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An accounting concept which treats a business separately from its owner. The separate entity assumption states that the transactions conducted by a business are separate to those conducted by its owners. For example, if a business owner bought an asset for their personal use, the asset is not the property of the business. In accounting, a business entity is treated as a separate entity from the owners. Therefore, any capital injections made by the owners are recorded as capital contribution from owners in the books of the business entity. The owner private expenditure/spending are not recorded in the books of the business entity. There are many instances whereby the owner withdrew money from the business for their personal use. This is actually a lending of money from the business to the owners and should be recorded as such in the books of the business entity. On the other hand, when the owners inject cash into the business to help easing tight cash flow situation faced by the business entity, it is a lending of money from the owner to the business and should also be recorded as such in the books of the business entity.
Many owners of small businesses (Three Most Common Types of Small Businesses) fail to see this "line" drawn between the business and the owners. The direct consequence is the recording of private/personal expenditure in the books of the business entities and therefore the financial position and results of the business entities do not show a "true picture" of the business entities. The business entities may face the following problems: -
Private/personal expenses not adjusted from the profit/income reported for income tax purposes and therefore understating the income subject to tax. Unnecessary penalty and more seriously, jail terms are possible outcome.
It may cause the application for banking facility unsuccessful should the assessor of the application notice that the owner's private expenditure is included in the financial statements of the business entities.
In general, this does not do well to the application submitted by the business entities whereby financial statements are to be included in the application (e.g. project tender, grant application & etc.)
This problem of keeping the books/accounts of business entities "clean" from owners private expenditure can be further compounded if the transactions record keeping of the business entities is poor, making any effort to identify these private expenditure recorded in the books of the business entities for adjustment purposes difficult.
A CPA has 3 rooms in a house he has rented for $3,000 per month. He has setup a single-member accounting practice and uses one room for the purpose. Under the business entity concept, only 1/3rd of the rent or $1,000 should be charged to business, because the other 2 rooms or $2,000 worth of rent is expended for personal purposes.
The CPA received $900 bill for utilities. He paid the whole amount using his business account. $600 is to be considered a withdrawal because only $300 (1/3rd) related to business and the other $600 was for domestic purpose.
Assuming each public accounting business is required to pay $100 to a local association of CPAs each month. If the CPA pays that amount from a personal bank account the amount shall be considered additional capital.
Mr. John has three rooms in a house he has rented for $3,000 per month. He has set up a single-member accounting practice and uses one room for the purpose. Under the business entity concept, only 1/3 of the rent or $1,000 should be charged to business, because the other two rooms or $2,000 worth of rent are expended for personal purposes.
Various accounting systems and techniques are designed to meet the needs of the management. The information should be recorded and presented in such a way that management is able to arrive at right conclusions. The ultimate aim of the management is to increase profitability and losses. In order to achieve the objectives of the concern as a whole, it is essential to prepare the accounting statements in accordance with the generally accepted principles and procedures. The term principles refer to the rule of action or conduct to be applied in accounting. Accounting principles may be defined as "those rules of conduct or procedure which are adopted by the accountants universally, while recording the accounting transactions."
The accounting principles can be classified into two categories:
I. Accounting Concepts.
II. Accounting Conventions.
I. Accounting Concepts
Accounting concepts mean and include necessary assumptions or postulates or ideas which are used to accounting practice and preparation of financial statements. The following are the important accounting
(1) Entity Concept;
(2) Dual Aspect Concept;
(3) Accounting Period Concept;
(4) Going Concern Concept;
(5) Cost Concept;
(6) Money Measurement Concept;
(7) Matching Concept;
(8) Realization Concept;
(9) Accrual Concept;
(10) Rupee Value Concept.
II. Accounting Conventions
Accounting Convention implies that those customs, methods and practices to be followed as a guideline for preparation of accounting statements. The accounting conventions can be classified as follows:
(1) Convention of Disclosure.
(2) Convention of Conservatism.
(3) Convention of Consistency.
(4) Convention of Materiality.
Financial statements are prepared to help the users with their decisions. Hence, all such information which has the ability to affect the decisions of the users of financial statements is material and this property of information is called materiality. In deciding whether a piece of information is material or not requires considerable judgment. Information is material either due to the amount involved or due to the importance of the event.
The government of the country in which the company operates in working on a new legislation which would seriously impair the company's operations in future. Although there are no figures involved but the impact is so large that disclosure is imminent.
The remuneration paid to the executives and the directors is material.
The accounting policies are material because they help the users understand the figures.
Materiality might be based on a percentage of sales such as 0.5% of sales or on total assets. Materiality is helpful in determining which figures are to be reported on income statement and balance sheet and which one in the notes. It is also helpful in helping decide which items should appear as line items and which ones are aggregated with others.
Land and building
Long term bank loan
1) Closing stock is RM19500
2) Depreciation for:
New balance value
Furniture = 55000 x 5 % = 2750
Office equipment = 72000 x 10 % =7200
3) Provision for doubtful debt (PFDD) is 5% on net sales
PFDD = 5% x 17000 = 850
(-) PFDD = (17000-850 = 16150
4) Accrued advertising is
(+) Income statement
Current liabilities / balance sheet
Income Statement for the year ended 31/7/2011
Less : Cost of goods sold
(-) Purchases return
(+) Carriage inwards
Cost of goods available for sale
(-) Closing Inventory
Advertising (1500 + 200)
Depreciation for furniture
Depreciation for office equipment
Provision for doubtful debt
Balance Sheet as at 31/7/2011
Debtors (Accounts receivable)
(-)Provision for doubtful debt
Creditors (Accounts payable)
(+) Net Profit