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Accounting Theory- Concepts, Assumptions And Conventions

Updated on October 25, 2011


Accounting concepts are particular statement of accounting theory. They are also referred to as priciples or fundamental accounting postulates, they are rules adopted as guides to actions which rest on general acceptance rather than basic undeniable truths. A concept is general and offers a guide. Accounting concept do not prescribe exactly how economic events affecting the business should be collected, recorded or evaluated; there is an infinite number of possible events and no rule could be prescribed for every conceivable eventually.

The following important accounting concept should require attention:

* The Accrue Concept : The accrue concept states that income(profit) arises from events which affect the owner's equity only. This is the same as the matching concept which stipulates that profit will be recorded at the point of sale irrespective of whether cash due accrue or is in arrears. The attributable cost or expense is also simultaneously recognized when incurred and not necessarily when cash is paid. The concept holds that for any accounting period, the earned revenue and all the incurred cost that generated the revenue have to be match and reported for the period. if revenue is carried over from a prior period or deferred to a future period. all elements of cost and expense relating to that revenue are usually carried over or deferred as the case may be.

* Business Entity : A distinction is drawn between a business and its owner and therefore all trasactions can be recorded as they affect the business as distinct from the owner. The distinction can easily be maintained in the case of a company because the law accords to the business, a personality of its own, wherby it can sue and be sue in its own name instead of in names of all its owners, the shareholders. Every economic unit, regardless of its legal form of existence, is treated as a separate entity (in accounting) from parties having proprietary or economic

* Quatifiable/Money Measurement : This states that every item in the account should be measurable in monetary terms, viz in dollar and cent. That is monetary values are placed upon each of the items. The simple reason for this is that money is accepted both as a valye and a medium of exchange.

* Duality : This ia a convention associated with the systems of double-entry book-keeping. To every debit there is an equal and a corresponding credit, e.g an asset is acquired by either the creation of a liability or the use of a resource of equal value.

* Periodicity : In accounting, the intervals or accountingt periods are normally one year, although for management purposes,reports ( often called interim statements) are prepared at much shorter intervals. Although the result of a business unit cannot be with precision until its final liquidation, the business is divided into accounting periods (usually one year) and changes in position are measured over these periods.

* Realization : The recognition of revenue in an accounting period is the subject of discussion under the realization concept. There are four categories;
> Recognition of revenue at time of scale
> Recognition of revenue during production
> Recognition of revenue at the completion of production
> Recognition of revenue subsequent to sale e.g at the point of cash collection.
The concept establishes the rule for the periodic recognition of revenue as as;
> it is capable of objective measurement.
> The value of asset receive or receivable in exchange is reasonbly certain.
It is possible to recognize revenue at a variety of pionts, e.g when goods are produce, at the piont goods are delivered, or when the transaction is completed. choice,in most cases is an industrial norm, and depends on which of the ppoints is the critical event. only when this event is passed can revenue be legitimately recognized.

* Historical : The historical cost concept holds that cost is the appropriate basis for initial accounting recognition of all asset acquisitions, services rendered or receive,expenses incurred, creditors and owners interest; it also holds that subsequent to acquisition costs are retained throughout the accounting process

B. Assumptions of Accounting : The accountant has to make certain assumptions in order to limit the possible range of interpretations. There are two basic assumptions.
(i) Stability and
(ii) Continuity

> Stability : in accounting the monetary unit is normally assumed to be stable; in other words the Dollar of 1990 is assumed to be the same as the Dollar of 2009. During times of inflation, this is quite evenly not true.
> continuity : unless there is good evidence to the contrary. accounting assumes that the business will continue to operate for the foreeable future. This is an important assumption as far as valuation of assets is concerned, since the value to a firm of some assets would be much higher on the going concern basis than would be if the organisation were to go into liquidation. This is particularly true if the assets have only small scrap values owing to non-marketability of the assets concerned. The assumptions is that the business unit will operate in perpetuity; that is the business is considered a going concern if it is capable of earning a reasonable net income and there is no intention or threat from any source to curtail significantly its line of business in the foreeable future.

C. The following important accounting convention are also recognized;
(i) objectivity
(ii) Prudence
(iii) Materiality
(iv) Consistency

* objectivity : Business operate in an environment of economic change and uncertainty. in the case of uncertainty the accountant strives to choose data that is reliable and objective as much as possible. The term objectivity rtelates to data that can be independently verified and is not influence by the personal feeling or judgement of the accountant or any person within the firm.
* Prudence : This convention states that where an accountant colud deal with an item in more than one way in deciding between alternatives, that which is more prudent should have precedence. For example, stock valuation is at the lower of cost and net realization value. if an asset appreciates in value, this gain should not be recorded until the asset is sold. However a loss in value due to use or obsolenscence should be recognized and incorporated in the financial statements. This principle demands exercising great care in the recognition of profit whilst all known losses are adequately provided for. This is however not a justification for the creation of secret or hidden reserves
* Materiality : The essence of materiality is to assess the significance of an item in relation to the whole and according such item strict accounting treatment based on its size or monetary significance. For example an item of revenue of $500,000 in the accounts of a company with turnover of $15 million can be considered material and hence requiring special attention while the same amount of $500,000 will not be considered material for a company with turnover of $30 million. However it does require that where the accounting treatment is hanged, say a change in accounting policy on depreciation from straight line to reducing balance method of depreciation. The effect of the change and the position under both the old and new methods are clearly shown. usually there is more than one way in which an item may be treated in the accounts, without violating accounting principles.
* consistency : The concept of consistency holds that when a company selects a method it should continue ( unless condition warrant a change ) to use that method in sebsequent periods so that a comparison of accounting figures over time may be meaningful. The concept ensures that the accounting treatment of similar items is consistent, taking accounting period with another.

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    • profile image

      Nayaz 

      6 years ago

      Hello Vicogon40, congrats for this well written hub. Readers will find it helpful. If you agree, may I share the following linnk with your readers who may supplement what they learn from you:

      http://principlesofaccounts.weebly.com

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