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Accounting Concept or Principles

The principles of accounting are built on a foundation of a few basic concepts. They are basic rules that are applied when
recording transactions and preparing financial statements. These rules must be applied for accounting records to provide
reliable information
The basic concepts used in accounting are:
Concept
Assumption/
Explanation
Definition
All transactions Only transactions that can
(1) Money
are recorded in be recorded in monetary
measurement
the
common terms are recorded in the
or Monetary
monetary unit
accounts.
Non
current
asset,
inventory, trade payable
and trade receivable can
be recorded in the books
as they have resulted
from transactions that can
be expressed in monetary
terms
business The owner and the
(2) Entity or The
unit is separate business are separate.
Business
from the owner. This is shown by the
concept
credit balance in the
capital account which
shows that the owner is a
creditor as the business
owes
him
money.
Personal
assets
and
liabilities are excluded
from
the
business
accounts. If the owner
owns separate businesses,
each one is treated
separately.
(3)
Going The business is
assumed to carry
concern
on its operation
indefinitely and
is not likely to
be liquidated in
the foreseeable
future.
(4) Historical Business events
and transactions
cost
are recorded at
the
historical
cost of that
event
or
transaction

Significance

Criticisms

It
enables
many
otherwise unlike items
to be added together. It
also makes it possible to
compare
financial
statements
between
different businesses.

By using this concept,


accounting does not give
a complete account of
the happenings in a
business. This means
that we are not taking
some important factors
such as skills of workers
(as they cannot be
measured)
into
consideration hence not
showing the true value
of the business.
When the owner lives on
his business premises, it
is quite difficult to
apportion
expenses
between business and
private.

This concept enables the


accountant to draw a line
between assets/liabilities
of the business and that
of the owner. In
recording events in
accounting the important
question is: How do
these events affect the
business? and not the
owner

Unless, there is good Historical cost instead of


evidence to the contrary, realizable value is used.
accounting assumes that
the business will continue
operation
for
an
indefinitely long period in
the future.

The convention could be


revoked if the business
is about to be liquidated,
so, liquidating value
would be used.

An asset is ordinarily
entered in the accounting
records at the price paid
to acquire it (i.e. at its
cost) and that this cost is
the
basis
for
all
subsequent
accounting
for the asset.

It ignores the changing


value of money. In times
of inflation financial
statements might be
misleading
and
meaningless.
Like
money
measurement,
historical cost concept
does not allow things
that do not have
monetary value to be
recorded in the books.

Assets purchased and


liabilities incurred many
years ago are still
recorded at their original
costs even though their
market value might be
different now.

(5)Dual aspect

Assets= Capital
- Liabilities

The concept of duality


recognizes that there are
two aspects for each
transaction- represented
by debit and credit entries

(6) Prudence The adoption of Profits should not be


cautious
overstated and losses
or
accounting
should be provided for as
conservatism
soon
as
they
are
concept
recognized. Profits must
be realistic
Example: Writing off bad
debt
and
valuing
inventory at lower of cost
and net realizable value

Revenues
is In
general,
trading
generally
industries usually choose
recognized
to recognize revenue
when it had when
goods
are
been earned
delivered.
Example: When a trader
sends goods on sales or
return
basis
to
a
customer, no sales take
place until the customer
informs the seller that he
has decided to buy the
good
revenue Only revenue relevant to
(8) Matching All
earned in an an accounting period and
/other
accounting
expenses relevant to that
receivables
and
other period should be periods revenue are
matched against recognized.
payables
all costs and Example: Other payable
concept
expenses
and other receivable
incurred
in
generating
revenues
All accounting Once a company has
(9)
practices being decided on a certain
Consistency
used should be method of accounting for
consistent
a given class of events, it
within
one will use the same method
accounting
of accounting for all
period
to subsequent events of the
another.
same character unless it
has a sound reason to do
otherwise.
Example
applying
straight line method of
depreciation every year.
(7) Realisation

The resources owned by


a business are called
assets. The claims of
various parties against
these assets are called
liabilities. What the
business owns (assets)
has been provided by the
owner (capital) and
external
parties
(Liabilities)
All assets and revenues
are reported at the
lowest
of
several
possible values. All
liabilities and expenses
are reported at the
highest
of
several
possible values. All
anticipated losses are
reported even before
they
occur.
Only
realized
profits
are
reported.
In measuring revenues
the basic guide is the
realization
concept,
which is that revenues
are generally recognized
in the period in which
goods are delivered to
customers

Every event that is


recorded in the accounts
affects at least two
items; there is no
conceivable way of
making a single change
in the accounts.

The
application
of
prudence concepts leads
to creation of secret or
undisclosed reserves (in
the form of provision)

By using this concept,


profit is not equivalent
to cash.

Revenue and expenses Is much most complex


reported should be for that
cash
basis
the same period. Any accounting.
expenses
charged
against the revenue of
that period concerned
must be associated to the
production
of
the
revenue.
Helps
to
avoid
misleading interpretation
of items within one
accounting period. Also
enable
effective
comparison
of
the
results of one accounting
period to another.

The convention does not


prevent any change in
accounting method if
there is a need to do so.

(10)
Materiality

The treatment of
an item depends
on
its
importance and
relevance

(11) Substance The substance of


a
transaction
over form
takes
precedence over
the legal form of
the transaction.

(12)
Objectivity

(13)
Subjectivity

The use of a
method which
all can agree to.

The degree of importance


and relevance varies from
firm to firm and from
situation to situation/
What is material for one
firm is not material for
another.
The
practical
view
(substance) is preferred to
legal view (form) in the
accounting
treatment.
Basically, it is that
accounting should show
the economic reality of a
transaction rather than
simply the legal reality.
Examples: hire purchases
and finance lease.
To use cost for the value
of an asset is therefore a
way to be objective.

This concept permits


departures from the
other concepts in the
interest of simplicity
when the effect of such
departures
is
not
material.
An asset acquired under
a Hire Purchase or
Finance lease does not
legally belong to the
purchaser. Yet, it is
shown as an asset in the
statement of financial
position of the purchaser
and
depreciation is
provided for it in the
accounts
Information which is
free from bias will
increase the reliance
people place on it.

There is no definitive
rule
that
separates
material from immaterial
information.

Accounting does not


reflect the exact legal
position involving Hire
Purchase or Finance
lease.

To be objective, one
must always follow the
rules or concepts of
accounting. It therefore
prevents the accountants
from using their own
judgments.
Everyone using The use of a method When
you
are The application of this
their
own based on ones own subjective, it means that concept may lead to a lot
different method judgment.
you want to use your of contradictions.
own
method
even
though no one else may
agree to it.