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Accounting Concepts
Business Entity
The business is seen as a separate entity from its owner(s).
The proprietor(s) and other interested parties (eg creditors, tax authorities) are concerned with the profit
earned by and the capital employed by the business. For the small trader, this may appear to be artificial
where the liability may legally be unlimited so that creditors can call on much more than the reported
accounts may show. For the large corporation, the entity separation from the shareholders is more
obvious, but the accountant applies the same principle, regardless of size and legal structure. This has the
effect of capital introduced and profits generated by the entity as liabilities of the business to the
owner(s).
Going Concern
This concept assumes that the entity will continue to operate in the foreseeable future, unless
there is clear evidence to the contrary. The balance sheet and income statement are drawn up
on the basis that the assets will not be liquidated but have a continuing value to the business. If
this were not true, all assets would have to be valued on a liquidation basis, which would
seriously, financially understate most businesses.
This particular principle has received considerable attention by the financial and business press over
recent years, due to uncertainties created by the world's financial difficulties. Accountants have been
obliged to pay more attention as to whether companies can properly support their financial viability; i.e.
to prove that they are going concerns, so have the capacity to trade for the foreseeable future.
Periodicity (Accounting Period)
The final accounts of the company, i.e. income statement (profit and loss account), balance
sheet and, for larger companies, cash flow statements, have to be prepared on an annual basis,
(for the UK per the Companies Acts of 1985, 1989 and 2006).
More generally, this concept supports the need for the owners of the business to receive periodic
financial statements on the progress and status of the business. Other interested parties will also
require these updates, eg creditors for assessing the liquidity of the business for their own
payment receipts. The London Stock Exchange also requires its members to produce interim
reports as well as does the Securities and Exchange Commission (SEC) of the USA.
The periodicity principle is closely associated with going concern; i.e. regular reports
for the entity of an indefinite life.
Money Measurement
Transactions are recorded in money terms. Financial statements are drawn up with all revenues,
expenses, assets and liabilities similarly expressed. A common unit of measurement is required
for such records and reports.
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Historical Cost
Assets, liabilities and expenses are all entered into the books of accounts at their actual cost to
the business. This results in all costs being objective and verifiable. It is the extension of the
money measurement concept with similar drawbacks, particularly the impact of time on values
which is ignored (with few exceptions). Assets are valued at cost or a cost based figure, eg cost
less depreciation (explained in Unit 3). Revenues at current values are matched with historical
costs to derive a profit or loss to the entity.
Materiality
Information is material if it could influence user’s decisions on the basis of the financial
statements. This helps to counter the excessive work that would result by a detailed control on
every item of expenditure. For example, stocks of pencils would not normally be checked at year
end for entering into the balance sheet. Insignificant items will be merged with others. Judgement
is required as to what is appropriate for each business entity.
Duality (Dual Aspect)
The double entry system is fundamental to accounting. Every entry into the accounts has twofold
effect. Every time something is received, something is given; for every debit there is a credit. It is
a very convenient system of ensuring that the books of accounts always balance (if done
properly)! It has given rise to the term double-entry book-keeping.
Realisation (Revenue Recognition)
Profit on a transaction is realised when the legal title of the goods has been transferred, eg sold.
The vendor then has a legal right to the receipt of money. The event is certain and so is
connected with the historical cost concept, it is objective though criticised as overly cautious.
Unrealised gains from assets are therefore not considered, regardless of their appreciation in
market terms. Profits from long term contracts are difficult to recognise until completed, though
special conditions may be allowed, by meeting certain prescribed conditions.
Matching
Costs are matched with revenues in a given accounting period.
This concept arises out of the periodicity requirement of regular financial reports and realisation
which determines the revenues to be included. Many complicated accounting activities have to
take place to meet this principle, such as:
a. Depreciation calculations in order to apportion part of (long term) non-current asset2 costs to
the revenue of the period.
b. Valuation of stocks which carry forward from one period to the next.
c. Provide for estimated liabilities, eg bad debts.
d. Accruals
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Where costs have been incurred with no related income in the period or expected in the future,
they are treated as cost of the period incurred.
Prudence (Conservatism)
Revenue and profits are not anticipated, but provision is made for all known expenses and
losses, whether their amounts are known with certainty or can only be estimated.
This arises out of the number of estimates that have to be made to complete the accounts of a
period in order to derive the profit or loss for that period. An example is the provision of a bad
debt, where there is reasonable doubt that the outstanding debt will be paid. Similarly, in a
situation of a fixed contract of £20,000 revenue and costs are estimated to be £15,000, no profit
will be assumed until it is actually realised. If, however, costs are expected to be £22,000, the
anticipated loss of £2,000 will be recorded in the income statement even before the contract is
complete.
Overall, if in doubt, overstate losses and understate profits.
Consistency
The accounting treatment of like items should be the same from one period to the next.
Once accounting policies have been enacted, they should be consistently applied over time. This
aids the comparability of reported results between different years and assists outsiders to more
effectively understand and compare against other reporting entities. Should there be good
reason to change; the revised policy must be fully disclosed in the reports. For UK public
companies, it is a requirement that the prior year’s published accounts must be restated showing
the impact of the changed policy had it been implemented for the prior year.
Within the extractive industries, the particular accounting policies selected (e.g. depreciation
method) may have an impact upon reported profit.
Objectivity
Accounts should be:
factual
free from bias
verifiable
Financial statements should not be prepared in such a way as to influence the judgement of the
reader in a predetermined way. Judgement is required in accounts preparation, and where
difficulty arises, the prudence principle will normally take precedence.

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Accounting Concepts Business Entity The business is seen as a separate entity from its owner(s). The proprietor(s) and other interested parties (eg creditors, tax authorities) are concerned with the profit earned by and the capital employed by the business. For the small trader, this may appear to be artificial where the liability may legally be unlimited so that creditors can call on much more than the reported accounts may show. For the large corporation, the entity separation from the shareholders is more obvious, but the accountant applies the same principle, regardless of size and legal structure. This has the effect of capital introduced and profits generated by the entity as liabilities of the business to the owner(s). Going Concern This concept assumes that the entity will continue to operate in the foreseeable future, unless there is clear evidence to the contrary. The balance sheet and income statement are drawn up on the basis that the assets will not be liquidated but have a continuing value to the business. If this were not true, all assets would have to be valued on a liquidation basis, which would seriously, financially understate most businesses. This particular principle has received considerable attention by the financial and business press over recent years, due to uncertainties created by the world's financial difficulties. Accountants have been obliged to pay more attention as to whether companies can properly support their financial viability; i.e. to prove that they are going concerns, so have the capacity to trade for the foreseeable future . Periodicity (Accounting Period) The final accounts of the company, i.e. income statement (profit and loss account), balance sheet and, for larger companies, cash flow statements, have to be prepared on an annual basis, (for the UK per the Companies Acts of 1985, 1989 and 2006). More generally, this concept supports the need for the owners of the business to receive periodic financial statements on the progress and status of the business. Other interested parties will also require these updates, eg creditors for assessing the liquidity of the business for their own payment receipts. The London Stock Exchange also requires its members to produce interim reports as well as does the Securities and Exchange Commission (SEC) of the USA. The periodicity principle is closely associated with going concern; i.e. regular reports for the entity of an indefinite life. Money Measurement Transactions are recorded in money terms. Financial statements are drawn up with all revenues, expenses, assets and liabilities similarly expressed. A common unit of measurement is required for such records and reports. Historical Cost Assets, liabilities and expenses are all entered into the books of accounts at their actual cost to the business. This results in all costs being objective and verifiable. It is the extension of the money measurement concept with similar drawbacks, particularly the impact of time on values which is ignored (with few exceptions). Assets are valued at cost or a cost based figure, eg cost less depreciation (explained in Unit 3). Revenues at current values are matched with historical costs to derive a profit or loss to the entity. Materiality Information is material if it could influence user’s decisions on the basis of the financial statements. This helps to counter the excessive work that would result by a detailed control on every item of expenditure. For example, stocks of pencils would not normally be checked at year end for entering into the balance sheet. Insignificant items will be merged with others. Judgement is required as to what is appropriate for each business entity. Duality (Dual Aspect) The double entry system is fundamental to accounting. Every entry into the accounts has twofold effect. Every time something is received, something is given; for every debit there is a credit. It is a very convenient system of ensuring that the books of accounts always balance (if done properly)! It has given rise to the term double-entry book-keeping. Realisation (Revenue Recognition) Profit on a transaction is realised when the legal title of the goods has been transferred, eg sold. The vendor then has a legal right to the receipt of money. The event is certain and so is connected with the historical cost concept, it is objective though criticised as overly cautious. Unrealised gains from assets are therefore not considered, regardless of their appreciation in market terms. Profits from long term contracts are difficult to recognise until completed, though special conditions may be allowed, by meeting certain prescribed conditions. Matching Costs are matched with revenues in a given accounting period. This concept arises out of the periodicity requirement of regular financial reports and realisation which determines the revenues to be included. Many complicated accounting activities have to take place to meet this principle, such as: a. Depreciation calculations in order to apportion part of (long term) non-current asset2 costs to the revenue of the period. b. Valuation of stocks which carry forward from one period to the next. c. Provide for estimated liabilities, eg bad debts. d. Accruals Where costs have been incurred with no related income in the period or expected in the future, they are treated as cost of the period incurred. Prudence (Conservatism) Revenue and profits are not anticipated, but provision is made for all known expenses and losses, whether their amounts are known with certainty or can only be estimated. This arises out of the number of estimates that have to be made to complete the accounts of a period in order to derive the profit or loss for that period. An example is the provision of a bad debt, where there is reasonable doubt that the outstanding debt will be paid. Similarly, in a situation of a fixed contract of £20,000 revenue and costs are estimated to be £15,000, no profit will be assumed until it is actually realised. If, however, costs are expected to be £22,000, the anticipated loss of £2,000 will be recorded in the income statement even before the contract is complete. Overall, if in doubt, overstate losses and understate profits. Consistency The accounting treatment of like items should be the same from one period to the next. Once accounting policies have been enacted, they should be consistently applied over time. This aids the comparability of reported results between different years and assists outsiders to more effectively understand and compare against other reporting entities. Should there be good reason to change; the revised policy must be fully disclosed in the reports. For UK public companies, it is a requirement that the prior year’s published accounts must be restated showing the impact of the changed policy had it been implemented for the prior year. Within the extractive industries, the particular accounting policies selected (e.g. depreciation method) may have an impact upon reported profit. Objectivity Accounts should be: factual free from bias verifiable Financial statements should not be prepared in such a way as to influence the judgement of the reader in a predetermined way. Judgement is required in accounts preparation, and where difficulty arises, the prudence principle will normally take precedence. Name: Description: ...
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