Basic Accounting Concepts

The basic accounting concepts are the ground rules that govern how the accountants measure, process and communicate financial information. These principles have been developed by the accounting profession over the years to provide a consistent system of financial reporting in a constantly changing business environment ( Smith, Keith, et al, 1993).

Basic Accounting Concepts

These concepts assure users of the financial statements that the reports are prepared in specific ways so that they are reliable and comparable for the usefulness of these reports rests on their reliability and comparability.

Purpose of Basic Accounting Concept

They help increase the confidence of financial statement users that the financial statements are presentationally faithful. They provide companies and accountants who prepare the financial statements with guidance on how to account for and report economic activities. And they provide independent auditors of financial statements with basis for evaluating the fairness and completeness of those statements (Chasteen, Flaherty, OConnor 1998)

Basic Accounting Concepts

(1) ENTITY CONCEPT
-under the entity concept, the business is regarded as having a separate and distinct personality from that of the owners generating its own revenue, incurring its own expenses, owning its own assets, and owing its own liabilities (Smith, Keith 1993)

Basic Accounting Concepts

Business transaction a business event that can be measured in terms of money that affect the enterprise. This would give rise to an exchange between the business and another party: value received and value parted with.

Basic Accounting Concepts

(2) MONETARY UNIT CONCEPT Money is used as a unit of measure in preparing the various financial reports of the company. The stable money concept assumes that, monetary unit of measure does not change value overtime, even if in fact it does. The assumption is made in order to ensure objectivity in reporting data on the financial statement.

Basic Accounting Concepts

(3) TIME PERIOD CONCEPT
Also known as Periodicity concept.

It divides the life of the business into regular intervals (usually one year) at the end of which financial statements are prepared.
This means that the economic activities undertaken during the life of an accounting entity are assumed to be divisible into various artificial time periods for financial reporting purposes.

Basic Accounting Concepts

In choosing one year, the business has two options:
(1) Calendar Year a twelve month period beginning January 1 and ending December 31 (2) Fiscal Year The length of the fiscal period is determined by the nature of the business and the frequency of the need for data regarding financial condition and progress of the business. It does not start Jan 1 and end Dec 31.

Basic Accounting Concepts

(4) REVENUE REALIZATION CONCEPT
Revenue is the inflow of assets that results from producing goods or rendering services. Revenue Realization concept provides that income is recognized when earned regardless whether cash is received. This means that both of the following conditions are met: (1) The earning process is complete (2) An exchange has taken place ( Smith, Keith 1993)

Basic Accounting Concepts

Two points of income recognition
(1) Income is considered earned when services are fully rendered. (2) Income is considered earned when goods or merchandise are fully delivered.

Basic Accounting Concepts

(5) ACCRUAL CONCEPT
This concept requires that income be recorded when earned regardless whether cash is received. And an expense be recognized when incurred (e.g., when services or benefits have already been received) regardless whether payment is made. To apply the accrual concept, accountants have developed the accrual accounting.

Basic Accounting Concepts

The accrual method of accounting attempts to record the financial effects on a company of transactions and other events and circumstances in the periods in which those transactions, events and circumstances occur rather than only the periods in which cash is received or paid by the firm.
This means that the accrual accounting consist of all techniques developed by accountants to apply both accrual and matching concepts. (Needles, Powers..1999)

Basic Accounting Concepts

(6) MATCHING CONCEPT
This concepts states that all expenses incurred to generate revenues must be recorded in the same period that the income are recorded to properly determine net income or net loss of the period. There is a cause and effect recognition implicit in this definition.

Basic Accounting Concepts

Example:
Revenues earned in June and collected in June P Revenues earned in June but collected in July Revenues earned in May but collected only in June Expenses incurred in June and paid in June Expenses incurred in June but payable in July Expenses incurred in May but paid in June 30,000 20,000 10,000 10,000 15,000 7,000

Basic Accounting Concepts

(7) OBJECTIVITY OR RELIABILITY CONCEPT
This concept requires that all transactions must be evidences by business documents free from personal biases and independent experts (e.g. CPA) can verify

(8) COST CONCEPT

Assets, i.e., resources acquired by the business, must be recorded at acquisition price (i.e. what you have given up in exchange for an ownership of an asset) and no adjustments are made on this valuation in later periods.

Basic Accounting Concepts

The cost principle assumes that assets are required in business transactions conduCted at arms length transactions, i.e. transaction between a buyer and a seller at the fair value prevailing at the time of transaction.
For non cash transaction conducted at arms length, the cost principle assumes that the market value of the resources given up in the transaction provides reliable evidence for the valuation of the of the item acquired ( Dyckman, T Dukes, Davis C. 1998)

Basic Accounting Concepts

The cost principle provides guidance primarily at the initial acquisition date. Once acquired, the original cost basis of some assets in then subjected to depreciation. Depletion, amortization, etc, overtime to reflect the said assets in the Statement of Financial Position in a more realistic valuation.

Basic Accounting Concepts

(9) GOING CONCERN CONCEPT
In the absence of information to the contrary, this concept assumes that the business is to continue its operation indefinitely. This means that the business will stay in operation for a period of time sufficient to carry out contemplated operations, contracts and commitments.

Basic Accounting Concepts

(10) CONSERVATISM CONCEPT
This concept has a powerful influence in valuing assets and measuring net income. When faced with uncertainties, the accountant traditionally leans towards the direction of caution, choosing the method that would give the business a less favorable condition and lower net income. The reason behind this assumption is that investors prefer information that does not unnecessary raise expectations.

Basic Accounting Concepts

(11) CONSISTENCY CONCEPT
This concept states that once a method is adopted, it must not be changed from year to year to allow comparability of financial statements between years and between businesses.

Basic Accounting Concepts

(12) MATERIALITY CONCEPT
This concept refers to relative importance of an item or event. An item/event is considered material if knowledge of it would influence the decision of prudent users of financial statements

Basic Accounting Concepts

(13) DISCLOSURE CONCEPT
All relevant and material events affecting conditions/position of a business and the results of its operations must be communicated to users of financial statements.

Basic Accounting Concepts

Supplemental information is disclosed in a variety of ways including (1) Parenthetical comments or modifying comments placed on the face of the financial statement (2) Disclosure notes conveying additional insights about the company operations, accounting principles, contractual agreements, and pending litigation.