ACCOUNTING CONCEPTS and PRINCIPLES

Accounting concepts ()
Recording has been based on certain assumptions.() e.g. Can we made depreciation using straight line method for 2001, but using reducing balance method for 2002, using revaluation method for 2003???

One set of final accounts for all purposes

Copies of the same set of final accounts are given to all the different people.

True and fair concept

A firm should disclose all significant information in the financial statements to the concerned parties so that the users may have a true and fair view of the state of affairs of the firm.

The need for objectivity()

Financial accounting ensures objectivity by using generally agreed methods in preparing financial statements. This helps to provide objective, uniform and useful accounting information for different user.
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Accounting Concepts
1. 2. 3. 4. 5. 6. 7. 8. 9. Money measurement concept () The going concern concept () The business entity concept () The realisation concept () Accrual /Matching concept() Materiality Concept() Prudence/Conservaitsm Concept() Consistency Concept () Historical Cost Concept ()

Money measurement concept ()

It can be measured in money Most people will agree to the money value of the transaction. Assumes that the value or purchasing power of money is constant, ignoring the effects of inflation or deflation.(/)

Money measurement concept ()

e.g. Accounting doesnt tell how good the quality of employees skills are although this is important for the success of a business.

The Going concern concept ()

This concept implies that the business will continue to operate for the foreseeable future. This is why we use the historical cost concept and ignore the current market value in asset valuation.

The Going concern concept ()

e.g. Fixed assets are shown at cost less accumulated depreciation.

The Business entity concept ()

This concept implies that the affairs of a business are to be treated as being quite separate from the non-business activities of its owners. Personal transactions of the owner should not be included.

The Business entity concept ()

e.g. A directors private car should not be included in the fixed assets of the company.

The Realisation concept ()

This concept holds to the view that profit can only be taken into account when realisation has occurred. Generally, sales revenue arising from the sale of goods is recognised when the goods are delivered to the customers.

The Realisation concept ()

e.g. Profit is earned when goods or services are provided to customers. Thus it is incorrect to record profit when order is received, or when the customer pays for the goods.

Accrual concept ()
The accrual concept says that net profit is the difference between revenues and expenses. Determining the expenses used up to obtain the revenues is referred to as matching expenses against reveues. Income and costs are recognised as they are earned and incurred but not as they are received or paid.

Accrual concept ()
e.g. Expenses have to take into account of amounts payable at the end of an accounting year even though the cash has not yet been paid.

Materiality Concept ()
Financial statement should separately disclose significant items for they would influence decisions of users. Accounting does not serve a useful purpose if the effort of recording a transaction in a certain way is not worthwhile. In other words do not waste your time in the elaborate recording of trivial items.

Materiality Concept ()
e.g. A stock of stationery worths $10 should be treated as an expense when it was bought.

Prudence/Conservaitsm ()
The accountant should always be on the side of safety. The prudence concept means that normally he will take the figure which will understate rather than overstate the profit. Provision is made for all known liabilities.

Prudence/Conservaitsm ()

E.g. Provision for doubtful debts should be deducted from debtors in balance sheet.

Consistency ()
When a firm has once fixed a method for the accounting treatment of an item, it will enter all similar items that follow in exactly the same way. Frequent changes in the accounting methods would lead to misleading profits calculated from the accounting records. It states that when a firm has chosen a method for the accounting treatment of an item, all similar items should be treated in the same way.

Consistency ()
E.g. Depreciation method of certain fixed assets once adopted should be used in the following years.

Historical Cost concept ()

Assets are normally shown at their original costs of acquisition. Any changes in the market value after the purchase are ignored. Historical cost is the most objective measure of the value of an asset. However, it cannot reflect the current value of an asset.

Historical Cost concept ()

E.g. A fixed asset acquired at a cost of $100,000 would be recorded at this amount in the books. Even if its market value may have gone up or down in future, it should be recorded at its original cost $100,000.

Exercises