Accounting Concepts and Conventions Flashcards
There is a large number of concepts and conventions, which are the guidelines and principles which govern the way the figures are calculated and presented in the statements. Here are the eight main ones.
List the eight concepts/conventions
- Business entity convention
- Prudence convention
- Duality concept
- Objectivity/Fairness convention
- Stable monetary section convention
- Going concern convention
- Historic cost convention
- Money measurement convention
Money measurement convention
Only items which can be expressed in monetary terms are included in the financial statements. This eliminates brand reputation, customer loyalty, employee talent, the quality of the company’s processes, etc.
Historic cost convention
All assets are stated on the balance sheet of the company at their historic cost i.e. their acquisition cost.
Business entity convention
Accounting treats the owner as separate from the business and the owners are dealt with as having a claim on their own business. There are legal liability differences.
Stable monetary section convention
This convention assumes that money will not change in value over time. Inflation is not accounted for. lt is necessary to be cognisant of this when reading a balance sheet.
Going concern convention
Financial statements will be prepared on the assumption that the company will continue to exist in the foreseeable future. This is important because the value of assets in a company which is about to be sold (e.g., due to bankruptcy) may be lower and provision for the losses would need to be taken into account in the statements.
Objectivity/Fairness convention
Financial statements should be based on objective verifiable, reliable, evidence.
Duality concept
This refers to the fact that each recorded economic transaction has two aspects, both of which will affect the balance sheet in an equal and opposite way, so that the balance sheet continues to balance. This is the result of the double-entry bookkeeping system which is used in accounting.
Prudence convention
Understate rather than overstate profits, assets, and alike. Provide for any known contingencies. Anticipated losses should be recorded but profits recognised only when they are realised. The question of when profits are realised is one related to a concept known as the realisation concept.
