Topic 11 – Fundamental Accounting Concepts and IAS
Definition of an accounting concept
A concept may be defined as an idea. Thus, an accounting concept is an assumption that
underlies the preparation of the financial statements of the organisation. These are
accounting procedures that have developed over the years to form the ‘basic rules of
accounting’.
Fundamental Accounting Concepts
The four important accounting concepts which are used in preparing periodic financial
statements of a business are as follows:
Fundamental Accounting Concepts
Consistency
Going concern
Accruals Prudence
Going concern concept
The going concern concept implies that the business will continue to operate for the
foreseeable future. In other words, it is assumed that the business will continue to trade for a
long period of time and there are no plans to cease trading and/or liquidate the business.
Accruals concept (or matching concept)
The accruals concept says that net profit is the difference between revenues and expenses
rather than the difference between cash received and cash paid.
Revenue – Expenses = Net Profit
Sales are revenues when the goods or services are sold and not when the money is
received, which can be later in the accounting period. Purchases are expenses when goods
are bought, not when they are paid for. For example, items such as rent, insurance and
motor expenses are treated as expenses when they are incurred, not when they are paid for.
, Adjustments are made when preparing financial statements for expenses owing and those
paid in advance (prepayments).
Identifying the expenses used up to obtain the revenues is referred to as matching expenses
against revenues, which is why this concept is also called the matching concept.
By showing the actual expenses incurred in a period matched against revenues earnedin the
same period, a correct figure of net profit will be shown in the profit and loss account.
Consistency concept
The consistency concept requires that the same treatment be applied when dealing with
similar items not only in one period but in all subsequent periods. The concept states that
when a business had adopted a method for the accounting treatment of an item, it should
treat all similar items that follow in the same way when preparing the financial statements.
Examples of when the consistency concept is used include:
Method of depreciation;
Stock valuation.
This concept is important since it assists in analysis of financial information and decision
making and it is vital that the organisation uses the same accounting principles each year. If
the organisation was constantly changing its methods then this would result in misleading
profits being calculated and inaccurate analyses, hence the reason why the convention of
consistency is used. However this does not mean that the business must always use a
particular method; it may make changes provided it has good reason to do so and each
change is declared in the notes to the financial statements.
Prudence concept
When preparing financial statements, accountants often have to use their judgement in
determining the valuation of a particular asset or perhaps deciding whether an outstanding
debt will ever be paid. It is the accountant’s duty and responsibility to ensure that the
financial statements are prepared as accurately as possible in disclosing the appropriate
facts about a business. Therefore, the accountant should ensure that assets are not
overvalued and similarly all liabilities should be identified. In other words, the accountant
should display a certain amount of caution when forecasting a business’s net profit or when
valuing assets for balance sheet purposes.
The prudence concept means that accountants will take the figure that will understate rather
than overstate the profit. They must also ensure that all losses are recorded in the books but
equally so ensure that profits are not anticipated by recording them before they have been
gained.
Other accounting concepts
In addition to the fundamental accounting concepts there are several other concepts and
conventions which are followed when preparing financial statements.
Definition of an accounting concept
A concept may be defined as an idea. Thus, an accounting concept is an assumption that
underlies the preparation of the financial statements of the organisation. These are
accounting procedures that have developed over the years to form the ‘basic rules of
accounting’.
Fundamental Accounting Concepts
The four important accounting concepts which are used in preparing periodic financial
statements of a business are as follows:
Fundamental Accounting Concepts
Consistency
Going concern
Accruals Prudence
Going concern concept
The going concern concept implies that the business will continue to operate for the
foreseeable future. In other words, it is assumed that the business will continue to trade for a
long period of time and there are no plans to cease trading and/or liquidate the business.
Accruals concept (or matching concept)
The accruals concept says that net profit is the difference between revenues and expenses
rather than the difference between cash received and cash paid.
Revenue – Expenses = Net Profit
Sales are revenues when the goods or services are sold and not when the money is
received, which can be later in the accounting period. Purchases are expenses when goods
are bought, not when they are paid for. For example, items such as rent, insurance and
motor expenses are treated as expenses when they are incurred, not when they are paid for.
, Adjustments are made when preparing financial statements for expenses owing and those
paid in advance (prepayments).
Identifying the expenses used up to obtain the revenues is referred to as matching expenses
against revenues, which is why this concept is also called the matching concept.
By showing the actual expenses incurred in a period matched against revenues earnedin the
same period, a correct figure of net profit will be shown in the profit and loss account.
Consistency concept
The consistency concept requires that the same treatment be applied when dealing with
similar items not only in one period but in all subsequent periods. The concept states that
when a business had adopted a method for the accounting treatment of an item, it should
treat all similar items that follow in the same way when preparing the financial statements.
Examples of when the consistency concept is used include:
Method of depreciation;
Stock valuation.
This concept is important since it assists in analysis of financial information and decision
making and it is vital that the organisation uses the same accounting principles each year. If
the organisation was constantly changing its methods then this would result in misleading
profits being calculated and inaccurate analyses, hence the reason why the convention of
consistency is used. However this does not mean that the business must always use a
particular method; it may make changes provided it has good reason to do so and each
change is declared in the notes to the financial statements.
Prudence concept
When preparing financial statements, accountants often have to use their judgement in
determining the valuation of a particular asset or perhaps deciding whether an outstanding
debt will ever be paid. It is the accountant’s duty and responsibility to ensure that the
financial statements are prepared as accurately as possible in disclosing the appropriate
facts about a business. Therefore, the accountant should ensure that assets are not
overvalued and similarly all liabilities should be identified. In other words, the accountant
should display a certain amount of caution when forecasting a business’s net profit or when
valuing assets for balance sheet purposes.
The prudence concept means that accountants will take the figure that will understate rather
than overstate the profit. They must also ensure that all losses are recorded in the books but
equally so ensure that profits are not anticipated by recording them before they have been
gained.
Other accounting concepts
In addition to the fundamental accounting concepts there are several other concepts and
conventions which are followed when preparing financial statements.
