information about how an enterprise
obtains and spend cash, about its borrowing and repayment of borrowing,
about its capital transaction including cash dividends and other
distributions of enterprise resource to owners, and about other factors that
may affect an enterprise's liquidity or solvency.
VII. Financial reporting should provide information about how management
of an enterprise has discharged its stewardship responsibility to owners
(stock holder) for the use of enterprise resources entrusted to it.
VIII. Financial reporting should provide information that is useful to managers
and directors in decision-making.
Objectives of financial reporting are primarily targeted to ward the needs of
external users of accounting data who lack the authority to prescribe the
information they desire.

Lo2 Identify and apply financial services industry
guidelines, procedures andlegislation
Qualitative Characteristics of Accounting Information
After identifying the type of information required in financial reporting, the
second phase of the conceptual framework dealt with what characteristics those
information should fulfill in order to be useful.
These qualitative characteristics assist information user in choosing among
financial information and distinguish more useful information from less useful
one for decision-making purpose.
The following figure presents the hierarchy of qualitative characteristics of
accounting information.

Hierarchy of Accounting Qualities
Decision Makers
User of Accounting and their characteristics
Information (for example, understanding
or prior knowledge)
Pervasive constraints Benefits > Costs
User specific Qualities Understandability
Decision usefulness
Primary decision Relevance Reliability
Specific qualities
Ingredients of
Primary
Qualities
Productive Timeliness Verifiability Representation
Value of faithfulness
Feed back value Neutrality
Secondary and Interactive Comparability
Qualities (including consistency)
Threshold for Materiality
Recognition

The characteristics of information that make it a desirable commodity can be
viewed as hierarchy of qualities for which usefulness for decision making being
the most important one. As indicated in the hierarchy, the qualitative
characteristics are divided into four major components.
I. User specific qualities
II. Primary qualities
III. Secondary qualities; and
IV. Constraints to qualitative characteristics; cost benefit and
materiality.
I. User specific qualities- understandability and usefulness for decision-
making.
User specific qualities include understandability and usefulness for decision
making that are not inherent in the information.
Understandability
Understandability is the quality of information that enables user to perceive its
significance accounting information should be understandable to user who have a
reasonable knowledge of business and economic activities and are willing to study
the information with reasonable diligence
Understandability of information is related to the characteristics of the decision
maker as well as the characteristics of the information itself and, therefore,
understandability cannot be evaluated in overall terms but must be judge in relation
to a specific class of decision makers.
The quality of understandability is necessary for decision usefulness; as
information cannot be useful for decision making unless it is understood, though
the information is relevant and reliable.

Usefulness for decision-making
The central quality of the hierarchy is decision usefulness. It is considered as
overall quality of pervasive criterion. All other characteristics are viewed in terms
of their contribution to the usefulness of information for decision-making.
II. Primary decision specific qualities:-FASB identified relevance and
reliability as the primary qualities inherent in useful accounting
information. Primary qualities of information (relevance and reliability)
distinguish "better" information from "inferior" information with some
other characteristics that those qualities imply.
a. Relevance
Accounting information is relevant if it can make a difference in decision by
helping users predict the out come of past, present, and future event, or confirm
or correct prior expectations.
For information to be relevant it must be timely and it must have predictive
value of feedback value, or both.
b. Reliability
Reliability is another primary quality identified involving the degree to which
accounting information is free from error and bias, and its faithful
representation of facts. However, reliability doesn't mean absolute accuracy.
For accounting information to be reliable, it should incorporate ingredients of
verifiability, Validity (representational faithfulness) and neutrality.
If either of relevance of reliability is completely missing, the information will
not be useful. Theoretically the choice of an accounting alternative should
produce information that is both more reliable and more relevant.

Lo3Identify sustainability issues for the financial services
industry
Secondary qualities
The usefulness of information enhance when the secondary qualities are
achieved in addition to the primary qualities indicated. The secondary qualities
compose comparability and consistency.
A. Comparability
This involves the quality of information being compared with similar
information about another enterprise. This is inter-company comparison that
enables user to identify and explain similarities and differences between
enterprises. It also enable to identify favorable and unfavorable trends
happening in a given enterprise over periods.
In general, comparability deals with the measurement and reporting of financial
statements in similar manner as different entities. However, this may be
difficult to achieve as enterprises may use different accounting methods and
estimation.
B. Consistency
This is the feature of information being compared across periods about the same
enterprise. This deals with inter-company comparison. Accounting information
will be consistent if accounting policies and procedures remain unchanged and
confirm from period to period. However, change in accounting methods may be
desirable due to change in the economic condition or issuance of new preferable
accounting methods.

Comparability and consistency are very much independent each other as
consistency are an important condition that enhances comparability across
periods. That is financial information to be comparable; accounting methods
should be applied consistently from period to period.
III. Constraints to qualitative characteristics identified
All the qualitative characteristics identified are affected by two constraints:
Cost effectiveness and materiality.
Cost-effectiveness-pervasive constraints
This is a pervasive constraint affecting all informational qualities. For
information to be considered, It should be ensured that the benefits to be
achieved from using the information should exceed the cost of obtaining the
information given if the information meets all the qualitative characters tics
mentioned.
Materiality - Threshold for recognition
Materiality is a constraint mainly related to the primary qualities of relevance
and reliability. It determines the threshold for recognition of accounting items;
addressing the issue of "is a given item material enough to be recognized and
reported even if it is relevant and reliable?" Relevant information (useful for
decision making) may not disclosed in financial report if the amount involved is
too small to make a difference in the decision of user. Reporting of items in
financial statements or disclosure in notes to the financial statements is required
only for material items.

Elements of Financial Statements of Business Enterprises
The financial accounting standard Board (FASB) identified tea interrelated
elements (building blocks) of financial statements: Assets, Liabilities Equity,
Investments by owners, Distributions to owners, Comprehensive income, Revenue,
Expenses, Gains, and Loses. These elements were defined by the (FASB) as
follows:-
Assets:- Are probable future economic benefits obtained or controlled by a
particular entity as a result of past transactions or events.
Liabilities:- are probable future sacrifices of economic benefits arising from
present obligations of a particular entity to transfer assets or provide services to
other entities in the future as a result of past transaction of events.
Equity:-is the residual interest in the assets of an entity that remains after
deducting its abilities. In business enterprises, the equity is the ownership interest.
Investment by owners:- are increase in net assets of a particular enterprise
resulting from transfers to it from other entities of something of value to obtain of
increase ownership interests (equity) in it Assets are most commonly received as
investments by owners, but that which is received may also include services or
satisfaction or Conversation of liabilities of the enterprise.
Distribution to Owners:-are decreases in net assets of a particular enterprise
resulting from transferring assets, rendering services, or incurring liabilities by the

enterprise to owners. Distributions to owner decrease ownership interests (or
equity) in an enterprise.
Comprehensive income:-is the change inequity (net assets) of an entity during a
period from transactions and other events and circumstances from non owner
sources. It includes all changes in equity during a period except those resulting
from investments by owners and distribution to owners.
Revenues:-are inflows or other enhancements of assets of an entity or settlements
of its liabilities (or a combination of both) during a period from delivering or
producing goods, rendering services, or other activities that constitute the entity's
ongoing major or central operations.
Expenses:- are outflows or other using up of assets of incurrence or liabilities (or a
combination of both) during a period from delivering or producing goods rendering
services, or carrying out other activities that constitute the entity's on going major
or central operations.
Gains:-are increases in equity (net assets from peripheral or incidental transactions
of an entity and from all other transactions and other events and circumstances
affecting the entity during period except those that result from revenues or
investments by owners.
Losses:-are decreases in equity (net assets) from peripheral of incidental
transactions and other events and circumstances affecting the entity during a period
except those that result from expenses or distribution to owners.

Lo4:- Manage information
Generally accepted Accounting Principles
Definition - GAAP- are set of assumptions concepts, conventions, postulates and
accepted practices that explain and guide the accountants activity in recording and
reporting the financial affairs of an enterprise. In general, they are laws or rules
used as a framework in financial reporting. Generally accepted accounting
principles are broad guide lines, conventions, rules, and procedures of accounting
that are delivered in relation to objectives of financial reporting and financial
statements.
I. Basic Assumptions
A) Economic Entity concept (business entity concept)
 Keeping a separate accounting record for the financial affairs of each
enterprise.
 All business entities are considered as a separate and distinct from their
owners and any other business unit, regardless of the legal consideration
given for various forms of business organizations. Thus, the economic
activities of a business enterprise should be reported separate and distinct
from its owners and any other business unit.
Some accounting activities underling business entity principle include:
 Measuring income as it occurs to the entity; not when it is distributed to
owners.
 Recording obligation of the business to owners as liability.

B) Going concern Assumption (continuity)
This assumes on indefinite life existence of a business entity, long enough to carry
out its presented plans and contractual commitments. But, it doesn’t imply that a
business entity would remain permanently.
Hence, this assumption provides the basis:
1. To record probable future economic benefits as assets and probable future
outlats as liabilities.
2. To classify assets and liabilities in the balance sheet as current and non
current on the basis of their ultimate disposition or legal priority.
3. To report assets and liabilities at their historical cost amounts.
Normally, it is assumed that assets will be used in the future operations of the
business and allocated as expense (as depreciation and amortization for instance)
only when consumed. Thus, no need arises to express them in terms of their
current market values.
C. Monetary Unit Assumption
Accounting assumes money as a common denominator by which economic
activities are measured and reported; thus, providing a basis for standard
accounting measurement. Monetary unit is the most effective means of expressing
changes in capital and exchange of goods and services as it is relevant, simple,
universally available, understandable, and useful.
 There are two limitations of monetary unit assumption:
o Some information that is important to measure the business operation
cannot be quantified and expressed in terms of money.

o It ignores happening of price-level change (inflation or deflation) by
assuming the value of money to remain stable.
D. Periodicity Assumption
Accurate measurements regarding the results of a given are possible at its
completion. Similarly, the operation results of a business can be measured
accurately upon its liquidation. However, for the sake of providing periodical
financial reporting to financial statement users (both internal and external), the
economic activities of an enterprise can be divided into artificial time periods
carried fiscal periods. These vary to be months quarter, semi annuals or years.

Lo5 Plan work to be completed taking into consideration
time, resources and other constraints
Basic Accounting Principles
A. Objective Principle
Data entered into the accounting records and later reported on the financial
statements must be supported by objectively determinable evidence.
B. Historical cost principle
The economic activities or elements (items) of an enterprise are initially measured
and recorded at cost (original value) and this cost should be retained (maintained)
as the value of the item affected until the item is consumed, sold, or liquidated.
C. Revenue Recognition principle
This deals with when revenues should be recognized and, thus, determining the
critical event that indicates revenue is realized and justifies recoding the changes in
net assets. Revenue is recognized when it is realizable or realization and earned.
Both features should be met before
Realization of revenue
Revenues are realized when products (goods or services), merchandize, or other
assets are exchanged for cash or claims to cash. Revenuers are realizable when
assets received or held are readily convertible when they are salable of
interchangeable in a market at readily determinable prices with significant
additional cost.

Earning of Revenue
Revenue is said to be earned when the seller substantially accomplishes its
performance or obligations that would entitle the seller to the benefits represented
by the revenues.
Revenue realization principle is related with valuation principle for the case it
suggests that assets (such as inventory) should be carried at their historical cost
until appreciation in value in realized through sales. After realization, valuations of
monetary assets received in exchange for productive assets approximate their
current fair values.
Once revenue of the period is measured and recognized, it should be matched
againsts expresses incurred to generate the revenue.
D. Matching Principle
In an attempt to measure the periodic income properly, appropriate recognition of
revenues and exposes should be made. Thus, after revenue for a given period is
determined in the line with revenue recognition principle, the next crucial point
follows to be when expenses should be recognized. This indicates that expense
recognition is closely tied to revenue recognition.
The matching principle states cost should be recognized as expenses when the
goods or services represented by the cost actually make contribution to revenue:
dictating, “let the expense follow revenues”. The basic for this being creating cause
and effect association of accomplishments achieved (revenue) and efforts
expended (expenses). This addresses the "issue" what caused the revenues
generated (the effect)? This is referred as direct matching that involves associating

expenses with revenues on the basis of a presumed causes and effect relationship
some expenses recognized under this approach include:
 Cost of goods sold (that involve direct manufacturing costs of purchasing
cost of the items deducted from the periods revenue as goods are sold.
 Cost of sales commission directly related to the period's sales transactions
recognized as expense
In conclusion, the matching principles dictates that expenses should be recognized
in either of the following means placed in order of their appropriateness:
 By creating cause and effect relationship
 By rational and systematic allocation of costs (if cause-and-effect
relationship is difficult to create): or
 Immediate recognition of expenses (when both cause an effect relationship
and systematic and rational allocation of costs are not possible to achieve)
The revenue recognition principle and the matching principle are fundamental
basis for accrual basis accounting.

Lo6:- Plan work to be completed taking into consideration time,
resources and other constraints
E. Accrual principles
Revenue should be recorded when earned regardless of collection of cash.
Expenses should be recorded when incurred or when assets are consumed
regardless of payment of cash. In short, revenues or expenses are recognized at a
time earned or incurred.
F. Disclosure Principle
Financial statements should be complete. by disclosing all information that is
significant enough to influence the judgment and decisions of users. This is
essential This is essential as omission of certain information misleads financial
statement users.
The most important information is generally disclosed in either of the four
alternatives:
 Within the body of the financial statement;
For instance, reporting earning-per-share in the body of income statement.
 In the notes to the financial statements;
 By way of schedules;
 As supplementary information;
Notes to the financial statements explain the items ,presented in the body of the
financial statements; such as:
 Significant accounting policies or methods adopted

 Related party transactions;
 Description and pension plans;
 Amount and nature of loss contingencies and commitments;
 Terms and status of proposed business combinations;
 Significant subsequent events that occur after the balance sheet date until
financial statements are issued.
Disclosures in the notes to the financial statements should supplement or explain
the information in the body of the financial statements. They shouldn't be used as
correction to the improper information presented or information omitted in the
body of the statement.
Schedulespresent detailed computations of figures presented in the financial
statements such as inventory, receivables, payables, operating expense, etc.
Supplementary informationcommunicates matters such as:
 Details or amounts that present a different perspective from that adopted in
the financial statements; such as financial statements adjusted for the effects
of inflation;
 Management's explanation of the financial information and its discussion of
the significant of that information
The disclosure principle doesn't require listing all available information. Further,
precision (reporting exact dollar amounts) is not necessarily expected. Rather only
significant items to influence the decision of information users are disclosed and

approximation of figures is possible
The primary qualitative characteristics (relevance and reliability) are important
features to consider in deciding whether to disclose a given item or not.

Lo7:- . Develop and maintain personal competency
CONSTRAINTS TO THE ACCOUNTING PRINCIPLES
These are commonly referred as modifying conventions as they modify the
theoretical basis or treatment of certain events, thus, allowing to depart from rigid
interpretations of accounting principles. In other words, they are exceptions to the
accounting principles.
Why Exceptions to Accounting principles?
Exceptions or constrains to accounting principles are justified for the following
three major reasons
 Regardless the relevance and precision of the information to be provided,
benefits expected should exceed (or at least equal to) costs of obtaining the
information;
 Facts and circumstances among enterprises or industries may differ;
 The accounting theory should be applied differently under conditions of
uncertainty.
Constraints to accounting principles identified include: cost-benefit relationship
materiality, industry practices, and conservatism.
Cost-benefit Relationship
As indicated earlier, in providing information with the qualitative characteristics,
accounting principles are applied strictly if the information they provide is more
beneficial than the costs incurred in applying the principles. The benefits of
applying the accounting theory should exceed (in times equal to) the costs.

Materiality
An item is considered to be material, if, in the light of surrounding circumstances,
the magnitude of the item omitted or misstated in financial reporting is such that
the judgment of a reasonable person relying upon the report would have been
changed or influenced by the inclusion or correction of the item.
To the contrary, an item is considered as immaterial if its omission have no impact
on decision makers.
Thus, the constraint of materiality applies in manner that diversion from pre-set
accounting theories or principles is "Owed if the item is considered to be
immaterial; while the accounting principle is strictly applied if the amount is
determined to be material.
Two factors should be considered in deciding whether a given item is material
(deserving strict application of the GAAPs) or immaterial (that diversion from the
GAAPs is possible):
 Relative size of the item. This is consideration for the quantitative nature by
observing the relationship between the item and key financial variables such
as asset, liability, owner's equity, revenue, expense, net income, etc. Thus,
an item determined to be material for a given firm may be immaterial for
another with larger magnitude of the financial variables mentioned.
 Basic nature of the item. This is qualitative consideration such as contractual
violation or representation of illegal acts of certain transactions
However, it is not always possible to put a clear line in demarcating an item is
either material or immaterial in a tangible manner. Thus, the concept of materiality
requires exercising judgment and professional expertise of individuals.

Industry Practices
This involves modifications of accounting principles necessitated by the unusual
characteristics of some industries. These modifications are part of the GAAP as
they enhance the usefulness o~ information provided given the peculiar nature of
some industries and business concerns
For example, recognition of revenue before the point of sale using percentage-of
contract-completed revenue recognition method is allowed for companies in the
construction industry. This is modification to revenue recognition principle that
dictates point of sale revenue recognition: when it is realized and earned.
Conservatism
This is a modifying convention to be applied in times of doubt or uncertainties
dictating to choose the alternative that is least likely to overstate assets and income.
Uncertainties influence pessimism rather than optimism.
Conservatism is not deliberate understatement of net income and net assets.
Rather, it is the case to l1;nderstate net income and net assets in cases of
uncertainties in order to be prudent and less risky in measurement. This helps to
avoid legal consequences. The major issue is: if the matter is in doubt, it is better
to understate than overstate. If there is no doubt prevailing, the conservatism
constraint is not to be applied. Companies are not allowed to select the most
conservative accounting treatment in all situations.
Some examples of conservatism
 Lower-of-cost-or-market valuation of inventories and marketable equity
securities;
 Recognition of losses before they are incurred;
 Immediate expensing of research and development costs and advertisement

even if future benefits are likely;
Self Test
1. What is the most important qualitative chrematistic of accounting
information according to the financial Accounting standards Board?
2. Are generally accepted accounting principles applicable to both financial
accounting and Managerial accounting? Explain.
3. What is comprehensive income as defined by the financial Accounting
standards Board?
4. Define the revenue realization principle.
5. What meant by the continuity or going-concern principle of accounting?

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