Financial Accounting Concepts

What Are 12 Accounting Concepts? – A Summary

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 unacceptable. 

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 financial.

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 to grow 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 the customer will receive payment 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 concerns 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 concept of accounting is a fundamental idea that in order to make informed decisions, investors and decision-makers must be able to compare and analyse performance over time. This means measuring the performance of a business using consistent periods, such as on an annual or quarterly basis. The reason for this is that without the concept of periodicity, it would be difficult to accurately gauge how well a business is doing with its financials when compared to previous years or quarters.

The concept of periodicity allows investors and decision-makers to easily observe any trends in performance from month-to-month, quarter-to-quarter and year-to-year. It helps them assess whether any progress has been made by the company over time and can help identify potential problems that may need addressing.

Matching Concept

The matching concept is an accounting principle that requires expenses to be matched with revenues. This concept is used to produce accurate financial statements. The matching concept is based on the accrual principle, which states that expenses should be recorded in the period they are incurred. The matching concept requires that all expenses incurred in a period be included in determining net income for that period.

The matching concept is important because it provides a true picture of a company’s financial performance. Without this concept, a company could easily manipulate its financial statements. For example, a company could choose to defer recognition of certain expenses to make its net income appear higher than it actually is.

The matching concept is also important because it provides useful information in decision-making. For example, if a company is considering expanding its operations, the matching concept would require that all of the costs associated with the expansion be considered. This would include costs such as advertising, research and development, and employee training.

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. Still, assets and revenues should be recorded only when they are certain to be received.

The conservatism concept is crucial because it helps to ensure that financial statements are not overstated. If accountants were to use too optimistic assumptions when estimating the value of items, then the financial statements would be misleading.

The conservatism concept is also important because it helps ensure accountants do not take on too much risk. If accountants were to use too optimistic assumptions when estimating the value of items, then they might be taking on more risk than they realize.

There are a few different ways the conservatism concept can be applied in accounting. One way is to use historical costs when valuation items instead of current market values. This approach is based on the idea that it is better to use a value known with certainty than to use a value estimated.

Another way to apply the conservatism concept is to use lower cost or market value when valuing inventory. This approach is based on the idea that it is better to use the lower value when there is uncertainty about the value of an item.

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 somehow enhances the reported financial performance. If such a modification is made, thoroughly describe the resulting effects and include them in the notes to the financial statements.

Accounting consistency allows users to make valid comparisons between different periods or entities. It also enables external auditors to evaluate a company’s books without establishing whether similar transactions were treated differently. In addition to ensuring accurate tax calculation, consistency prevents corporations from altering their reporting technique to evade tax obligations.

Materiality Concept

The materiality concept in accounting states that an event is only considered to be material if it could influence the economic decisions of users of the financial statements. This means that not all events and transactions are material and therefore need to be disclosed in the financial statements.

For example, a company may choose not to disclose a small purchase made during the year because it is not material to the financial statements. However, a large purchase would need to be disclosed because it could influence the economic decisions of users of the financial statements.

Business 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. Each identifier is unique, whether it is a Social Security Number, an Employer Tax Identification Number, or an Individual Taxpayer Identification Number.

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

Unless there is solid evidence to the contrary, accounting makes the assumption that the business entity will remain in operation for a very long time. According to this definition, the business will continue to operate for at least the foreseeable future. In other words, there is neither a need for the specific company to endeavour to be liquidated shortly nor a plan to do so. This presumption causes the accountant to disregard the value of forced sales when evaluating assets. In fact, the foundation for many accounting values and allocations is the presumption that the business won’t be liquidated in the near future.

Without the going concern concept, businesses would have to show their financial statements in a way that would make it difficult to understand their financial position. For example, if a business did not have the going concern concept, it would have to show its assets and liabilities as of the date of the financial statements. This would make it difficult to compare the financial statements of different businesses.

The going concern concept is important because it allows businesses to show their financial statements in a way that is easy to understand. This concept is used in accounting when preparing financial statements.

Dual Aspect Concept

The dual aspect concept is a fundamental principle of accounting that states that every financial transaction has two aspects, a debit and a credit, which must be recorded in a company’s accounting system. This concept, also known as the duality principle, is the foundation of double-entry bookkeeping.

Under this concept, each transaction is recorded in two accounts, one of which is debited and the other credited. In accordance with the accounting equation: assets = liabilities + equity, the total amount of debits must always equal the total amount of credits in a transaction.

For instance, when a business purchases inventory, the inventory account is debited, and the cash account is credited. This means that the company’s inventory asset account increases by the same amount as its cash asset account decreases. This maintains the accounting equation’s equilibrium.

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