Concepts of accounting

When an accountant prepares the accounts for a business, there are a number of key accounting concepts that he or she must apply. The accounts of a business should present a true and fair view of the financial position of the business. The accounts of the business will be used by a variety of people, from the business owners to the bank. These users will make financial decisions based upon the information in the accounts. The key accounting concepts must be applied.

Going concern The accountant makes the assumption that the business will continue to trade into the foreseeable future. This means that the assets are shown in the accounts of the business at the book value.

Consistency The same principles of constructing the accounts must be used from one year to the next. For example, a business should use the same methods of depreciation and stock valuation.

Prudence When an accountant values a transaction, he or she must use a conservative approach and not over-value the transaction. For example, in the accounts, stock must be valued at cost or market value, whichever is the lower. The business must not overstate profits or the book value of the business.

Accrual/matching Revenues and costs are recorded in the accounts when they occur and not when the cash is received or paid. Revenues and costs are matched against each other for the same financial period. The accountant will make adjustments in the accounts for amounts owing and prepaid amounts.

Money measurement Only items that can be measured in money, and have a value that can be agreed, can be entered in accounting records. For example, how well the workforce is trained or motivated cannot be measured in money and a value agreed.

Objectivity The accounts should be prepared using accounting methods, e.g. for depreciation, that can be agreed.

Realisation This is the point at which a business earns the profit on a transaction. The profit is earned by a business when the goods or services are passed to the customer and the customer owes the business for the goods and services. It is not earned when the order is received.

Business entity The books of the business must be separate from the books of the owner. If an owner makes drawings on a business, this must be recorded as a drawing because it will reduce the capital.

Cost Transactions must be recorded in the accounts at the original cost. The final accounts of a business will show all the transactions at the historic cost.

Materiality The accountant must be careful that the recording of a transaction in a certain way shows a true picture in the accounts. For example, the purchase of a computer would be shown as an expense for a large business, but it would be a material amount for a small business and should be shown as a fixed asset. Fixed assets should be shown separately because they are material. Small items of expense, such as reams of paper, can be lumped together because they are not material.