ACCOUNTING CONCEPTS / PRINCIPLES
Accounting has developed a number of rules which must be applied by accountants when recording any
financial information or producing a set of financial statements. This ensures that there is uniformity in
preparing account irrespective of who is preparing them. Rules which set down how the financial activities
of a business are recorded are known as accounting concepts or principles.
Following these concepts ensure that the accounts prepared are a true and fair reflection of the business.
Moreover, it also means that the accounts drawn up are free from bias and do not mislead. Accounting
concepts also play a role in standardising accounting processes and this makes it possible to compare the
accounts of different businesses.
Consistency
The consistency concept states that any accounting policy or method used, must be applied consistently
from one period to another. (A change can be made only if it is fair and reasonable)
Example, using the same method for an asset every year, valuing inventory using the same method each
year.
Prudence
This concept aims at conservatism. Accountants should ensure that all profits and assets are not
overstated and that liabilities and assets are not understated. Accordingly, all expected costs, losses and
expenses must be taken into account but not the anticipated profits or income.
Example – provision for irrecoverable debts
valuing inventory at the lower of cost and Net Realisable Value
providing for depreciation
Accruals or matching
This concept states that all incomes earned during a period must be taken into account, irrespective of
whether money was received or not, and matched against all costs and expenses incurred to earn it,
irrespective of whether you paid the money or not.
Example – Adjustments made to the financial statements in respect of accruals and prepayments
Charging depreciation in order to allocate the cost of non current assets over the years it is in
use.
Materiality
The materiality concept applies when the value of assets are relatively insignificant and as such, do not
warrant separate recording. These assets are written off as revenue expenditure in the year of purchase
even if it is to be used in the business for more than one accounting year.
Example, a pocket calculator purchased for office use will be treated as a revenue expenditure, although it
is an asset that can be used for over a period of one year.
Money measurement
According to this concept, only those items and transactions that can be objectively expressed in money
terms should be taken into accounting records.
Example, the morale of the business’s workforce, brand value or the effectiveness of a good manager all
play an important part in the success of a business, but they will not appear in the accounting records as
their value cannot be expressed in monetary terms.
Business entity
This concept states that the business is treated as being completely separate from the owner of the
business (being two separate entities). The personal assets of the owner, his personal spending et cetera
do not appear in the business records.
Example – when the owner introduces capital into the business, it is credited to the capital account
showing that the business owes the amount to the owner.
Maintaining of a separate drawings account to record the owner’s personal expenses made from the
business