Accounting concepts
Mr. Barry
A-level Accounting Year 12
Learning objectives
• Describe the assumptions that are made when
recording accounting data
• Explain what accounting standards are and
why they exist
• Explain how the concepts of accounting affect
the recording and adjustment of accounting
data
Mr. Barry
A-level Accounting Year 12
So far…
• Recording has been based on certain
assumptions which have deliberately not been
discussed in detail.
Mr. Barry
A-level Accounting Year 12
Standards…
• What does it mean?
Mr. Barry
A-level Accounting Year 12
Standards…
• Businesses are often owned by more than just
one person and the accounting statements
produced are used by all.
• If the financial statements were solely for the
use of the owner then there would be no
need to adopt a common framework for the
presentation of the information contained
within them.
Mr. Barry
A-level Accounting Year 12
Mr. Barry
A-level Accounting Year 12
One set of final accounts for all purposes
• Standardisation means that no matter which
stakeholders want to see the financial
statements they all see the same documents.
• What problems are there with this?
• What benefits are there which outweigh the
problems?
Mr. Barry
A-level Accounting Year 12
A matter of trust
• Because everyone receives the same trading
and profit and loss account and balance sheet,
in order to be of any use, all the various
stakeholders have to believe that the
assumptions upon which the financial
statements are founded are based are valid
and appropriate. If they don’t they wont trust
the financial statements.
Mr. Barry
A-level Accounting Year 12
Activity
• What would you value your text books at?
• How would you value them?
• How have you come to a consensus?
Mr. Barry
A-level Accounting Year 12
Objectivity and subjectivity
• Valuing the books at what price you paid for them
(based upon factual occurrence) is valuing assets
objectively
• Valuing the books at what you perceive to be their
value (usefulness for exams) is subjective.
• Subjective valuations seem right to the person who
makes them but most other people would probably
disagree with the value arrived at, because they may
not see it as being objectively based.
Mr. Barry
A-level Accounting Year 12
Underlying accounting concepts
• The historical concept:
– Assets are normally shown at cost price, and that this is the basis for
the valuation of the asset
•
the business entity concept:
– The affairs of the business are to be treated as being quite separate
from the non-business activities of the owners
– The items recorded in the books of the business are, therefore,
restricted to the transactions of the business. Activities of the owners
are completely disregarded
– Why?
• The dual aspect concept:
– There are two aspects of accounting, one represented by the assets of
the business and the other by the claims against them. The concept
states that these two aspects are always equal to each other
Mr. Barry
A-level Accounting Year 12
Underlying accounting concepts
• the time interval concept:
– Financial statements are prepared at regular
intervals of the year. For internal management
purposes they may be prepared far more
frequently
– Why?
Mr. Barry
A-level Accounting Year 12
Fundamental accounting concepts
• These comprise a set of concepts so important
that they have been enforced through
accounting standards/companies act
Mr. Barry
A-level Accounting Year 12
Fundamental accounting concepts
• Going concern concept
– Implies that the business will continue to operate
for the foreseeable future. It means that it is
considered sensible to keep to the use of the
historical cost concept when arriving at the
valuations of assets.
– What would happen if this concept was not used?
Mr. Barry
A-level Accounting Year 12
Going concern concept
• A business drawing up their accounts on 31st
December 2008. normally using the historical cost
concept, the assets would be valued at £100,000. But
it is known that the business will be forced to close
down on February 2009 and the assets are expected
to be sold for £15,000
• In this case it would not make sense to keep to the
going concern concept and so have to reject the
historical cost concept.
• In the balance sheet at 31st Dec 2008 the assets will
be shown as £15,000
Mr. Barry
A-level Accounting Year 12
Examples where the going concern
assumption should be rejected are:
• If the business is going to close down in the
near future
• Where shortage of cash makes it almost
certain that the business will have to cease
trading
• Where a large part of the business will almost
certainly have to be closed down because of a
shortage of cash
Mr. Barry
A-level Accounting Year 12
Fundamental accounting concepts
• Consistency:
– When a business has fixed a method for the
accounting treatment of an item, it will enter all
similar items that follow in exactly the same way
(some concepts open to interpretation
– Each business should try to choose the method
that gives the most reliable picture of the
business.
– This cannot be achieved if one method is used one
year and another the following year
Mr. Barry
A-level Accounting Year 12
Fundamental accounting concepts
• Prudence:
– It is the accountants duty to see that people get the proper
facts about a business. They should make certain that
assets are not valued too highly and liabilities to low.
– Otherwise someone may unadvisedly lend money to the
business
– The accountant should always show caution when dealing
with uncertainty and make sure that financial statements
are neutral. That gains and losses are not overstated and
understated. This is known as prudence
Mr. Barry
A-level Accounting Year 12
Activity 10.2
• Do you agree with the view that the prudence
concept results in accountants producing
financial statements that understate profits
and gains and therefore present a value for
capital that is lower than it should be?
• Justify your answer
Mr. Barry
A-level Accounting Year 12
Fundamental accounting concepts
• Realisation:
– Profit and gains can only be taken into account when
realisation has occurred and that realisation occurs when
the ultimate cash realised is capable of being assessed
with reasonable certainty.
– Recognising profit and gains now that will be 100% known
in future periods is unlikely to mean that the correct
amount has been recognised.
– Misjudgements can arise when for example, profit is
recognised in one period, only to discover later that this
was incorrect because the goods involved have been
returned in a later period because of defieciency
Mr. Barry
A-level Accounting Year 12
Fundamental accounting concepts
• Accruals concept:
– Determining the expenses used up to obtain the
revenues is referred to as matching expenses
against revenues.
– The key to the application of the concept is that all
income and charges relating to the financial
period should be taken into account without
regard to the date of the receipt of payment
Mr. Barry
A-level Accounting Year 12
Fundamental accounting concepts
• Materiality:
– Do not waste your time in the elaborate recording of trivial
items
– If a box of paperclips was bought it would be used up over
a period of time, and this cost is used up every time
someone used a paper-clip. It is possible to record this as
an expense every time a paper-clip is used but obviously,
the price of a paper-clip is so small that it is not worth
recording in this fashion, nor is the entire box of
paperclips.
– The paper-clips are not a material item and therefore the
box would be charged as an expense in the period it was
bought, irrespective of the fact that it could last for more
than one accounting period
Mr. Barry
A-level Accounting Year 12