ACCOUNTING CONCEPTS Cont.

REALIZATION CONCEPT (Revenue Recognition Concept)

 This concept requires that income should not be recognized without it is earned.
 Accordingly the income should be identified, when it is earned legally.

Application of the concept

 If it is a good (stock) at the time that the entity has transferred to the buyer, the significant
risk and rewards of ownership of good is treated as the time of realization.
 With regards to services at the time that the service was provided is treated as the time of
realization.

MATCHING CONCEPT
 According to this concept the income should be matched with (compared with) the total
expenses for the period, when calculating the operational results of the accounting
period(profit or loss).
Ex: Comparing cost of sales with sales to calculate the profit.

Application of the concept

1. Adjusting of closing inventories.

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2. Adjusting of bad debts.
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3. Adjusting provision for doubtful debts.
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4. Adjusting provision for depreciation.
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HISTORICAL COST CONCEPT

 According to this concept business transactions are recorded at the value at which the
transaction has taken place.
 Accordingly assets should be recoded at the cost at which it was acquired and liabilities
are recorded at the value prevailed at the time that the liability originated.
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Situations where a firm deviate from the historical cost concept
o When assets are recorded at revalued amount.
o When there’s a stock loss.
o When assets are impaired.
o When there’s a going concern issue.

PRUDANCE CONCEPT
 According to this concept income, expense, assets and liabilities should be recorded at
their actual values.
 Prudence concept has a major role in the preparation of financial statements to show the
financial position, financial performance and cash flows of an entity.
 Due to this concept, an entity gets a financial protection.

Application of the concept

1. Identification of inventory losses.
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2. Recording of depreciation.
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3. Recording of doubtful debts.
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MATERIALITY CONCEPT
 This means the importance of an item recorded in the financial statement.
 It depends on the nature and the volume of the transactions of the entity considered.

 Whether an asset is capitalized or written off as an expense, whether an asset is

recorded separately or recorded with other assets is decided based on this
concept.
 Here materiality depends on the extent at which how far it affects the decisions
made by the interested parties on the entity.

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SUBSTANCE OVER FORM CONCEPT

 There are 2 aspects of a transaction.
I. Legal aspect
II. Economic aspect
 According to this concept the priority should be given to the economic substance of the
transaction rather than the legal aspect.
 As per conceptual framework, accounting information should be true and fair, the
financial statements should show the economic substance of transactions.

Application of the concept

1. Recording of leased properties as assets in the statement of financial position.
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2. Depreciation of leased properties

CONSISTANCY CONCEPT
 The presentation and classification of items in the financial statements should be
remained unchanged from one period to the next period.
 When the financial statements are prepared under the consistency concept , they can be
compared with ,
a) Historical information.
b) Competitor’s information
c) Industry’s information
d) Budgeted information

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 An entity can change a policy, if the change will result in a more appropriate presentation
of transactions or events in the financial statements of the enterprise.
 However an entity can change its accounting policies as per LKAS 08 in the following
situations.
 If there’s a new accounting standard for law.
 To provide more relevant and reliable information.