These are the broad basic assumptions under which financial statements are prepared and these principles are used by the entire profession in preparing financial accounting information.
01. Business Entity Concept.
This concept separate the individuals behind a business from the business itself, and only records transactions in the accounts that affect the business.
02. Going Concern Concept.
Unless there is good evidence to the contrary, accounting assumes that the business will operate for the foreseeable future. It is also assumed that the business has no intention or necessity to liquidate or curtail the scale of its operations. Based on this concept all resources are usually valued at cost.
03. Consistency Concept.
Where there are similar items, similar treatment must be given within an accounting period and from one period to another.
This concept is also applied to the treatment of groups of similar items. For example the same depreciation method should be used for similar types of fixed assets, and the same stock valuation method should be used for similar types of stocks.
The Concept of prudence or conservatism is that a business should not lay claim to any profits before they have been earned with reasonable certainty and on the other hand it should anticipate fully expenses and losses that it expects to incur in future periods. that is losses should be written off in full as soon as they are anticipated.
05. Realisation Concept.
This concept dictates that we recognise sales revenue as having been earned at the time when goods and services haven been supplied and an invoice is issued. Similarly costs are incurred when goods or services have been received and not when they paid for. Revenue must not be overstated by a sale which was not realized although a promise or an intention to purchase goods may have been expressed.
06. Materiality Concept.
Accounting statements are prepared for the benefits of various user groups, it is essential that the information provided is both significant and easily understood. Materiality concept ensures that the information provided is clear by omitting items that are significant to the user in understanding the overall financial position of the organisation.
The distinction between what is significant and what is not varies depending on the size of the organization and it is a matter of judgement.
Factors determining the materiality.
This concept assumes that financial results(profit/loss) of a company is calculated at predefined accounting periods (annually, half-yearly, quarterly, monthly) and not deferred until the termination of the business. And it states that every transaction should be assigned to its relevant accounting period. However this is governed by various accounting standards such as accruals prudence and realisation concepts.
08. Accruals and Matching Concept.
The accruals concept states that expenditure incurred in a particular accounting period accounted for in that period, irrespective of whether or not it has been involved or paid for. Similarly income that has been earned in that period should be accounted for that period irrespective of the date of the invoice or the receipt of money from the transaction.
09. Money Measurement Concept.
Under this concept transactions/events that can be valued in terms of cash are recognised in the accounting, i.e. any event or transaction if a price tag cannot be attached it would not get recorded in the accounts even though it may be of significant importance to the company.
10. Historical Cost Concept.
This concept means that transactions are recorded at their cost values as evidenced by cash flow or agreed liability of the parties. The validity of the concept is undermined in times of the inflation.
11. Objectivity Concept
An accounting statement should not as far as is possible, be influence by the personal bias of the person preparing it. Thus figures used in accounting statements should be objective. The most objective value that can be place on an asset is the historical cost actually paid for it, which can be proved by an invoice and verified as the market value in the date of acquisition.
12. Fairness Concept
The fairness concept follows from the objectivity concept and states that in preparing the financial statements, the accountant (and in auditing them, the auditor) must serve all interested user groups equitably and not be biased towards any particular users.
13. Dual Aspect Concept
The twofold aspects of transactions are recognised when recording for the transaction.
SSAP (Statutory Statement of Accounting Principle) have specified four accounting concepts as “Fundamental Accounting Concepts”.