Sunday, 2 March 2014

Accounting Concepts

"It is a capital mistake to theorize in advance of the facts"

-Author Conan Doyle, "Sherlock Holmes"

Bruce Springsteen “The Boss”

To be The Boss of accounting you need to know the major concepts of accounting. To master these concepts puts you firmly on the path to becoming a successful Accountant. Whatever you do in accounting you will always be able to refer back to these concepts no matter what.

The Going Concern Concept

Leonard Cohen still going strong

A Going concern is an entity such as a business that will continue trading for the foreseeable future. This means the company has the liquidity i.e. cash to continue trading.

Going concern is a significant concept with regards to the valuation of assets.

For example a company, P. Moore’s Telescopes sell and make lenses for its telescopes. In 2011 it bought a special machine to make better quality lenses at a cost of €50000 which will last 10 years. This would be put into the balance sheet at €50000 or the cost less the deprecation for example 10% so it would be €45000. As long as the business continues trading as a going concern the machine is valuable for the next decade.

However if the business is in trouble the machine could possibly be not worth €45000. It might have to be sold off at less than its value in the balance sheet of €25000. The loss of €20000 will appear in the income statement.
With the concept of going concern it is assumed the business will continue trading which allows the business to value assets at cost less the deprecation.

Check out this link to learn more about the concept of going concern:

The Prudence Concept

Prudence is a valuable concept to know inside out to become a great Accountant. This states that assets and incomes are not overstated and liabilities and expenses are not understated. In order words we do not expect gains and we provide for foreseeable losses.

For example a company, Trulli Ltd. expects it debtor not to pay their debts for the month. Trulli Ltd. decides to make a provision just in case its debtor does not pay its debts. This is known as being prudent.
The concept of prudence is also called the concept of conservatism.

Check out this link to learn more about the concept of prudence:

The Accruals Concept

This is also known as the matching concept. The concept of accruals states that a business matches its expenditures with the expected income it generates. In order words, don’t account on a cash flow basis.

For example a company, Ponosanic has an electricity bill for April. The figure for the bill will be recorded in the April Income Statement. If the company waited until the end of September to pay  and record the bill it would distort the view of accounts. It would show the there was no expenses for the electricity for April but there would be an increase in September along with Septembers bill for electricity. The company must record the expense when it has occurred. As stated above the expenditure must be match with the income during the month of April in which the bill occurred.

Here is an example of sales on credit. A company, Sany Inc. make sales on credit from its customers. The sale is completed and is treated as an income for the company. The company does not wait for the cash from the customer. This would distort the accounts if they waited for the cash from the customer.

Check out this link to learn more about the Concept of Accruals:

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