Accounting theories [Ch 5.6,9,10,11,13 and 14]

Question 1

Explain monetary theory.

Answer 1

This theory states that only business activities that can be measured in monetary terms are recorded.

Question 2

Name and explain the accounting theory applied for treatment on drawing.

Answer 2

Accounting entity theory (treatment of drawings)
This theory states that the business is a separate entity from its owner and that all transactions are recorded from the point of view of the business.

Question 3

Explain objectivity theory (applicable to source documents)

Answer 3

This theory states that transactions are recorded based on information that is reliable and verifiable, that is, supported by source documents.

Question 4

Explain historical cost theory (applicable to non-current assets).

Answer 4

This theory states that transactions should be recorded at their original cost.

Question 5

Explain the following: Going concern theory and Accounting period theory, Matching theory (applicable to depreciation, income and expense adjustments)

Answer 5

Going concern theory
This theory states that the business has an indefinite economic life.

Accounting period theory
This theory states that the economic life of a business is divided into regular intervals such as a month, a quarter or half a year and a year. This is known as the financial period or accounting period.

Question 6

Explain prudence theory (applicable to depreciation and impairment loss of trade receivables)

Answer 6

This theory states the accounting treatment chosen should be the one that least overstates assets and profits and least understates liabilities and losses.

Question 7

Explain materiality theory (applicable to capital expenditure and revenue expenditure)

Answer 7

This theory states that an item is considered material if it is significant compared to the size of the business, in term of its profit. If the item is not material it is recorded as a revenue expenditure and not a capital expenditure.

Question 8

Explain consistency theory (applicable to using the depreciation method.)

Answer 8

This theory states that the accounting methods used by a business must be consistent from period to period so that its financial performance can be meaningfully compared across financial periods.

Question 9

Explain accrual basis of accounting theory (Income and expense adjustments)

Answer 9

This theory states that all business activities that have occurred must be recorded in the relevant accounting period regardless of whether cash is paid or received.

Question 10

Explain matching theory (applicable to depreciation, income and expense adjustments)

Answer 10

Matching theory (applicable to depreciation, income and expense adjustments)This theory states that income earned and expenses incurred during the same financial period should be matched to arrive at the profit for the financial period.