Financial Accounting

What Are 12 Accounting Concepts? – A Summary

What are Accounting Concepts?

Accounting Concepts are the underlying assumptions used to produce a business’s financial statements. The term “concept” refers to an idea or thought.

Concepts are the fundamental assumptions and conditions that underpin accounting principles. There are 12 accounting concepts. These are explained below:

Money Measurement Concept

The money measurement concept  (alternatively referred to as monetary measurement) emphasises that in accounting and economics in general, every recorded event or transaction is quantified in terms of money, the local currency’s monetary unit of measurement. A fact, occurrence, or event that cannot be quantified in terms of money is not recorded under this principle’s accounting books. Thus, non-quantifiable items such as employee skill levels or excellent customer service quality are not acceptable. 

One of the fundamental principles of historical cost accounting is the “Measuring Unit principle” (or stable measuring unit assumption): The accounting unit of measure shall be the most relevant currency’s base money unit.

Additionally, this principle presupposes that the unit of measure is stable; that is, changes in its general purchasing power are not deemed significant enough to warrant adjustments to the fundamental financial statements. The inflation that occurs over time is ignored. Only those are considered that can be quantified in monetary terms or are of a financial nature.

Cost Concept

The cost concept (alternatively called the cost principle of accounting) states that a business’s assets and liabilities should be recorded at their historical cost.

The historical cost of an asset is the price paid to acquire it and may differ from the asset’s current market value. Assume, for example, that a herbal medicine company pays $25,000 in cash to acquire land for the purpose of growing herbs. The company will record a land cost of $25,000 in its accounting records. Five years later, in a booming real estate market, the land’s fair market value may be $35,000. While the market value of the land has increased significantly, the balance sheet and other accounting records would remain unchanged at the cost of $25,000.

Liabilities require a similar presentation. In exchange for goods and services, businesses issue various liabilities (accounts payable, bills payable, notes payable, and bonds payable). Typically, these liabilities are reported at cost. For instance, a business acquires a tract of land for an agreed-upon price of $12,000 and issues a $12,000 note payable to cover the full payment. The expense of recording a note payable in accounting records would be $12,000.

Realisation Concept

The Realisation concept is a principle of revenue recognition that asserts that income or revenue is recognised only when earned. The corporation is reasonably assured that payment will be received from the customer in exchange for the same. It is often employed when the underlying commodities are delivered, risk and reward are transferred, or income becomes payable, regardless of whether the full amount is obtained.

The realisation concept is concerned with revenue recognition, i.e., profit should be realised when goods or risks and rewards are transferred. When it comes to revenue, revenue must be acknowledged when it is due. Revenue or income must be recognised using the percentage completion approach in the event of a continuing service business such as real estate.

According to this concept, revenue should be recognised only when it is generated or when it becomes reasonably certain that the company will receive payment from a client, where revenue is realised when risk and rewards are transferred or when income is due. The realisation principle is not conditional on the receipt of cash, i.e., income or revenue must be realised or recognised even if cash is not received. For instance, income cannot be recorded if an advance is received, but items are not transferred. It is only to be recognised upon delivery of items.

Periodicity Concept

The periodicity assumption asserts that an organisation’s financial performance can be reported within certain time periods. This often refers to an entity’s continuous monthly, quarterly, or annual reporting of its performance and cash flows.

Matching Concept

The matching concept is an accounting principle that requires businesses to record revenue and associated expenses in the same accounting period. Businesses report “revenues,” that is, the sum of their “revenues” and their “expenses.” The matching concept’s objective is to avoid understating earnings for a period.

Conservatism Concept

Conservatism is an accounting concept that refers to the idea that expenses and liabilities should be recognised as soon as feasible in situations where the outcome is uncertain, but assets and revenues should be recorded only when they are certain to be received.

Consistency Concept

Consistency requires that once an accounting concept or procedure is adopted, it be followed consistently in subsequent accounting periods. Change an accounting principle or procedure only if the new version enhances the reported financial performance somehow. If such a modification is made, thoroughly describe the resulting effects and include them in the notes to the financial statements.

Materiality Concept

In accounting, the concept of materiality relates to the idea that all significant things should be accurately disclosed in the financial statements. Material elements are those whose inclusion or omission significantly alters the decision-making process for users of business information.

Entity Concept

In accounting, a business or organisation and its owners are considered two distinct entities. This is referred to as the concept or principle of the entity. The business operates independently of other organisations as a distinct economic unit.

This straightforward sentence makes it easy to recall… Each entity has its own unique tax identification number. Whether it is a Social Security Number, an Employer Tax Identification Number, or an Individual Taxpayer Identification Number, each identifier is unique.

Accrual Concept

Accrual accounting is a method businesses use to record financial transactions as they occur, regardless of whether a monetary transaction is completed. In contrast to cash accounting, which considers transactions legitimate for recording only when cash is really received or paid, accrual accounting considers transactions valid for recording when cash is actually received or paid.

Accounting’s accrual principle demands that financial accounts represent transactions as they occur, not necessarily when cash changes hands. Except for the cash flow statement, this accounting principle is typically employed in the preparation of financial statements. Revenue is recorded when it is earned, not when it is received, and costs are recorded when incurred, not when paid.

Going Concern Concept

A going concern is an accounting term that alludes to a financially stable firm enough to pay its commitments and continue operations shortly. Specific costs and assets may be delayed in financial statements if a business is considered to continue in operation.

Dual Aspect Concept

According to the dual aspect principle, because each transaction has a twofold consequence, accounting records must reflect this to accurately depict the movement of funds. For instance, a buyer pays cash for an item acquired, while the seller receives cash for the item sold. This creates a dual transaction, impacting two accounts concurrently, and so should be registered as such.

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