Basic Concepts of Accounting
Submitted To: Miss Tahira Tariq
Submitted On: 16/1/2017
PreparedBy: Fariha Ijaz
The business entity concept, also known as the economic entity assumption, states that all
business entities should be accounted for separately. In other words, businesses, related
businesses, and the owners should be accounted for separately. Even though the tax law looks at
a sole proprietorship and the owner as one entity, GAAP disagrees. The owner and the business
are two separate entities and should be accounted for separately. The same goes for partnership
and corporations. The partners and shareholders' activities should be kept separate from the
partnership and corporate transactions because they are separate economic entities.
Mike, a partner in Big House Realty, LLC, often uses his company credit card for
personal expenses like dry cleaning and new clothes. He insists that these are business expenses
because he must wear new clothes in order to show houses. Unfortunately, these are not business
expenses. Clothing is a personal expense and can't be recorded in the company financial
statements. This would violate the business entity concept. Instead, these transactions should be
accounted for as an owner withdrawal.
The objectivity principle states that accounting information and financial reporting should
be independent and supported with unbiased evidence. This means that accounting information
must be based on research and facts, not merely a preparer's opinion. The objectivity principle is
aimed at making financial statements more relevant and reliable.
A company is trying to get financing for an extra plant expansion, but the company's
bank wants to see a copy of its financial statements before it will loan the company any money.
The company's bookkeeper prints out an income statement from its accounting system and mails
it to the bank. Most likely the bank will reject this financial statement because an independent
party did not prepare it.
In accounting, the cost principle is part of the generally accepted accounting principles.
Assets should always be recorded at their cost, when the asset is new and also for the life of the
1.land purchased for $30,000 is appraised at the much higher value because the housing
market has risen, but the reported value of the land will remain $30,000.
2. if equipment is acquired for the cash amount of $50,000, the equipment will be
recorded at $50,000. If the equipment will be useful for 10 years with no salvage value, the
straight-line depreciation expense will be $5,000 per year (cost of $50,000 divided by 10 years).
The equipment's market value, replacement cost or inflation-adjusted cost will not affect the
annual depreciation expense of $5,000. The company's balance sheets will report the equipment's
historical cost minus the accumulated depreciation. other words, this income statement violates
the objectivity principle.
An accounting guideline which allows the readers of financial statements to assume that
the company will continue on long enough to carry out its objectives and commitments. In other
words, the accountants believe that the company will not liquidate in the near future. This
assumption also provides some justification for accountants to follow the cost principle.
In 2011, Gibson Guitar Factory was raided by the Federal government for illegally
smuggling endangered wood into the country. The Federal government took more than $250,000
worth or Gibson's inventory and slapped them with large fines for violating international laws.
Gibson is still considered a going concern, because it is not likely the fines and punishment will
stop its operations.
Stable dollar assumption:
A basic premise used by business accountants when putting together financial statements
dominated in US. Dollars that the currency’s value does not fluctuate significantly. Of course the
stable dollar assumption breaks down when the US dollar rises or fall substantially relative to
other currencies on the foreign exchange market. Also called stable monitory unit.
Assume that in 1970, you purchased land for $20,000. In 1990, you sell this land for $30,000.
Under generally accepted accounting principles, which include the stable dollar assumption, you
Have made a $10,000 gain on the sale. Economists would have point out, however, that$30,000
in 1990 represents less buying power than did $20,000 in 1970. When the relative buying power
of the dollar in 1970 and 1990 is taken into consideration, you come out behind on the purchase
and the sale of this land.
Accounting Ethics - Fundamental Principles
A professional accountant’s responsibility is not exclusively to satisfy the needs
of an individual client or employer, but to act in the public interest. Thus, the
responsibility of the professional accountant is to ensure that the financial statements
present information that is relevant, reliable and useful to a wide range of users who are
not in a position to demand reports tailored to meet their particular information needs.
2. Fundamental principles:
The fundamental principles of the Code include the following:
(a) Integrity: A professional accountant shall be honest and base decisions in all professional
and business relationships on the facts available. The integrity of the professional accountant is
underpinned by his/her responsibility to serve the public interest, dealing with fairness and
To maintain his/her integrity, a professional accountant should not be associated with reports or
any other information where he/she believes that the information:
(i) contains a materially false or misleading statement;
(ii) contains statements or information furnished recklessly; or
(iii) omits or obscures information required to be included, where such omission or obscurity
would be misleading.
(b) Objectivity: A professional accountant shall be unbiased and not allow any conflict of
interest or undue influence of others to override his/her professional or business judgement. The
objectivity of the professional accountant reflects his/her level of integrity in that the decisions
made are based on facts, irrespective of the effect on his/her personal interest or business
(c) Professional competence and due care: A professional accountant has a responsibility to
maintain professional knowledge and skills at the level required to ensure that clients receive the
best professional service based on current developments in the profession, legislation and
techniques. A professional accountant should take steps to ensure that those working in a
professional capacity under the professional accountant’s authority have appropriate training and
(d) Confidentiality: A professional accountant shall respect the confidentiality of information
obtained while rendering professional or business services and shall not disclose any such
information to third parties without proper and specific authorization to do so. However, in
certain cases (e.g. fraud), a professional accountant may be required to disclose such information
if there is a legal or professional right or duty to do so. Furthermore, confidentiality of
information is closely associated with the integrity of the professional accountant, in that the
professional accountant shall not use confidential information acquired while rendering the
professional services for his/her personal advantage or that of third parties.
(e) Professional behavior: A professional accountant shall comply with the relevant laws and
regulations and should avoid any actions that may discredit the profession. This includes actions
which a reasonable and informed third party, having knowledge of all relevant information,
would conclude that they negatively affect the good reputation of the profession.
In marketing and promoting themselves and their work, professional accountants should not
bring the profession into disrepute by:
making exaggerated claims for the services they are able to offer, the qualifications they
possess or experience they have gained; or
Making disparaging references or unsubstantiated comparisons to the work of others.
3. Professionalaccountant’s responsibility with respectto the Code
The professional accountant does not have to follow the Code rigidly, blindly or merely because
the rules are there. However, the professional accountant has a responsibility to identify,
evaluate and address the threats to compliance with the fundamental principles of the Code. If
the threats identified are considered to be significant, a professional accountant shall, where
appropriate, apply measures and safeguards to eliminate or reduce them to an acceptable level
that will not compromise the compliance with the fundamental principles of the Code.
The Code of Ethics for Professional Accountants places greater emphasis on the manner in
which the professional accountants conduct themselves in their professional and business
relationships with clients and employers while fulfilling their ultimate responsibility of serving
the interest of the public.