Accounting principles, concepts and conventions
The framework
Financial statements rest on assumptions that answer the question 'when and how much do we record?' The business entity concept separates the owner's private money from the firm's, so drawings are not an expense. Going concern assumes the business will continue, which justifies carrying assets at cost rather than at break-up value. Historical cost records assets at what was paid - a limitation as much as a rule. Money measurement means only items with a monetary value are recorded.
The adjusting concepts
Accruals (matching) places income and expenses in the period they relate to, not when cash moves. Prudence says do not anticipate profit but provide for all known losses - hence closing stock at the lower of cost and net realisable value, and provisions for doubtful debts. Consistency requires the same method each year, for example depreciation, so results are comparable. Materiality allows trivial items to be treated simply. Realisation recognises revenue when the sale is made, not when cash is received.
Traps candidates meet
- Treating prudence as a licence to understate assets deliberately; it is reasonable caution, not hidden reserves.
- Mixing up an accrual (expense owing) with a prepayment (expense paid in advance).
- Charging the owner's personal fuel bill to the business - a business entity error.
- Claiming the trial balance proves accuracy; it only proves equal debits and credits.
Worked example
A trader pays P2,400 insurance on 1 October for the year to 30 September, and the year end is 31 December. Only three months belong to this year: expense = 2,400 × 3/12 = P600; prepayment (current asset) = P1,800. Cash paid was P2,400, but the accruals concept reports P600.