Accounting Concepts and Conventions - www.BookKeeping-Online.net - BookKeeping Online
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Accounting Concepts and Conventions - www.BookKeeping-Online.net - Online Bookkeeping
In drawing up accounting statements a clear objective has to be that the accounts fairly reflect the true financial position of the business and the results of its operations.
The theory of accounting has developed the concept of a ‘true and fair view’. The true and fair view is applied in assessing that the accounts do reflect accurately the activities of the business. To support this, accounting has adopted certain concepts and conventions which ensure the accounting information is presented accurately and consistently.
Accounting Conventions
The ‘Historical Cost’ convention requires that transactions are recorded at their cost at the time of purchase and that assets are to be valued at original cost. Under this convention no account is taken of changing prices in the economy.
The ‘Monetary Measurement’ convention ensures that account is only taken for items that can be quantified in monetary terms.
The ‘Separate Entity’ convention ensures that the owner of the business and his personal transactions are kept separate to the transactions of the business.
The ‘Realization’ convention ensures that the accounts recognize transactions and any profits arising at the point of sale or transfer of legal ownership rather than when cash actually changes hands, example, a sale is recognized as a sale in the accounts even if the sale was made on credit terms with the buyer.
The ‘Materiality’ convention is used when a degree of judgment is used in preparing the accounts. Where decisions are required regarding how appropriate a particular accounting judgment is the ‘materiality’ convention ensures it should only be an issue if the judgment is significant, or ‘material’ to the user of the accounts.
Accounting Concepts
Four important accounting concepts underpin the preparation of any set of accounts:
The ‘Going Concern’ concept means that accountants assume that unless there is evidence to the contrary a company is not going broke.
The ‘Consistency’ concept ensures that transactions and methods of valuation are treated the same from period to period and year to year. This enables users of the accounts to make more meaningful comparisons of the company’s financial performance from period to period or year to year. If accounting policies of a company are changed the company is required to disclose this and explain the impact of any change.
The ‘Prudence’ concept ensures that profits are not recognized until a sale has been completed and in addition that any future costs are provided for in the accounts as soon as there is a reasonable chance that such costs will be incurred in the future.
The ‘Matching’ or ‘Accruals’ concept ensures that income should be properly ‘matched’ with the expenses of a given accounting period.
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