SUMMARY OF BASIC FINANCIAL ACCOUNTING ASSUMPTIONS AND CONCEPTS
There are four basic concepts (assumptions) in accounting:
· ENTITY ASSUMPTION - The entity concept views an accounting entity as being separate,
distinct and apart from its owners.
· GOING CONCERN ASSUMPTION - The going concern concept assumes that a business will
continue and remain in business indefinitely.
· TIME PERIOD ASSUMPTION - Since we have assumed that a business will continue indefinitely,
we must also assume that we can arbitrarily break down the life of the business into
meaningful reporting periods.
· THE STABLE UNIT OF MEASURE ASSUMPTION - This is the most difficult assumption to
accept. What we are assuming is that the value of currency remains constant over
a period of time. Historical evidence would suggest that this is not a reasonable
assumption to make.
From the four basic assumptions, we can derive a set of several principles which
will allow a framework for accounting:
REVENUE REALIZATION PRINCIPLE -Since we have assumed that we can arbitrarily breakdown
the life of a business into meaningful reporting periods (the time period assumption),
we must then establish principles when we realize revenue. This principle establishes
when it is appropriate to recognize revenues. An example is accrual accounting.
EXPENSE RECOGNITION PRINCIPLE - This principle is closely related to the matching
principle. This also is a result of the time period assumption. Not all costs (expenses)
are covered by the matching principle, for example the loss of an asset for which
no revenue was recognized. The expense principle defines expenses,(expired costs)
measures expenses (decrease in value of an asset or increase in a liability), and
recognizes expenses (when assets have been used or liabilities increased in the process
of earning revenue).
MATCHING PRINCIPLE - Since we have divided the life of an entity into periodic arbitrary
units of time, and we have established when revenue is recognized, we must therefore
recognize the costs associated with the revenues being reported for in the accounting
period.
OBJECTIVITY PRINCIPLE - Accounting information should be free from bias (objective)
and verifiable. That is there is an "arm’s length" transaction (objective) that
can be verified outside of the entity by a non-related party.
COST PRINCIPLE - The cost principle states that transactions be recorded at their
historical cost. We do not recognize any increases in value over time of our assets
or any decreases in the value of liabilities. The reason for this is that any changes
in value are subjective at best. Furthermore there has been no transaction that
is verifiable outside of the entity by a "non-arm’s length" party (objectivity).
CONSERVATISM PRINCIPLE - This principle states that when there is a choice between
two acceptable accounting alternatives, we must select the one that produces the
lowest current amounts for net income and net assets.
CONSISTENCY PRINCIPLE - This principle states that the same accounting principles,
policies and procedures should be followed from one accounting period to the next
so that the presentation of financial information is comparable from one year to
the next.
MATERIALITY PRINCIPLE - There is a cost benefit in producing financial information.
Simply stated, there is no point in producing information if the cost of producing
the required information outweighs (is greater than) the benefits that will be derived
from having that information.
DISCLOSURE PRINCIPLE - The disclosure principle requires that the financial statements
contain all the relevant information that is necessary to the users of the financial
statements in order that they can make an informed decision. For example, the omission
of a subsequent event may cause a user to make a different decision than would have
otherwise been the case.
