Accounting assumptions and principles

Question 1

Accounting Entity

Answer 1

The business is an entity separate from the owner. The transactions are recorded from the viewpoint of the business and the owners are treated as outsiders. The accounting process is concerned with the activities of the business organisation and not that of the owners.

Question 2

Monetary Assumption

Answer 2

It assumes that all transactions affecting the business are recorded in the common monetary unit in use, i.e. in dollars and cents. Any transaction of the business that cannot be expressed in money terms will be excluded from the accounting records.

Question 3

Historical Cost

Answer 3

Assumes that business transactions are recorded in terms of their cost at the time the transaction occured.

Question 4

Going Concern

Answer 4

It is assumed that the business will continue to operate for a long time and will not be selling its assets in the near future. As such, we report assets at their historical costs.

When a firm is going out of business or into liquidation, the firm will typically report their assets at their liquidating values (selling price) instead.

Question 5

Prudence

Answer 5

The adoption of cautious accounting practices. When determining the periodic profit for a business, accountants traditionally tend towards caution with profits recognised only when they have actually been earned. On the other hand, provision must be made to account for all probable loss.

Question 6

Accounting Period

Answer 6

Assumes that the indefinite life of a business is divided into arbitrary time periods.

This period is generally one year for reporting to external parties, but can be varied for internal reporting (e.g. 1 month, 1 qtr)

Question 7

Principle of Consistency

Answer 7

The accounting methods adopted should remain unchanged from period to period so that accounting reports for consecutive periods have greater comparability.

Question 8

Principle of Disclosure

Answer 8

All information and explanation necessary for interpretation of reports and statements should be conveyed to users.

Question 9

Principle of Materiality

Answer 9

The treatment of an item depends on its importance and accounting significance. It depends on the judgement of the accountant and the size of the business

e.g. cents are ignored

Question 9

Matching Principle

Answer 9

Matching of expenses with the revenue generated during the period by the expenses.

Question 9

Accrual Basis of Accounting

Answer 9

Recognises revenue and expenses in the same period when they are earned or incurred, not when cash has been received or paid for that transaction.