INTRODUCTION TO aCCOUNTING

INTRODUCTION TO ACCOUNTING

ACCOUNTING CONCEPT REFERS TO THE BASIC
ASSUMPTIONS AND RULES AND PRINCIPLES
WHICH WORK AS THE BASIS OF RECORDING OF
BUSINESS TRANSACTIONS AND
PREPARING ACCOUNTS. THIS CONCEPT
ASSUMES THAT, FOR ACCOUNTING PURPOSES,
THE BUSINESS ENTERPRISE AND ITS OWNERS
ARE TWO SEPARATE INDEPENDENT ENTITIES.

THE OBJECTIVITY
CONCEPT OF ACCOUNTING

THE OBJECTIVITY PRINCIPLE STATES THAT FINANCIAL AND
ACCOUNTING INFORMATION NEEDS TO BE INDEPENDENT . THIS MEANS
THAT FINANCIAL REPORTING LIKE A COMPANY’S FINANCIAL
STATEMENTS NEED TO BE BASED ON EVIDENCE AND NOT OPINIONS.
 THE PURPOSE OF THE OBJECTIVITY PRINCIPLE ALONG WITH ALL OF
GAAP IS TO MAKE FINANCIAL STATEMENTS MORE USEFUL TO
INVESTORS AND END USERS. THE OBJECTIVITY PRINCIPLE,
SPECIFICALLY, AIDS TO ENSURE THAT FINANCIAL STATEMENTS ARE
RELIABLE AND VERIFIABLE. OBJECTIVITY PRINCIPLE HELPS MAINTAIN A
HIGH LEVEL OF RELIANCE AND VERIFIABILITY IN FINANCIAL REPORTING.

THE HISTORICAL COST CONCEPT

A historical cost is a measure of value used in
accounting in which the price of an asset on the balance
sheet is based on its nominal or original cost when
acquired by the company. Under the historical cost
concept, business transactions are recorded in
the accounting books at the transaction price--that is,
their actual cost at the time the transaction took place.
Consequently, income, expenses, assets, liabilities and
equity items are reported in the financial statements at
their original cost.

THE MONEY MEASUREMENT CONCEPT

Money Measurement Concept in accounting, also known as
Measurability Concept, means that only transactions and
events that are capable of being measured in monetary terms
are recognized in the financial statements. All transactions
and events recorded in the financial statements must be
reduced to a unit of monetary currency. Where it is not
possible to assign a reliable monetary value to a transaction
or event, it shall not be recorded in the financial statements.













THE PERIODICITY
CONCEPT

THE ACTIVITY WITHIN THE SCOPE OF AN ACCOUNTING PERIOD
THAT MUST BE RECORDED WITHIN THE TIME PERIOD ON A
FINANCIAL STATEMENT.

THE MATERIALITY CONCEPT

• The materiality concept refers to a situation where the financial information of a company is
considered to be material from the point of view of the preparation of the financial statements if
it has the potential to alter the view or opinion of a reasonable person. In short, all those
important financial information that is likely to influence the judgment of a knowledgeable
person should be captured in the preparation of the financial statements of the company. The
materiality concept in accounting is also known as materiality constraint.

• The concept of materiality in accounting is very subjective, relative to size and
importance. Financial information might be of material importance to one
company but stand immaterial to another company. This aspect of materiality
concept is more noticeable when the comparison between companies which
vary in terms of their size i.e. a large company vis-à-vis a small company. A
similar cost may be considered to be the large and material expense for a
small company, but the same may be small and immaterial for a large company
because of their large size and revenue.

• As such, it can be said that the main objective of the materiality concept in
accounting is to assess whether the financial information under consideration
makes any significant impact on the opinion of the financial statement users. If
the information is not material, then the company does not need to worry
about including it in their financial statements. The financial statement users
mentioned here can be auditors, shareholders, investors etc.

• In general, thumb rule for materiality of financial information is stated as,

• On the Income statement, a variation of more than 5% of before-tax Profit
or more than 0.5% of sales revenue may be seen as “large enough to
matter”

• On the Balance sheet, a variation in the entry of more than 0.5% of total
assets or more than 1% of total equity may be viewed as “large enough to
matter”

THE CONSISTENCY CONCEPT

• The concept of consistency means that accounting methods once adopted must be
applied consistently in future. Also same methods and techniques must be used for
similar situations.

• It implies that a business must refrain from changing its accounting policy unless on
reasonable grounds. If for any valid reasons the accounting policy is changed, a
business must disclose the nature of change, the reasons for the change and its
effects on the items of financial statements.

• Consistency concept is important because of the need for comparability, that is, it
enables investors and other users of financial statements to easily and correctly
compare the financial statements of a company.

• Company A has been using declining balance depreciation method for its IT equipment.

According to consistency concept it should continue to use declining balance
depreciation method in respect of its IT equipment in the following periods. If the
company wants to change it to another depreciation method, say for example the
straight line method, it must provide in its financial report, the reason(s) for the change,
the nature of the change and the effects of the change on items such as accumulated
depreciation.

• Company B is a retailer dealing in shoes. It used first-in-first-out method of inventory
valuation in respect of shoes at Branch X and weighted average inventory valuation
method in respect of similar shoes at Branch Y. Here, the auditors must investigate
whether there are any valid reasons for the different treatment of similar inventory
located at different locations. If not, they must direct the company to use any one of the
valuation method uniformly for the whole class of inventory.

The Prudence Concept

Prudence Concept or Conservatism principle is a key accounting
principle which makes sure that assets and income are not overstated
and provision is made for all known expenses and losses whether the
amount is known for certain or just an estimation i.e expenses and
liabilities are not understated in the books of accounting.

The prudence principle in accounting is many times described using
the phrase “Do not anticipate profits, but provide for all possible losses.”

In other words, it takes into consideration all prospective losses but not
the prospective profits. The application of the prudence concept
ensures that the financial statements present a realistic picture of the
state of affairs of the enterprise and do not paint the better picture than
what actually is.

Substance over 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.

Substance over form concept entails the use of judgment on the
part of the preparers of the financial statements in order for them to
derive the business sense from the transactions and events and to
present them in a manner that best reflects their true essence.
Whereas legal aspects of transactions and events are of great
importance, they may have to be disregarded at times in order to
provide more useful and relevant information to the users of
financial statements.

Thank You