Financial Accounting – Concepts

Accounting Concepts :: Assumptions & Practices

1. Business Entity Concept :

   In accounting, a business or an organization and its owners are treated as two separately identifiable parties. This is called the entity concept. The business stands apart from other organizations as a separate economic unit.
   

2. Going Concern Concept :

   A going concern is a business that is assumed will meet its financial obligations when they fall due. It functions without the threat of liquidation for the foreseeable future, which is usually regarded as at least the next 12 months or the specified accounting period (the longer of the two). The presumption of going concern for the business implies the basic declaration of intention to keep operating its activities at least for the next year, which is a basic assumption for preparing financial statements that comprehend the conceptual framework of the IFRS. Hence, a declaration of going concern means that the business has neither the intention nor the need to liquidate or to materially curtail the scale of its operations.

3. Accounting Period Concept :

   An accounting period, in bookkeeping, is the period with reference to which management accounts and financial statements are prepared. In management accounting the accounting period varies widely and is determined by management. Monthly accounting periods are common.

4. Matching Concept :

   In accrual accounting, the matching principle instructs that an expense should be reported in the same period in which the corresponding revenue is earned, and is associated with accrual accounting and the revenue recognition principle states that revenues should be recorded during the period in which they are earned, regardless of when the transfer of cash occurs. By recognizing costs in the period they are incurred, a business can see how much money was spent to generate revenue, reducing “noise” from timing mismatch between when costs are incurred and when revenue is realized. Conversely, cash basis accounting calls for the recognition of an expense when the cash is paid, regardless of when the expense was actually incurred.

5. Cost Concept :

   In accounting, the cost principle is part of the generally accepted accounting principles. Assets should always be recorded at their cost, when the asset is new and also for the life of the asset.

6. Money Measurement Concept :

   The money measurement concept underlines the fact that in accounting and economics generally, every recorded event or transaction is measured in terms of money, the local currency monetary unit of measure.

7. Dual Aspect Concept :

   Each transactions has two aspects > Receiving the Benefit or Giving the Benefit
   The dual aspect concept states that every business transaction requires recordation in two different accounts.
   Assets = Liabilities + Equity

8. Revenue Recognition (realization) concept :

   The revenue recognition principle is a cornerstone of accrual accounting together with the matching principle. They both determine the accounting period in which revenues and expenses are recognized. (Ex. Services Rendered / Goods Delivered)

9. Accrual Concept

   Accrual of something is, in finance, the adding together of interest or different investments over a period of time. It holds specific meanings in accounting, where it can refer to accounts on a balance sheet that represent liabilities and non-cash-based assets used in accrual-based accounting. (Ex. Events are recorded as they occur regardless when cash is paid/received)

10. Materiality

    Materiality is a concept or convention within auditing and accounting relating to the importance/significance of an amount, transaction, or discrepancy.

11. Consistency

    The concept of consistency means that accounting methods once adopted must be applied consistently in future. That means accounting practices and policies are consistent from one period to the other.

12. Conservatism

    In accounting, the convention of conservatism, also known as the doctrine of prudence, is a policy of anticipating possible future losses but not future gains. This policy tends to understate rather than overstate net assets and net income, and therefore lead companies to “play safe”. When given a choice between several outcomes where the probabilities of occurrence are equally likely, you should recognize that transaction resulting in the lower amount of profit, or at least the deferral of a profit.

13. Full Disclosure

    The full disclosure requires that all material facts must be disclosed in the financial statements. For example, in the case of sundry debtors, not only the total amount of sundry debtors should be disclosed, but also the amount of good and secured debtors, the amount of good but unsecured debtors and amount of doubtful debts should be stated. This does not mean disclosure of each and every item of information. It only means disclosure of such information which is of significance to owners, investors and creditors.