Accounting Concepts, Principles and Assumptions
Accounting Concepts, Principles and Assumptions
This domain tests the conventions that make financial statements comparable and reliable. Questions usually describe a situation and ask which concept applies, or require an adjustment consistent with accrual accounting and prudence.
Core rules
- Business entity: the business is separate from its owner; personal transactions are excluded.
- Going concern: assume the entity continues operating, so assets are not valued at break-up prices.
- Money measurement: record only items capable of reliable monetary measurement.
- Historical cost: assets are initially recorded at cost, subject to depreciation or impairment.
- Accruals/matching: revenue is matched with the expenses incurred to earn it in the same period, regardless of cash movement.
- Consistency: apply the same accounting methods unless a change is justified and disclosed.
- Prudence: exercise caution; do not overstate assets or profit.
- Realisation: recognise revenue when goods or services are delivered and title passes, not when an order is received.
Worked example
Inventory costing RM12,000 has a net realisable value of RM10,500 at year end. Prudence requires valuation at the lower RM10,500, so RM1,500 is written down as an expense. Separately, December rent of RM2,000 is unpaid at 31 December. Accruals accounting records RM2,000 rent expense and a RM2,000 liability in the current year, not the next year when cash is paid.
Traps
- Using prudence to create hidden reserves or deliberately understate profit.
- Treating a change in method as acceptable without disclosure.
- Recording revenue when an order is placed rather than when performance occurs.
- Applying the business entity concept only to large companies; it applies to sole traders too.
Key points
- Accruals match revenue and expenses, not cash
- Prudence chooses the less optimistic valuation
- Going concern supports cost-based values
- Consistency needs disclosure if changed
- Business entity excludes owner's private items