Examining different Accounting concepts and principles

Published: Last Edited:

This essay has been submitted by a student. This is not an example of the work written by our professional essay writers.

It means that assets are normally shown at cost price, and that this is the basis for valuation of the assets. (Frank Wood & Alan Sangster) (pg 110)

The accounting process does not try to measure the current market of a business. Instead, assets are recorded in cost (historical cost). This cost figure will be recorded in the accounts, until the asset is sold or used up. Cost is defines as the cash equivalent given up in exchange for the asset in an arm's length between two individuals or parties. This means that the price agreed upon should be the result of a bargained transaction and not based on some other relationships. In this sense, cost is an objective measure resulting from a market transaction. (Andrew Leong & Wong Sei Van) (pg 324)

Under the historical cost concept, assets are initially recorded at cost. As you will see in later chapters, many assets, such as inventory, will still be recorded at cost in the statement of financial position in subsequent periods although their value has increased. Some other assets, such as property, plant and equipment, can be revalued periodically. Thus, in reading a statement of financial position it is important to note at what valuation the assets are being recorded. (Ken Trotman & Michael Gibbins) (pg 21)

Accounting transactions need to be measured in a common denominator, which in Australia is, not surprisingly, the Australian dollar. This allows comparisons across periods and across different companies. Transactions that cannot be reasonably assigned a dollar value are not included in the accounts. This concept also assumes that the value of the monetary unit is constant over time, which ignores inflation. (Ken Trotman & Michael Gibbins) (pg 21)

The accounting process records and reports transactions which can be measured in terms of ringgit. It would be meaningless to add physical units of say, pineapples and mangoes to obtain a meaningful total, on the accounting sense. However the use of the ringgit as a common measuring unit assumes that the value of the ringgit is stable. However, the value of the ringgit, i.e. money, will not remain unchanged because of the influence of such factors as inflation and changes in purchasing power. Nevertheless, these are not normally taken into consideration in accounting reports. (Andrew Leong & Wong Sei Van) (pg 325)

Accounting information has traditionally been concerned only with those facts which are it can be measured in monetary units and most people will agree to the monetary value of the transactions. This limitation is referred to as the money measurement concept, and it means that accounting can never tell you everything about a business. (Frank Wood & Alan Sangster) (pg 110)

(iii) The Business Entity Concept (or Accounting Entity Assumption/Concept)

The business entity concept implies that the affairs of a business are to be treated as being quite separate from the non-business activities of its owners. The items recorded in the books of the business are, therefore, restricted to the transactions of the business. No matter what activities the proprietors get up to outside the business, they are completely disregarded in the books kept by the business. The only time that the personal resources of the proprietors affect the accounting records of a business is when they introduce new capital into the business, or take drawings out of it. (Frank Wood & Alan Sangster) (pg 110)

In accounting, the business is considered to be a complete unit or entity which is different from its owners, creditors, employers, customers and other persons. All of the dealings or transactions of the business with these groups are recorded from the point of view of the business, as a separate entity. Suppose one of the owners of a business transfers some of his personal assets to the business, for business use. These assets are now considered to be the property of the business, from the business's point of view. From the point of view of the owner of the business, this is of course seen as an investment by the owner in the business. (Andrew Leong & Wong Sei Van) (pg 325)

Under this concept the accounting entity is separate and distinguishable from its owners. For examples, the accounting entity of a sole trader is differentiated from the financial affairs of the owner. Similarly, a company is a separate entity from its shareholders. If either the sole trader or a shareholder of a company goes out and buys a new set of golf clubs, it may affect his or her personal finances but does not affect the accounting entity. Accounting entities do not necessarily correspond to legal entities. For example, as noted above, the personal financial affairs of the sole trader can be separated from the finances of the business, although there is no legal distinction. This concept puts a boundary on the transactions that are to be recorded for any particular accounting entity. It also allows the owner to evaluate the performance of the business. (Ken Trotman & Michael Gibbins) (pg 21)

(iv) The Time Interval Concept (or Accounting Period Assumption/Principle)

Generally, the life of a business is assumed to cover a long period of time and for accounting purposes it is divided into units of equal length called accounting periods. Accounting periods may be of any length of time but periods of one year in length are the most commonly used. The purpose of having accounting periods is to enable comparisons and analysis of the business's financial position over a period of time. After all, it would not serve very much purpose to the investors, managers and owners of a business if the business is analyzed only after it closes down as the period covered would be too long. Accounting periods are therefore a convenient way of dividing up the life of the business into smaller units of time. (Andrew Leong & Wong Sei Van) (pg 325)

One of the underlying principles of accounting, the time interval concept, is that financial statements are prepared at regular intervals of one year. Companies which publish further financial statements between their annual ones describe the others as 'interim statements'. For internal management purposes, financial statements may be prepared far more frequently, possibly on a monthly basis or even more often. (Frank Wood & Alan Sangster) (pg 111)

The life of a business needs to be divided into discrete periods to evaluate performance from that period. Dividing the life of an organization into equal periods to determine profit or loss for that period is known as the accounting period concept. The time periods are arbitrary, but most organizations report at least annually, with large companies preparing half-yearly and quarterly financial statements for outside purposes (in some countries) and at least monthly (sometimes more frequently) for management purposes. (Ken Trotman & Michael Gibbins) (pg 21)

(v) Going Concern Assumption

In accounting the business enterprise is assumed to have an indefinite life unless there is evidence that it is going to be liquidates in the near future. This means that the accountant ignores the current liquidation values of the resources in the business because he assumes that these resources will not be sold but will be utilized by the business in its normal operations. The going concern concept therefore permits accounting measurement to be made on the basis of long-term considerations and not in terms of current liquidating values. (Andrew Leong & Wong Sei Van) (pg 324)

Financial statements are prepared on the premise that the organization will continue operations as a going concern in the foreseeable future. If this is not the case, it is necessary to report the liquidation values of an organization's assets. (Ken Trotman & Michael Gibbins) (pg 21)

It is assumed that the business will continue to operate for at least twelve months after the end of the reporting period. Suppose, however, that a business is drawing up its financial statements at 31 December 2008. Normally, using historical cost concept, the assets would be shown at a total value of $100,000. It is known, however, that the business will be forced to close down in February 2009, only two months later, and the assets are expected to be cols for only $15,000. In this case it would not make sense to keep to the going concern concept, and so we can reject the historical cost concept for asset valuation purposes. In the balance sheet at 31 December 2008 the assets will therefore be shown at the figure of $15,000. Rejection of the going concern concept is the exception rather than the rule. (Frank Wood & Alan Sangster) (pg 111 & 112)