Principles and concepts of accounting FA2 Maintaining Financial Records Foundations in Accountancy Students

The Going concept in accounting states that a business activities will be carried by any firm for an unlimited duration This simply means that every business has continuity of life. This is an important assumption of accounting as it provides a base for representing the asset value in the balance sheet. Therefore, the business entity concept states that the business and the business owner are two separate/distinct persons.

• For example, a business may compare its sales and expenses from one month to the next to see if there are any areas where costs can be reduced or where profits can be increased.
• Receipts serve as proof that the transaction took place and allow those transactions to be processed for tax purposes.
• The International Financial Reporting Standards (IFRS) is the most common set of principles outside the United States.
• We record all the financial transaction of a business in keeping this point of view in our mind that a business unit is a going concern; not a gone concern.
• This graphic representation of a general ledger account is known as a T-account.

The accountant strives to provide an accurate and impartial depiction of a company’s financial situation. Materiality means that all material facts should be recorded in accounting. Accountants should record important data and leave out insignificant information. Conservatism is the convention by which, when two values of a transaction are available, the lower-value transaction is recorded. By this convention, profit should never be overestimated, and there should always be a provision for losses. Personal systems of accounting may have worked in the days when most companies were owned by sole proprietors or partners, but they do not anymore, in this era of joint stock companies.

What Does Accounting Concepts Mean?

The historical cost concept is important because it helps to ensure that the company’s financial statements are accurate and reliable. The duality concept is important because it ensures that the accounting equation is always in balance. This helps to ensure that the financial statements are accurate and reliable. The duality concept states that every financial transaction has two equal and opposite effects on the accounting equation. The accounting equation is a mathematical formula that states that assets must equal liabilities plus equity.

Payroll also includes fringe benefits distributed to employees and income taxes withheld from their paychecks. In accounting, liquidity describes the relative ease with which an asset can be sold for cash. Assets that can easily be converted into cash are known as liquid assets. Accounts receivable, securities, and money market instruments are all common examples of liquid assets.

• The ending account balance is found by calculating the difference between debits and credits for each account.
• Rather, that there are no errors or omissions in the depiction of any phenomena and that the processes used to produce the reported information have been selected and applied with no errors in the process.
• Therefore, the firm will initially record the amount as a liability in the unearned revenue account.
• Generally accepted accounting principles (GAAP) refer to a common set of accounting rules, standards, and procedures issued by the Financial Accounting Standards Board (FASB).

The SEC requires that publicly traded companies in the U.S. regularly file GAAP-compliant financial statements in order to remain publicly listed on the stock exchanges. GAAP compliance is ensured through an appropriate auditor’s opinion, resulting from an external audit by a certified public accounting (CPA) firm. Matching Principle – states that all expenses must be matched and recorded with their respective revenues in the period that they were incurred instead of when they are paid. This principle works with the revenue recognition principle ensuring all revenue and expenses are recorded on the accrual basis. In addition, if Andrea withdraws money for personal expenses, the nature of the expense is not recorded. All that is necessary is to record the fact that Andrea withdrew funds – with a debit entry in the drawings account and credit entry in the bank account.

Money Measurement Concept

We also know that the employment activities performed by an employee of a company are considered an expense, in this case a salary expense. In baseball, and other sports around the world, players’ contracts are consistently categorized as assets that lose value over time (they are amortized). Theoretically, there are a number of bases that could be used to derive the value at which transactions are recorded. However, historical cost is the only one of these that needs to be considered in the context of FA2.

Accounting Concepts and Principles FAQs

Thus, we should assume that there will be another accounting period in the future. Cost Benefit Principle – limits the required amount of research and time to record or report financial information if the cost outweighs the benefit. Thus, if recording an immaterial event would cost the company a material amount of money, it should be forgone. We define an asset to be a resource that a company owns that has an economic value.

The business entity concept

Theory Base of Accounting consists of accounting concepts, principles, rules, guidelines, and standards that help an individual in understanding the basics of accounting. These principles are developed over time to bring consistency and uniformity to the accounting process. This enables the investors or shareholders to know the exact profit and loss of the business. For example, the plant and machinery was purchased by a company of Rs. 10 lakhs and its life span is 10 years. According to the Going concept, every year some amount of assets purchased by the business will be represented as an expense and the balance amount will be shown as an asset in the books of accounts.

However, because of the differences between the two standards, the U.S. is unlikely to switch in the foreseeable future. Materiality refers to the impact of an
omission or misstatement of an
information the profitability ratio and company evaluation in a company’s financial
statements on the user of those
statements.  If the owner has a barber shop, the cash of the barber shop should be
reported separately from his personal cash.

Accounting Period Concept

As GAAP issues or questions arise, these boards meet to discuss potential changes and additional standards. For instance, when the COVID-19 pandemic hit, the board members met to address how governments and businesses must report the financial effects of the pandemic. It is essentially a way of adjusting future revenues, expenses, and debts for inflation. This allows others within the business to understand those projections’ potential impacts in relatable terms. Accountants sometimes make future projections with respect to revenues, expenses, and debts. The concept of « present value » (PV) describes calculated adjustments that express those future funds in present-day dollars.

The SEC is an independent federal agency that is charged with protecting the interests of investors, regulating stock markets, and ensuring companies adhere to GAAP requirements. Accounting conventions are certain restrictions for the business transactions that are complicated and are unclear. Although accounting conventions are not generally or legally binding, these generally accepted principles maintain consistency in financial statements.

This allows accountants to prepare financial statements on a regular basis. Accounting concepts provide a general framework for recording and reporting financial transactions, while accounting conventions can be used to fill in the gaps where accounting concepts do not provide specific guidance. The conservatism or prudence concept believes in playing safely, while recording the transactions in the book of accounts. According to this concept, an organization should adopt a conscious approach and should not record its profits until they are realised.

Here are the nine most important accounting concepts small-business owners should know. All business transactions that will be entered in the accounting
records must be duly supported by verifiable evidence. Even if the fair market value of the machine increases to $12,000, the machine would continue to be recorded in the accounting records at its historical cost of $10,000.