Accounting Principles and Basic Assumptions

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Questions and Answers

Explain the significance of the accounting period assumption in the context of financial reporting.

The accounting period assumption allows businesses to close accounts at regular intervals (typically 365 days, 52 weeks, or 1 year) to provide users of financial statements with timely operational results and financial position updates.

How does the accounting entity assumption affect the recording of transactions, especially concerning the owner's personal transactions?

The accounting entity assumption treats a business as separate from its owners. Personal transactions of the owner are not recorded in the business's books unless they directly affect the business.

Provide an example of a situation that would not be recorded under the 'money measurement assumption', and explain why.

A dispute between the sales manager and the production manager is not recorded because its impact on the business cannot be reliably measured in monetary terms.

Describe how the dual aspect concept applies when a business purchases equipment with cash.

<p>When a business acquires equipment with cash, it receives the benefit of the asset (equipment) and gives the benefit of cash. This represents the two aspects recorded in the double-entry system.</p> Signup and view all the answers

What is the 'matching concept', and why is it important for accurate profit determination?

<p>The matching concept dictates that expenses should be recognized in the same period as the revenues they helped to generate. This ensures the recorded profit accurately reflects business performance.</p> Signup and view all the answers

Explain the implications of the 'going concern concept' for the valuation of assets on a company's balance sheet.

<p>The going concern concept assumes the business will operate for a long time. This justifies valuing assets at their historical cost, rather than liquidation value, as it is assumed they will be used for ongoing operations.</p> Signup and view all the answers

Differentiate between 'bookkeeping' and 'accounting' regarding the scope of their activities.

<p>Bookkeeping primarily focuses on the <em>recording</em> of financial transactions. Accounting includes bookkeeping, but also involves analysis, interpretation, and communication of financial information.</p> Signup and view all the answers

Explain why 'analysis and interpretation' is typically considered a function of accounting rather than bookkeeping.

<p>Bookkeeping primarily involves recording and organizing financial data, while accounting uses this data to analyze trends, interpret results, and provide insights for decision-making.</p> Signup and view all the answers

In the accounting cycle, what is the role of the 'books of original entry', and give two examples of such books?

<p>Books of original entry initially records transactions. Examples include the cash book and sales book.</p> Signup and view all the answers

Describe the relationship between the 'trial balance' and the 'final accounts' in the accounting cycle.

<p>The trial balance is prepared before the final accounts. It verifies the equality of debits and credits. The final accounts, such as the balance sheet and income statement, are prepared using data from the adjusted trial balance.</p> Signup and view all the answers

Explain the fundamental principle behind the accounting equation.

<p>The accounting equation states that a company's assets are equal to the sum of its liabilities and owner's equity (Assets = Liabilities + Owner's Equity).</p> Signup and view all the answers

How does borrowing money from a bank affect the accounting equation?

<p>Borrowing money increases <em>both</em> assets (cash) and liabilities (loan payable) by the same amount, maintaining the equation's balance.</p> Signup and view all the answers

If a company purchases inventory with cash, how does this transaction affect the total assets in the accounting equation?

<p>The total assets remain unchanged. Cash (one asset) decreases, while inventory (another asset) increases by the same amount.</p> Signup and view all the answers

What does 'double-entry accounting' refer to, and why is it essential for maintaining the balance of the accounting equation?

<p>Double-entry accounting requires every transaction to impact at least two accounts. This ensures that the accounting equation remains in balance, with debits always equaling credits.</p> Signup and view all the answers

What are 'final accounts,' and what primary statements are included in them?

<p>Final accounts are financial statements prepared at the end of an accounting period. They include the balance sheet, profit &amp; loss account (income statement), and trading account.</p> Signup and view all the answers

How are 'liabilities' defined in the context of the accounting equation?

<p>Liabilities are debts or obligations that a business owes to external parties, such as creditors and banks.</p> Signup and view all the answers

What is the journal proper?

<p>The journal proper is where transactions that don't fit in other specific journals (like cash book, sales book) are recorded.</p> Signup and view all the answers

If a business owner invests personal cash into their business, how does this affect the accounting equation?

<p>Assets (cash) in the business increase, and owner's equity increases by the same amount.</p> Signup and view all the answers

Why is it important for an accountant to supervise the work of a bookkeeper?

<p>The accountant ensures the bookkeeper's recording are correct, complete, and in compliance with accounting principles, before they are used for analysis and reporting.</p> Signup and view all the answers

Explain the difference between a 'general ledger', 'creditors ledger' and 'debtors ledger'.

<p>The general ledger contains all the accounts of the business. The creditors ledger tracks the amounts owed to suppliers, and the debtors ledger tracks amounts owed by customers.</p> Signup and view all the answers

What will happen to the accounting equation if some equipment depreciates?

<p>The assets decreases. Owner's equity decreases to reflect the decrease in value of assets.</p> Signup and view all the answers

If a company provides services on credit, what accounts are affected, and how are they affected?

<p>Accounts receivable (an asset) increases, and service revenue (part of owner's equity) increases.</p> Signup and view all the answers

A company uses cash to pay off the principal on loan. What accounts are affected, and how are they affected?

<p>Cash decreases, and the loan payable decreases.</p> Signup and view all the answers

Provide an example and describe a transaction for Barter Transactions in a company?

<p>A Barter Transaction is when a company exchanges goods or services directly for other goods or services without involving cash. For example, a printing company may exchange printing services for office maintenance service from another company.</p> Signup and view all the answers

Explain why the accounting equation can be expressed as Resources = Claims on Resources.

<p>Assets are the resources available to the company. Liabilities and Owner's Equity represent the creditors' and owner's claims on those resources.</p> Signup and view all the answers

Flashcards

Accounting Concepts

Basic assumptions and conditions upon which accounting is based.

Accounting Period Assumption

Financial statements need periodical reports to know the operational result and the financial position of the business concern.

Accounting Entity Assumption

A business is treated as a separate unit apart from its owners, creditors, and others.

Money Measurement Assumption

Only business transactions and events of a financial nature are recorded.

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Dual Aspect Concept

The basis for the Double Entry System of bookkeeping.

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Matching Concept

The cost (expense) are matched to revenue to ascertain the profit.

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Going Concern Concept

The business will exist for a long period, and transactions are recorded from this viewpoint.

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Accounting

The art of recording, classifying, and summarizing in terms of money to interpreting the result.

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Book Keeping

The art of recording business transactions in the books in a regular and systematic manner.

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Accounting Cycle

A complete sequence of accounting process, beginning with recording business transactions and ending with preparing final accounts.

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Accounting Equation

A statement showing the equality of business assets and liabilities.

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Assets

Items of value owned by the business.

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Owner's Equity

Funds provided by owners and entitled to him.

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Liabilities

Debts owed by a business to external parties.

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Balanced Accounting Equation

Accounting equation will always be in balance because every business transaction affects at least two of a company's accounts.

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Double Entry Accounting

Accounting system where every transaction affects at least two accounts.

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Study Notes

Accounting Principles

  • The term "concepts" refers to the foundational assumptions or conditions on which accounting is based.

Accounting Period Assumption

  • Financial statement users need regular reports to understand a business's operational results and financial health.
  • It is important to close accounts regularly
  • The standard accounting period is typically 365 days, 52 weeks, or one year.

Accounting Entity Assumption

  • A business is treated as a separate entity from its owners, creditors, and other stakeholders.
  • The proprietor of a business is distinct from the business they control.
  • All business transactions are recorded in the books from the business's perspective.

Money Measurement Assumption

  • Only business transactions and events that are financial in nature are recorded in accounting.
  • For example, relationship issues between managers wouldn't be recorded because they lack a monetary value.

Dual Aspect Concept

  • The dual aspect principle is the foundation of the double-entry bookkeeping system.
  • Each transaction has two aspects: receiving a benefit and giving a benefit.
  • When a business acquires an asset (receives a benefit), it must provide something in return, such as cash (giving a benefit).

Matching Concept

  • Businesses aim is to make a profit.
  • Costs (expenses) are matched to revenue to determine profit.
  • The revenue generated during a specific period is matched against the expenses incurred.

Going Concern Concept

  • The business is assumed to operate for a long duration, and transactions are recorded with this in mind.
  • There is no intention or need to end the business in the near future.

Accounting vs Book Keeping

  • Accounting involves recording, classifying, summarizing financial data, and interpreting the results in monetary terms.
  • Bookkeeping is the recording business transactions in a systematic manner.

Distinction Between Book-Keeping vs Accounting

  • Book Keeping focuses on the recording and maintenance of books
  • Accounting includes analysis, interpreting and communication of information
  • Book Keeping Maintains systematic records of business transactions
  • Accounting ascertains the net result of business operations
  • Book Keeping is routine and clerical
  • Accounting is analytical and executive
  • A book-keeper is responsible for recording business transactions
  • An accountant is also responsible for the work of a book-keeper.
  • The book-keeper does not supervise and check the work of an Accountant
  • An accountant supervises and checks the work of the book-keeper

Accounting Cycle

  • An accounting cycle is a complete sequence of accounting processes, that starts with business transactions, and concludes with the preparation of final accounts.
  • The accounting cycle includes business transactions like cash, credit, barter and paper transactions
  • The business transactions are placed in books of original entry like cash books, purchase books, sales books, purchase returns books, sales returns books, bills receivable books, bill payable books, and the journal proper
  • Then it moves to the ledger, general ledger, creditors ledger and debtors ledger
  • Following that is a trial balance
  • Ending with the final accounts, balance sheet, profit & loss account and then the trading account

Introduction of Accounting Equation

  • An accounting equation shows the equality of business assets and liabilities.
  • Those who contribute assets to a business have legal claims on those assets.
  • Assets of the business are equal to the assets contributed by the owner and by creditors: Assets = Liabilities + Owner's Equity. Assets = Liabilities + Owner's Equity.
  • Resources (assets) = Claims on Resources (liabilities + owner's equity).

Accounting Equation

  • Assets are valuable items owned by the business.
  • Owner's equity represents the funds invested in the business by its owners, plus any retained profits.
  • Liabilities are debts owed by a business to external parties, such as creditors.
  • Examples of assets include buildings, motor vehicles, office equipment, fixtures, stock, cash in hand, and cash at bank.
  • Owner's equity consists of capital and profits.
  • Liabilities include creditors, loans from banks, and other forms of credit.

Accounting Equation Balance

  • Accurate accounting records ensure that the accounting equation remains balanced.
  • The left side (assets) should always equal the right side (liabilities plus owner's equity).
  • Every business transaction affects at least two accounts in a company.

Double Entry Accounting

  • Borrowing money from a bank increases both assets and liabilities by the same amount.
  • Purchasing inventory for cash increases one asset (inventory) and decreases another (cash).
  • Double entry accounting is when there are two or more accounts affected by a transaction

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