Topic 2: Accounting Concepts
What is the Accounting Entity Concept?
Accounting Entity Concept – Each business is a separate entity from its owner.
For accounting purposes, the business is regarded as an accounting entity or a business entity. It exists as a unit by itself, separate from its owner. This means that all financial information relating to the business is recorded and reported separately from the owner’s personal financial information.
What is the Going-Concern Concept?
Going-Concern Concept – The business entity will continue to operate indefinitely.In accounting, the business is always assumed to be a going concern, i.e. to operate for an indefinite period of time.
What is the Accounting Period Concept?
Accounting Period Concept – The life of a business is divided into specific periods of time for the purpose of preparing financial reports.
The accounting period may be a month, a half-year, a full year, or any other length of time, depending on the volume and nature of the business.
What is the Historical Cost Concept?
Historical Cost Concept – All transactions of a business entity are recorded at the original cost to the business.
Resources are recorded at the actual values at which they were bought or sold, called ‘historical costs’. This means that a piece of land purchased years ago is still recorded at its original cost even though its value is considerably higher now. This practice is based on the assumption that the business is a going concern and is not likely to be liquidated, so the market or realizable value is not relevant.
Alice, owner of Courts, bought a TV at $5,000. Her friend, Miss Chew offered to buy it from her at $10,000. Based on historical cost concept, Alice should only record the TV in her books as $5,000.
What is the Matching Concept?
Matching Concept – Revenue earned during an accounting period has to be matched with the expenses associated with earning that revenue.
Impress Furniture sold a sofa set for $1,000 to a customer on 25th December 2001. The cost of the sofa set is $350. In 2002, a dining set which cost $150 was sold for $800.In this case, the sale of $1,000 should be matched with the cost of $350 for the year 2001. The sale of $800 should be matched with the cost of $150 for the year 2002.
What is the Materiality Concept?
Materiality Concept – This concept requests the disclosure of information which, if known to users, would seriously affect them in decision-making.
Example: Impress Furniture’s book-keeper forgot to record a sale of furniture $100 made in 2001. The total sales of the business for 2001 amount to $5 million.The omission to record the $100 sale is immaterial because it has no serious effect on those who use the profit figure in decision-making.
What is the Monetary Concept?
Monetary concept – This concept states that only transactions which can be measured in money terms are recorded.
What is the Prudence (also known as Conservatism) Concept?
Meaning: If an accountant is given two alternatives of reporting an item, the alternative which gives a lower profit or lower asset value should be adopted.
The following examples indicate the application of conservatism in accounting:
Valuation of closing stock at cost price or market price whichever is less
Creating provision for bad debts
Writing off fictitious assets from the books as early as possible
What is the Consistency Concept?
The same accounting method should be applied in each accounting period when preparing financial reports. If a certain method of accounting treatment had been applied to an item, the same method is applied in the future.
What is the Objectivity Concept?
There must be objective verifiable evidence for reporting any accounting information.According to this principle, a business transaction should be supported by documentary evidence. Objectivity means the document should contain facts in an unbiased manner. Accounting should be done without prejudice.
What is the Realisation Concept?
This concept states that income should be recorded as earned in the period in which goods or services are provided to customers by the business.
What is the Monetary Concept?
This concept means that only transactions which can be measured in money terms are recorded.