MOMBASA CAMPUS
Accounting.
There are a number of various accounting concepts and principles. They include;
Under the prudence concept, do not overestimate the amount of revenues recognized or
underestimate the amount of expenses. You should also be conservative in recording the
amount of assets, and not underestimate liabilities. The result should be conservatively-stated
financial statements.
This concept states that the accountant should always exercise caution when dealing with
uncertainty while, at the same time, ensuring that the financial statements are neutral – that
profits and losses are neither overstated nor understated. (Frank Wood – 10th edition 2005).
Its importance in Financial Accounting is that the accountant is required to write down fixed
assets when their fair values fall below their book values, but which do not allow you to write
The going concern principle is the assumption that an entity will remain in business for the
foreseeable future. Financial statements are prepared on the assumption that the business will
Under this principle, revenue and expense recognition may be deferred to a future period,
when the company is still operating. Otherwise, all expense recognition in particular would
be accelerated into the current period. An entity is assumed to be a going concern if there is
This concept importance to Financial Accounting implies that financial statements do not
represent a company’s worth if its assets were to be liquidated, but rather that the assets will
be used in future operations. This concept also allows businesses to spread (amortize) the cost
3. Materiality Concept
The materiality concept of accounting states that all substantial items must be properly
material or important if its inclusion or omission significantly impacts the decision of the
Its importance to financial accounting is that it enables users of financial information make
decisions as transactions should be recorded when not doing so might alter the decisions
made by a reader of a company's financial statements. This tends to result in relatively small-
size transactions being recorded, so that the financial statements comprehensively represent
financial statements.
b) Cumulative effect: accountants not only take into account the individual amounts but
c) Nature of the item: depends on the cash amount as well as nature of the item or event.
4. Consistency Concept
Once a business chooses to use a specific accounting method, it should continue using it on a
go-forward basis. By doing so, the financial statements prepared in multiple periods can be
reliably compared.
Each business should try to choose the methods which give the most reliable picture of the
business. This cannot be done if one method is used in one year and another method in the
next year. The consistency concept says that when a business has once fixed a method for the
accounting treatment of an item, it will enter all similar items that follow in exactly the same
This is important in Financial Accounting as it’s easier for users to compare past and current
5. Accruals Concept
The accruals concept says that net profit is the difference between revenues and the expenses
consumed. This concept means that a business may recognize sales, profits and losses in
amounts that vary from what would be recognized based on the cash received from customers
It is the most fundamental principle of accounting which requires recording revenues when
they are earned and not when they are received in cash, and recording expenses when they
liabilities and retained earnings which improves analysis of the company’s financial
This concept states that accounting should show a transaction in accordance with its real
substance which is, basically, how the transaction affects the economic situation of the
business and will not reflect the exact legal position concerning that transaction. This is
because legal form of a transaction can differ from its real substance. (Frank Wood, 2005).
This concept is the basis of the fundamental accounting equation: Assets = Liabilities +
Capital.
This states that there are two aspects of accounting, one represented by the assets of the
business and the other by the claims against them. The concept states that these two aspects
This is equation forms the most fundamental aspect of Financial accounting; therefore its
importance is utmost.
It states that financial statements are prepared at regular intervals of one (fiscal/calendar)
year. For internal management purposes they may be prepared far more frequently, possibly
This makes presentation of financial statements to relevant users for decision making all the
The transactions of a business are to be kept separate from those of its owners. By doing so,
statements. Accounts are kept for entities and not the people who own or run the
company/business.
The business entity concept implies that the affairs of a business are to be treated as being
quite separate from the non-business activities of its owner(s). The items recorded in the
books of the business are, therefore, restricted to the transactions of the business (Frank
Wood, 2005).
This concept states that for an accounting record to be made it must be able to be expressed in
monetary terms. For this reason, financial statements show only a limited picture of the
business.
Accounting information has traditionally been concerned only with those facts covered by (a)
This limitation is referred to as the money measurement concept, and it means that
accounting can never tell you everything about a business. For example, accounting does not
e) Whether a rival product is about to take away many of the best customers,
f) Whether the government is about to pass a law which will cost the business a lot of
1. Users
Management accounting: It aims at preparing and reporting the financial data to the
financial information to parties within the organization itself. Users include Top, middle and
2. Measurement
terms of money/monetary values. This is because the final recipients of the necessary
information are only interested in the financial position of the business or its bottom line.
Management accounting: Management accounting may adopt any measurement unit like
labour hours, machine hours or product units for the purpose of analysis. This is because the
consumers of this information are interested in increasing production/revenues while
Financial accounting: It is a discipline by itself and has its own principles, policies and
conventions to adhere to. Among these are discussed above i.e. money measurement concept,
Financial accounting: focuses on historical data. This mean its information prepared through
the use of past events that took place in running the business.
Management accounting: focuses on the future. This means that its presented information is
5. Time interval
Financial accounting: Here, data is presented for a definite period, say one (fiscal/calendar)
weekly or even daily and are presented to users on request. (Britton & Waterston, 2013).
6. Aggregation
7. Efficiency
Financial accounting reports on the profitability (and therefore the efficiency) of a business.
Managerial accounting reports on specifically what is causing problems and how to fix
8. Proven information
Financial accounting requires that records be kept with considerable precision, which is
Managerial accounting frequently deals with estimates, rather than proven and verifiable
like Tax Accounting are based on cash basis”. Discuss the validity of this statement with
justifications.
method, businesses record revenue from sales and expenses from purchases when and as they
are earned and incurred. This is regardless of whether cash from sales has been collected or
cash for purchases has been paid. To determine the sale or purchase transaction date for
recording, business entities must determine the completeness of the sale or purchase.
Recording doesn’t take place until the completion of the sale or purchase orders.
Tax accounting often is referred to as cash-based accounting, and thus focuses primarily on
actual cash receipts and cash payments, rather than their related sale or purchase transactions.
Companies don't record a sale or purchase transaction at the time of the transaction until cash
Business Impact
The accrual-based financial accounting and the cash-based tax accounting can impact a small
business differently. While financial accounting can accurately track business transactions as
they are taking place, it doesn't show a business's actual cash reserve situations. A small
business using the accrual method may report a good level of income in its accounting books
but may be low on cash at its bank account if customers haven't paid yet. The cash-based tax
accounting allows a small business to follow its cash situations more closely. But on the other
hand, the cash-based method may mislead on a business's profitability if customers all pay
their bills in a single period, causing a jump in cash receipts. (Jay Way, 2007).
Tax Impact
The election of an accounting method for business recording and financial reporting will have
a tax impact on a small business because the same accounting method often is also used for
preparing tax returns. Depending on the time of the year when a business transaction occurs
and when the monetary settlement takes place, a small business may pay more or less on
taxes for its current tax year. For example, using cash accounting, if a small business didn't
make cash payment for a current-year purchase until next year, it could not declare a tax
deduction on the purchase expense and thus would pay more taxes for the current tax year.
References
2. Jay Way (MBA), (2007). Financial Reporting Accounting vs. Tax Accounting 3(1) . Retrieved
16 March 2018, from Chron Web site: http://smallbusiness.chron.com/financial-reporting-
accounting-vs-tax-accounting-15390.html
5. Britton, A., & Waterston, C. (2013). Financial accounting. Harlow: Financial Times Prentice
Hall.