We are going to discuss on four basic assumptions of accounting six basic accounting concepts and four modifying principles of accounting.
Accounting entity assumption; the assumption states that the business transactions are separate from the owner’s personal transactions. For example, Sam Alex and Ken runs a business on shares of 25, 35 and 40 percentage of profits and the business is on loss now. But, they are only liable to this loss for the percentage of shares they own.
Next assumption is money measurement assumption; states the record only those transactions which can be recorded in terms of money. For example, Daniel purchase a building for his business use, so he’ll record this event but he will not record that the building is in small town or in a big city.
Going concern assumption; as per this assumption, businesses will last forever and will not wind up in near future. For example, Sam assumes that his hotel business will run for years.
Accounting period assumption states that to divide up the complex ongoing activities of a business into periods of a year, quarter, month, week etc. For example, Alex closed books of accounts in a year.
Let’s now discuss about basic concepts. First concept is dual aspect concept. The concept states that every business transaction requires recordation in two different accounts. For example, Sam purchases furniture for his hotel, he paid cash to receive furniture.
Revenue realization concept states that revenue can only be recognized after it has been earned. For example, Daniel sell some chocolates to his friend Neil on credit, here goods have been delivered. So, Daniel records this in his book of accounts.
Historical cost concept states that the price of an asset on the statement of financial position is based on its nominal or original cost when acquired by the company. For example, Sam purchases had tail for 1 million dollars 5 years ago entered in books of accounts. In this, original cost will be shown same1 million dollars even after next 10 years in the books of accounts.
Matching concept states that write only relevant cost of the period, revenues are reported along with the expenses that bought them in same period. For example, Daniel purchase our building $30 000 that will be useful for 80 months. Here the company will match 30 thousand dollars of expense each month to its monthly income statement.
Materiality principle; this principle states that an accounting standard can be ignored if the net impact of doing so has such a small impact on the financial statements that a reader of the financial statements would not be misled. For example, Daniel spent ten dollars to buy a wastebasket that has a useful life of ten years. The materiality principle allows him to expense the entire ten dollars in the year it is acquired, instead of recording depreciation expense of $1.00 per year for 10 years.
Consistency principle; now this principle states that once you adopt an accounting principle or method continue to follow it consistently in future accounting periods. For example, Neal purchase machine and use written down value method of depreciation for this year. So, he must follow the same for next coming years.
Prudence principle states that do not overestimate the amount of revenues recognized or under estimate the amount of expenses. For example, Daniel thinks that Neal will not be able to pay his money back, then this is a loss for Daniel. So, he’ll record this in books of accounts. But, suppose Daniel think that he will earn twice the cost of the chocolates, when he’ll sell rests then he’ll not record this in his books as this profit is not yet earned.