Unit 6

UNIT 6
ACCOUNTING CONCEPTS
&
PRINCIPLES
Introduction
 The accounting concepts act as a guide to the ‘proper’ way of
recording and presenting accounting transactions and
statements.
Accounting concepts are not laws in the traditional sense of the

word but are meant to provide a framework of informal rules
and guidance for those who are meant to construct the financial
statements of business entities.
For limited companies, these concepts are integrated into a range

Introduction
Accounting standards are a series of continually evolving statements and
guidelines as to how the accounts of limited companies are constructed.
These standards have evolved over time and are gradually being more
closely integrated into a common set of international standards.
 Over the last thirty years the International Accounting Standards

Board (IASB) (until 2001 this was known as the International Accounting
Standards Committee) has sought to develop a set of accounting standards
which can be applied by an increasing number of countries.
Some countries still operate under their own GAAP rules and regulations.
Principles, Assumptions, and Concepts of Accounting
 The Financial Accounting Standards Board (FASB) is an independent,
nonprofit organization that sets the standards for financial accounting and
reporting, including generally accepted accounting principles (GAAP), for both
public- and private-sector businesses.
 GAAP are the concepts, standards, and rules that guide the preparation and
presentation of financial statements. International accounting rules are called
International Financial Reporting Standards (IFRS).
 Publicly traded companies (those that offer their shares for sale on exchanges in
the United States) have the reporting of their financial operations regulated by the
Securities and Exchange Commission (SEC).
Financial statements - The underlying principles
The Framework for the preparation and presentation of Financial
Statements was issued by the IASB.
Its main objective was to provide guidance to assist businesses both in

how their financial statements were to be prepared (i.e. what rules were
to be applied) and in how to present them (i.e. how the financial
statements would appear).
The main objective of the financial statements is to provide a true and

fair view of the financial position of the business for the user groups of
the business.
Financial statement- The underlying principles
To ensure that the accounts are true and fair, the framework sets out
four requirements for financial statements:
1. Understandability;
2. Relevance;
3. Reliability and
4. Comparability.
1. Understandability
Financial statements should be accessible enough to be understood by
the users of the information. The framework sets out the main users of
the financial statements as follows;
● Investors
● Employees
● Lenders
● Suppliers
● Customers
● Government
● The public.
Accounting underlying principles
2. Relevance
Financial statements should provide relevant information.
 Information would be judged as relevant if it enables users of the

information, such as investors, to make judgments as to the past,
present and hopefully future performance of the business.
3. Reliability
Financial statements must reliably show the effects of financial
transactions on the firm’s financial position.
Accounting underlying principles
4. Comparability
The financial statements must be prepared in such a manner as
to ensure that comparisons can be made with earlier time
periods.
This requires accounting policies to be consistently applied

and an outline of what policies have been used and any
changes that are made to such policies.
Accounting Concepts
1. Accruals concept (Matching concept)
The accruals concept means that the financial statements are
constructed on the basis that incomes and expenses are linked to
the period in which they are incurred rather than when the
money for the income or expense changes hands.
For example, the sales made in one period of time would

appear as income for that period even if the receipt of money
for the sales was received in a later period of time.
1. Accruals concept (Matching concept) continued......
 Accountants follow a simple rule in recognizing expenses: “Let the expenses

follow the revenues.” Thus, expense recognition is tied to revenue
recognition.
 It states that we must match expenses with associated revenues in the

period in which the revenues were earned.
 A mismatch in expenses and revenues could be an understated net income in

one period with an overstated net income in another period.
 There would be no reliability in statements if expenses were recorded

Accounting concepts cont’d
2. Prudence
 To be prudent is to be careful. The concept of prudence requires the
accounts to be constructed with a fair degree of caution.
 The implications of this are that profits should not be anticipated

before they are reasonably certain. Provision should be made with a lot
of caution.
 The prudence concept links with the requirement of reliability for the
financial statements. This concept is sometimes known as
conservatism.
Accounting concepts cont’d
2. Prudence continued......
 This concept is important when valuing a transaction for which the

value cannot be as clearly determined, as when using the cost
principle.
 Conservatism states that if there is uncertainty in a potential financial

estimate, a company should err on the side of caution and report the
most conservative amount.
Accounting concepts
3. Consistency
 Any accounting methods that are selected should be used in a
consistent manner. For example, depreciation policy for non-current
assets should be maintained consistently so as to ensure fair
comparisons to be made with earlier accounting periods.
4. Materiality
 A ‘material’ amount refers to a monetary amount that is significant
enough to be recorded separately.
 More importantly, expenditure on some items could be classified as

either an asset or an expense – this will depend on the type of the
Accounting Principles
1. HISTORICAL COST PRINCIPLE:
 States that virtually everything the company owns or controls (assets)
must be recorded at its value at the date of acquisition.
 The primary exceptions to this historical cost treatment, are financial

instruments, such as stocks and bonds, which might be recorded at
their fair market value.
 Once an asset is recorded in the books, the value of that asset must
remain at its historical cost, even if its value in the market changes.
2. FULL DISCLOSURE PRINCIPLE
 States that a business must report any and all business activities that
could affect what is reported on the financial statements.
 These activities could be non-financial in nature or be supplemental

details not readily available on the main financial statement.
 Some examples of this include any pending litigation, acquisition

information, methods used to calculate certain figures, or stock
options.
Accounting assumptions
 These assumptions are used in the construction of financial statements

and the recording of accounting transactions.
1.Business / Seperate entity
 The accounting records of a business should be for the business alone.
 All items that relate to the owner’s personal dealings should remain
separate from those of the business.
 Implications of this concept are that expenses incurred by the
business are the only ones that appear in the business records.
 The financial statements must only show the true business expenses.
Any use of business resources for private matters should be recorded in
the accounts as drawings.
2. Going concern
 The assumption is made that the business will continue trading into the
future, and that the business and its assets are not expected to be sold
off in the near future.
 As a result, the valuations of the assets of the business should not be

based on potential resale value but on more objective, verifiable means,
such as historical cost.
3 . Time period Assumption :
 States that a company can present useful information in shorter
time periods, such as years, quarters, or months.
 The information is broken into time frames to make comparisons

and evaluations easier.
 The information will be timely and current and will give a

meaningful picture of how the company is operating.
3 . Time period Assumption :
 A potential or existing investor wants timely information by which to
measure the performance of the company, and to help decide whether
to invest.
 Because of the time period assumption, we need to be sure to

recognize revenues and expenses in the proper period.

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Accounting concepts are not laws in the traditional sense of the

For limited companies, these concepts are integrated into a range

 Over the last thirty years the International Accounting Standards

Its main objective was to provide guidance to assist businesses both in

The main objective of the ﬁnancial statements is to provide a true and

 Information would be judged as relevant if it enables users of the

This requires accounting policies to be consistently applied

For example, the sales made in one period of time would

 Accountants follow a simple rule in recognizing expenses: “Let the expenses

 It states that we must match expenses with associated revenues in the

 A mismatch in expenses and revenues could be an understated net income in

 There would be no reliability in statements if expenses were recorded

 The implications of this are that proﬁts should not be anticipated

 This concept is important when valuing a transaction for which the

 Conservatism states that if there is uncertainty in a potential financial

 More importantly, expenditure on some items could be classiﬁed as

 The primary exceptions to this historical cost treatment, are financial

 These activities could be non-financial in nature or be supplemental

 Some examples of this include any pending litigation, acquisition

 These assumptions are used in the construction of ﬁnancial statements

 As a result, the valuations of the assets of the business should not be

 The information is broken into time frames to make comparisons

 The information will be timely and current and will give a

 Because of the time period assumption, we need to be sure to

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