Accounting Concepts

In everything we do in life, certain rules and / or guidelines apply. This ensures that there is uniformity and/or consistency in the practice of such act. To this end, accountants have come up with some rules and guidelines to be kept sacred in the preparation and presentation of accounting information as well as running business concerns. Hence, accounting concepts and conventions are the basis rules and assumptions that underline the preparation and presentation of accounting (stewardship) reports. They tend to define and streamline the manner in which accounting is to be practiced in terms of presentation of the stewardship report.

The following concepts and conventions are herein discussed below.

   1.    Money Measurement Concept

In our introductory chapter, we wrote that “account” is provision of explanation of events that have money value.

Thus, the money measurement concept says that accounting events should be stated or measured in money terms. This is why the figures reported are usually in naira, dollars, cedi, euro, pounds, etc.

   2.    Going Concern Concept

Everyone going into business wishes to run the business for a long time, make and maximize profit and of course grow his wealth over time.

The going concern concept states that a business entity will continue its operation into the future indefinitely, believing that there is no plan to curtail any significant part of its operation, unless it is stated otherwise.

This is one of the areas of interest to the users of accounting information. This concept enables the users of accounting information make informed decisions regarding the financial statements prepared and presented by the entity.

Decisions by Users of Accounting Information

Users of accounting information tend to be interested in knowing whether the business entity can be in existence in the foreseeable future, thereby helping them to take informed decisions regarding the business.

In the case of sole traders, this concept is greatly threatened as the death of the sole proprietor may ruin the operations of the business. This is so as most of the business decisions are centralized in the hands of the sole proprietor, who acts as the owner and the chief executive at the same time.

In the case of limited entities, this is very unlikely as many shareholders pulled their resources together (in terms of shares) to run the business. Even when a chief executive of a limited company dies, another chief executive will automatically be appointed from among other top management staff of the company. Thus, the company continues its operation without (most of) the stakeholders knowing that a CEO is dead. This is the beauty of the concept.

Valuation

 There are two ways of making valuation of the resources of the business entity. When a business entity is seen to be a going concern, its accounting (stewardship) reports are prepared on the going concern basis. For this, its fixed (non-current) assets are valued and reported on historic basis before charging depreciation as applicable. When the going concern concept of such business entity is threatened (ie the business is coming to an end) the assets of the business are then valued and sold at a forced sale. Recall that business entity can be liquidated by a court order, by voluntary liquidation, etc.

   3.    Entity Concept

This concept depicts that every business firm should be treated separately from its owner(s) irrespective of its legal form or status.

For this, all the business transactions are done for and on behalf of the business. Though, the owner(s) contributed money to establish or own the business yet the business is seen to be different and separate from them.

   4.    Matching Concept

This concept states that the total earned income must be matched with the total expenses incurred to earn that income in the given accounting period.

Matching concept justifies the end-of-year adjustments usually carried out in the preparation of final accounts of an entity. The reason being that those expenses reported by way of additional information to the trial balance actually refer to the period to which the trial balance refers; thus, adjusting for any additional information in the final accounts is in compliance with the matching concept.

   5.    Historical Cost Concept or the Cost Concept for Short

The cost concept holds that assets and liabilities of any business firm should be states at their historical cost price as this would serve as the basis of future valuation of such items.

Where fixed assets are shown or reported as per their cost price, depreciation of such assets will eventually display their current net book values.

To report asset at their net book value directly would imply that their respective depreciation values have been credited to the assets accounts as this automatically show their running balances at net book values.

   6.    Realization Concept

The concept posits that revenue can only be recognized when it is capable of being objectively measured.

This implies that for a sale of goods, revenue is not recognized until sale has been effected.

For cash transactions or cash sale, a sale is made as soon as cash is received and goods delivered to the customer.

For credit sale, a sale is made as soon as the customer accepts liability for the goods sold to him.

   7.    Periodicity Concept

As the lifespan of a business firm cannot be measured with certainty, this concept depicts that for the purpose of reporting, the business life has to be divided into accounting periods, usually every year. In doing this, the results of different periods can now be compared for the purpose of performance measurement.

   8.    Consistency Concept.

Different business firms have the choice of methods of reporting particular item in the financial statements. Consistency concept states that when a firm has selected a method, such firm should consistently apply such method overtime to allow comparison of accounting reports.

However, there are instances where it becomes indispensable for such firm to change its chosen method(s). These instances include:

a)   A change in accounting standard

b)   A change in legislation

c)   Where it is felt that the new method will show a better picture of the results of the business operations

   9.    Materiality Concept

This concept depicts that only items (transactions) that have material values should be given strict treatment as per classification.

The implication of this is that treatment of transactions should be done in line with the benefits derivable from such treatment.

For instance, a firm bought a stapler and, feeling that such stapler fulfils some of the conditions for recognition as a fixed asset, may want to capitalize it in the books. But considering the value of the stapler, it becomes more appropriate to classify it as stationery rather than a fixed asset.

   10.  Prudency Concept

The basis of this concept is that the chickens are not to be counted before the eggs are hatched.

Thus, in preparing accounting reports, all foreseeable expenses are accounted for before arriving at the profit position.