Accrual Concept

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QUESTION 1

Accounting follows a certain framework of core principles which makes the

information generated through an accounting system valuable. Without these core

principles accounting would be irrelevant and unreliable. These principals include:

Accrual Concept - Business transactions are recorded when they occur and not

when the related payments are received or made. This concept is called accrual basis of

accounting and it is fundamental to the usefulness of financial accounting information.

Going Concern Concept - Financial statements are prepared assuming that the

company is a going concern which means that the company intends to continue its

business and is able to do so. The status of going concern is important because if the

company is a going concern it has to follow the generally accepted accounting

standards. The auditors of the company determine whether the company is a going

concern or not at the date of the financial statements.

Business Entity Concept - In accounting we treat a business or an organization

and its owners as two separately identifiable parties. This concept is called business

entity concept. It means that personal transactions of owners are treated separately from

those of the business. Businesses are organized either as a proprietorship, a partnership

or a company. They differ on the level of control the ultimate owners exercise on the

business, but in all forms the personal transactions of the owners are not mixed up with

the transactions and accounts of the business.

Monetary Unit Assumption - In accounting we can communicate only those

business transactions and other events which can be expressed in monetary units. This

is called monetary unit assumption. There are certain other frameworks for reporting

business performance such as triple bottom line which focuses on "people, planet

profit" the three pillars; corporate social responsibility reporting, etc. Accounting

focuses on the financial aspects of the business and that too for matters which can be

expressed in terms of currencies. One aspect of the monetary unit assumption is that

currencies lose their purchasing power over time due to inflation, but in accounting we

assume that the currency units are stable in value. This is alternatively called stable

dollar assumption. However, there are exceptional circumstances called hyperinflation

when the accounting standards require adjustment of prior period figures.

Time Period Principle – Although businesses intend to continue in long-term,

it is always helpful to account for their performance and position based on certain time

periods because it provides timely feedback and helps in making timely decisions.

Under time period assumption, we prepare financial statements quarterly, half-yearly

or annually. The income statement provides us an insight into the performance of the

company for a period of time. The balance sheet (also known as the statement of

financial position) provides us a snapshot of the business' financial position (assets,

liabilities and equity) at the end of the time period. The statement of cash flows and the

statement of changes in equity provide detail of how the company's financial position

changed during the time period. One implication of the time period assumption is that

we have to make estimates and judgments at the end of the time period to correctly

decide which events need to be reported in the current time period and which ones in

the next. Revenue recognition and matching principles are relevant to time period

assumption. Revenue recognition principle provides guidance on when to record

revenue while matching concept tells us how to reach an accurate net income figure by

creating 1-1 correspondence between revenues and expenses.

Revenue Recognition Principle - Revenue recognition principle tells that

revenue is to be recognized only when the rewards and benefits associated with the

items sold or service provided is transferred, where the amount can be estimated

reliability and when the amount is recoverable. Accrual basis of accounting is used in

recognizing revenue which tells that revenue is to be recognized ignoring when the cash

inflows occur.

Full Disclosure Principle - Full disclosure principle is relevant to materiality

concept. It requires that all material information has to be disclosed in the financial

statements either on the face of the financial statements or in the notes to the financial

statements.

Historical Cost Concept - Accounting is concerned with past events and it

requires consistency and comparability that is why it requires the accounting

transactions to be recorded at their historical costs. This is called historical cost concept.

Historical cost is the value of a resource given up or a liability incurred to acquire an

asset/service at the time when the resource was given up or the liability incurred. In

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QUESTION 1 Accounting follows a certain framework of core principles which makes the information generated through an accounting system valuable. Without these core principles accounting would be irrelevant and unreliable. These principals include: Accrual Concept - Business transactions are recorded when they occur and not when the related payments are received or made. This concept is called accrual basis of accounting and it is fundamental to the usefulness of financial accounting information. Going Concern Concept - Financial statements are prepared assuming that the company is a going concern which means that the company intends to continue its business and is able to do so. The status of going concern is important because if the company is a going concern it has to follow the generally accepted accounting standards. The auditors of the company determine whether the company is a going concern or not at the date of the financial statements. Business Entity Concept - In accounting we treat a business or an organization and its owners as two separately identifiable parties. This concept is called business entity concept. It means that personal transactions of owners are treated separately from those of the business. Businesses are organized either as a proprietorship, a partnership or a company. They differ on the level of control the ultimate owners exercise on the business, but in all forms the personal transactions of the owners are not mixed up with the transactions ...
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