UNIT -6 Basic Concepts And Conventions

FINANCIAL ACCOUNTING

Basic Concepts And Conventions Accounting principles are usually rules and conventions which have been adopted as a general guide to action by the accountancy profession. 1. The Business Entity Concept All accounts are kept in respect of business entities which are distinct from the persons who own or manage these entities. Sometimes the law makes the same distinction, as in the case of a limited company which is a separate legal entity from the shareholders or its Directors. . !oneta"y Concept Accounting uses money to express certain facts of a business and in such a way that they can be a useful expression of the wealth of the business. #. $isto"ica% &Cost' Concept The price paid to acquire an asset is recorded in the books and forms a basis for subsequent treatment. The result is that at any moment of time the values recorded in the books do not necessarily reflect the current value of the assets. The income of the business is measured by the difference between the value obtained for selling its products compared to the cost of the resources used in making them. The costs not yet expended are shown in the balance sheet. (. Goin) Conce"n Concept The accounting system will treat the values on the assumption that the business will continue trading. f the business decides to liquidate or become bankrupt then a different approach to valuation is required. *. +ua% Aspect Concept All business events are regarded as having a dual aspect. n all business transactions equal values are exchanged. !ach transaction involves two entries, a debit entry and a credit entry. !very debit must have a corresponding credit, and vice versa. Since every debit has a corresponding credit, the total debits must at any time equal the total credits. "hether this be so or not is easily ascertained by means of a Trial #alance.

FINANCIAL ACCOUNTING

6. Acc"ua% Concept The income accruing to the owner of a business is not necessarily the amount of cash actually received in a period of account. $any difficult problems arise in deciding how much income has actually accrued in any period. Accrual of income is always measured over a period of time which is normally the accounting year. !xpenses are costs incurred in earning revenues. Those expenditures which may be charged against revenues for a period will be considered as operating expenses. The accrual concept is applied both in ascertaining the revenues for a period and in ascertaining the expenses to be charged against the revenues. ,. The -ea%isation Concept %evenue is considered as earned on the day which it is realised and this is when goods are transferred to the customer in exchange for a valuable consideration. The Accountant usually uses the date the product is shipped to the customer or the date on the invoice, whichever is the later. .. Conse"vatis/ "hilst the accountant will be prepared to anticipate possible future losses, he is not prepared to bring into account possible future profits, however likely these may be. "henever a decision is to be made on the valuation of assets he will generally decide in favour of that valuation which underestimates the profits or the balance sheets values of the firm. 0. Consistency This means that whilst certain alternatives are considered equally acceptable, the accountant having adopted one, must follow that method over a reasonable period of time. "hilst changes of methods may be made it is accepted that these should not be made frequently nor for the purpose of mis&representing the profits of the firm. 11. !ate"ia%ity This means that the si'e of the amount will influence the treatment of it. (umbrous controls and procedures should not be applied to items of small importance. Similarly, in presenting final accounts and #alance Sheets of a large company, the figures will be rounded off to the nearest dollar.

FINANCIAL ACCOUNTING

22A3

- +isc%osu"e o4 Accountin) 3o%icies

The first sentence of SSA) * sums it up+ , t is fundamental to the understanding and interpretation of financial statements that those who use them should be aware of the main assumptions on which they are based., The Standard therefore sets out ,to improve the quality of information disclosed, by ensuring that the principle accounting policies adopted in drawing up a set of accounts are clearly explained in the notes to those accounts. The terms used in the Standard are classified into three tiers+ -. .undamental accounting concepts & the basic assumptions which underlie all accounts, and specifically+ a/ 0going concern0 & the assumption that the business will continue to trade for the foreseeable future, and so assets are valued at historic cost, less depreciation if applicable, rather than at their forced sale value at the accounting date. b/ 0accruals0 & determines when transactions should be entered in the accounts. %evenue and costs are recognised as they are earned or incurred rather than as money is received or paid. c/ 0consistency0 & there should be consistency of accounting treatment of like items each year and from one year to the next. d/ 0prudence0 & controls when items can appear in the )rofit and 1oss Account. ncome and profits should not be anticipated. They should be included in the accounts only when realised in cash or other real assets. 2owever, liabilities should be included, at least as an estimate, as soon as they are known with reasonable certainty. *. Accounting bases & the various alternative ways these fundamental concepts have been or can be applied to financial transactions. 3. Accounting policies & the specific accounting bases adopted by the business in question. n some circumstances more than one accounting basis is acceptable. Accounts should therefore disclose which ones have been used so that readers of the accounts can more fully understand them and can make meaningful comparisons between different businesses. n the absence of any clear statement to the contrary it is presumed that the four fundamental accounting concepts have been followed.

FINANCIAL ACCOUNTING

SSA) * was issued in 4ovember -56- and remains the current standard for company accounts. The AS# issued exposure drafts for a revised Statement of )rinciples in -557 and $arch -555 which will eventually replace SSA) * and will reduce the emphasis previously placed on the prudence and accruals concepts. 4ow replaced by .%S &-8