ACCOUNTING CONCEPTS

Accounting is based on a number of concepts, the most important being the following: 

THE ACCOUNTING ENTITY

The accounts deal with the affairs of a specific business enterprise.   These affairs are separate from the private activities of the persons who are the owners of the business. 

MONEY VALUES

Records are expressed in terms of money.   As they are entered at the time the transactions occurred they are essentially historical.    Money can be an imperfect means of management since the value of money and assets change. 

CONTINUITY OF ACTIVITY

There is an assumption that the entity will continue its business operations. 

HISTORICAL COST

Involves recording transactions at the amount of cash paid (or payable) at the time of acquisition. 

ACCOUNTING PERIOD

Results are recorded in periods.   An important task for an Accountant is to adjust the records so that the report on activities of a particular period is as accurate as possible.   For instance, with regard to goods that have been brought and not yet sold, sales made but for which payment has not been made, payments made at balance date. 

ACCRUAL BASIS

There are two methods in the measurement of net profit-  the cash basis and the accrual basis of profit measurement.

·         Under the cash basis of accounting, revenues are recorded in the period in which cash is received and expenses are recorded in the period in which cash is paid.   In this system, net profit is the excess of cash inflows of revenues over cash outflows for expenses.

·         Under the accrual basis of accounting, revenue is recognised in the period in which a business sells its goods and services, including amounts unpaid by debtors at period end.   Expenses are the costs incurred in the accounting period, including amounts unpaid to creditors at period end.

·         Generally the accrual basis is used, as this basis of profit measurement allows more accurate profits to be recorded. 

MATCHING

Requires that all expenses incurred for a particular accounting period are matched accurately with all revenues earned for that period.   This concept is in line with the accrual basis of measurement in that it tries to ensure more accurate recording of profits made by the organization.   Therefore, balance date adjustments like depreciation, expenses accrued, income due, deferred revenue and prepaid expenses are very important considerations at the end of the accounting period. 

CONSISTENCY

Using consistent policies and procedures from one period to the next.   This is especially important in accounting reports so that reports for one period may be compared with those for another. 

CAUTION

An Accountant tends to be cautious in the judgements and estimates that are necessary to prepare accounts.   For instance, he makes provision for possible losses that may occur but he would refrain from taking into account profits that have not been actually realised.   He considers that it is better to guard against overstating profit. 

DISCLOSURE

Disclosure is providing information that will enable a proper appraisal of the situation to be made and appropriate decisions taken.   Relevant facts must be stated fully and clearly, unusual circumstances noted, and additional notes given to achieve this. 

MATERIALITY

Important facts and important results should be stressed.   Businesses of different types and scales of activity call for differences in emphasis.   What is material to one may not be material to the other, and in this respect an Accountant must use his professional judgement. 

REALISATION

In determining profit by matching revenue with expenses, it is necessary to choose a point in time at which the revenue is deemed to be recognised and the profit on the activity thus realised.   Conventionally, the point of sale has been used. 

TRUE AND FAIR VIEW

It is a responsibility to produce reports which give a true and fair view of the financial affairs of the entity.   A true and fair view implies:

·         Disclosure.  All material items should be disclosed and shown separately.   Similar items should be appropriately grouped and subtotalled.   Unusual items should be clearly shown

·         Materiality.  Implies relative importance and what is material will depend on the size and circumstances of the particular entity

·         Consistency.   Once selected, accounting principles should be consistently adhered to.   When a change becomes necessary in order to adopt a more suitable principle, the fact that the changes have been made and the effects of the change should be adequately disclosed.

·        Understandable, Objective and Significant Accounting Principles.   Principles will be understandable if they are those customarily employed or if they are clearly explained in the accounts, objective if the results obtained by their use will not be unduly affected by the personal opinions of those applying them, and significant if they result in producing financial information suitable for the purpose for which the accounts are normally required.