Basic Accounting Concepts

Basic accounting concepts Basic accounting concepts are the broad assumption, which underline the periodic financial accounts of business enterprises. Most important concepts and conventions are:- •Going concern assumption •Accruals basis accounting •Prudence •Consistency •The materiality concepts •Historical cost There also other concepts. Such as : •Entity concepts •Money measurement concepts •Separate valuation principle The Going Concern Assumption

The going concern assumption implies that the business will continue in operation for foreseeable future, and that there is no intention to put the company into liquidation or to make drastic cutbacks to the scale of operations.

Suppose that J&J company bought a printing machine for their printing business with the cost of $150000. And it is expected to last that machine for 15 years. And the depreciation cost is set 10000 per year. According to going concern assumption it is assumed that the business will continue its operations and asset will live out its full 15 years in use.

And depreciation charge of 10000 will be charged every year.

After one year the net book value will be (150000-10000)= 140000 after two years it will be 130000 after three years it will be 120000 and so on. Thus it will be written down until it has been written down to value of zero after 15 years. Suppose that it has no other operational use outside the business. So in a forceful sale it would have to sale as scrap only. And the scrap value is only 5000. So after the one year the value of the asset will be 140000.

The Basic Accounting Concepts

But if it had to sale forcefully after one year, the value will be only 5000.

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And in the balance sheet it should be written down only 5000. And rest of the value that means (net book value – scrap value) 135000 will be shown as expenses. Accruals basis Accounting Prudence Prudence is the inclusion of a degree of caution in the exercise of judgements needed in making the estimates required under conditions of uncertainty, such that assets or income are not overstated and liabilities and expenses are not understated. Consistency

Consistency requires that similar items should be accorded similar accounting treatment. •Similar items within a single set of accounts should be given similar accounting treatment. •The same treatment should be applied from one period to another in accounting for similar items. Materiality “Information is material if its omission or misstatement could influence the economic decision of users taken on the basis of the financial statements. Materiality depends on the size of the item or error judged in the particular circumstances of its omission or misstatement.

Thus, materiality provides a threshold or cut-off point rather than being a primary qualitative characteristic which information must have if it is to be useful. ” Historical Cost In historical cost accounting, historical cost is the original monetary value of an economic item. Depreciation affects the carrying value of an asset on the balance sheet. The historical cost will equal the carrying value if there has been no change recorded in the value of the asset since acquisition. Improvements may be added to the cost basis of an asset.

Historical cost does not generally reflect current market valuation. Different accounting standards may require that the carrying value of an asset (or liability) be updated to the market price (mark-to-market valuation) or some other estimate of value that better approximates the real value. Accounting standards may also have different methods required or allowed (even for different types of balance sheet assets or liabilities) as to how the resultant change in value of an asset or liability is recorded, as a part of income or as a direct change to shareholders’ equity.

Examples where the going concern assumption should be rejected : •If the business is going to close down in the near future •Where shortage of cash makes it almost certain that the business will have to cease trading •Where a large part of the business will almost certainly have to be closed down because of shortage of cash Consistency Each business should choose the methods which gives the most reliable picture of the business. The consistency concepts says that when a business has once fixed a method for the accounting treatment of an item, it will enter all similar item that follow in exactly the same way.

Prudence The accountant should always exercise caution when dealing with uncertainty while, at the same time, ensuring that the financial statement are neither- that gains and losses are neither overstated nor understated- and this is known as prudence. The prudence concept requires that the financial statement are “ neutral” that is that neither gains nor loss should be overstated or understated. Accruals/{matching} All income and charges relating to the financial period to which the financial statement relate should be taken in to account without regard to the date of receipt or payment.

Materiality Do not waste your time in the elaborate recording of trivial items (back up) Historical cost (Book _$60) problems with historical cost •The original cost •Half of historical cost ( portion of historical cost) •Value in secondhand market •Replace the machine with more modern machine •Economic value •Replace with identical machine •comply with IASs •depreciation policy •valuation of inventory •overriding for fair presentation