ACCOUNTING CONCEPTS
These are basic rules/guidelines that are applied in recording transactions and
preparing financial statements.
They are also known as accounting principles or conventions.
They include:
1. Business entity.
States that financial affairs of the business should remain separate from the
financial affairs of the owner (s).
only business revenues and expenditures are recorded in the books of accounts.
However, when the owner introduces new capital or withdraws capital, this is
recorded within business records because it affects the business.
2. Money measurement concept
Items are only shown in the financial records if they can be measured in money
terms.
Thing/transactions which cannot be expressed in monetary terms are not recorded in
accounts though they affect business performance
Example: serious problems with the work force, government laws which
negatively/positively affect business operations - should not be recorded in financial
records
3. Consistency concept
Similar items should be treated in the same way in the same accounting period and in
all future accounting periods
Examples:
- Redecoration of premises should always be
debited to an expenses account
charged to the income statement as an expense
not be debited in premises account
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- Noncurrent assets of the same nature to be depreciated at a the same rate
using the same method – e,g all vehicles to be depreciated at 25% p.a using
the straight line method.
A change in the method requires much consideration and should be noted in
the financial statements.
Consistency enables comparisons of:
Financial statements of different accounting periods for a business
Financial statements of similar businesses (in the same industry).
4. Materiality concept
- Requires that any item recorded be material/significant amount to the
business.
- Expenses of small amounts therefore should be summed up and recorded as
general/miscellaneous/sundry expenses.
- Fixed assets of small value such as staplers, paper clips, paper punch should be
written off as expenses in the year of purchase and should not be subjected to
depreciation.
5.Prudence concept.
- Requires that the profits or losses of a business should be realistic and fair.
- Assets, incomes and profits should not be overstated
- Liabilities, expenses and losses should not be understated.
- The accountant should maintain a conservative/objective/neutral approach
when preparing financial statements.
- Anticipated losses and expenses such as allowance for doubtful debts should
be provided for as soon as they are recognized.
6. Accruals/Matching concept
- Revenues earned in a given accounting period should be matched against
expenses of the same period.
- Thus,
Revenues should be recognized in the year they are earned not when
received.
Expenses should be recorded in the year they are incurred not when
they are paid.
Adjustments for accruals and prepayments have to be done.
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- This ensures an accurate/fair profit for the year.
- It requires annual depreciation to be matched against the revenues that the
noncurrent assets generated.
7. Going concern concept
It states that a business will continue its present operations for the foreseeable
future i.e it is not likely to stop trading in the near future.
Application:
- Reporting noncurrent assets at the carrying value is an application of this
concept.
8.Historic cost concept.
Transactions should be recorded at their cost value i.e amounts which have actually
been paid and can proved/objectively verified.
9.Realisation concept
Revenues should only be recognized when the exchange of goods and services is
certain. This ensures that profits are only recognized when goods pass to the
customer and he accepts to pay for the goods.
A business should not anticipate sales.
Importance of applying International Accounting Standards
