2 fundamental accounting concepts and principles

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CHAPTER 2: FUNDAMENTAL ACCOUNTINGCONCEPTS AND PRINCIPLESBy Annie WPL

Compiled by Annie WPL

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LEARNING OBJECTIVESUnderstand the meaning of accounting

concepts and conventions.

Learn the basic accounting concepts and

conventions.

Conventions developed by the business and

its significant.


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ACCOUNTING CONCEPTS


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INTRODUCTIONAccounting concepts and principles are

general guidelines for sound accounting

practices.


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INTRODUCTION (CONTINUE)Accounting concepts are:

Business entity concept.

Dual aspect concept.

Going concern concept.Accounting period concept.

Monetary concept/money measurement concept.

Historical (cost) concept/cost concept.Matching concept.

Accrual concept.


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BUSINESS ENTITY CONCEPT Proprietor of an enterprise is considered

distinct and separate from the business.

Only the business transactions are recorded

and reported, and not the personaltransactions of the proprietor.

The personal assets of the owners or

shareholders are not considered whilerecording and reporting the assets of thebusiness entity.


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DUAL ASPECT CONCEPT This is the basic principle of accounting.

All business events/transactions are

regarded as having a dual aspect that is

twofold effect.

Each receiver is also a giver, and every giver

is also a receiver.


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DUAL ASPECT CONCEPT (CONTINUE) Example 1: Mr A purchases furniture for cash

RM1,000, he receives furniture on one hand,

and pays RM1,000 on the other. Thus the

twofold effect is Increase in one asset that is furniture.

Decrease in other asset that is cash.


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DUAL ASPECT CONCEPT (CONTINUE) Example 2, goods sold for cash. The two

aspects are

Cash received.

Giving away of goods.

The financial statements of a business

should reflect the twofold effect of each

business transaction.


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DUAL ASPECT CONCEPT (CONTINUE) Each transaction involves two entries, a debit

entry and a credit entry.

Every debit must have a corresponding

credit, and vice versa.

Since every debit has a corresponding credit,

the total debits must at any time equal the

total credits.


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GOING CONCERN CONCEPTA going concern is defined as any enterprise

which is expected to continue operating

indefinitely in the future.


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GOING CONCERN CONCEPT (CONTINUE) Significant of this concept:

Financial statements are prepared on the basis

of this concept.

Continuity of business activities are ensured tooutsiders over an indefinite period of time.

The fluctuations in the market value of fixed

assets is not taken into account.On the basis of this concept, a business is

judged for its capacity to earn profits in future.


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ACCOUNTING PERIOD CONCEPT The net income can be measured by

comparing the assets of the business

existing at the time of its commencements

with those existing at the time of itsliquidation.

Since life of business is assumed to be

indefinite, the measurement of incomeaccording to this concept is not possible for a

very long period.


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ACCOUNTING PERIOD CONCEPT (CONTINUE) The proprietor of the business cannot wait for

such a long period.

Therefore accountants choose some shorter

and convenient time for the measurement of

income.

Twelve months period is normally adopted

for this purpose.

This time interval is called accounting period.


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MONETARY CONCEPT/MONEY MEASUREMENTCONCEPT Every transaction is recorded in terms of

money.

A fact or happening which cannot be

expressed in terms of money is not recorded

in the account books.


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MONETARY CONCEPT/MONEY MEASUREMENTCONCEPT (CONTINUE) Example, general health condition of the

chairman of the company, quality of products,

sales policy pursued by the company,

general working conditions of a worker etc,cannot be expressed in terms of money.


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MONETARY CONCEPT/MONEY MEASUREMENTCONCEPT (CONTINUE) For example, if a business has a cash

balance of RM7,000, a building containing 20

rooms, a piece of land of 2,000 meters, 40

tables, 20 fans, 2 machines, one tone of rawmaterial and so on then in the absence of

money measurement concept these different

types of assets cannot be added to giveuseful information.


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MONETARY CONCEPT/MONEY MEASUREMENTCONCEPT (CONTINUE) But if they are expressed in monetary terms

RM7,000 cash, RM50,000 of building,

RM200,000 of land, RM8,000 of tables,

RM6,000 of fans, RM160,000 of machines,RM80,000 of raw material, it is possible to

use them for comparison or any other

purpose.


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HISTORICAL (COST) CONCEPT/COST CONCEPTAsset is recorded at the price paid to acquire

it that is at cost.

This cost is the basis for all subsequent

accounting for the asset.

This cost price at the time of purchase is

systematically reduced by the process called

depreciation.


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MATCHING CONCEPTAll expenses incurred in an accounting year

are compared with the revenues during that

year.

For this we have to recognise the revenues

or inflow during an accounting period and the

expenses incurred in securing those inflows.

Net income is arrived at by applying theformula

Net income = Revenues Expenses


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ACCRUAL CONCEPT The term accrual means something that

becomes due especially an amount of money

that is yet to be paid or received at the end of

the accounting period.

Revenue is realised at the time of sale of

goods or services irrespective of when the

cash is received.


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ACCRUAL CONCEPT (CONTINUE) The financial statements will not reveal true

and fair view of the affair of a business unit,

unless all the transactions or events of the

concerned year are brought into the books ofaccounts.

Expenses are recognised at the time the

services are received irrespective of whenactual payment for the service is made.


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ACCOUNTING CONVENTIONS


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INTRODUCTIONConventions are developed by business to

facilitate its recording of business

transactions in the books of accounts.

They help in comparison of accounting data

of different business units or of the same unit

for different periods.

The object is to make accounting data moreuseful.


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INTRODUCTION (CONTINUE)Accounting conventions are:

Convention of disclosure.

Convention of materiality.

Convention of consistency.

Convention of conservatism.


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CONVENTION OF DISCLOSUREAll accounts must be honestly prepared.

All material information must be disclosed

therein.

The balance sheet and profit and loss

account are to be prepared as per the law.


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CONVENTION OF DISCLOSURE (CONTINUE)All material facts must be disclosed

compulsory.

Financial statements including all their

related foot notes and other disclosure.

Should contain all of the relevant data

essential to users understanding of the

entitys financial status.


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CONVENTION OF MATERIALITYUnimportant items are either left out or

merged with other items.

If certain items are immaterial, then it does

not matter how you deal with it in theaccounts, because it cannot possibly haveany significant effect on the results.

The materiality convention allows the otherconventions to be ignored and a simpleraccounting treatment to be adopted.


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CONVENTION OF MATERIALITY (CONTINUE) It should be noted that an item of material for

one concern may be immaterial for another.

Similarly an item material in one year may

not be material in next year.


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CONVENTION OF CONSISTENCY It states that, once specific accounting

policies have been adopted, they should be

followed in all subsequent accounting

periods.


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CONVENTION OF CONSISTENCY (CONTINUE) For example, if a fixed asset is to be

depreciated, there are so many methods of

depreciation.

But a concern should follow the convention ofconsistency.

That is if one method of depreciation is followed

it should be consistently followed for all theyears.

Any change from one method to another will

result in inconsistency.


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CONVENTION OF CONSISTENCY (CONTINUE) It gives confidence to the users of accounting

statements, because if the accounts have

been prepared on a consistent, they can be

assured that they are comparable withprevious set of accounts.


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CONVENTION OF CONSERVATISM/PRUDENT This is the policy playing safe.

The need to make estimates and form

judgements when preparing financial

statements.

The conservatism states that, the accountant

should error the side of caution.


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CONVENTION OF CONSERVATISM/PRUDENT(CONTINUE) In other words, a prudent accountant will

tend to:

Understate revenue, profits and assets.

Overstate expenses, losses and liabilities.

It ensures that financial statements do not

give and over-optimistic view of the financial

performance and position of a business.


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QUESTION State which accounting concepts or conventions most

probably being adopted in dealing with the followingproblems:1. Electricity consumed in 2009 and paid for in 2010.

2. Equipment originally purchased for RM20,000, whichwould now cost RM30,000.3. A customer who might go bankrupt owing the company

RM5,000.4. The proprietor who has supplied the business capital

out of his own private bank account.5. Stock valuation method would be changed from AVCO

to FIFO.

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