There are basic assumptions which underline the preparation of financial statements of business enterprise. There are stated below:
- Going concern concept: accounting assumes that the business will continue to operate for a long period of time. In other words, it means continuity in business or Continuity Assumption.
The continue preparation of financial statement in accordance with International Financial Reporting Standard (IFRS) is an evidence of going concern. Even the auditor may also carry out investigation see that the going concern is intact.
Example of going concern is prepayment and accrual of expenses. The company accept these expenses because they believe the business will continue to run. If for example any part or section or department or product line is discontinue, it does not means there is no longer a going concern. Going concern is for the entire company.
During Covid19, a lot of companies had financial issues and were unable to pay their obligation. Various government gives those companies a bailout and a guarantee of all payments to creditors. The companies are a going concern despite of its current weak financial position. But if government imposes a restriction on the manufacture of a certain goods and service for the period say 1 year. Then the company will no longer be a going concern since they might not be able to sell any product.
2. Entity concept: This accounting concept separates the business from its owner. Meaning the business is a legal entity. It can sue and be sued. It also means the owners of a business are limited to how much he has invested not his personal resources. So for example, if the owner brings in additional capital into the business, we will treat this as a liability on the balance sheet of the business.Entity concept ensures that each company is tax separately.
Let look at these examples, Mrs. Ese bought a building having 5 office space for $5000 per month. She uses three office for his business and two for personal purpose. In line with business entity concept, only $3,000 (the rent of two offices) is a valid expense of the business
Another example is when owner of a business lends loan to his company. It would be strictly recorded as a liability and that has to be paid back to the owner.
3. Matching Concept:This concept states that the revenue and the expenses of a transaction should be included in the same accounting period. So to determine the income of a period all the revenues and expenses (whether paid or not) must be included. The matching accounting concept follows the realization concept. First, the revenue is recognized and then we match the costs associated with the revenue. So costs are matched with revenue, the reverse would be an incorrect system.
4. Dual concepts: this says that there are two aspects of accounting. It is represented by the assets of the business and liabilities (i.e. claims against it). Assets =liabilities + capital. So for example. Say the business buys an asset worth N10, 000. So now the Fixed Assets of the company will increase by N10, 000. But at the same time, the bank or cash balance will reduce by N10, 000 and so the transaction will have a dual effect in accounting. And also the Balance Sheet will stay balanced.
5. Realization concepts: in accounting, profit should not be recognized until the goods are passed to the customer.
6. Money measurement concept: Accounting is only concerned with the facts that can be measured in monetary terms with fair degree of objectivity. Accounting does not record that the firm has a bad or good management team, poor morale among staff. So for example, if the company underwent a major management overhaul this would have no effect on the accounting records. This concept is actually one of the major drawbacks of accounting.
7. Accrual concept: Revenue and cost are usually recorded in accounts when they are earned or incurred rather than when the money is received or paid.
8. Full Disclosure Concept: This concept states that all relevant information will be disclosed in the accounting statements. A lot of external users depend on these financial statements for their information to make investing decisions. So no information/transactions etc of relevance to any one of them will be omitted from these statements for the benefit of the company.
9. Cost Concept: This accounting concept states that all assets of the firm are entered into the books of account at their purchase price (cost of acquisition + transport + installation etc). In the subsequent years to, the price remains the same (minus depreciation charged). The market price of the asset is not taken into consideration.
10. Accounting Period Concept:Every organization, according to its needs, chooses a specific period of time to complete an accounting cycle. Generally, the time chosen is a year we call the accounting year. The time period is mentioned in the financial statements.
11. Substance over form: usually transactions are recorded and accounted for by their commercial realities rather than their legal form. Substance over form is an accounting concept which means that the economic substance of transactions and events must be recorded in the financial statements rather than just their legal form in order to present a true and fair view of the affairs of the entity.
12. Faithful representation: For financial report to be useful, the financial information must not only represent relevant phenomena but must faithfully represent the phenomena that it purports to represent.
13. Timeliness: It means having information available to decision makers in time to be capable of influencing their decisions. The older the information the less important it become.
14. Relevance: Relevant information is capable of making a difference in the decisions made by users.
15. Comparability: The information about a firm is more useful if it can be compared with similar information about other enterprise and with similar information about the same enterprise for another period or date.
By Ojeaburu Friday ACA, MSc
Ojeaburu, Friday (ACA, BSc, MSc, PhD) is a seasoned Chartered Accountant with over 14 years accounting experience. He has experience in corporate accounting, financial accounting, financial management, financial audit, public sector accounting, environmental accounting, entrepreneurial accounting, Cv writing, business plan writing, online coaching, research writing etc.