BM4112/ IT2853

PRINCIPLES OF FINANCIAL ACCOUNTING

TOPIC 5:
ACCOUNTING PRINCIPLES

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Accounting Principles
Accounting/ Business Entity
Monetary Measurement
Historical Cost
Accounting Period
Accrual (Revenue Recognition & Matching)
Going Concern
Conservatism/Prudence
Consistency/Comparability
Disclosure
Objectivity/Reliability
Materiality
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Accounting/ Business Entity
The owner and business are treated as
separate entities

They are accounted for separately

Transactions are recorded from the

viewpoint of the business

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 Monetary Measurement

Transactions are recorded using money

Money is used as the unit of measurement

Assets, liabilities, revenue and expenses are

expressed in dollars & cents

Transactions that cannot be measured in $ will

not be recorded

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Historical Cost

Transactions are recorded using the cost at the point of

transaction
Historical cost or Original cost
Example
A business bought a building for $500,000 in 20X4. In 20X9,
the market value of the building had gone up to $900,000.

Should the business adjust the cost of building from

$500,000 to $900,000?
Answer: No, should remain as $500,000
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Accounting Period
Transactions that occurred in the month have to
be recorded in that month.

Estimates are used in preparing the financial

statements.

Eg. When the financial statements for March are

being prepared, the electricity bill for March has
not been received. So an estimate of the
electricity expense for March has to be made.

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Accounting Period

Business is assume to continue indefinitely.

Futile to evaluate business performance at the end of life

span.

Divide life span into fixed periods of time

• Financial statements are prepared for a period of time

Example
• Statement of Comprehensive Income can be prepared for
 A month ; month ended 31 March 20x8
 A year ; year ended 31 December 20x8

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Accrual

Accrual is made up of TWO principles:

 Revenue Recognition

 Matching

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Accrual – Revenue Recognition

Revenue is earned and recorded when goods

are delivered or services performed.

Cash may be collected later on.

For example, a painting contractor completed a

job in July and payment was received in August.
When should revenue be recognized?

Answer: July
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Accrual – Matching

Expenses incurred must match against the

revenue earned and recorded in the same
period.

Purchases and expenses are recorded when

the goods and services have been received.

For example, salesman’s salaries and

commission for March should be match with
March’s sales.

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Going Concern

In accounting, we assume that the business will

continue to operate for the foreseeable future.

This means the business is not going to stop or close

down.

Example
Land is shown at $2m. This is the cost it was bought. If
the business had to close down, the land would be
shown at the closing down value. This value might be
less than $2m.

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Conservatism/ Prudence

 In accounting for transactions, accountants tend

to be cautious and pessimistic.

 Assets/revenue should not be over recorded.

 Revenue should not be recorded unless it is

earned

 Inventories are stated at the lower of cost or

realisable value.

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Conservatism/ Prudence
 Liabilities / expenses should not be under
recorded.

 Possible losses should be recorded.

 If a business is being sued and is likely to lose

the case, it should record the loss even if the
court verdict is not known

 business needs to accrue for its utilities

expense for the month, it should estimate a
higher amount.

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Consistency/ Comparability

Accountant uses same basis to prepare financial

statements every year.

E.g. If a straight line method is used for

depreciation, the method should not be changed.

Allows for meaningful comparison of financial

results from period to period.

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Disclosure

The business should report (disclose) enough

information to the users of its financial
statements.

The business also needs to let the users know of

any important events of the business.

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Objectivity/ Reliability
 All transactions reported must be based on
objective evidence
 Facts, not subjective
 Then the accounting information reported is
accurate
 Users can rely on this information.

What is the objective evidence for:

Estimating the allowance for impairment of
receivables?
Answer: Historical data and Receivables Ageing Report
Recording of purchase cost of fixed assets?
Answer: Invoice/ Receipt
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Materiality

 Business are required to account for transactions that

are significant or substantial.

 What amount is considered material?

Affect the decision of users of the financial
statements.
Example

Business buys a sharpener for $10 and records it as a

fixed asset. Depreciation of $0.50 for the sharpener is
recorded each month.

For immaterial items, the principle allows writing off the

value in the easiest and most convenient way (treat as
expense rather than fixed asset).
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 Application of Accounting Principles
when recording transactions

On 1 November, 20x8, Chris Chee started a sole proprietorship

called NetSolutions.

The business provides web design and software applications

services to individuals and small businesses at a fee.

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 Which accounting principle/(s) is/(are)
applicable for this transaction?

Entry A.
A, E, D L, R, C
Owner deposits $25,000 in
a bank account for Increase Debit Credit
NetSolutions on 1 Nov. Decrease Credit Debit

General Journal
Date Description Debit Credit
1/11 Cash $25,000
Capital $25,000

Business Entity Concept

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 Which accounting principle/(s) is/(are)
applicable for this transaction?

Entry B.
NetSolutions buys equipment A, E, D L, R, C
for $20,000 (special price) Increase Debit Credit
cash on 2 Nov. Market value is Decrease Credit Debit
$22,000
General Journal
Date Description Debit Credit
2/11 Equipment $20,000
Cash $20,000

Historical Cost Objectivity/ Reliability

Going Concern Conservatism/ Prudence

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 Which accounting principle/(s) is/(are)
applicable for this transaction?

Entry C. A, E, D L, R, C
On 5 Nov, NetSolutions Increase Debit Credit
purchased $1,350 Decrease Credit Debit
supplies using cash.

General Journal
Date Description Debit Credit
5/11 Supplies $1,350
Cash $1,350

Objectivity

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 Which accounting principle/(s) is/(are)
applicable for this transaction?

Entry D. A, E, D L, R, C
NetSolutions provided Increase Debit Credit
services on credit, $7,500 Decrease Credit Debit
on 8 Nov.

General Journal
Date Description Debit Credit
8/11 Accounts Receivable $7,500
Fees Earned $7,500

Accrual - Revenue Recognition

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 Which accounting principle/(s) is/(are)
applicable for this transaction?
Entry E.
NetSolutions incurred the followig
A, E, D L, R, C
expense in Nov but not paid:
Increase Debit Credit
Salaries : $2,125;
Rent : $800; Decrease Credit Debit

Utilities : $450
General Journal
Date Description Debit Credit
28/11 Salaries $2,125
Rent $800
Utilities $450
Other payable $3,375

Accrual - Matching Principle Accounting Period 23

 Which accounting principle/(s) is/(are)
applicable for this transaction?

Entry F.
A, E, D L, R, C
Chris Chee withdraws
Increase Debit Credit
$2,000 in cash for personal
Decrease Credit Debit
use on 30 Nov.

General Journal
Date Description Debit Credit
30/11 Drawings $2,000
Cash $2,000

Business Entity
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LECTURE ILLUSTRATION 1

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