subject line: Second Course – How accounting works (i.e The Accounting Concepts)
Hello [newsfield name=”name”],
It’s time for your second course in Grow your business with accounting
Challenge. I hope you found course one informative and that you have a
better understanding of what Accounting is and how it functions.
In this lesson we are going to go over some of the underling assumptions of how accounting works. Let’s get started!
Accounting is the language of business communication within the business itself and also with the other interested parties like bankers, tax authorities and others. This communication is made through the financial statement.
In order for the financial statement to take care of the interest of all parties or stakeholders concerned, certain assumptions, concepts, convention and principles which provide essential framework for expressing accounting information are used. This include
- BUSINESS ENTITY CONCEPT
Accounts are kept in respect of business entities which are distinct from the persons who own or manage the entities.
The law makes the same distinction, as in case of a limited liability company which is a separate legal entity from the stakeholder or its directors. In the case of partnership and sole trader such distinction are not made in law, but even so the book of accounts are kept so as to maintain the distinction.
- THE COST CONCEPT
All the transaction in the account of a company are recorded at the cost of acquiring the assets be it plants and machinery, land and building or raw material, and form a basis for subsequent treatment. The result is that at any moment of time, the values recorded in the books do not necessarily reflect the current value of the assets.
- MONEY AS A COMMON DENOMINATOR
Accounting uses money to express certain facts about a business and in such a way that they can be added or subtracted. For instance, the ownership of raw materials worth N100,000 can be added to the ownership of raw material worth N150,000 and a useful expression of the wealth of the business is obtained.
- GOING CONCERN CONCEPT
The value of business transactions are recorded and treated in the accounting system on the assumption that the business will continue trading. If the business decides to liquidate or become bankrupt then a different approach to valuation is required.
- ACCRUAL CONCEPT
In accounting, the income accruing to the owner of a business is not necessary in amount of cash actually received in a period of account. Any event which increases the proprietor’s capital involves the accruals of time which is normally the accounting year.
- REALISATION CONCEPT.
Revenue is considered as earned on the day which is realized and this is when goods are transferred to the customers in exchange for a valuable consideration. The account usually uses the date the product is shipped to the customer or the date on the invoice whichever is the later.
- DUALITY CONCEPT
All business events are regarded as having a dual aspect. In the balance sheet, the dual aspect is static since it shows the state of the business at one moment of time. The accounts are dynamic, since they record changes in the state of the business.
Accounting conventions are generally observed in interpreting accounting concepts.
- Conservatism: in accounting, possible future losses are always anticipated whereas possible future profits are not bought into account however likely these may be.
- Consistency: this means that whilst certain alternatives are considered equally acceptable, the accountant having adopted one must follow that method over a reasonable period of time e.g. stock valuation, depreciation and others. Whilst changes of methods may be made it is accepted that these should not be made frequently nor for the purpose of mis-representing the profit of the firm.
- Materiality: This means the size of an amount will influence the treatment of it. Heavy controls and procedures should not be applied to items of small importance.
With so many users of financial statement, accounting must take cognizance of the above concepts and conventions in preparing financial statement that is devoid of subjectivity and conflict of interest.
That’s it for today’s lesson. In your next lesson we will be talking about users of financial statement or stakeholders.
Again, I appreciate your joining me for this challenge. If you have
any questions or need any assistance please feel free to contact me at
anytime. I will be glad to help.
Yours in enhancing your profitability and growth
J. Taiwo Popoola