THE ACCOUNTING CONCEPTS

 

THE ACCOUNTING CONCEPTS

They are therefore rules and assumptions that are usually followed to determine methods of recording data that will then result to accounting information. They include;

i.                  Going concern

It’s also called continuity assumption. It is assumed that the accounting entity will continue with the operation into the foreseeable future and has no intentions of coming to an end or curtailing its operations.

This implies that the management should view all the available information in the light of the foreseeable future, but not only for the current period.

ii.             Accounting period assumption

It’s also known as the time concept. It is assumed that the continuous lifetime of the entity is divided into small equal periods to ease the burden of reporting. These subdivisions are called the financial year.

iii. Business entity concept

It’s also known as accounting entity assumption. The assumption is that the business is a separate legal entity; distinct from the owners and the management. The financial affairs of the business entity are recorded and reported separately from those of the owners of the capital or the managers

iii.           Monetary principle

It’s also known as unit of measurement assumption. It is assumed that the financial impact of the business entity is broken down into transactions that are assessed and quantified in some unit of measure. The underlying assumption is that, for the sake of commonness, the unit of measure is a monetary one.

v. Accrual concept

The accruals concept is also known as matching concept. In the principle, revenues and costs are recognized when earned or incurred and not as the monetary attachment is received or paid. What this means is that the time when the revenue is received, or the expense is incurred is completely disregarded. This leads into two scenarios; prepayments and accruals.

Prepayments occur when money is received for a period that it has yet to be earned, or an expense is paid for but has not yet been incurred.

Accruals occur when the expense for the money is being paid for has already been incurred i.e. the expense belongs to a past period, or when an income is received way after the period of earning has expired.

THE ACCOUNTING PRINCIPLES/ CONVENTIONS

This constitutes of ground rules of financial reporting. They are referred to as generally accepted accounting principles (GAAPS). They are broad in nature and developed by accountants to meet the needs of users of financial information. They include;

i. Historical cost

It specifies that assets should be recorded at cost, at the purchase price or at the acquisition price. This ignores the effects of inflation on cost as the assets are kept by the business over the years.

It recognizes that for example a building purchased 40 years ago for Sh. 29,000 would be reported today in the statement of financial position at that historical price even though its actual worth today may be Sh. 2.9 million.

However, this problem has been overcome by asset revaluation as an alternative to the historical cost of accounting.

ii. Monetary principle

This principle holds  that  accounting  will  only  endeavor  to  deal  with  those  items  to  which  a monetary value can be attached. As such, financial statements reflect only the items

that can be measured in monetary terms. Goodwill for example is never shown in the statements because it has no monetary measurement.

iii. Revenue realization concept

It states that a sale should be recognized when the event from which it arises has taken place and the receipt of cash from the transaction is reasonably certain.

Revenue realization demands that only when the money receivable is reasonably certain of reception should accountants recognize it as income. For instance, it may not be prudent to recognize a sale when a customer makes an inquiry because the requisition may be revoked well before the goods are even ordered or delivered.

iv. Prudence

Prudence states that where alternatives exist, the one selected should be one that gives the most cautious presentation of the financial position of the business. Assets and profits should not be overstated, but a balance must be achieved to prevent the material overstatement of liabilities and losses.

Where a loss is foreseen, it should be anticipated and taken immediately into account. In other words, accountants should never anticipate for gains but must always provide for losses.

 v. Consistency

The items in the financial statement should be presented and classified in the same manner from one period to the next unless there is a significant change in the nature of the operations of the business, or a review of its financial statement presentation demonstrates that relevance is better achieved by presenting items in a different way, or a change is required by a new international standard.

For instance, an entity is not allowed to change form LIFO to FIFO or otherwise unless:

ü  There is a significant change in the business

ü  There is a new accounting order

ü It helps present the information better.

 vi. Materiality

Information is material if its non-disclosure could influence the decisions of users. Materiality depends on the size and the nature of the item being judged. Strict adherence to accounting rules is not necessary in accounting for trivial items such as loose tools, e.g. a stapler should not be capitalized, and a bribe cannot be itemized under expenses.

vii. Duality

Duality principle emphasizes the double entry book-keeping entry that every transaction has two effects, for every debit there is a corresponding, equal and opposite credit entry. As such it forms the basis of the double entry system of bookkeeping.

viii. Substance over form

Some transactions have a real nature that differs from their legal form. This principle states that whenever it is legally possible, the real substance prevails over the legal form. 

ix. Matching principle

Revenue should be matched against the costs associated with generating it. Matching revenue and expenses is the first activity in the measurement of the results of operation of that period. Costs are matched with revenue in three ways;

ü direct association of costs with specific revenue transactions

ü systematic allocation of costs to the useful life of the expenditure

ü Direct write off the expenditure to the profit/ loss account where no association can be identified reasonably.

x. Objectivity/ neutrality principle

The value of assets and liabilities must be reasonably verified. The value must be independent of the person valuing the assets/ liabilities. Objectivity is therefore the independence of the person valuing assets. This principle recognizes that information statement should be supported by evidence other than imaginations.

xi. Full disclosure

This means that all the material and relevant factors concerning financial positions and results of operation must be accomplished either in the financial statement or in form of notes to accompany financial statements.