Accounting Concepts

and Principles

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Users of Financial Statements
• Investors
– Need information about the profitability, dividend yield
and price earnings ratio in order to assess the quality
and the price of shares of a company
• Lenders
– Need information about the profitability and solvency of
the business in order to determine the risk and interest
rate of loans
• Management
– Need information for planning, policy making and
evaluation
• Suppliers and trade creditors
– Need information about the liquidity of business in order
to access the ability to repay the amounts owed to them
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• Government
– Need information about various businesses for statistics
and formulation of economic plan
• Customers
– Interested in long-tem stability of the business and
continuance of the supply of particular products
• Employees
– Interested in the stability of the business to provide
employment, fringe benefits and promotion opportunities
• Public
– Need information about the trends and recent
development

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Limitations of conventional
financial statements
• Companies may use different
methods of valuation, cost calculation
and recognizing profit
• The balance sheet does not reflect
the true worth of the company
• Financial statements can only show
partial information about the
financial position of an enterprise,
instead of the whole picture
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Accounting Concepts

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Introduction
• Actually there are a number of accounting
concepts and principles based on which we
prepare our accounts
• These Generally Accepted Accounting
Principles (GAAP) lay down accepted
assumptions and guidelines and are
commonly referred to as accounting
concepts

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Accounting Concepts:
1. Business entity
2. Money Measurement
3. Going Concern
4. Historical Cost
5. Prudence/conservatism
6. Materiality
7. Consistency
8. Accruals/matching

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Business Entity

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Business Entity
• Meaning
– The business and its owner(s) are two
separate existence entity
– Any private and personal incomes and
expenses of the owner(s) should not be
treated as the incomes and expenses of
the business

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• Examples
– Insurance premiums for the owner’s
house should be excluded from the
expense of the business
– The owner’s property should not be
included in the premises account of the
business
– Any payments for the owner’s personal
expenses by the business will be treated
as drawings and reduced the owner’s
capital contribution in the business

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Money Measurement

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Money Measurement
• Meaning
– All transactions of the business are
recorded in terms of money.
– It provides a common unit of
measurement
• Examples
– Market conditions, technological
changes and the efficiency of
management would not be disclosed in
the accounts
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Going Concern

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Going Concern
• Meaning
– The business will continue in operational
existence for the foreseeable future
– Financial statements should be prepared
on a going concern basis unless
management either intends to liquidate
the enterprise or to cease trading, or
has no realistic alternative but to do so

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• Example
– Possible losses from the closure of
business will not be anticipated in the
accounts
– Prepayments, depreciation provisions
may be carried forward in the
expectation of proper matching against
the revenues of future periods
– Fixed assets are recorded at historical
cost

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Historical Cost

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Historical Cost
• Meaning
– Assets should be shown on the balance
sheet at the cost of purchase instead of
current value
• Example
– The cost of fixed assets is recorded at
the date of acquisition cost. The
acquisition cost includes all expenditure
made to prepare the asset for its
intended use.

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Prudence/Conservatism

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Prudence/Conservatism
• Meaning
– The accountant should always be on the
side of safety and should account for
the least favourable events that may
affect income.
– Provision is made for all known expenses
and losses whether the amount is known
for certain or just an estimation.

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• Example
– The provision for doubtful debts should
be made
– Fixed assets must be depreciated over
their useful economic lives

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Materiality

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Materiality
• Meaning
– This means that anything is presented in
a financial statements should be of
interest to the shareholders/investors.

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• Example
– Small payments such as postage,
stationery and cleaning expenses should
not be disclosed separately. They should
be grouped together as sundry expenses
– The cost of small-valued assets such as
pencil sharpeners and paper clips should
be written off to the profit and loss
account as revenue expenditures,
although they can last for more than one
accounting period
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Consistency

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Consistency
• Meaning
– Companies should choose the most
suitable accounting methods and
treatments, and consistently apply them
in every period
– Changes are permitted only when the
new method is considered better and
can reflect the true and fair view of the
financial position of the company
– The change and its effect on profits
should be disclosed in the financial
statements
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• Examples
– If a company adopts depreciation
straight line method and should not be
changed to adopt reducing balance
method in other period
– If a company adopts weight-average
method as stock valuation and should not
be changed to other method e.g.
first-in-first-out method
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Accruals/Matching

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Accruals/Matching
• Meaning
– Revenues are recognized when they are
earned, but not when cash is received
– Expenses are recognized as they are
incurred, but not when cash is paid
– The net income for the period is
determined by subtracting expenses
incurred from revenues earned

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 Class activity
1. Business entity
2. Money Measurement/stable
monetary unit
3. Going Concern
4. Historical Cost
5. Prudence/conservatism
6. Materiality
7. Consistency
8. Accruals/matching
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1. The assumption that the firm is
going to continue to operate.__
2. Account for the least favourable
effect on income.___
3. The unchanging use of the policies
decided upon.__
4. The firm is operating apart from its
owners.__
5. Account for all expenses and
revenues of a period.__
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6. Transactions of monetary concerns
are recorded.__
7. Assets shown at purchase price__
8. All small expenses such as postages
are recorded as sundry expenses.__

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Solutions

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1. The assumption that the firm is
going to continue to operate.__Going
2. Account for the least favourable
effect on income.___ Prudence
3. The unchanging use of the policies
decided upon.__ Consistency
4. The firm is operating apart from its
owners.__ Entity
5. Account for all expenses and
revenues of a period.--Accrual
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6. Transactions of monetary concerns
are recorded.___Money
7. Assets shown at purchase price__
Historical
8. All small expenses such as postages
are recorded as sundry
expenses.__Materiality

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