Chapter 10: Accounting Rules

Learning objective

• Explain and recognize the application of accounting principles

• Understand the objectives in selecting accounting policies

• Distinguish between capital and revenue expenditure

• Distinguish between capital and revenue receipts

• Effect on profit due to incorrect treatment

• Rules of inventory valuation

 Accounting Rules

• Business entity: business is treated as a complete separate

entity from the owner.
• Eg, capital is a liability of the business

• Consistency: once a method has been selected it should be

used consistently from one accounting period to other.
• Eg, use of same method of depreciation

• Duality: every transaction has a dual aspect- a giving and

receiving.
• Eg, every transaction is recorded as a debit and a credit
• Going concern: a business will continue to operate for an
indefinite period of time.
 Accounting Rules

• Historical cost: all assets and expenses are initially recorded at

their actual cost.
• Eg, Assets are recorded at purchase price

• Matching: The revenue of the accounting period is matched against

the costs of the same period.
• Eg, accrued and prepaid expenses and income

• Materiality: Items of very low value are not worth recording as

separate items.
• Eg, Calculator is an asset as it gives benefit for a long period but due
to its low value its purchase is treated as stationery expense.
 Accounting Rules

• Money measurement: Only information which can be expressed in

terms of money are recorded.
• Eg, Training employees will increase their efficiency but it is not
accounted as it can be valued in monetary terms.

• Prudence: Profits and assets are not overstated and liabilities are
not understated.
• Eg, Provision for doubtful debts, Inventory valuation, Provision for
Depreciation.

• Realisation: Revenue is only regarded as being earned when the

legal title to goods or services passes from the seller to the buyer.
• Eg, Sale is recorded in books of accounting when invoice is
generated.
 International Accounting Standards

• IAS ensure that financial statements are prepared using the

same rules and guidelines internationally.
• Comparability: Information contained in financial statements
can be compared with financial statements of another business
or for another accounting period of same business.
• Relevance: Information should be provided in time.
• Reliability: Information provided should be - free from bias,
free from significant errors, dependable as being true
representation of facts.
• Understanding: Information provided should be clear so that it
is understood by users.
 Capital and Revenue

• Capital expenditure: Money spent on purchasing non-

current assets and improving or extending them.
• Revenue expenditure: Money spent on running a business
on a day-to-day basis.
Eg, salary, conveyance
• Capital receipt: Money is received other than from normal
trading activities.
Eg, proceeds from sale of non-current asset
• Revenue receipt: Money received from normal business
activity.
Eg, discount, commission
 Inventory valuation

• Inventory is valued at the lower of cost or net realizable

value.

• Cost = purchase value + carriage inwards

• Net realizable value= estimated receipts from the sale of the
inventory – cost of completing the goods or cost of selling
the goods.

• It is application of principle of prudence as overvaluing the

inventory causes both the profit and the assets to be
overvalued.
Example
Solution
Effect of Overvaluation of Inventory