Accounting Concepts and Principles

A complete set of vocabulary flashcards covering key fundamental accounting concepts, definitions, advantages, limitations, and applications based on lecture notes.

Accounting entity concept

The concept that accountants see a business to have its own life and be separate from the owner for recording and reporting purposes

Give an example of accounting entity concept

Drawing or capital

Legal entity concept

The concept that accountants see a business to have its own life and be separate from the owner for decision making in the eye of the law

Give an example of legal entity concept

• owner’s and partners have unlimited liability

• Shareholders have limited liability

Duality concept

The concept that accountants see total assets as equal to total equities (liabilities + owners' equity), and that each transaction has at least two effects on the accounting equation ($\text{Assets} = \text{Liabilities} + \text{Owners' Equity}$ ).

Give an example of duality concept

In TB: total credit = total debit

In BS: Asset = L + OE

Prudence concept

The guideline stating an accountant should exercise care and caution when dealing with uncertainties in measurement, always making provision for anticipated losses but not profits

Give an example of prudence concept

• valuing stock at the lower of cost

• NRV

• Allowance for doubtful debt

Advantage of prudence concept

• profit and asset value will not be overstated

Disadvantage of prudence concept

• conflicts with consistency concept as it recognizes unrealized losses but not unrealized gains

Historical cost concept

To record assets and liabilities at the money value at the time the transaction actually took place

Advantage of historical cost concept

• objective and a reliable form of measurement

Disadvantage of historical cost concept

Does not reflect current market value

Example of historical cost concept

• NCA is recorded at cost price

• Liabilities are recorded at actual cost incurred

Cash concept

profit is defined as the difference between revenue receipts and expenses paid during an accounting period

Example of cash concept

• utilized in the cash flow statement to measure net cash flow from operating activities.

• CFS uses cash concept to measure NCF from operating activities

Advantage of cash concept

• not easily manipulated

Disadvantage of cash concept

• only suitable for small business where most transactions are in cash basis

Example of accrual concept

requiring balance day adjustments for:

• depreciation

• Accruals

• Prepayments

Accrual concept

An accounting approach where profit is defined as the difference between revenue earned and expenses incurred during an accounting period

Advantage of accrual concept

• provide accurate profit for decision making

Disadvantage of accrual concept

• require adjustments for all accruals and prepayment at the end of period

Faithful presentation concept

The principle that financial statements should show the true and fair view of business performance and position by ensuring information is complete, neutral, and free from error.

Example of faith presentation concept

To balance all day adjustments

Advantage & disadvantage of faithful presentation

+ provide accurate profit for decision making

- subject to diversify accounting policy

Going concern concept

The assumption that a business enterprise will continue indefinitely

Example of going concern concept

recording non-current assets in the balance sheet at cost price rather than at current market value.

Accounting period concept

The assumption that the life of a business can be broken up arbitrarily into predetermined time periods

Advantage & disadvantage of accounting period

+ to allow timely measurement of performance and position for user decision-making.

- estimates must be made for that period

Example of accounting period

TB as at xxx

IS for the period ended xxx

BS as at xxx

Realization concept

The principle to recognise revenue at the point of delivery when stock is sold or services are provided.

Eg: sales revenue

Reliability concept / objectivity concept

The principle that information is reliable if it can be checked against a business document and is not subject to personal bias or opinion.

Adv & disadvantage of reliability concept

+ objective and reliable measurement

- only transactions with evidence will be recorded

Exp of reliability concept

• cost price of NCA & NCL is supported by documents

Consistency concept

The rule that once an accounting method is adopted, it should be used for all similar items for at least a number of years to make comparisons possible across different periods.

Adv & disadvantage of consistency concept

+ makes comparison possible between different periods

- methods used may not be the best

Exp of consistency concept

• use same methods of depreciation

• Same stock flow assumptions

Monetary unit concept

The principle that only those transactions that can be valued in monetary terms will be recorded in the accounts.

Eg: assets or liabilities in balance sheet are at $xxx

Adv & disadvantage of monetary concept

+ allow objective measurement if business performance and position

- not able to give full picture of the business

Materiality concept

The rule that only important information that will influence the decision making of the user will be recorded into the accounts

Exp of materiality concept

for example, grouping small expenses together as sundry expenses).

Adv & disadvantage

+ enhance understanding of financial statements

- personal judgement is required to decide on its materiality