Accounting concepts/principles

 Rules or guidelines that are applied in recording accounting transactions and preparing financial statements

Accounting concept Definition/Description Application

Duality Recognises that there are two aspects for  Accounting equation where assets =
each transaction – represented by debit and capital + liabilities
credit entries in accounts  Statement of financial position
Money measurement Only transactions that can be expressed in There are non-monetary items which cannot
monetary terms are recorded be recorded e.g. skills of workers,
satisfaction of workers, reputation of
business, brand loyalty
Historical cost Transactions are recorded at their cost to the A property cost 100,000 and is recorded in
business books. After 5 years, the value gone up to
200,000. The cost in your books will still
remain at 100,000
Business entity Every business is regarded as having an Capital and drawings account
existence separate from its owner – only
record transactions related to business in
business’ books
Going concern It is assumed that the accounts of a business If the business is not a going concern,
are prepared with the intention of statement of financial position should not
continuing business for the foreseeable be reflecting cost but realisable value (value
future where you can sell assets)
Realisation Revenue is recognised by the seller when it
is earned – when receive cash or invoice is
issued
Matching / accruals Revenue and cost/expenses must be
matched to the same accounting period
Substance over form The economic substance of the transaction
must be recorded over its legal form
Prudence Profits should not be overstated and losses
A customer goes into a shop and says he will
return tomorrow to buy shoes – there is no
sale yet because he did not agree that he
will pay. However, if an invoice was issued
to the customer, then a sale can be
recorded
A business pays rent of 100 per month for
12 months. This means the yearly rental
expense is 1,200. Even if the business
forgets to pay 1 month of rent, the
statement of profit and loss will have to
show 1,200 rent expense
A machine bought on hire purchase remains
the property of the seller until the full
amount has been paid. This it the legal
position, or the ‘form’
However, the machine is being used in the
buyer’s business in the same way as any
other machine. This is the ‘substance’. So
the machine has to be shown as an asset.
Hire purchase = buying machine/vehicle on
loan
Mortgage = buying property on loan
Should not record as sales or profit on
 should be provided for as soon as they are
recognised
Consistency Transactions of similar nature should be
recorded in the same to allow comparison
Materiality A business may depart from generally
accepted principles for recording
transactions if the items are not considered
material/significant (amounts)
ongoing negotiations for a large customer
contract. At the same time, if it is known
that a customer is going bankrupt, then the
loss should be reflected in accounts
Method of calculating depreciation and
provision for doubtful debt
Calculator should be classified as non-
current asset as used for more than 1 year.
But business can choose to classify it as
stationery expenses because the amount is
insignificant
True and fair view – Principle that states financial statements should be accurate and objective
Evaluation
Advantages
 Provides consistency between different businesses
(types and geographical location) so they can be
compared effectively
 Users of financial information can rely on the
information to make informed decisions
 Forms a framework on how to prepare financial
statements
 Comply with International Accounting Standards and
mandatory in each country
Conclusion: Must say that accounting concepts are beneficial
Disadvantages
 Specialist knowledge is required – cost of training or
hiring staff with this knowledge
 Ignore non-financial factors in evaluating the
performance of a business (e.g. environmental
factors)
 Some concepts contradict each other e.g. materiality
 Some concepts are open to interpretation which
may result in financial statements being not
perfectly comparable