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Accounting concepts
This document discusses key accounting concepts and principles: - The business entity concept treats the business and its owners as separate entities. - The historical cost principle records assets at their original cost rather than current value. - The matching principle recognizes revenues when earned and expenses when incurred to match revenues with related expenses over the same period. - The materiality concept means that only significant items are disclosed separately in financial statements.
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Accounting concepts
- 1. 1 Accounting ConceptsAccounting Concepts andPrinciplesand Principles By; Prof. Snawer GillBy; Prof. Snawer Gill MS-FinanceMS-Finance
- 3. 3 Introduction • Actually thereare a number of accounting concepts and principles based on which we prepare our accounts • These generally accepted accounting principles (GAAP) lay down accepted assumptions and guidelines and are commonly referred to as accounting concepts
- 4. 4 Users of FinancialStatements • Investors – Need information about the profitability, dividend yield and price earnings ratio in order to assess the quality and the price of shares of a company • Lenders (Banks etc) – Need information about the profitability and solvency of the business in order to determine the risk and interest rate of loans • Management – Need information for planning, policy making and evaluation • Suppliers and trade creditors – Need information about the liquidity of business in order to access the ability to repay the amounts owed to them
- 5. 5 • Government – Needinformation about various businesses for statistics and formulation of economic plan • Customers – Interested in long-tem stability of the business and continuance of the supply of particular products • Employees – Interested in the stability of the business to provide employment, fringe benefits and promotion opportunities • Public – Need information about the trends and recent development
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- 8. 8 Business Entity • Meaning –The business and its owner(s) are two separate existence entities (bodies) – Any private and personal incomes and expenses of the owner(s) should not be treated as the incomes and expenses of the business
- 9. 9 • Examples – Insurancepremiums for the owner’s house should be excluded from the expense of the business – The owner’s property should not be included in the premises account (Assets) of the business – Any payments for the owner’s personal expenses by the business will be treated as drawings and reduced the owner’s capital contribution in the business
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- 11. 11 Money Measurement • Meaning –All transactions of the business are recorded in terms of money – In accounting, the record of that transaction is made that is measurable into money. • Examples • Value of assets and goods will be recorded, • Wining of a price will not be recorded
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- 13. 13 Going Concern • Meaning –The business will continue in operational existence for the foreseeable future – Financial statements should be prepared on a going concern basis unless management either wants to dissolve the business.
- 14. 14 • Example – Ownerof the business must provide finance as needed to keep the business alive. – Proverb “Sale a House for Shop”
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- 16. 16 Historical Cost • Meaning –Assets should be shown on the balance sheet at the cost of purchase instead of current value. • Example – The cost of fixed assets is recorded at the date of acquisition cost. – if business purchases a building for Rs.500,000, it will be recorded in books at Rs. 500,000 even its market value at that time may be Rs. 600,000/-
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- 18. 18 Prudence/Conservatism • Meaning – Theprudence concept mean to prevent to be overstated. If profit is overstated, a trader may believe that his income is more than it really is, and he may withdraw too much money from business. That will decrease the capital injected in business.
- 19. 19 • Example – Stockvaluation sticks to rule of the lower of cost and net realizable value – The provision for doubtful debts should be made – Fixed assets must be depreciated over their useful economic lives
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- 21. 21 Materiality • Meaning – Immaterialamounts may be aggregated with the amounts of a similar nature or function and need not be presented separately – Materiality depends on the size and nature of the item
- 22. 22 • Example – Smallpayments such as postage, stationery and cleaning expenses should not be disclosed separately. They should be grouped together as sundry expenses
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- 24. 24 Objectivity • Meaning – Theaccounting information should be free from bias and capable of independent verification – The information should be based upon verifiable evidence such as invoices or contracts
- 25. 25 • Example – Therecognition of revenue should be based on verifiable evidence such as the delivery of goods or the issue of invoices
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- 27. 27 Consistency • Meaning – Companiesshould choose the most suitable accounting methods and treatments, and consistently apply them in every period – Transactions of similar nature should be recorded in the same accounting and in all future accounting periods.
- 28. 28 • Examples – Ifa company adopts straight line method and should not be changed to adopt reducing balance method in other period • the cost of recording building should always be debited to expense account.
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- 30. 30 Accruals/Matching • Meaning – Revenuesare recognized when they are earned, but not when cash is received – Expenses are recognized as they are incurred, but not when cash is paid
- 31. 31 • Example – Expensesincurred but not yet paid in current period should be treated as accrual/accrued expenses under current liabilities – Mr. A pays rent of Rs. 2000 per month. In November, he has paid Rs. 3,000, So, he will record rent expense as Rs. 2000. November: Rent paid = 3,000 Less prepaid = 1,000 2,000
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- 33. 33 Realization • Meaning • Revenuesshould be recognized when the major economic activities have been completed • Sales are recognized when the goods are sold and delivered to customers.
- 34. 34 Example; • Mr. Ranaplaces an order to Mr. Gill for supply of goods. But, goods are delivered by Mr. Gill in the next month. So, sales will be recorded at that time when goods are delivered and payment is made.
- 35. 35 DualityDuality (Dual Aspect Concept)(DualAspect Concept)
- 36. 36 Relevance • Meaning – Thisconcept tell us that there are two aspects for each transaction represented by Dr and Cr, This concept is the basis of accounting equation; assets = liabilities + capital
- 37. Example • Mr. Ranastarted business with cash Rs. 30, 000; Cash (assets) 30,000 to Capital (liability) 30,000 ___________________ 37
- 38. 38 Substance over FormSubstanceover Form
- 39. 39 Substance over Form •Meaning Substance over form is the treatment according to the transaction. So that the real effect of the transaction on the business is recorded.
- 40. Example • A machineis purchased on hire purchase (installment basis) remains the property of the seller until the final installment has been paid. If the purchaser fails to pay the installments, the seller may claim the machine. 40