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ACCOUNTING PRINCIPLES

The preparation of Income Statement and Balance Sheet of a business is


based on certain assumptions. These assumptions are called Accounting
Concepts/Principles.
Accounting concepts are very helpful in applying commonly established
procedures in preparing financial statements.
Observance of accounting principles makes accounting records and
information (results) true and fair, making them reliable, realistic and
understandable.
1. Going Concern Concept
Accounts are kept under the assumption 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
requiring the ceasing of business for example persistent losses or
liquidity 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.
2. Historical Cost Concept
Transactions are recorded in terms of the actual amount at which they
occurred in the past.
This concept has the advantage of being objective. The amount at which
a transaction took place cannot be disputed over which is also the
amount found on the document (e.g. invoice) issued or received during
the transaction.
This concept, therefore, eliminates subjectivity associated with valuation
in accounting records.
Implication
Assets and expenses are recorded at the actual amount spent. Revenues
are recorded at actual amount received/ receivable. Liabilities are
recorded at actual amount borrowed, therefore, payable.
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3. Business Entity also known as Accounting Entity Concept


The owner and the business are considered as two different persons,
distinct from each other. The business unit is separate and an
independent body from its owner.
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
Personal transactions and private property of the owner are not recorded
in the books.
Capital and Drawings accounts are kept to record amounts the owner
gives to or takes from the business.
4. Money Measurement Concept
Only those transactions that can be expressed in monetary terms
(financial transactions) are recorded in the books.
Non-financial transactions are therefore not recorded.
Implication
Some strengths or benefits of the business may not be reflected in the
books since they cannot be expressed in money terms examples are
quality of work force and market share.
5. Accounting Period/Year Concept
According to this concept, the lifespan of a business is divided into fixed
period of time (months, quarters, half-years or years) for which accounts
are prepared.
In most cases an accounting period is a year. Note that the accounting
year need not be the same as the calendar year. For example, the
accounting year for business X can be from 1 June to 31 May, for
business B from 1 September to 31 August or for business C from 1 April
to 31 March.
Implication
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Accounts of the business are closed at a specific date every year and
final accounts are prepared (profits/ losses calculated)
6. Accruals Concept / Matching Principle
According to the Accruals concept, when calculating the profit of a given
period, revenues earned in that period need to be matched against
expenses incurred for that same period. This is done irrespective of
amount received as revenue or amount paid for the expenses.
Implication
Adjustment are made in accounts for accrued and prepaid items so that
accounts reflect revenue earned (not amount received) and expenses
incurred (not amount paid for).
7. Prudence Concept/Conservatism
This concept prevents the anticipation of future profits before they are
realised but requires to make provisions for losses as soon as they are
recognised. Accounting records should be maintained on a cautious
basis.
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.
Provisions for doubtful debts are made for potential loss in amount owed
by credit customers.
8. Materiality Concept
The treatment and recording of transactions depends on its significance
in value.
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.
A classical example here would be the way an accountant will treat a
stapler costing $2 in the accounts. Though this item is bought by a
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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.
Rather, their costs are written off at one against profit in the period they
are bought.
9. Consistency Concept
All similar items need to be given the same accounting treatment in the
same accounting period and from one period to another.
Unless 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
The same depreciation method is applied for similar items in the same
period and from one period to another.
10. Dual Aspect Concept
This concept takes into account the two aspects of accounting
represented on one side by the assets of the business and on the other
by the claims against those assets.
This duality is also explained by the accounting equation as follows:
Assets = Capital + Liabilities
What a business owns is what is owes.
Implication
Transactions are recorded using the double entry system whereby each
transaction has a debit entry and a corresponding credit entry.

Mr. Sufyaan