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Accounting Concepts: 1. Business Entity Concept or Separate Entity Concept

1. The document discusses 12 key accounting concepts: business entity, money measurement, going concern, historical cost, prudence, materiality, consistency, matching, realization, duality, substance over form, and time interval. 2. The business entity concept recognizes the separation of a business's activities from its owners' personal affairs. Only transactions related to the business should be recorded. 3. The money measurement concept specifies that only transactions measurable in monetary terms with general agreement on valuation should be recorded, excluding items like workforce quality. 4. Financial statements are prepared assuming a business will continue operating indefinitely per the going concern concept.

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Tawanda Tatenda Herbert
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2K views4 pages

Accounting Concepts: 1. Business Entity Concept or Separate Entity Concept

1. The document discusses 12 key accounting concepts: business entity, money measurement, going concern, historical cost, prudence, materiality, consistency, matching, realization, duality, substance over form, and time interval. 2. The business entity concept recognizes the separation of a business's activities from its owners' personal affairs. Only transactions related to the business should be recorded. 3. The money measurement concept specifies that only transactions measurable in monetary terms with general agreement on valuation should be recorded, excluding items like workforce quality. 4. Financial statements are prepared assuming a business will continue operating indefinitely per the going concern concept.

Uploaded by

Tawanda Tatenda Herbert
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as DOCX, PDF, TXT or read online on Scribd
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ACCOUNTING CONCEPTS

1. Business entity concept or Separate entity concept


It recognises the fact that the personal activities of owners are quite separate from the affairs of the
business enterprise. Matters which do not relate to the business such as private transactions should not
be recorded in the books of the entity.
Examples
 Payment of private rentals from the owner’s private resources should be excluded from
the business expenses.
 The owner’s buildings should be excluded from the business’s building account.

NB Any payment of private expenses from the business resources affects the entity and should be
accounted for as drawings. Likewise, payment of business expenses from personal resources constitutes
capital to the business.

2. Money measurement concept


It implies that only transactions which are capable of being measured or expressed in monetary terms
and for which there is a general agreement on the measurements should be recorded in the books.
This means those items which cannot be quantified in monetary terms are considered to be outside the
purview of accounting and therefore not recorded even though they might be valuable to the business.
Items which are normally excluded from the financial statements because they cannot be measured in
monetary terms and there is no general agreement on the measurements include:
 Skilled workforce
 Strategic location of the business
 Reliability of suppliers
 Customer loyalty
 Quality of management

3. Going concern concept


Financial statements should be prepared on the basis that the entity will continue in operational
existence for the foreseeable future. Effectively, this means management has no intention to cease
trading or the business is not likely to be liquidated in the near future.
Examples
 Non-current assets are recorded at historical cost less accumulated depreciation rather than
their net realisable or market value.
 Inventory is valued on the basis that it will be sold in a normal course of the business rather than
in a forced sale.
 Non-current liabilities remain as long-term liabilities but if a firm is not a going concern the non-
current liabilities are reclassified as current liabilities.

1 Compiled by T T Herbert (0773 038 651 / 0712 560 772)


4. Historical cost concept
Assets should normally be stated at the cost of purchase (original cost) instead of their current value.
Thus, no account is taken of changing prices in the economy. This means during inflationary conditions
the applicability of this concept is considered to be misleading.
Example
 If an asset is purchased, it is recorded at the price paid to acquire it and that cost is considered
to be the base for all future accounting.

5. Prudence or conservatism concept


Here profits or income are not recognised until the firm is reasonably certain that they will be realised.
On the other hand, losses and expenses should be provided for as soon as there is a reasonable chance
that they will be incurred in the future.
This embraces a cautious view as optimism is exhibited when making judgments about uncertain items
such as possible expenses and pessimism is displayed when it comes to anticipated income. In general,
profit and assets should be understated and losses and expenses overstated.
Examples
 Providing for bad and doubtful debts.
 Valuing inventory at the lower of cost and net realisable value.
 Depreciating assets over their useful economic life.

6. Materiality concept
It suggests that trivial or insignificant items should not be presented separately but may be aggregated if
they are to be presented. Materiality depends on the nature and size of an item being considered. An
item is considered material if its omission would influence the economic decision of the users.
Examples
 It is common practice, to group together items such as payments for postage, printing and
stationery and disclose them as sundry expenses in the financial statements.
 The cost of small items such as staplers, punchers and ashtrays is usually written off in the
statement of comprehensive income as revenue expenditure although these items normally last
for more than one financial period.

7. Consistency concept
It takes the view that entities should choose the most suitable accounting policies, procedures and
treatments and consistently apply them from period to period unless a change is required by legislation
or it is reasonable to do so.
As a general rule financial statements should be prepared in a uniform manner to enable shareholders
to measure any progress or deterioration of their business from year to year.
There is a requirement to disclose any change in accounting policies as well as the impact of any change.

2 Compiled by T T Herbert (0773 038 651 / 0712 560 772)


Examples
 Once a firm has adopted the FIFO method of stock valuation, this should not be changed to
other methods such as AVCO unless it is justified to do so, that is, if it will result in a fairer
presentation of accounts.
 A company currently using the straight line method cannot just change to reducing balance in
the next period.

8. Matching or Accruals Concept


Revenue should be recognised in the period in which they are earned rather than in the period when the
relevant cash is received.
Likewise expenses should be recognised in the period they are incurred rather than in the period when
cash is paid.
The essence of this concept lies in the view that all expenses which are associated to a certain period
should be matched with the relevant revenues associated to the same period in order to determine
profit or loss for the period.
Examples
 Expenses incurred but not yet paid in the current period are normally treated as accrued
expenses in the current income statement and shown as current liabilities in the current
statement of financial position.
 Expenses paid for now though they will be incurred in the next accounting period will be treated
as a current asset in current statement of financial position and deducted from the current
period in the income statement.

9. Realisation concept
Accounts recognise transactions if an event has crystallised, that is, if it is probable that revenue will be
received. This means revenue is recognised when activities have been substantially completed.
Examples
 Goods sent to customers on sale or return basis are part of our closing stock and are not treated
as normal sales unless a customer has accepted the responsibility to pay for the goods.

10. Dual Aspect or Duality concept


This concept is the basis of the double entry bookkeeping system. In essence, every transaction involves
two entries in the books. It implies that for every debit entry there should be a corresponding credit
entry. Thus the accounting equation of the duality concept can be represented as follows:

Equity + Liabilities = Assets

Examples
 Cash received from a debtor is accounted for by increasing cash (debit entry) and reducing the
amount owed by the debtor (credit entry).

3 Compiled by T T Herbert (0773 038 651 / 0712 560 772)


11. Substance over form concept
In legal terms the asset acquired on hire purchase terms only becomes the property of the buyer after
paying the last installment. However, in substance the asset can be said to be the property of the buyer
as he uses it to derive economic benefits. Thus for accounting purposes the asset is taken to be the
property of the buyer and is recognised in his books.

12. Accounting period or time interval concept

Examination questions

Question 1
Explain the following concepts:

a) The historical cost concept [5]


b) The money measurement concept [5]
c) The business entity concept [5]
d) The dual aspect concept [5]
e) The time interval concept [5]
(Fin acc 1-ICMZ October 2008)

4 Compiled by T T Herbert (0773 038 651 / 0712 560 772)

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