ACCOUNTING CONCEPTS

Accounting Concepts are basic assumptions and conditions which form

the basis upon which the accounting profession has been laid.
Lesson objectives

 Identify Accounting Concepts(Cost, money measurement, Entity, Dual aspect,

realization, time interval, going concern, accrual, consistency, prudence,
accrual, substance over form, materiality, matching.
 Explain each of the accounting concept
 Illustrate each of the accounting concept
 Explain the limitations of the accounting concept
ACCOUNTING CONCEPTS……….

1.HISTORICAL COST CONCEPT

The concept states that assets should be shown at cost in the Statement of
Financial Position. Where there is provision for depreciation the original cost
must be shown before depreciation is subtracted on the Statement of Financial
position. The original cost of the non current asset is shown in the asset account.
Limitation: Prices change with time and the actual values of assets are far
understated or overstated.
 Accounting Concepts Cont`d

2.MONEY MEASUREMENT CONCEPT

Events that have monetary value are recorded in the books of accounts. Events
that have no monetary value are ignored. helps to avoid or reduce subjectivity.
Limitations: Some items may be assets or liabilities to the business but are not
recorded. For example good managers, motivated employees may help the
business to earn more profits but are not recorded in the books. Also bad
managers and demotivated and untrained workforce may be liabilities to a
business.
Accounting Concepts Cont`d
3.BUSINESS ENTITY CONCEPT
It states that business transactions must be separated from private transactions of the owners. This
would enable the business to ascertain the profits for the year and the assets it owns.
Limitations: There are many things owners do for the business but they are recorded.

4.THE DUAL ASPECT CONCEPT

The resources of the business equals the sources(Capital and liabilities)from which the resources
were obtained. ASSETS =CAPITAL + LIABILITIES. The resources cannot be greater than the sources.
5.TIME INTERVAL CONCEPT
Financial Statements are prepared at regular intervals of one year, interim
statements may be prepared/published in the course of the accounting year by
businesses.
6.ACCRUAL CONCEPT
The accrual assumption requires that adjustments to be made in the trial
balance before final statements are prepared so that profits are not overstated
and losses are not understated. Also assets, liabilities and capital must not be
overstated or understated.
Accounting concepts cont`d

 Limitation: It is difficult to apportion expenses in some situations. For

example advertising made in a certain year may yield results in subsequent
years or repairs of machines in one year will be benefited in the following
year.
7.GOING CONCERN
The business is expected to continue in operation for ever until it is liquidated.
Therefore the balances of asset, capital and liability accounts are carried
forward to the following year.
Limitation: In the event of liquidation the company will have assets valued at
the market values, and as such these values will be different from the value
determined at cost.
 Accounting Concepts Cont`d…

8.SUBSTANCE OVER FORM

Sometimes legality may be overlooked in the presentation of financial statements.
For example legally a business does not own items on hire purchase until
instalments are fully paid. But businesses show hire purchase items as non current
assets while still paying instalments on statement of financial position. This is the
assets on hire purchase are used to generate revenue as all other non current
assets. In this case substance has taken preference over legality or form.
9.MATERIALITY
It determines whether the omission or mistreatment of information in a financial
report would impact a reasonable user`s decision making.
Limitation: Forming judgements can be difficult since materiality depends on the
size and nature of the business. Sometimes there is a need to hire a professional to
decide whether the transaction is material or immaterial
Accounting concept Cont`d

10.CONSISTENCY
The concept states methods used by the business should not be changed
frequently. This, however does not mean that methods cannot be changed.
Limitation: It restricts the use of new and more advanced methods of accounting
to be followed by the business
11.PRUDENCE/CONSERVATISM
This concept states that profits must not be overstated and losses must not be
understated. It is always better to understate profits than overstate the.
Limitation:
Accounting concepts cont`d
12.MATCHING
This concept states that revenue for the year must be matched against the
expenses that were made to earn revenue.
This is similar to accrual concept. But the accrual concept is more about
adjustments to trial balance while Matching is made before the trial balance.
13.RELEVANCE
Information presented by financial statements should help users to be able to
evaluate past, present and future events.
14.NEUTRALITY
Accounting information must be free of bias. Both expected gains and losses
must be recognized.
Accounting Concepts Cont`d

15.REALIZATION
This concept states that revenue that should be recognized from given sale ,
refers to inflows of cash or claim to cash arising from sale of goods and services.
Realization is not the time when the order is received, nor payment is made.
APPLICATION OF ACCOUNTING CONCEPTS

CONCEPT APPLICATION
1.Historical cost Statement of Financial Position, ledger, depreciation
2.Money measurement Recording transactions in the books
3.Business entity Drawings
4.Dual Aspect Double Entry
5.Time Interval Financial Statements
6.Accrual End of year adjustments
7.Going Concern Closing/Opening Balances for assets, liabilities, Capital
APPLICATION OF ACCOUNTING CONCEPTS

CONCEPT APPLICATION
8.Materiality Financial Statements
9.Prudence Provision/Allowances , Valuation of inventory
10.Realisation Income Statement
11.Matching Depreciation, End of year adjustments to income statements
12.Consistency Depreciation, inventory valuation
Limitation of Accounting Concepts