Basic Assumptions
The basic assumptions of accounting are like the foundation pillars on which the structure of accounting is based. The four basic assumptions are as follows:
Accounting Entity Assumption
According to this assumption, business is treated as a unit or entity apart from its owners, creditors and others. In other words, the proprietor of a business concern is always considered to be separate and distinct from the business which he controls. All the business transactions are recorded in the books of accounts from the viewpoint of the business. Even the proprietor is treated as a creditor to the extent of his capital.
Money Measurement Assumption
In accounting, only those business transactions and events which are of financial nature are recorded. For example, when Sales Manager is not on good terms with Production Manager, the business is bound to suffer. This fact will not be recorded because it cannot be measured in terms of money.
Accounting Period Assumption
The users of financial statements need periodical reports to know the operational result and the financial position of the business concern. Hence it becomes necessary to close the accounts at regular intervals. Usually, a period of 365 days or 52 weeks or 1 year is considered as the accounting period.
Going Concern Assumption
As per this assumption, the business will exist for a long period and transactions are recorded from this point of view. There is neither the intention nor the necessity to wind up the business in the foreseeable future.
Basic Concepts of Accounting
These concepts guide how business transactions are reported. On the basis of the above four assumptions, the following concepts (principles) of accounting have been developed.
Dual Aspect Concept
Dual aspect principle is the basis for Double Entry System of book-keeping. All business transactions recorded in accounts have two aspects - receiving benefit and giving benefit. For example, when a business acquires an asset (receiving of benefit) it must pay cash (giving of benefit).
Revenue Realisation Concept
According to this concept, revenue is considered as the income earned on the date when it is realised. Unearned or unrealised revenue should not be taken into account. The realisation concept is vital for determining income pertaining to an accounting period. It avoids the possibility of inflating incomes and profits.
Historical Cost Concept
Under this concept, assets are recorded at the price paid to acquire them and this cost is the basis for all subsequent accounting for the asset. For example, if a piece of land is purchased for Rs.5,00,000 and its market value is Rs.8,00,000 at the time of preparing final accounts the land value is recorded
only for Rs.5,00,000. Thus, the balance sheet does not indicate the price at which the asset could be sold for.
Matching Concept
Matching the revenues earned during an accounting period with the cost associated with the period to ascertain the result of the business concern is called the matching concept. It is the basis for finding accurate profit for a period which can be safely distributed to the owners.
Full Disclosure Concept
Accounting statements should disclose fully and completely all the significant information. Based on this, decisions can be taken by various interested parties. It involves proper classification and explanations of accounting information which are published in the financial statements.
Verifiable and Objective Evidence Concept
This principle requires that each recorded business transactions in the books of accounts should have an adequate evidence to support it. For example, cash receipt for payments made. The documentary evidence of transactions should be free from any bias. As accounting records are based on documentary evidence which is capable of verification, it is universally acceptable.
Modifying Principles
To make the accounting information useful to various interested parties, the basic assumptions and concepts discussed earlier have been modified. These modifying principles are as under.
Cost-Benefit Principle
This modifying principle states that the cost of applying a principle should not be more than the benefit derived from it. If the cost is more than the benefit then that principle should be modified.
Materiality Principle
The materiality principle requires all relatively relevant information should be disclosed in the financial statements. Unimportant and immaterial information is either left out or merged with other items.
Consistency Principle
The aim of consistency principle is to preserve the comparability of financial statements. The rules, practices, concepts and principles used in accounting should be continuously observed and applied year after year. Comparisons of financial results of the business among different accounting period can be significant and meaningful only when consistent practices were followed in ascertaining them. For example, depreciation of assets can be provided under different methods, whichever method is followed, it should be followed regularly.
Prudence (Conservatism) Principle
Prudence principle takes into consideration all prospective losses but leaves all prospective profits. The essence of this principle is “anticipate no profit and provide for all possible losses”. For example, while valuing stock in trade, market price or cost price whichever is less is considered.
The Institute of Chartered Accountants of India has constituted Accounting Standard Board (ASB) in 1977. The ASB has been empowered to formulate and issue accounting standards, that should be followed by all business concerns in India.
Questions
1. Stock in trade is to be recorded at cost or market price whichever is less is based on _____________ principle.
2. The assets are recorded in books of accounts in the cost of acquisition is based on _____________ concept.
3. The benefits to be derived from the accounting information should exceed its cost is based on _____________ principle.
4. Transactions between owner and business are recorded separately due to _____________ assumption
5. Business concern must prepare financial statements at least once in a year is based on ___________ assumption.
6. _____________ principle requires that the same accounting methods should be followed from one accounting period to the next.
[Answers: 1. prudence, 2. historical cost, 3. cost-benefit, 4. business entity, 5. accounting period, 6. consistency]
The basic assumptions of accounting are like the foundation pillars on which the structure of accounting is based. The four basic assumptions are as follows:
Accounting Entity Assumption
According to this assumption, business is treated as a unit or entity apart from its owners, creditors and others. In other words, the proprietor of a business concern is always considered to be separate and distinct from the business which he controls. All the business transactions are recorded in the books of accounts from the viewpoint of the business. Even the proprietor is treated as a creditor to the extent of his capital.
Money Measurement Assumption
In accounting, only those business transactions and events which are of financial nature are recorded. For example, when Sales Manager is not on good terms with Production Manager, the business is bound to suffer. This fact will not be recorded because it cannot be measured in terms of money.
Accounting Period Assumption
The users of financial statements need periodical reports to know the operational result and the financial position of the business concern. Hence it becomes necessary to close the accounts at regular intervals. Usually, a period of 365 days or 52 weeks or 1 year is considered as the accounting period.
Going Concern Assumption
As per this assumption, the business will exist for a long period and transactions are recorded from this point of view. There is neither the intention nor the necessity to wind up the business in the foreseeable future.
Basic Concepts of Accounting
These concepts guide how business transactions are reported. On the basis of the above four assumptions, the following concepts (principles) of accounting have been developed.
Dual Aspect Concept
Dual aspect principle is the basis for Double Entry System of book-keeping. All business transactions recorded in accounts have two aspects - receiving benefit and giving benefit. For example, when a business acquires an asset (receiving of benefit) it must pay cash (giving of benefit).
Revenue Realisation Concept
According to this concept, revenue is considered as the income earned on the date when it is realised. Unearned or unrealised revenue should not be taken into account. The realisation concept is vital for determining income pertaining to an accounting period. It avoids the possibility of inflating incomes and profits.
Historical Cost Concept
Under this concept, assets are recorded at the price paid to acquire them and this cost is the basis for all subsequent accounting for the asset. For example, if a piece of land is purchased for Rs.5,00,000 and its market value is Rs.8,00,000 at the time of preparing final accounts the land value is recorded
only for Rs.5,00,000. Thus, the balance sheet does not indicate the price at which the asset could be sold for.
Matching Concept
Matching the revenues earned during an accounting period with the cost associated with the period to ascertain the result of the business concern is called the matching concept. It is the basis for finding accurate profit for a period which can be safely distributed to the owners.
Full Disclosure Concept
Accounting statements should disclose fully and completely all the significant information. Based on this, decisions can be taken by various interested parties. It involves proper classification and explanations of accounting information which are published in the financial statements.
Verifiable and Objective Evidence Concept
This principle requires that each recorded business transactions in the books of accounts should have an adequate evidence to support it. For example, cash receipt for payments made. The documentary evidence of transactions should be free from any bias. As accounting records are based on documentary evidence which is capable of verification, it is universally acceptable.
Modifying Principles
To make the accounting information useful to various interested parties, the basic assumptions and concepts discussed earlier have been modified. These modifying principles are as under.
Cost-Benefit Principle
This modifying principle states that the cost of applying a principle should not be more than the benefit derived from it. If the cost is more than the benefit then that principle should be modified.
Materiality Principle
The materiality principle requires all relatively relevant information should be disclosed in the financial statements. Unimportant and immaterial information is either left out or merged with other items.
Consistency Principle
The aim of consistency principle is to preserve the comparability of financial statements. The rules, practices, concepts and principles used in accounting should be continuously observed and applied year after year. Comparisons of financial results of the business among different accounting period can be significant and meaningful only when consistent practices were followed in ascertaining them. For example, depreciation of assets can be provided under different methods, whichever method is followed, it should be followed regularly.
Prudence (Conservatism) Principle
Prudence principle takes into consideration all prospective losses but leaves all prospective profits. The essence of this principle is “anticipate no profit and provide for all possible losses”. For example, while valuing stock in trade, market price or cost price whichever is less is considered.
The Institute of Chartered Accountants of India has constituted Accounting Standard Board (ASB) in 1977. The ASB has been empowered to formulate and issue accounting standards, that should be followed by all business concerns in India.
Questions
1. Stock in trade is to be recorded at cost or market price whichever is less is based on _____________ principle.
2. The assets are recorded in books of accounts in the cost of acquisition is based on _____________ concept.
3. The benefits to be derived from the accounting information should exceed its cost is based on _____________ principle.
4. Transactions between owner and business are recorded separately due to _____________ assumption
5. Business concern must prepare financial statements at least once in a year is based on ___________ assumption.
6. _____________ principle requires that the same accounting methods should be followed from one accounting period to the next.
[Answers: 1. prudence, 2. historical cost, 3. cost-benefit, 4. business entity, 5. accounting period, 6. consistency]
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