Accounting Concepts

Business Entity Concept

The owner is treated completely seperate from the business. This is known as the business entity concept

Common Examples are adjusting drawings and creating a seperate account for capital. Other simpler examples are adjusting transactions related to the owners personal stuff like rent and treating them as drawings if it is made by the business' funds

Money Measurement Concept

Only information that can be expressed in terms of money is recorded in the accounting records

Again only quantitative information can be recorded in the books of accounts. Factors such as skill of work force and moral can not be expressed in terms of money and so is not recorded

Matching/Accurals Concept

The Cost of a financial period must be matched against the revenue for that same year when calculating profit

Common examples are calculating depreciation and maintaining provision for doubtful debts...

Most pf the time, they will ask how an accounting treatment is an example of Matching/Accurals Concept. You need to adjust the above definition and say the cost and revenue related to that object

Prudence Concept

The business should not overstate profits and assets

Again, this is an example of depreciation and doubtful debts and futhermore, an example of inventory valuation

For the definition of how inventory must be valued according to prudence concept is:

Prudence concept states profit and assets should not be overstated and so must use lower at cost or net realisable value for inventroy valuation

Again keep in mind, when ever the question says to explain why something is an example of the prudence concept. Be specific and mention the specific asset and the expense that causes a reduction in profit

In other words, prudence is making sure losses are realised as early as possible, a way of expecting the worse

Duality Concept

Every Transaction has two equal effects. One as a credit and the other as a debit

Most business are advised to follow the duality concept as it is the correct way of maintaining proper records. When the business do not follow the duality principle then we say the business has incomplete records

Going Concern

The business assumes that it will continue to operate for an indefinite period (unforseeable future) and there is no reason for the business to close down or significantly reduce its value

A common example is calculating profit annually

Consistency Concept

The same accounting treatment must be applied to similar items at all times

For example, using the same accounting policies such as depreciation methods and inventory valuation methods

The reason why we follow this is to allow meaningful comparison between years

Realisation Concept

The business should not account for profit until it is earned and realised and must use cost price rather than selling price

Common examples are making sure you record sales only when goods are delivered to the customer

However, a delivery of goods does not necessarily mean it is earned. If the goods are sent on sale or return basis then according to the realisation concept we should not record it until the customer confirms it

Historic Concept

Assets and Expense should be recorded in their ledger account at their actual cost

Materiality Concept

Small value items such as calculators and clocks should be charged to a single accounting period even though they have a benefit for more than a year

A good example is writing of whole of stationary as an expense for that financial year

Substance Over Form

The purchase of a non current asset on hire purchase must be treated in the same manner in the financial records as other assets even though the ownership is with the seller

You may have heard equal installments, this is hire purchase and the actual ownership is not with the buyer until the last payment is paid but the commercial right is with the buyer

Advantages of Accounting Concepts

1. The Accounting Concepts provides a framework for preparing financial statements

2. Allows comparisons between business as the statements are prepared in the same way

3. Prevents frauds and avoids misstatements

Disadvantages

1. Some concepts are in conflict with each other... Example Accurals and Materiality

2. Requires alot of skill and knowledge to follow correctly