Accountancy · Ch 2 — Theory Base of Accounting
Summary
Summary
- Accounting Principles: Rules and guidelines (GAAP) that ensure consistency, reliability, and comparability of financial statements. They are divided into concepts (assumptions) and conventions (practices).
- Basic Accounting Concepts: The fundamental ideas or basic assumptions underlying the theory and practice of financial accounting, which act as broad working rules for all accounting activities.
- Business Entity Concept: The business is separate from its owner. Personal transactions of the owner are not recorded in the firm's books.
- Money Measurement Concept: Only transactions that can be expressed in monetary terms are recorded. Non-monetary events (e.g., skill of staff) are ignored.
- Going Concern Concept: The business will continue to operate indefinitely. This justifies valuing assets at cost (not liquidation value) and deferring prepaid expenses.
- Accounting Period Concept: The indefinite life of a business is divided into equal periods (usually a year) to measure performance periodically.
- Cost Concept: Assets are recorded at their purchase price (historical cost). This cost is the basis for all subsequent accounting, not current market value.
- Dual Aspect Concept: Every transaction has two effects — debit and credit. This is the foundation of the double-entry system: Assets = Liabilities + Capital.
- Revenue Recognition (Realisation) Concept: Revenue is recorded when it is earned (goods delivered or service performed), not when cash is received.
- Matching Concept: Expenses incurred in earning revenue for a period must be matched against that revenue to determine net profit. This leads to adjustments for prepaid/accrued items.
- Full Disclosure Concept: All material and relevant information must be fully disclosed in financial statements (usually via notes to accounts).
- Consistency Concept: Accounting methods (e.g., depreciation, valuation of inventory) should be applied uniformly from one period to the next to allow comparison.
- Conservatism (Prudence) Concept: Anticipate no profit but provide for all possible losses. Example: valuing inventory at cost or net realisable value, whichever is lower.
- Materiality Concept: Only items significant enough to influence a user's decision need to be separately disclosed. Trivial items can be ignored.
- Objectivity Concept: Accounting transactions should be recorded on the basis of verifiable, documentary evidence, free from the personal bias of the accountant.
- Systems of Accounting: Transactions may be recorded under the double entry system (both two-fold effects of every transaction are recorded — a complete system) or the single entry system (incomplete records). …