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Accounting concepts

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Archford Nyika
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6 views

Accounting concepts

Uploaded by

Archford Nyika
Copyright
© © All Rights Reserved
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
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Accounting concepts

 These are rules that all accountants use when preparing the financial statements of a
business
 Some of these rules are enshrined in law and in international accounting standards
 The application of these rules by all accountants means that users of the financial
statements can rely on the information they contain
 The major accounting concepts include the following:

1. The business entity concept

 The business entity concept states that only the revenues and expenses relating to the
business are recorded in the business books of accounts
 Transactions relating to the private affairs of the owner are not part of the business.
Therefore, they should not be included in the business books of accounts
 The transactions of a business should be kept completely separate from the personal
transactions of its owners.
 For example, the owner's private electricity bills should not be included as business
expenditure

2. Historic cost concept

 The actual price paid for the assets, expenses and liabilities should be recorded in the
books
 The advantage of recording assets and expenses at historic value is that their value can be
checked easily against the amounts recorded for the price on invoice and receipts
 However, the market value of some assets e.g. land may change significantly over time.
These assets should be recorded at the new revalued amount.

3. Money measurement concept

 All business transactions that can be expressed in monetary terms should be recorded in
the business books of accounts.
 Items that are difficult or cannot be recorded in monetary terms should not be entered in
the business books. Examples of such items include the following:
1. The skill and efficiency of the workforce
2. Good customer relations
3. Good after-sales-service
4. Management expertise

4. The going concern concept

 A business is a going concern if it is able to continue trading or providing service to earn


revenue well into the future
 Financial statements should be prepared on the assumption that the business will continue
trading for the foreseeable future and that the owners have no intention to close it down
 This means that the assets of the business can be valued at cost less accumulated
depreciation
 If there's any reason to believe that the business cannot continue its operations, it's assets
will need to be recorded at their realizable value

5. Consistency concept

 The concept requires that once a method of treating information has been established, the
method should continue to be used in subsequent years' financial statements
 If information is treated differently each year, inter-year results cannot be compared. It
will be difficult to determine trends
 For example, a company should not change from using straight-line method of
depreciation one year to using reducing balance method in the next year.
 A business should only really change its accounting methods if the new methods would
give more appropriate financial results

6. Prudence concept

 Prudence requires that revenues and profit are only recorded in the books when they're
realized or their realization is reasonably certain
 Profit should not be overstated by ignoring foreseeable losses
 The prudence concept allows provision to be made for all expenses and losses when they
become known.
 The phrase ‘never anticipate a profit, but provide for all possible losses’ is often used to
describe the principle of prudence.

7. The realisation concept

 The realisation concept states that profits are normally recognized when the title to the
goods passes to the customer, not necessarily when money changes hands
 Goods sent on sale or return are not sales, and therefore should not be treated as sales
until the potential customer has indicated that they wish to purchase the goods
 Goods sent on sale or return remains as inventory in the sender's books of accounts

8. Duality concept

 Every transaction has two aspects (debit and credit) and both aspects should be recorded
in the business books of accounts.
 The duality concept is the basis of all double-entry booking and accounting equation
 Each transaction has an effect on both of the following aspects:
1. Assets of the business
2. Capital or liabilities of the business

9. Materiality concept

 It applies to items of very low value (that are immaterial) which are not worth recording
as separate items
 Expenditures that are not important cannot materially affect the profits of a business
 Individual items which will not affect materially the profit or value of a business do not
need to be recorded separately
 Such small expense items can be recorded in total as sundry expenses or general expenses

10. The matching concept


 It is also known as the accruals concept
 It is an extension of the realisation principle to include other income and expenses.
 The revenue of the accounting period is matched against the costs of the same period (the
timing of the actual receipts and payments is ignored).
 The figures shown in an income statement must relate to the period of time covered by
that statement, whether or not any money has changed hands.
 Accrued income and expenses must be included in the calculation of profit
 Prepaid incomes and expenses must be excluded in the calculation of profit

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