What accounting principles and assumptions do you know?

Assumptions

When writing accounts and financial statements, accountants have to follow a number of assumptions, principles and conventions. An assumption is something that is generally accepted as being true. The following are the main assumptions used by accountants:

The separate entity or business entity assumption is that a business is an accounting, unit separate from its owners, creditors and managers, and their assets. These people can all change, but the business continues as before.

The time-period assumption states that the economic life of the business can be divided into (artificial) time periods such as the financial year, or a quarter of it.

The continuity or going, concern assumption says that a business will continue into the future, so the current market value of its assets is not important.

The unit-of-measure assumption is that all financial transactions are in a single monetary unit or currency. Companies with subsidiaries — that is, other companies that they own — in different countries have to convert their results into one currency in consolidated financial statements for the whole group of companies.

Principles

The following are the most important accounting principles

● The full-disclosure principle states that financial reporting must include all significant information: anything that makes a difference to the users of financial statements

●  The principle of materiality, however, says that very small and unimportant amounts do not need to be shown.

●  The principle of conservatism is that where different accounting methods are possible,you choose the one that is least likely to overstate or over-estimate assets or income.

●  The objectivity principle says that accounts should be based on facts and not on personal opinions or feelings. Accounts, therefore, should be verifiable: it should be possible for internal and external auditors to show that they are true. This isn’t always possible, however: depreciation or amortization, and provisions for bad debts, for example, are necessarily subjective — based on opinions.

 

● The revenue recognition principle is that revenue is recognized in the accounting period in which it is earned. This means the revenue is recorded when a service is provided or goods delivered, not when they are paid for.

●  The matching principle, which is related to revenue recognition, states that each cost or expense related to revenue earned must be recorded in the same accounting period as the revenue it helped to earn.

What is known as the consistency principle?

The consistency principle states that, once you adopt an accounting principle or method, continue to follow it consistently in future accounting periods. Only change an accounting principle or method if the new version in some way improves reported financial results. if such a change is made, fully document its effects and include this documentation in the notes accompanying the financial statements.

What does the historical cost principle state?

The historical cost principle states that businesses must record and account for most assets and liabilities at their purchase or acquisition price. In other words, businesses have to record an asset on their balance sheet for the amount paid for the asset. The asset cost or price is then never adjusted for changes in the market or economy and changes due to inflation.

Under what circumstances do some countries use replacement cost accounting? What does it value?

Some countries with regular high inflation use replacement cost accounting, which values all assets at their current replacement cost – the amount that would have to be paid to replace them now.