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An Assignment on Accounting Principles and Assumptions

Fundamentals of Financial Accounting (B-108)




In order to make financial statements more relay able and accurate some principles, assumption and rules are followed. The laters also put a balance of the financial statements of different countries. These principles, assumptions and rules are explained here after.

Accounting Principles:
Accounting principles are the rules and guidelines of accounting. They determine such matters as the measurement of assets, the timing of revenue recognition, and the accrual of expenses. The "ground rules" for financial reporting are referred to as Generally Accepted Accounting Principles (GAAP).Accounting Principles included in GAAP are as follow. 1. Historical cost principle: According to this principle assets are reported and presented at their original cost and no adjustment is made for changes in market value. Because of this accounting principle asset amounts are not adjusted upward for inflation. In fact, as a general rule, asset amounts are not adjusted to reflect any type of increase in value. Hence, an asset amount does not reflect the amount of money a company would receive if it were to sell the asset at today's market value. An exception is certain investments in stocks and bonds that are actively traded on a stock exchange. For example, if a machine has brought at 20000tk and after one year its price comes to 21000tk then the machine must be recorded at 20000tk not at 21000tk 2. Full Disclosure Principle: This principle says that if certain information is important to an investor or lender using the financial statements, that information should be disclosed within the statement or in the notes to the statement. It is because of this basic accounting principle that numerous pages of "footnotes" are often attached to financial statements. For instance, information about how the closing stock is valued. 3. Accrual Basis accounting principle: It indicates that economic events must be recorded when it is occurred not when the money is paid or earned. The opposite of accrual basis is Cash basis. Under cash basis accounting, revenues are recognized only when the company receives cash or its equivalent, and expenses are recognized only when the company pays with cash or its equivalent. For example, if a good is sold this year but the payment will be obtained in the next year then it must be recorded in this year. When the payment will be obtained another entry has to be recorded. 4. Revenue recognition principle: According to this principle revenue is earned and recognized upon product delivery or service completion, without regard to the timing of cash flow. Suppose a store orders five hundred compact discs from a wholesaler in March, receives them in April, and pays for them in May. The wholesaler recognizes the sales revenue in April when delivery occurs, not in March when the deal is struck or in May when the cash is received. 5. Matching principle: This accounting principle requires companies to use the accrual basis of accounting. The matching principle requires that expenses be matched with revenues. For

example, wages to employees are reported as an expense in the week when the employees worked and not in the week when the employees are paid. 6. Relevance, reliability and consistency: To be useful, financial information must be relevant, reliable, and prepared in a consistent manner. Relevant information helps a decision maker understand a company's past performance, present condition, and future outlook so that informed decisions can be made in a timely manner. . Reliable information is verifiable and objective. Consistent information is prepared using the same methods in each accounting period, which allows meaningful comparisons to be made among different accounting periods and among the financial statements of different companies that use the same methods. 7. Principle of conservatism: If a situation arises where there are two acceptable alternatives for reporting an item, conservatism directs the accountant to choose the alternative that will result in less net income and/or less asset amount. For example, if the market value of closing stock is 2000tk and the purchasing value is 1900tk then the closing stock has to be reported in 1900tk according to the principle.


Materiality principle: Because of this basic accounting principle or guideline, an accountant might be allowed to violate another accounting principle if an amount is insignificant. Professional judgment is needed to decide whether an amount is insignificant or immaterial. For example, if and a rim a paper costs 20tk then it should not be recorded an asset instead it must be recorded as supplies

Accounting assumptions:
Assumptions are traditions and customs, which have been developed over a period of time and well-accepted by the profession. Basic accounting assumptions provide a foundation for recording the transactions and preparing the financial statements there from. There are four basic assumptions that are considered as cornerstones of the foundation of accounting. These are:

1. Economic entity assumption: According to this assumption business unit is considered a distinct entity from its owners and all other entities having transactions with it. This assumption enables the accountant to distinguish between the transactions of the business and those of the owners. For example, if the owner brings in cash or any other asset, it will result in increase in assets of the business and capital of the firm. This capital represents firm's liability to the owner. The expenses of the owner paid by the firm assets are recorded as withdrawals from the business. This means the profit and loss account will show the revenues and expenses related to the business entity only. Consequently, balance sheet will show the assets and liabilities of the business entity only. This assumption is followed in all organizations irrespective of their form.

2. Money Measurement Assumption: This assumption requires use of monetary unit as a basis of measurement. Here the currency of the country is to be used where the organization is to report its operations. This implies that those transactions which cannot be measured by monetary unit will not be recorded in the books of accounts, For instance, if a worker is hired then it will not be considered as a economic event as there is no way of monetary measurement, But suppose the worker is compensated with 200tk then it will be recorded as this can be measured in taka 3. Going Concern Assumption: In the ordinary course, accounting assumes that the business will continue to exist and carry on its operations for an indefinite period in the future. The entity is assumed to remain in operation sufficiently long to carry out its objects and plans. This validates the methods of asset capitalization, depreciation, and amortization. Only when liquidation is certain this assumption is not applicable. For this assumption assets are shown in their cost price not in the market price 4. Time Period Assumption: Though it is thought that a business will go on, the interest holders want to know about the economic condition and loss or profit. In order to meet the interest of the later and for ease of accountancy the long life of the business is divided into many small parts. For instance, an organization may divide its one year life time into three months, four months, six months even it would be one day periods. In all parts all of the accounting cycles are almost maintained.

Accounting Conventions:
Due to practical constraints and industry practice, GAAP principles are not always applied strictly but are modified as necessary. The following are some commonly observed modifying conventions: 1. Cost-benefit convention: It is a modifying convention that relaxes GAAP requirements if the expected cost of reporting something exceeds the benefits of reporting it. For example it is not necessary to record the transaction of purchase of a metallic cost .50taka. 2. Industry practices convention: According to this convention accepted industry practices should be followed even if they differ from GAAP. For example, due to the prevalent banking practice in some point bankers do not comply with GAAP 3. Objectivity Convention: The company financial statements provided by the accountants should be based on objective evidence. It means thats all of the accounting transactions must be recorded under strong evidence.