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Accounting Concepts

The preparation of Income Statement and Balance Sheet of a business is based on certain assumptions. These assumptions are called Accounting Concepts. Accounting concepts are very helpful in applying commonly established procedures in preparing financial statements. Below is a list of basic accounting concepts: Going Concern Concept Definition It is assumed that the business will continue to operate in the foreseeable future (as far as one can predict . Therefore! there is no intention of closing down. This concept may not be applied if there are evidences or conditions re"uiring the ceasing of business # for e$ample persistent losses or li"uidity problem. Implication Assets are valued at historical cost less aggregate depreciation and not at disposable value since there is no intention to dispose of them. Historical Cost Concept Definition Transactions are recorded in terms of the actual amount at which they occurred in the past. This concept has the advantage of being ob%ective. The amount at which a transaction too& place cannot be disputed over! which is also the amount found on the document issued or received during the transaction. This concept! therefore! eliminates sub%ectivity associated with valuation in accounting records. Implication Assets and e$penses are recorded at the actual amount spent. 'evenues are recorded at actual amount received( receivable. )iabilities are recorded at actual amount borrowed! therefore! payable. Business Entity also known as Accounting Entity Concept Definition The owner and the business are considered as two different persons! distinct from each other.

Transactions are recorded from the point of view of the business and not the owner. As such! any amount invested by the owner in the business is considered as a liability by the business. Also! only those transactions that concern the business are recorded. Implication *ersonal transactions and private property of the owner are not recorded in the boo&s. Capital and +rawings accounts are &ept to record amounts the owner gives to or ta&es from the business. Money Measurement Concept Definition ,nly those transactions that can be e$pressed in money terms (financial transactions are recorded in the boo&s. -on.financial transactions are therefore not recorded. Implication Some strengths or benefits of the business may not be reflected in the boo&s since they cannot be e$pressed in money terms # e$amples are "uality of wor& force and mar&et share. Accounting Period Concept Definition According to this concept! the lifespan of a business is divided into fi$ed period of time (months! "uarters! half.years or years for which accounts are prepared. In most cases an accounting period is a year. -ote that the accounting year need not be the same as the calendar year. /or e$ample! the accounting year for business 0 can be from 1 2une to 31 4ay! for business B from 1 September to 31 August or for business C from 1 April to 31 4arch. Implication Accounts of the business are closed at a specific date every year and final accounts are prepared (profits( losses calculated Accruals Concept and the Matching Principle Definition According to the Accruals concept! when calculating the profit of a given period! revenues

earned in that period need to be matched against e$penses incurred for that same period. This is done irrespective of amount received as revenue or amount paid for the e$penses. According to the matching principle! when calculating profit! revenues need to be matched against those e$penses incurred to earn the revenues. Implication Ad%ustment are made in accounts for accrued and prepaid items so that accounts reflect revenue earned (not amount received and e$penses incurred (not amount paid for . Prudence Concept also known as Conser atism Definition This concept prevents the anticipation of future profits before they are realised but re"uires to ma&e provisions for losses as soon as they are recognised. Therefore! according to this concept! assets and revenue are not overstated while liabilities and losses are not understated. Implication Inventory of goods are valued at the lower of cost and net realisable value. *rovisions for doubtful debts are made for potential loss in amount owed by credit customers. Materiality Concept Definition According to this concept! when recording transactions! the accountant should consider whether disclosure and non.disclosure of such transaction will affect the decisions of persons reading the accounts. Also! the accountant should consider whether the benefits obtained from the particular treatment to a transaction is worth the effort put to it. A classical e$ample here would be the way an accountant will treat a stapler costing 56 in the accounts. Though this item is bought by a business and will be used for several years! it does not have significant value. Implication Some items (stapler! paper clips etc are not considered non.current assets though they may be used by the business for a long period of time. 'ather! their costs are written off at one against profit in the period they are bought. Consistency Concept Definition

All similar items need to be given the same accounting treatment in the same accounting period and from one period to another. 7nless there is a valid reason! no changes are allowed in the accounting policy chosen. This concept especially prevents accountants from manipulating the results of a business by simply changing the accounting policies Implication