ACCOUNTING CONCEPTS
See note 10.3 Page 114 (12 edition)
th
The preparation of final accounts is based on certain assumptions. These
assumptions are known as the concepts of accounting. Concepts are therefore
rules which the accountant has to follow when preparing final accounts.
The basic accounting concepts are:
1. The historical Cost concept
This concept says that assets are shown in the balance sheet at cost price and
that this is the basis for valuation of the assets.
2. The Money Measurement concept
This concept states that accounting only shows the facts measurable in money.
Accounting does not show whether there are any problems with the business,
whether there are good or bad managers, whether there is a rival product or
new laws in the country.
Therefore accounting and financial statements do not tell you everything about a
business.
3. The Business Entity Concept
This concept states that the accounting of a business shows only the transactions
and activities which have to do with the business and not the owner’s private
activities. The owner’s activities are shown in the accounting only when the
owner adds or reduces the capital of the business.
4. The Dual Aspect Concept
This establishes the accounting equation. It states that every transaction in
accounting deals with two aspects – assets and claims against them. The claims
against them are equal to the assets. So we can say:
Assets = Capital + Liabilities
5. Time Interval Concept
Accounting has to be made with regular intervals of one year. These intervals are
needed. Sometimes for the internal management, accounting is prepared more
frequently for example per month. The interval depends on the business or firm.
Fundamental Accounting Concepts
6. Going Concern Concept
In a business it is always assumed that the business is going to continue for a long
time so the assets are shown at cost price. This does not happen when the
business knows it is going to be suffering losses from assets or there is shortage of
cash in the business. i.e. if the business is undergoing difficulties it might not be a
going concern.
7. Consistency Concept
If policies of calculating certain figures are changed from one year to the other,
this would lead to misleading profits being calculated from the accounting
records.
In order to keep consistent in the preparation of accounts, policies should not be
changed unnecessarily. If policies need to be changed then a note should be
written in the accounts stating how and why the changed policy took place.
In this way, accounts of one year after another will be comparable.
8. Prudence
It is the accountant’s duty to see that people get the proper facts about a
business.
Accountants should always be on the side of safety, and this is known as
prudence. It is better to take the figure that will understate rather than overstate
the profit.
An accountant should also make sure that all losses are recorded in the books but
profits should not be shown until they have actually been made. This leads to the
realisation concept .
9. Realisation Concept
This is a broader concept of prudence where profit and gains can only be taken
into account when the ultimate cash realized is capable of being assessed (i.e.
determined) with reasonable certainty.
10. The Accruals Concept (Accrual basis)
This concept states that transactions are reported in the financial statements of
the period to which they relate. Net profit is the difference between
revenues(income) and expenses incurred in generating those revenues.
(i.e. revenues – expenses = net profit)
The term matching expenses against revenues means that an accountant
calculates the expenses used up to obtain the revenues.
11. Materiality
This concept tells us – do not waste your time in the elaborate recording of trivial
items.
Keep track only of items of material nature. Employing someone to record trivial
items will be more expensive for the business.