Accounting concepts

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The accounting concepts are defined as generally acceptable statements, consistent with the objectives of the financial statements, reflecting the nature of the accounting entity. Accounting as an information system uses various concepts using them for its own needs. The result of the adopted theoretical accounting concepts there is financial statements.

"Accounting is a service activity. Its function is to provide quantitative information primarily financial in nature about economic entities that is intended to be useful in making economic decisions - in making reasoned choices among alternative courses of action." (Percy C. Garcia, Benjamin Q. Mojar, Bienvenido A. Gemanil, 2006, p. 2)

Basic accounting concepts

The concepts are widely accepted and used in practice by preparers of financial statements and by auditors while verifying such statements (Banerjee, B K, 2010 p. 16-18).

  • Entity Concept The entity's concept assumes that the financial statements and other accounting information related to a specific enterprise that is different from its owners. Therefore, the analysis of business transactions including costs and revenues is expressed in terms of changes in the financial conditions of the company. This concept allows us to distinguish between personal and business transactions. This concept applies to all forms of business organizations, such as sole proprietorships, partnerships, companies and small and large enterprises.
  • Cost Concept The cost concept requires that assets be recorded in the books at their cost, i.e. the price paid or payable for the purchase of the asset. The cost of an asset may be higher or lower than the fair market price, but it should be recorded at the actual price. The concept of costs does not allow to show assets at their current value, because the market prices of assets are constantly changing. Because an asset is used to create goods and services, its cost expires, which is referred to as depreciation.
  • Matching Concept The concept of matching in accounting is the process of matching expenses to revenues based on the accrual system. This concept highlights which cost items are expenses in a given accounting period. This means that costs are recognized as expenses in the accounting period in which revenues related to these costs are recognized. Revenue must be taken into account in the accounting period in which the goods are sold or services rendered, and expenditure must be included in the accounting period in which they are used to generate or generate revenue. Actually, according to the matching principle, costs are recognized for a given accounting period and treated as costs incurred during that period. It is assumed that the right match occurs only when a reasonable relationship between revenue and expenditure is found.
  • Realization Concept or Revenue Recognition Concept According to this concept, revenue is considered to be earned when the goods have been transferred or services rendered to the customer. Revenues are recorded in the books as received or deemed to be received under the implementation convention. According to this convention, no income or profit can be gained until the sale has been made.
  • Accounting Period Concept Financial accounting provides information on the business activity of an enterprise in specific periods that are shorter than the useful life of the enterprise. Usually, the periods are of equal length to facilitate comparison. These periods are usually twelve months and at the end of this period financial statements are prepared to determine the results of operations. Thus, the abovementioned 12-month period is known as the accounting period. According to the convention of periodicity, accounting revenues or gains are the results of the entire transaction over the accounting period. The periodicity convention is currently established by provisions on the preparation of reports, such as the income statement and the balance sheet.
  • Money Measurement Concept According to this concept, all events/facts or transactions that occur during the accounting period that change the financial position of an enterprise or company and are measurable in terms of money should be recorded in the financial accounts. Events/facts that have a direct impact on business but that cannot be measured in monetary terms are not included in the financial accounts.

Among accounting concepts, we can distinguish the going-concern concept, accrual concept, conservatism concept, consistency concept, materiality concept, full disclosure concept, dual-aspect concept (Banerjee, B K, 2010 p. 16-18).

Examples of Accounting concepts

  • Generally Accepted Accounting Principles (GAAP): GAAP is a set of accounting principles, standards, and procedures that companies must follow when they compile their financial statements. GAAP aims to improve the clarity, consistency, and comparability of financial reporting across all organizations.
  • Revenue Recognition Principle: This principle states that revenue should be recognized when it is realized or realizable and earned. This means that revenue should be recorded when the goods or services have been provided to the customer, even if the customer has not yet paid for them.
  • Matching Principle: The matching principle requires that expenses be reported in the same period as the revenue they helped generate. This ensures that expenses and revenues are reported in the period in which they occurred, rather than all revenues being reported in one period and all expenses being reported in another.
  • Cost Principle: The cost principle states that assets should be recorded at their original cost. This means that when a company buys something, it should be recorded at the amount paid for it, rather than at its current market value.
  • Full Disclosure Principle: The full disclosure principle requires that all relevant and material information be disclosed in the financial statements. This includes information related to significant transactions and events, as well as any information that could be important to the users of the financial statements.

Advantages of Accounting concepts

The advantages of accounting concepts are as follows:

  • The accounting concepts provide a framework for the preparation of financial statements. This framework helps ensure the accuracy and consistency of financial statements, allowing users to compare the performance of different companies and other entities.
  • Accounting concepts also help to reduce the risk of misinterpretation of financial information. By providing a set of consistent rules, the concepts reduce the chances of errors or omissions in the preparation of financial statements.
  • Accounting concepts also help to simplify the accounting process by providing a set of guidelines and rules to follow. This reduces the amount of time and resources required to prepare financial statements.
  • Lastly, accounting concepts help to ensure that financial statements are prepared in a manner that is consistent with the objectives of the business. This helps businesses make informed decisions based on reliable financial information.

Limitations of Accounting concepts

The limitations of accounting concepts include:

  • The assumption of permanence: Accounting concepts assume that all activities of the business are ongoing and will not end. This assumption may not be true in the case of a business that produces a one-time product or a business that is in the process of winding up.
  • The assumption of objectivity: Accounting concepts assume that the figures reported in the financial statements are accurate and unbiased. However, in reality, the figures may be manipulated by management in order to achieve desired results.
  • The assumption of consistency: Accounting concepts assume that the same accounting principles and methods are used for all accounting periods. This may not be true in cases when the business changes its accounting methods or there are changes in the accounting standards.
  • The assumption of going concern: Accounting concepts assume that the business will remain in operation in the foreseeable future. This assumption may not be true in cases when the business is facing bankruptcy or liquidation.

Other approaches related to Accounting concepts

The following are some other approaches related to accounting concepts:

  • Cost Concept - this concept states that assets are recorded at their cost, which includes the purchase price plus any additional costs to make the asset ready for its intended use.
  • Monetary Unit Assumption - this concept states that all transactions must be recorded and reported in the measurement unit of a specific currency.
  • Going Concern Concept - this concept states that a business will continue to operate indefinitely, instead of being liquidated.
  • Matching Principle - this concept requires that the expenses of an accounting period are matched with the revenues of the same period.
  • Accrual Principle - this principle states that revenues and expenses must be recorded in the period in which they occur, even if payment has not been received or made.
  • Materiality Principle - this concept states that an amount is only considered material if it is large enough to influence the decisions of a reasonable person.

In summary, these approaches are related to accounting concepts because they form the basis of accounting standards and are used to ensure accuracy in financial reporting.


Accounting concepts — recommended articles
Accrual method — Money measurement concept — Cost principle — Accounting Convention — Creative accounting — Consistency principle — Periodicity concept — Time period concept — Matching principle — Contribution formula

References

Author: Weronika Chudzik

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