unit 05 accounting concepts

Accounting Concepts

Chapter No 5

RASHAIN PERERA CIMA Adv. Dip. MA, UOR (Mgt)

What are accounting concepts???

• Basic rules of accounting• Objective is to maintain uniformity and consistency in accounting records


Business Entity Concept• Meaning

– The business and its owner(s) are two separate existence entity

– Any private and personal incomes and expenses of the owner(s) should not be treated as the incomes and expenses of the business


• Examples– Insurance premiums for the owner’s

house should be excluded from the expense of the business

– The owner’s property should not be included in the premises account of the business

– Any payments for the owner’s personal expenses by the business will be treated as drawings and reduced the owner’s capital contribution in the business


Dual Aspect Concept• Dual aspect concept states that

there are two aspects of accounting, i.e. the assets of a business and the liabilities and / or capital of the business.

• In other words every transaction has two entries known as Debit and Credit


Money Measurement Concept• Meaning

– All transactions of the business are recorded in terms of money

– It provides a common unit of measurement

• Examples– Market conditions, technological

changes and the efficiency of management would not be disclosed in the accounts


• Examples– Health of managing director is not

recorded– Purchase of factory building Rs.10

mn is recorded– Rent paid 100 000 is being recorded– Delay in supply of raw materials is

not recorded


Going Concern Concept• Meaning

– The business will continue in operational existence for the foreseeable future

– Financial statements should be prepared on a going concern basis unless management either intends to liquidate the enterprise or to cease trading, or has no realistic alternative but to do so

– Assures investors that they will continue to get income on their investments.


• Examples– Possible losses form the closure of

business will not be anticipated in the accounts

– Prepayments, depreciation provisions may be carried forward in the expectation of proper matching against the revenues of future periods

– Fixed assets are recorded at historical cost

– Classifying assets and liabilities as current and non-current


Historical Cost Concept• Meaning

– Assets should be shown on the balance sheet at the cost of purchase instead of current value/NBV

• Example– The cost of fixed assets is recorded at

the date of acquisition cost. The acquisition cost includes all expenditure made to prepare the asset for its intended use. It included the invoice price of the assets, freight charges, insurance or installation costs


Accounting period concept

• This identifies the necessity to divide indefinite period of business life into shorter periods and prepare financial statements for each period.

• This helps in predicting future prospects

• The commonly accepted accounting period in Sri Lanka is usually 1 year


• If the accounting year begins from 1st of Jan and ends on 31st Dec, it is known as Calendar year

• If the accounting year begins on 1st of April and ends on 31st March, it is known as Financial year


Prudence/Conservatism Concept • Meaning

– Revenues and profits are not anticipated. Only realized profits with reasonable certainty are recognized in the profit and loss account

– However, provision is made for all known expenses and losses whether the amount is known for certain or just an estimation

– This treatment minimizes the reported profits and the valuation of assets


• Intended to prevent from being overstated

• Example– Stock valuation sticks to rule of the

lower of cost and net realizable value (unit 06)

– The provision for doubtful debts should be made

– Fixed assets must be depreciated over their useful economic lives


Materiality Concept• Meaning

– Immaterial amounts may be aggregated with the amounts of a similar nature or function and need not be presented separately

– Materiality depends on the size and nature of the item

– Here accountants may exclude insignificant details in financial statements


Realization concept• Realization concept specifies the

point of time at which revenue should be recognized and recorded in the book. It usually refers to the point of time when:

1. Goods or services are passed to the customers, and

2. The customers incur liability to pay.


Accrual Concept• Accrual concept states that

revenues and expenses are recognised in the profit and loss account for the period in which they have been earned or incurred, not when they are received.

• Under this concepts, accruals and prepayments are arouse.


Matching Concept• Matching concept sates that revenue

should be linked with its relevant expense or cost in the same period.

• Commission is the relevant expenses of Sales. (Commission is matched with Sales.)

• Depreciation of motor vehicle is matched with the time.


Full disclosure concept

• Financial statements should disclose fully and fairly which is sufficient and material for decision making.


Consistency concept• Transactions of similar nature

should be recorded in the same way in the same accounting period and in all future accounting periods


Substance over-form concept

• The substance of a transaction is not always consistence that which is apparent from their legal form


• State the accounting concept that has been violated by an entity if a bank loan obtained by the owner for repairing his house as included in business liabilities??????– Business entity concept

• State a principal qualitative characteristic of accounting information that would be affected when financial statements are prepared on historical cost basis while the general price level is continuously increasing???– Relevance


• State the accounting concept that provides the basis for classification of assets and liabilities as current and non current in the balance sheet??– Going concern concept

• A plot of land bought in the year 2006 for 15mn was recorded at its revaluated amount of 30mn in the balance sheet as at 31st March 2009. which of the accounting concept is not followed???– Historical Cost concept


• A provision of 150k for doubtful debts was included in the financial statements of ABC ltd. Which of the accounting concept provides the basis for this adjustment??– Prudence concept

• The balance sheet of Amarasena as at 31st March 2009 showed 500k and 200k as balances of debtors and creditors respectively. The underlying concept for this recognition is……………….– Going concern concept


Mark true or false• Money measurement concept indicates that

the items in the financial statements are initially measured at their historical cost.– False

• The disclosure of accounting policies and their changes in the financial statements facilitates the comparison of financial performance among different business entities– True

• The legal form of a transaction must always reflected in financial statements– False


• The accounting concept that allows an organization to record it’s transactions and events independently of other parties is………………..– Business entity concept

• State the qualitative characteristic of accounting information that is most preserved by the revaluation of assets?– Relevance

• Drawings made by the owners are treated as expenses for the relevant accounting period. (T/F)– True


• An enterprise proposes to value its assets at their current market prices to provide more realistic information. The accounting concept this proposal violates is………….– Historical cost concept

• The revenue recognition principle states that the revenues should be recognized……………………………………………– When it is earned and realized or realizable


• Nimal commenced a graphite mining business in the year 2000. he is waiting till the mine is exhausted to determine the financial result of the business. The accounting concept which is violated primarily by this decision is……………………..– Periodicity

• State the accounting concept that provides the basis for immediate recognition of an expected loss??– Prudence concept


• The entity concept in accounting applies to a business entity when it is a legal person only. (T/F)– False

• What is the underlying accounting concept that provides the basis the depreciation of non current assets?????– Going concern concept

• The accounting concept that provides the basis for the measurement of stock at the lower of cost or NRV is– Prudence


• The accounting concept that provides the basis for the recognition of part of cost of goods purchased during a year as cost of sales and remainder as the year end stocks as an asset is………………– Matching concept

• A provision made on doubtful debts complies with the matching concept.(T/F)– True

• ………………………. Doesn’t intends to liquidate business or cease trading of it in near future.– Going concern


• In times of rising prices the historical cost concept ………………..asset vales and …………………………the profit.– Understates, overstates

• In accordance with prudence concept, the lower of cost and NRV is used in the valuation of inventories. (T/F)– True

unit 05 accounting concepts

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