The document discusses several key accounting concepts: - Going concern assumes the business will continue indefinitely and financial statements are prepared on this basis. If not applicable, it must be disclosed. - Accruals recognizes transactions when they occur rather than when cash is received/paid to show the true trading position undistorted by cash flows. - Reliability means financial statements are free from material error or bias. - Prudence involves exercising caution when making judgments under conditions of uncertainty. - Neutrality means financial statements are free from bias and do not distort performance or position. - Comparability allows comparison of results over time and between entities by applying policies consistently.

1. Accounting concepts<br />Top tips. <br />There are plenty of accounting concepts to choose from. We give six here, although only four were required. But make sure you answer the question – explain how each of your concepts contributes to fair presentation.<br />Going concern<br />Under the going concern concept, users of financial statements are entitled to assume that the business will continue for the foreseeable future, and the financial statements are prepared on this basis. If this concept does not apply, this must be made clear in the financial statements and it will affect some items such as the valuation of assets.<br />Accruals<br />Under the accruals concept, transactions are recognised in the financial statements in the period in which they occur, rather than in the period in which any related cash is received or paid. This enables users to see the true trading position, undistorted by any cash management issues, and also gives them valuable information regarding outstanding assets and liabilities.<br />Reliability<br />Information in financial statements must be reliable if it is to be useful to users. It can be said to be reliable when itis free from material error or bias. This is not always so easy to achieve, but financial statements must seek to represent faithfully the transactions which have taken place during the year.<br />Prudence<br />Prudence is important when dealing with estimates and uncertainties in financial information. Under this concept, preparers of financial statements must exercise a degree of caution when making judgements under conditions of uncertainty.<br />Neutrality<br />Information in financial statements must be neutral, or free from bias. Users need to know that they are not being given a distorted view of the entity's performance or position. This is not the case if, for instance, accounting policies are selected which will give the most favourable impression of an entity's results.<br />Comparability<br />Users must be able to compare an entity's results to its results in previous years and to the results of other entities.In order for this to be possible, accounting policies must be applied consistently both within the financial statements and from one period to the next. Users must be informed of any changes of accounting policy or<br />accounting estimate and must be able to see the effects of such changes.<br />Multiple Choice Questions<br />Accounting Concepts <br />1. Which one of the following statements is true of the historical cost convention?<br />A It fails to take account of changing price levels over time<br />B It records only past transactions<br />C It values all assets at their cost to the business, without any adjustment for depreciation<br />D It has been replaced in accounting records by a system of current cost accounting<br />2 Which one of the following is the main aim of accounting?<br />A To maintain ledger accounts for every asset and liability<br />B To provide financial information to users of such information<br />C To produce a trial balance<br />D To record every financial transaction individually<br />3. Which accounting concept or convention which, in times of rising prices, tends to understate asset values<br />and overstate profits?<br />A The going concern concept<br />B The prudence concept<br />C The realisation concept<br />D The historical cost convention <br />4 Which accounting concept which requires assets to be valued at their net book value, rather than their<br />'Break-up' value?<br />A The materiality concept<br />B The going concern concept<br />C The historical cost convention<br />D The business entity convention <br />5 Which one of the following can the accounting equation can be rewritten as?<br />A Assets plus profit less drawings less liabilities equals closing capital<br />B Assets less liabilities less drawings equals opening capital plus profit<br />C Assets less liabilities less opening capital plus drawings equals profit <br />6 Which accounting concept should be considered if the owner of a business takes goods from inventory for<br />his own personal use?<br />A The prudence concept<br />B The capitalisation concept<br />C The money measurement concept<br />D The separate entity concept <br />7 Assets are usually valued under which basis?<br />A Replacement costB Historical costC Net realisable value<br />8 Sales revenue should be recognised when goods and services have been supplied; costs are incurred when<br />goods and services have been received.<br />Which accounting concept governs the above?<br />A The prudence concept<br />B The materiality concept<br />C The accruals concept<br />D The dual aspect concept <br />9 Which accounting concept requires that foreseen losses should be anticipated and taken into account<br />immediately?<br />A The consistency concept<br />B The accruals concept<br />C The prudence concept<br />D The going concern concept <br />10 A sale should be recognised when the goods or services have been provided and the invoice sent out, rather<br />than when the sale is agreed. Which accounting concept does this illustrate?<br />A The realisation concept<br />B The consistency concept<br />C The going concern concept<br />D The materiality concept<br />1 Listed below are some characteristics of financial information.<br />1 Neutrality<br />2 Prudence<br />3 Completeness<br />4 Timeliness<br />Which of these characteristics contribute to reliability, according to the IASB's Framework for the<br />Preparation and Presentation of Financial Statements?<br />A 1, 2 and 3 only<br />B 1, 2 and 4 only<br />C 1, 3 and 4 only<br />D 2, 3 and 4 only <br />2 Which of the following statements about accounting concepts are correct?<br />1 The money measurement concept is that only items capable of being measured in monetary terms<br />can be recognised in financial statements.<br />2 The prudence concept means that understating of assets and overstating of liabilities is desirable in<br />preparing financial statements.<br />3 The historical cost concept is that assets are initially recognised at their transaction cost.<br />4 The substance over form convention is that, whenever legally possible, the economic substance of a<br />transaction should be reflected in financial statements rather than simply its legal form.<br />A 1, 2 and 3<br />B 1, 2 and 4<br />C 1, 3 and 4<br />D 2, 3 and 4<br />3 Listed below are some comments on accounting concepts.<br />1 In achieving a balance between relevance and reliability, the most important consideration is<br />satisfying as far as possible the economic decision-making needs of users.<br />2 Materiality means that only items having a physical existence may be recognised as assets.<br />3 The substance over form convention means that the legal form of a transaction must always be<br />shown in financial statements, even if this differs from the commercial effect.<br />Which, if any, of these comments is correct, according to the IASB's Framework for the Preparation and<br />Presentation of Financial Statements?<br />A 1 only<br />B 2 only<br />C 3 only<br />D None of them <br />4 Which of the following explanations of the prudence concept most closely follows that in the IASB's<br />Framework for the Preparation and Presentation of Financial Statements?<br />A The application of a degree of caution in exercising judgement under conditions of uncertainty<br />B Revenue and profits are not recognised until realised, and provision is made for all known liabilities<br />C All legislation and accounting standards have been complied with <br />5 In times of rising prices, what effect does the use of the historical cost concept have on a company's asset<br />values and profit?<br />A Asset values and profit both understatedB Asset values and profit both overstated<br />C Asset values understated and profit overstatedD Asset values overstated and profit understated <br />6 Which of the following statements about accounting concepts and policies is/are correct?<br />1 The effect of a change to an accounting policy should be disclosed as an extraordinary item if<br />material.<br />2 Information in financial statements should be presented so as to be understood by users with a<br />reasonable knowledge of business and accounting.<br />3 Companies should create hidden reserves to strengthen their financial position.<br />4 Consistency of treatment of items from one period to the next is essential to enhance comparability<br />between companies, and must therefore take precedence over other accounting concepts such as<br />prudence.<br />A 1 and 4B 2 and 3C 3 and 4D 2 only <br />7 Which of the following most closely describes the meaning of prudence, as the term is defined in the IASB's<br />Framework for the Preparation and Presentation of Financial Statements?<br />A Ensuring that accounting records and financial statements are free from material error.<br />B The use of a degree of caution in making estimates required under conditions of uncertainty.<br />C Understating assets and gains and overstating liabilities and losses.<br />D Ensuring that financial statements comply with all accounting standards and legal requirements<br />8 Which, if any, of the following statements about accounting concepts and the characteristics of financial<br />information are correct?<br />1 The concept of substance over form means that the legal form of a transaction must be reflected in<br />financial statements, regardless of the economic substance.<br />2 The historical cost concept means that only items capable of being measured in monetary terms can<br />be recognised in financial statements.<br />3 It may sometimes be necessary to exclude information that is relevant and reliable from financial<br />statements because it is too difficult for some users to understand.<br />A 1 and 2 only<br />B 2 and 3 only<br />C 1 and 3 only<br />D None of these statements are correct<br />9. The principle which holds that all the expenses incurred in earning revenue should be identified with the revenue recognized and reported for the same period is the <br />A revenue principle<br />B Liability principle<br />C time- period principle<br />D matching principle<br />Objective Test Questions<br />Accounting Principles and Regulation <br />1 Which two of the following statements concerning the International Accounting Standards Board is true?<br />1 It develops and ultimately issues International Accounting Standards (IASs).<br />2 Each new standard issued by the IASB has to be approved by the Consultative Committee of<br />Accountancy Bodies.<br />3 The IASB has stronger legal backing than its predecessor the IASC.<br />4 Consensus of the Board is required to approve a new standard.<br />5 The IASB is accountable to the International Accounting Standards Committee (IASC).<br />2 According to Chapter 3 'Qualitative characteristics of financial information' of the IASB's Framework, which two of the following make information reliable?<br />1 It is understandable<br />2 It is relevant<br />3 Use of information that has the ability to influence decisions<br />4 Information that is free from material error<br />3 A newly-registered company is considering the accounting policies it should adopt.<br />Policies under consideration are:<br />1 Research and development expenditure should be capitalised and amortised over the years in which the resultant product is sold or used.<br />2 Inventory should be valued at the lower of cost and net realisable value.<br />3 Purchased goodwill should be written off immediately it arises against distributable profits.<br />Which of these possible accounting policies would, if adopted, contravene International Financial Reporting Standards?<br />4 There are generally agreed to be seven separate user groups for published accounting statements. Six groups are: owner/investors, loan creditor, analyst-advisers, business contact, the government and the public. Which is the missing group?<br />5 Which of the following accounting concepts means that similar items should receive a similar accounting statement?<br />1.Going concern2.Accruals3.Prudence4.Consistency<br />6 'The shareholder needs a statement of financial prospects, ie an indication of future progress. However, the supplier of goods on credit needs a statement of financial position, ie an indication of the current state of affairs.'<br />1.True2.False <br />7 You have recently been appointed as assistant accountant of PQR Co. You have assisted in preparing a forecast set of final accounts for the company whose year end is 31 December 20X7. The forecast shows that the company is expected to make a loss during the year to 31 December 20X7. This would be the first time that the company has made a loss since it was incorporated twenty years ago. The managing director is concerned that the company's shareholders would be unhappy to hear that the company had made a loss. He is determined to avoid making a loss if at all possible. He has made the following suggestions in order to remedy the situation.<br />1 Make no further provision for obsolete inventory and consider crediting the statement of<br />comprehensive income with the provision made in previous years.<br />2 Do not allow for depreciation for the year to 31 December 20X7.<br />3 Capitalise all research expenditure.<br />4 Do not make any further allowance for receivables and credit the statement of comprehensive income with the full amount of allowances made in previous years.<br />Which of these suggestions do you agree with?<br />A 1 and 2 only<br />B 2 and 3 only<br />C 1 and 3 only<br />D None of these statements are correct.<br />