Accounting Concepts and Conventions

Accounting as a System

• Accounting is guided by principles that classify and record transactions, known as the accounting process.

Accounting Concepts and Conventions

Separate Entity

• The business is separate from its owners, and transactions recorded must relate only to the business entity, not the owners' private life.
• Owners are viewed as 'creditors' to the business since the business owes them the value of resources invested.

Going Concern

• The business is assumed to have an indefinite life, with no intention to discontinue.
• Balances of assets, liabilities, provisions, and capital are carried down to the next time period.

Money Measurement / Unit of Measure

• Accounting is measured in money (monetary terms), and businesses report their financial results in their national currency.

Historical Cost Principle

• Assets, liabilities, and capital are recorded and presented at their original cost, or the cost when acquired.

Matching Principle

• Expenses and revenues are recorded in the period they are incurred or earned, even if the expense was not paid or the revenue was not received.
• Revenues are matched with the expenses used to generate those revenues.

Accrual Concept

• Revenues are recognized when earned, not when received.
  • Accrued revenues: earned but not yet received
  • Prepaid revenues: received but not yet earned
• Expenses are recognized when incurred or used up, not when paid.
  • Accrued expenses: incurred but not yet paid
  • Prepaid expenses: paid but not yet incurred

Prudence (Conservatism)

• Losses are recognized as soon as they are reasonably certain to occur.
• Example: creation of a Provision for Bad Debts (Doubtful) to provide a realistic figure for debtors (Accounts Receivable).

Consistency

• Valuation methods of assets are the same from period to period.
• Example: using the straight-line method of depreciation consistently.

The Accounting Cycle

• Businesses operate on a 12-month cycle, which may coincide with the calendar year or start from the date the business began.
• During the 12-month period, financial documents are entered into the books of account using either a manual or computerized system.
• At the end of the month, the books are balanced off, and a Trial Balance is drawn up from which financial statements are prepared.

Types of Business Organizations

Sole Trader

• An individual trading alone in their own name or under a recognized trading name.
• Solely liable for all business debts, but takes all profits when successful.
• Financial statements: Trading and Profit & Loss A/c, Statement of Financial Position (Balance Sheet).

Partnership

• A group of two or more people carrying on a business with the aim of making a profit.
• Financial statements: Trading and Profit & Loss A/c (includes P&L Appropriation A/c), Statement of Financial Position (Balance Sheet).

Limited Liability Companies

Private Limited Liability Company

• A legal entity with at least one shareholder and one director, who may be the sole shareholder.
• Shareholders have limited liability, limited to the amount they have agreed to invest.
• Financial statements: Trading and Profit & Loss A/c (includes P&L Appropriation A/c), Statement of Financial Position (Balance Sheet).

Public Limited Liability Company

• A legal entity with limited shareholder liability, regulated by the Companies Act.
• Can ask the public to subscribe for its shares.
• Financial statements: Trading and Profit & Loss A/c (includes P&L Appropriation A/c), Statement of Financial Position (Balance Sheet).

Cooperative Society

• A legally constituted business entity formed to further the economic welfare of its members and the wider society.
• Financial statements: Income & Expenditure A/c, Cash Flow Statement, Statement of Financial Position (Balance Sheet).

Non-Trading/Profit Organizations

• Clubs, associations, and other non-profit-making organizations run for the benefit of their members to engage in a particular activity.
• Financial statements: Receipts & Payments or Income & Expenditure A/c.

Role and Impact of Technology on the Accounting Process

• Computerized accounting packages offer all functions of a manual system, plus useful reports and management information more quickly and efficiently.
• Functions of a computerized accounting package include:
  • Sales
  • Purchases
  • Inventory control
  • General ledger
  • Wages/Salaries
  • Bank account management

Computerized Accounting Systems

• Advantages:
  • Rapid data input and processing
  • Greater accuracy
  • Automatic document production
  • Constant updating
  • Quick and easy access to financial data and reports
  • Electronic financial transactions
  • Efficient resource allocation
• Disadvantages:
  • High installation costs
  • Disruption caused by system introduction
  • Staff training required
  • System downtime can be disruptive
  • Frequent data backup essential
  • Fraudulent access can cause serious consequences
  • Security measures vital
  • Health risks associated with computer use

Statement of Financial Position (Balance Sheet)

• Accounting equation: Assets = Capital + Liabilities
• Components:
  • Non-current (fixed) assets
  • Current assets
  • Current liabilities
  • Capital (owner's equity/net worth)
• Format:
  • Assets
  • Less: Current liabilities
  • Capital

Effect of Transactions on the Statement of Financial Position

• Type of transaction:
  • Owner pays capital into the bank: Increase Asset (Bank), Increase Capital
  • Purchase of shop premises by cheque: Decrease Asset (Bank), Increase Asset (Shop Premises)
  • Buy goods on credit: Increase Asset (Inventory), Increase Liability (Accounts Payable)
  • Sale of goods on credit: Decrease Asset (Inventory), Increase Asset (Accounts Receivable)
  • Sale of goods for cash or cheque: Increase Asset (Cash/Bank), Decrease Asset (Inventory)
  • Pay supplier: Decrease Asset (Bank), Decrease Liability (Accounts Payable)
  • Customer pays money owing by cheque: Increase Asset (Bank), Decrease Asset (Accounts Receivable)

Learn about the principles that guide the classification and recording of transactions in accounting, including the concept of separate entity. Understand how this concept implies that business transactions are separate from owners' personal transactions.