chapter 9

Question 1

accounting concepts

Answer 1

basic rules for recording financial transactions and preparing financial statements. they are sometimes known as principles

Question 2

list of accounting concepts

Answer 2

duality
business entity
monetary measurement
historic cost
realization
consistency
materiality
matching
prudence
going concern
substance over form
objectivity

Question 3

duality

Answer 3

this concept recognizes that there are two aspects to each financial transaction, represented by debit and credit entries in account

Question 4

business entity

Answer 4

every business is regarded as having an existence separate from that of its owner. information can only be entered into the accounts if it has a direct impact on the business and must be don so from the business’s point of view

Question 5

money measurement

Answer 5

Only transactions that can be expressed in monetary terms are recorded in ledger accounts Goods, non-current assets, trade receivables and expenses may be recorded in ledger accounts because they have resulted from transactions that can be expressed in monetary terms.

Question 6

things that cannot be expressed in monetary terms

Answer 6

There are some things that cannot be expressed in monetary terms, such as the skills of workers or the business having a good reputation. This means that a business might be worth a lot more than the value of the items shown in the statement of financial position.

Question 7

why cannot things that cannot be expressed in monetary terms be valued

Answer 7

these items are subjective and so getting a valuation is difficult. Accountants take the view that something is worth what someone pays for it as soon as money changes hands, there is a valuation that can be recorded in the accounts.

Question 8

historic cost

Answer 8

financial transactions are recorded at their original cost of the business. Cost cannot be disputed as invoices or other documentary evidence may be produced to support it. Recording financial transactions in this way is said to be objective because it is based on fact and not on opinion.

Question 9

what can historic cost be applied to

Answer 9

This can be applied to purchases of non-current assets and inventory or expenses and, as we saw under money measurement, could be applied to the valuation of a whole business.

Question 10

disadvantages of recording transactions at their historic cost

Answer 10

it does not allow things that cannot be expressed in monetary terms to be recorded in accounting
inflation means that prices rise and the value of money falls. Using historic cost might cause a distortion.

Question 11

inflation

Answer 11

this is a general rise in the level of prices

Question 12

realization

Answer 12

revenue is recognised or accounted for by the seller when it is earned whether cash has been received from the transaction or not.

Question 13

goods on sale or return

Answer 13

this is not a concept but a very important point in relation to ownership of goods relating to a transaction. When a trader sends goods on sale or return to a customer, no sale takes place until the customer informs the seller that she or he has decided to buy them. the customer has the right to return the goods

Question 14

consistency

Answer 14

a financial transactions of similar nature should be recorded in the same way (that is consistently) in the same accounting year and in all future accounting years

Question 15

when can a change in consistency be made

Answer 15

Accountants are always trying to ensure that the accounts of a business represent a true and fair view. If an alternative method does give a better representation of what is going on, then a change can be made. What is not acceptable is changing methods to get a desired result

Question 16

what does consistency ensure

Answer 16

Consistency in the treatment of transactions ensures that the profits or losses of different periods, and statements of financial position, may be compared meaningfully.

Question 17

true and fair view

Answer 17

the financial statements are accurate and faithfully represent the financial performance and position of the business

Question 18

materiality

Answer 18

An amount may be considered material in the accounts if the way in which it is treated or even its omission or inclusion in the statement of profit or loss or statement of financial position would change the way in which people would read and interpret those financial statements. Whether something is material is a matter of opinion and its application might depend on factors like the size of the business. Many businesses will set out guidelines or monetary limits to help staff apply a consistent approach.

Question 19

matching concept (accruals concept)

Answer 19

the financial statements should show the revenue earned and the expenses incurred during an accounting year. this is significantly different from just recording the amount of cash flowing in and out of the business. statements of profit or loss should be prepared on the matching basis so that the expenses are matched to the revenue earned

Question 20

prudence

Answer 20

profits should not be over added and losses should be provided for as soon as they are recognized

Question 21

what happens when profit is overadded

Answer 21

a trader may believe that her income is more than it really is and may withdraw too much money from, the business. that would lead to capital invested in the business being depleted. if it happens too often, the business will collapse because there will not be enough money to pay trade payables or to renew assets when they are worn out. it may also cause the owner to be over-ambitious and result in her making poor decisions, which might also harm the business

Question 22

ways in which the concept can be applied

Answer 22

if there is an event that will potentially improve profit, it cannot be accounted for until it happens- this is the realization concept being applied
if there is an event that will potentially reduce profit or result in losses, it should be provided for as soon as it is recognized

Question 23

going concern

Answer 23

when there is no intention to discontinue a business in the foreseeable future. it is a going concern when it has the resources.

Question 24

what does the prudence concept require

Answer 24

it requires that the value of the assets in the statement of financial position be reduced. however this reduction in the value of the business assets might panic the owners, investors and trade payables into trying to ger their money back and anyone who might have wanted to buy assets might realize that the business is in trouble and offer less for them than they might have done

Question 25

what is the result of applying prudence concept with going concern

Answer 25

the result might be that the possible closure actually happens when it might have been avoided. in this case, going concern takes priority over prudence- the assets in the statement of financial position should be valued as if the business were expected to continue operating

Question 26

substance over form

Answer 26

the economic substance of the transaction must be recorded in the financial statements rather than its legal form. this is the accounting treatment of something that does not reflect the legal position; there are times when applying a strict legal approach will not provide a ‘true and fair view’ of what is really going on.

Question 27

what does substance over form allow

Answer 27

it allow the business to show the item as a non current asset immediately. in other words, the practical view (the substance) is preferred to the legal view (the form) in the accounting treatment

Question 28

objectivity

Answer 28

it is a principle which states that financial statements should not be influenced by personal opinions and bias. instead, they should be prepared using solid evidence. this is why only information that has been entered into the books of prime entry and then the ledgers can be used in the preparation of the financial statements