Accounting Concepts and Assumptions

Objective of Financial Statements

  • Provide info on financial position, performance, and changes.

  • Useful for economic decisions.

  • Prepared based on established concepts and accounting standards.

Objectivity in Accounting

  • Financial accounting aims for objectivity and consistency.

  • Achieved through fundamental rules known as accounting concepts.

  • Enforced via accounting standards.

Accounting Standards

  • Rules defining how financial info is recorded and presented.

  • Ensure consistency, comparability, and transparency.

  • Help ensure reliability and usefulness for decision-making.

Concepts - Money Measurement

  • Only facts measurable in monetary units are recorded.

  • Most people agree on the monetary value of transactions.

  • Doesn't recognize non-monetary items (e.g., employee skills).

Concepts - Historical Cost

  • Assets shown at cost price.

  • Historical costing records assets at original purchase prices; doesn't account for inflation.

Concepts - Business Entity

  • Business affairs separate from owner's non-business activities.

  • Transactions recorded are restricted to the business.

  • Violations include mixing personal/business finances.

    • Not keeping separate bank accounts, invoices, or records for each business violates the business entity concept.

    • Using business funds for personal purchases, like paying for groceries from the business account, violates the concept.

  • Important for accurate reporting, legal, and tax compliance.

Concepts - Dual Aspect

  • Two aspects: assets and claims against them.

  • Accounting equation: Assets = Liabilities + Equity

Concepts - Time Interval/Periodicity

  • Financial statements prepared at regular intervals.

  • Business life divided into distinct time periods for reporting.

Concepts - Accrual Concept

  • Transactions recorded when they occur, regardless of cash flow.

  • Revenues matched against expenses.

  • Provides an accurate financial picture.

  • Supported by IFRS and GAAP.

Concepts - Matching Concept

  • Match related revenues and expenses in the same period.

  • Ensures consistency in financial statements.

  • Long-term assets experience depreciation.

  • Helps in avoiding misstating profits for a period.

Accrual vs. Matching Concept

  • Accrual: recording transactions when incurred or earned.

  • Matching: recognizing and recording expenses transactions in business.

Depreciation and Matching Concept

  • Depreciation allocates the cost of long-term assets over their useful lives.

  • Spreads expense across multiple periods.

Revenue Recognition Principle

  • Revenue recognized when a critical event has occurred.

  • When a product or service has been delivered to a customer, and the dollar amount is easily measurable to the company.

  • Violation: recognizing revenue before goods are shipped.

Qualitative Characteristics of Financial Statements

  • Understandability

  • Relevance: Information is material if its omission or misstatement could influence the economic decisions of users.

  • Reliability: free from error and bias

  • Comparability: consistency in measurement and display

Substance Over Form

  • Transactions reflect economic substance, not legal form.

Concepts - Going Concern

  • Business will continue operating for at least 12 months after the reporting period.

  • Essential for valuing assets and accounting for liabilities.

  • Allows inference that company can meet responsibilities and commitments.